On Europe and Its Banking Industry

First of all, I’d like to use these first lines to thank everyone. Your recent words of support and encouraging evaluations have inspired me on continuing with the blog.

Special credit goes to the love of my life, who’s shown passionate interest and given me the strongest support in what I’m doing here. Additionally, I thank my family, friends, classmates, professors, and other ‘fellaz’ for their sincere words of encouragement. I also thank all the ‘silent’ readers, because I can still see all your names in my pageviews statistics... Just kidding, I only see your country and the browser you used. And your home address with a picture of you.

Without all of you, guys, the time I’m spending here would be, putting it mildly, a bit less worthwhile. So thank you!

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Plunging into the fascinating and incredibly exciting world of finance now. Yeah.

I recently had an honor to meet Josef Ackermann, CEO of Deutsche Bank. He was visiting Bocconi earlier this week with a speech on the state of Europe’s banking industry today. If someone is to listen up to, he is the one. Head of one of the 5 largest banks in the world, Ackermann is also a member of the supervisory board of Siemens, a member of the boards of Royal Dutch Shell and Zurich Financial Services, as well as an honorary professor of several European universities and a welcomed speaker at large international conferences like the World Economic Forum.

When this man isn’t happy, you know things aren’t right. Ackermann confirmed his worry that the banking environment in Europe has become more troublesome than ever. I developed and further researched some ideas he presented, and came up with the following conclusions on Europe’s economy and the banking sector.

The importance of Europe as a world’s financial center is eroding. Let’s look at some numbers. Back in 1999, 44% of the world’s top-25 banks were European. Europe was less exposed to the dotcom crisis and looked as a safe place for investment, as the leading economies were approaching the creation of a common currency, the euro. As of January 2012, only 16% of the world’s top-25 banks were from Europe, while the others were replaced by the banks from China and Brazil.

The number of European stock exchanges fell to 2 in the list of the world’s top-10 stock exchanges by market cap, while some of those previously on the list were replaced by China, India, and Brazil.

On top of that, European economies have been largely stagnant over the past couple of years. GDP growth in Germany was 3% in 2011, and is forecasted at the level below 1% for 2012. France, UK, Italy, and Spain only grew at 0.01-0.07% in 2011, while the growth contracted in Eastern European economies which are traditionally faster-growing ones.

Politics is sending conflicting signals to economy. It all started with the credit agencies (but hang in there – they’re not the ones to blame). They gave the legislators worrying signals that some economies, if not reformed, may have troubles meeting their obligations. In practice it means two things. One is that debt levels have to be reduced. The other is that yields on the existing sovereign debt will need to be increased, thereby increasing taxation and/or decreasing quality of public services.

What would you do as a European politician? That’s right, you’d go to banks and take their money. One completely… odd idea was the transactions tax proposed recently. Not only would it dramatically decrease banks’ earnings; it would also alienate many investors away from an already stagnant Europe.

Another reform, already enacted, is the requirement for banks to increase their Tier 1 capital ratios to 9%. The idea is to increase banks’ reserves and the quality of their portfolios. The outcome is, as evidenced by Ackermann, that banks need to resort to narrower business models and concentrate on core-activities. Additionally, as European sovereign debt is not anymore risk-free, banks are hurrying to de-leverage their portfolios and revise the risk profiles.

Apart from bad signals to economy, there are good ones as well. The problem, however, lies in the poor interaction of these pieces of legislation among themselves. EU politicians should agree on a strategic rather than an opportunistic approach to problem-solving within the Union.

Finally, the banking sector is getting less profitable. This is caused entirely by the above-said. As a result of de-leveraging and retraction from non-core activities, banks’ profit margins are shrinking. In the recent years, the industry has seen rapid shifts of individual market shares. Since many parts of legislation have yet to be enacted, we are probably going to see some more of these shifts in the industry very soon. For this reason, let me postpone discussion of this third point until sometime in the future, when the trends become evident.

Stick around until then. And I’m off for a cup of good Italian coffee.