Daily Management Review

US vs Europe: Which Banks Are Stronger?


Seven years passed after the peak of the financial crisis, yet the major European banks continue to behave as though they are still in the midst of the financial storm. Plans for a radical restructuring are shelved even before they begin to be implemented; at the time it does not stop personnel changes (i.e., the new head of Barclays was appointed last week).

Neither they have answer for the most basic questions, such as how much capital they need, or whether to reduce the amount of operations in the troubled investment units.

European indecision is clearly visible against the background of America's big banks, which have been restructured pretty quick. Although their incomes are still below pre-crisis levels, their balance sheets are stronger and management teams cooperate in a clear and coordinated manner.

European banks continue to stumble across non-core units and "bad" loans, while US banks move forward confidently.

Investors have taken note of it. Most of the major European banks, including Deutsche Bank and HSBC, are trading at a discount to the market value of tangible assets: theoretically, in such a situation, it would be better to liquidate and return the money to shareholders.

America's largest banks, with the exception of Citi, are traded at a higher price-to-book value of the assets. Shareholders’ incomes of American and European banks in the past were almost aligned. Today, there is a significant gap between them, says the British magazine The Economist.

Wall Street is relentlessly increasing the market share at the expense of Europeans in the investment banking services. European banks, of course, do not want to lose business in segments such as assisting companies in raising money in the capital market, trading bonds and the total cash flow.

However, clients, who are in need to attract investment, often leave banks such as Barclays and Credit Suisse for the sake of financial institutions like Goldman Sachs and JP Morgan.

Many factors have led to the current plight of European banks. Revenues on almost all types of activities have been hit hard due to the many years of sluggish economic growth. Certainly, American banks lend in a more stable environment.

Interest rates in the euro zone are likely to remain low for a long time, making it difficult to obtain the net interest margin from lending of a decent standard.

The European banking market is fragmented and consists of politically controlled lenders such as the German Landesbanken, which undermines the profit of all.

Leaders of European banks also explain their half-hearted strategy by constantly changing regulations. They are much more difficult to adapt to the new global rules, which are increasingly being attracted to the American model.

The introduction of financial leverage ratio (limiting the amount that a bank can borrow for a loan) is a transatlantic import.

It punishes the big banks for the presence of relatively safe assets such as mortgage loans or government bonds - the essence of the European banking sector.

In contrast, US banks act as an intermediary agent in the capital market on the balance sheet and have relatively small amounts of mortgage loans, partly due to the existence of such government agencies as Fannie Mae and Freddie Mac.

With regard to the investment business, the bankers in the US are much more effective. This is largely due to the home advantage: the entire half of the profits from global investment activities is generated in America.

Size also plays a role in the banking industry: big companies tend to increase market share. Investment banks in Europe are generally much smaller.

In addition, the US investment banks also have a lower cost, having reducing the number of staff before.

Approximately 70% of the income of European investment banks is spent on the staff maintenance, which is about 15% higher than that of their American counterparts. And it needs to be solved as quickly as possible.

By the way, Deutsche Bank has announced the upcoming mass reduction of employees.

European banks also need to catch up with competitors in the US and in the issue of capital. It is expected that the new boss of Credit Suisse Tidjane Thiam attract billions from its shareholders.

Deutsche Bank reduces assets, primarily its interest in Postbank having a poor performance (the bank specializes in retail lending). French banks are lagging behind here.

A union of two large companies - or at least merge their investment units - would be a great way to cut costs.

The new regulatory organizations are not against it: a transfrontier association could demonstrate the integration of the European financial market.

As for the customers, the European banking excess of capacity benefited them: they pay much less for some services than Americans (for example, the inclusion of shares in the quotation list of the stock exchange).

However, it seems few people mind paying a higher commission to Goldman Sachs or Merrill Lynch for operations that require global coverage. It may irritate the European bankers, but nothing can be done.

If their investment banks cannot remain profitable and competitive in the framework of existing law, the banks, not the regulations, must be changed.

source: The Economist