European banks will continue to struggle for profitability in the face of multiple headwinds, including higher capital requirements, low interest rates and a weak economy, according to new research published today.
The average return on equity across all banks in the EU stands at around three per cent, according to the report from consultancy giant KPMG. Meanwhile, the cost of capital – the expected return on investments – is considered to be around 10-12 per cent, according to the report.
Banks are being squeezed on multiple fronts. Increased capital requirements after the financial crisis – known as Basel III – were announced in 2010. Stricter requirements, which have been named “Basel IV” in some quarters, could add 0.5 per cent to the cost of bank funding.
Meanwhile, cost to income ratios since the financial crisis have averaged over 60 per cent for EU banks. The report finds that an increase in return on capital of one per cent would require a cut of 25 per cent in the cost to income ratio.
Another key challenge to profitability is the high proportion of non-performing loans, which have increased sharply in the wake of the financial crisis. Non-performing loans comprised only 1.5 per cent of loans for European banks in 2006 and 2007, but this figure rose to five per cent by the end of 2013, according to KPMG.
Italian banks in particular have become emblematic of this problem, with the world’s oldest bank, Monte dei Paschi, needing a bailout to lessen the burden of its bad debts.
Marcus Evans, a partner at KPMG’s European Central Bank Office, commented that “streamlining back‑office processes and moving to digital distribution channels is essential future-proofing and will ensure long-term savings.”