Scope’s European banking 2016 outlook report highlights the evolving dynamics of the sector driven by the new regulatory architecture, advances in digitalisation and a challenging macro environment; outlook for banks rated is on average stable to positive
In its third annual outlook report for the European banking industry Scope Ratings notes that the sector should continue to get safer in 2016, materially strengthened by several years of vigorous regulatory action. The rating agency points out that the ‘new normal’ in banking increasingly entails simpler and more transparent business models, a more robust risk management culture, reassuring prudential metrics and conduct practices, and last but not least appropriate risk-adjusted returns. The report highlights why Scope’s bank analysts believe that there are no contradictions among these goals.
The agency considers that a partial regulatory rollback in 2016 is neither likely nor desirable. The new regulations have been the real game changer, leading over several years of pain and uncertainty to the successful rebooting of most large European banks. In this respect, Scope believes that the recently established Single Supervisory Mechanism is a factor which will lead to the industry’s strengthening and should reassure investors.
Nevertheless, earnings, notably top-line revenue growth, will remain the sector’s Achilles’ heel in 2016. Net interest margins are likely to potentially weaken further against the backdrop of low-for-longer rates (negative in several European markets). Loan volume growth may remain less vibrant, as in parts of Europe where economic recovery moves forward bank credit is no longer the predominant driver – as it had been in the previous cycles. While many large banks have been able to boost their earnings from fees – notably asset management and bancassurance – Scope cautions that these segments are becoming increasingly competitive and the growth of the asset management industry may not continue at the same pace as in recent years.
Against this background, cost improvements will remain central to bank strategies, with management teams believing that they can have a stronger hand in cost controls than in top-line revenue growth. And yet, adds Scope, banks will need to continue to invest in 2016 in compliance capacity and especially in technology – both to face the digital competitive challenge and to strengthen cybersecurity.
Business model adjustments will continue
Scope believes that certain investment banking activities will continue to be scaled back, especially trading and other secondary-market areas. Second-tier players have largely exited investment banking and are not likely to return any time soon. The large European participants, however, should remain fully engaged in global capital markets, albeit on a lesser and more streamlined scale and each to a different degree.
Regarding retail business models, Scope warns that, even when they are well equipped and prepared for the digital age, traditional banks are still facing structural disruptive threats from new competitors – fintechs and/or P2P/B2P platforms, and nimbler banks as well.
Scope adds that it sees little appetite in 2016 for large-bank consolidation, especially cross-border. The challenge of coping with new regulations and compliance, as well as economic and socio-political headwinds have cooled considerably the M&A appetite of formerly expanding banks. Cultivating one’s own backyard is for bank management teams more important these days than expanding into new hills and valleys. The ‘hunter’ CEO is being replaced with the ‘farmer’ CEO, note the Scope analysts.
And yet, the rating agency considers that a new wave of bank consolidation may and should nevertheless occur in Europe in 2016 and beyond, more driven this time by bank supervisors who are increasingly concerned by the future of a multitude of smaller banks with an non-diversified revenue base which is shrinking (savings, cooperatives or private) and by some of the larger banks with unconvincing business models.
Scope warns that overcapacity is a threat not only for investment banking but also in retail and commercial banking – as there is simply too much supply compared to the more streamlined post-crisis demand. In the analysts’ opinion further technology advances (smartphone payments, robo-advisors, etc.) will worsen the supply-demand imbalance even further.
The agency also expects significant issuance by Europe’s larger European banks during 2016 to move towards the required TLAC and especially MREL coverage requirements, with junior securities but also senior unsecured debt. Taking note of the market debate about the safety of the latter, Scope comments that resolution for a large European bank with decent-to-good financials is an extremely remote scenario, as the SSM and any other European supervisor will do its utmost and then some to prevent a bank from actually getting there.
The 26-page report is titled ‘Better Regulatory Clarity but New Challenges Emerge: European Banking Outlook for 2016 and Beyond’ and is authored by the agency’s bank rating team. It includes a one-page summary and a full list of all banks and bank instruments publicly rated by Scope.