It is no secret that over the last couple of years, banks have been facing the greatest challenges in their history. Not only did the financial crisis induce regulatory tightening but also did self-made problems cause stakeholders to scrutinize the banking business further. On top of that, many new competitors arose disrupting bank’s business models in retail banking as well as more and more in their core economic function, which is to provide the economy with capital. While traditional banks fighting hard to defend their businesses, the question remains whether they can counter the constantly accelerating disintermediation process.
Looking at data collected by the ECB, the aggregated balance sheet size of European banks shrunk from €31.83 trillion in 2008 to €31.20 trillion in 2014 while the GDP increased by 1.1% at the same time. More precisely, bank loans to Corporates declined from €4.8 trillion in 2008 to €4.2 trillion in 2014 with an annual decline rate of 1.80%. Meanwhile, debt instruments issued by corporates increased from €0.70 trillion in 2008 to €1.1 trillion in 2014, underscoring the ongoing disintermediation process. Banks try to absorb this effect by increasing Debt Capital Markets business, however on a cost basis which has not decelerated as fast as the decreased balance sheet business would suggest. As a result, they have to try to convert most of their former interest rate margin, which shrunk on average from 2,05% in 2008 to 1,45% in 2014 and is expected to decline even further in 2015, into provision generating business to remain profitable.
This process started with the removal of government guarantees by the EU in 2005, which has undermined the competitive advantages of many banks by increasing funding costs. The financial crisis in 2008 furthermore reduced the conventional lending power of banks. The bankruptcy of Lehman Brothers afflicted market confidence severely and increased banks’ borrowing costs significantly. The financial crisis was later continued by Greece and other debt crisis. While banks were bruised and battered by the financial crisis and reduced their lending efforts, Corporates sought for alternatives and found them in newly arising asset managers specializing in new types of lending to corporates. On the back of that, new business models take the role of banks as originator, since they can provide the same services and market access as banks. However, more efficiently with regulation focused on their business model without impact from other businesses while operating on a lower cost basis compared to banks.
Likewise, the regulatory requirement is imposing restrictions on bank’s lending behavior. Basel II, implemented in 2008, requires to maintain higher cash reserves. That is, minimum capital requirement to cover risks incurred by their businesses. On top of that, Basel III was published in 2010, which requires banks to hold 4.5% of common equity (up from 2% in Basel II) related to their risk-weighted assets (RWAs). It also introduced minimum leverage ratio and liquidity ratios to strengthen global capital and liquidity with the goal of promoting a more resilient banking sector. These regulations will continue to decrease banks’ profitability. As an example, the capital requirements for unsecured loans will increase from 8% to 9.25% in 2016 and to 13% in 2019. As a result of Basel III, investors are expected to reduce their appetite for bank debt and equity further, weaken banks’ operating and lending capacity.
In summary it can be stated, that new business models in the investment fund industry, Fintech and other businesses will continue the disintermediation process and challenge banks in their core function even more. The horror scenarios conjured by some bankers, that regulation will lead to reduced financing for the economy will not hold. Instead, new disruptive businesses will accelerate the disintermediation process and provide new and more favorable ways of financing corporates in the future.
