The Pressures Under Which Banks Are Operating Today With Specific Reference To Europe.

The interest rates all around the world have been falling rapidly and the savings aspect in the general banking industry is slowly decaying. The current deposits are major and still decreasing constantly. The withholding tax propositions have further decayed the interest of individual and sole proprietor businesses to the point where they don’t do banking transactions until necessary.  Moreover, the withholding tax propositions on the non-residents of Europe, withholding tax on profits earned from Switzerland and withholding tax on profits earned from several other countries have further spoiled the banking case for European Banks. According to latest figures, the Stoxx Europe Banks index has hit its 21-year low. This describes the amount of pressure that European banks are going through as this index comprises of 600 major European Banks. The recent capital buffers have led to US banks offering major dividend increases and introducing repurchasing of their own shares programmes. These desperate measures have been a result of constant capital buffering. The US banks have also been on a low, as their current standing has been recently compared to that of the times of financial crisis of 2009. If we talk about the economic standing and capital of banks, the capital of European banks is frail as compared to their US rivals, but their performance has been weekend by several other factors as well. The lower interest rates and the lacklustre economic growth has also contributed towards weakening of the stances of the banks. The whole news of UK voting to leave the European Union (Brexit) has also not helped the shabby and debilitated banks of Europe. Moreover, the lower interest rates haven’t been the only problem as the Non-Performing Loans of European banks have crossed their expiry. The oldest bank in the world and one of the largest banks of Europe, Monte Dei Paschi di Siena, has become one of the biggest problems for Italy’s banking and European banking as well, as its Non-Performing Loans have recently hit 50bn Euros. As compared to the US markets and US banks, where the generation of Capital through reserved profits has been implemented as a last-ditch effort to keep afloat many banks of US, the same has been a problematic issue for the European Banks. Many major banks of Italy and Deutsche, etc. have been unable to generate any notable capital reserves through the retained profits.

1. Consider whether these problems are transitory and likely to diminish over time i.e. are secular rather than cyclical or may lead many banks in the industry being forced to shift to being utilities with low risk and correspondingly low return on equity.

Many of such problems are down to general economic and financial condition of the economies of the world. The low interest rates and the low return on equity have been major problems and banks and general banking industry in Europe seems to be helpless about it. Still, there are several factors and several decisions that the banks could take to turn around the tide. The first and foremost step would be to restructure the costs of the bank. The traditional banking costs are designed to cater the banking systems where there is endless equity and the pipelines are full and healthy. That hasn’t been the situation anymore. The banks need major restructuring in their cost structures to develop and retain equity and capital reserves that could keep them afloat. Due to the Non-Performing Loans and several other major factors, the earnings of the banks have been on a general declining course. This needs to be changed as well. As discussed above, the strong capital and deposit bases can turn the tide around in terms of earnings. The banks need fresh injection of Capital and Equity to get back to their feet and recover from the hits they have faced since the financial crisis of 2009 and since. The cost cutting down and capital reserves gained through retained and reserved profits can give the banks the room to regain their financial growth and earnings.

The eventual result of above mentioned problems could eventually lead to banks being operated as low risk entities. That path, however, is very far as these problems are not cyclic and they need proper legislative and regulatory measures in the favour of the banks to turn around the wave of financial and economic success in their favour again. Banks being operated as low risk entities and low return on equity is also not a possibility due to their extensive networks and volatile and saturated nature of the industry. The competition alone will kill the low returns on equity. The systemic risks in the global banking systems need intervention, as this would lead to a wave of decrease of capital shortfall that could lead to reinjection of life into the European banks and the banks all around the world.

2. Consider whether it is likely that banks can adapt their business model to the new economic, social, regulatory and technological environment (as they have been attempting already) by shifting to capital light activities or minimising the size of their trading books and shifting to ‘order matching’ i.e. a shift from principal to agency trading. Consider also whether many of today’s banks may be displaced by fintech companies and by new ‘challenger’ banks.

The talk of replacing the banks has been on the horizon way before the global financial crisis of 2009 and European Banking crisis of 2011. It is a possibility and loose forms of general banking and retail banking have been introduced by many companies to test the market. The market is very open to easy solutions to replace banks. The banks have their hooks deep in contemporary economic and financial situation. The replacement of banks completely by some other system is not a talk of today and is not possible. However, a gradual move in this era can become a reality may be after few decades. The banking system, however, needs to adapt to the contemporary economic and financial situation which has been challenging the core business, business practices and business models of banks. The shift from principal to agency trading again is a gradual process and would take years to complete. Some sort of adaptation and flexibility, however, on the part of the banks and their business model is essentially required for the banks to survive. The capital light activities can be a gold mine of an idea in this current scenario, where the major problem for the European banks and the banks all around the world has been the short fall of capital reserves and the equity shortfall. Shifting to a business model with capital light activities can lead to a banking system, where banks start regenerating their earnings without having to take drastic measures to gain and inject heavy flows of capital in the first place.

In the current ultra-low interest rate environment, the profitability of the banks has been a talking point amongst banking community. The need for revised banking models is a result of two needs of the banks, i.e. cost restructuring and search for alternative sources of income. The banks need to revise their business models in such a way that it leads to an environment where the interest rate based revenue is their least important stream of income. Also, the banks need to diversify into modern day usage products related to e-commerce. The interest rate based costs also need to be cut down to make it a profitable institute. The non-performing loans need to be dropped and their remains are needed to be converted into capital reserves along with their reserved profits.

3. Using Deutsche Bank as a case study, refer to what you have discovered in your research and what you have learned in class and explain the problems that this bank is currently suffering from and has been suffering from for some years. If you were the CEO of Deutsche Bank, how might you try to overcome its present difficulties? What steps would you take? Present and justify what you would make as your top three priorities.

Deutsche bank has been the talk of the major fall backs in the banking industry. The bigger they are, the harder they fall; fits right in the mix for the story of Deutsche. The bank has been performing well and when problems started to arise, everything went upside down. The bank currently doesn’t even have first-hand or second hand enough capital reserves in its pocket to finance the costs, fines and capital reserves of the bank. These things are necessary to run the bank on a daily basis and the bank can’t afford them. If I were the CEO of the bank, the first and foremost step would be to gain capital reserves through non-performing loans and their reserved profits. Drop them dead and take their ruins as first hand capital reserves for the bank. The non-performing loans are an anchor for the bank, no matter how hard the captains are trying to keep the ship afloat, the non-performing loans and 10bn Euros shortfall of capital will always weigh down the ship. The earnings of the Deutsche bank have been on a constant declining trend and as mentioned and discussed above, the bank needs to restructure costs to a business model where the costs are at a minimal level. The litigation provisions of Deutsche Bank and Commerzbank have also led to major problems and cost restructuring would resolve such problems as well. The third and one of the most critical step would be to take investors and shareholders in full confidence that the management of the bank knows what it is doing and that the tough times will pass and it’s a test of nerves not only for the management of the bank but all its stakeholders. This is critical for the bank because the bank’s share price has already two bind folded into a quarter of its book value and the investors taking the money out of the capital would send a shockwave so major into the bank that it wouldn’t be able to resist. Moreover, the capital demands of the bank for cost covering, pending penalties and fines and overall capital requirements of the bank need its investors to stay put.