Your browser does not support JavaScript!

Exchange of views: Bank fragmentation and prospects on further consolidation in the EU

Day 2 Afternoon

Thursday 04 April

Room :

Grand Ballroom - Exchange of views


Felix Hufeld
President, BaFin
Public Authorities
Korbinian Ibel
Director General, Micro-Prudential Supervision IV, ECB
Elke König
Chair, SRB
Fernando Restoy
Chairman, Financial Stability Institute, BIS
Industry Representatives
Jean Lemierre
Chairman, BNP Paribas
Fabrizio Saccomanni
Chairman, UniCredit S.p.A.

Objectives of the session

While we have come a long way since the establishment of the Single Supervisory Mechanism (SSM) four years ago, the Banking Union is far from complete. An efficient banking Union would break the sovereign- bank vicious circle, foster a more effective allocation of resources across the Eurozone (e.g. companies would be able to tap wider and cheaper sources of funding), help to achieve a better diversification of risks thus contributing to private risk sharing within the Union.

The limited strength of private risk-sharing channels in the euro area reflects both the underdevelopment of capital markets and a highly segmented banking system at the national level. There is little progress in cross-border lending, especially in the retail markets, or in other words, in lending to households and firms. Expanding this foreign activity would be important for the sound working of the euro area.

Despite the challenges faced in recent years, with the emergence of new competitors and low levels of profitability, many European countries’ banking systems remain oversized and still have surplus capacity. In addition, international consolidation processes have been few and far between, and this pattern has not changed since the launch of Banking Union.

The objective of this exchange of views is to assess the reasons why banking systems are so fragmented in the Eurozone despite the implementation of the Single Supervisory Mechanism and the Single Resolution Mechanism and to discuss the possible way-forward. Speakers will then be invited to express their views on the expected benefits and priorities needed to foster cross-border consolidation in the euro area.

Points of discussion

How to explain the increasing fragmentation of the banking sector and its oversized in the Banking Union?

What are priorities needed to foster cross-border consolidation in the euro area?

Background of the session

The Banking Union is failing to provide the expected degree of financial integration

The existence of the SSM and the SRM have not had any marked impact on the banking industry’s structure in Europe. Indeed, the banking sector in Europe is too fragmented, not concentrated enough and oversized.

A fragmented banking landscape in the European Union

Indicators are continuing to signal banking fragmentation in Europe. The share of cross-border loans to households and cross-border deposits from households remain negligible at around 1%. Direct cross-border loans to firms accounts for only around 8% and this figure has hardly changed since the creation of the banking Union.

The share of cross-border deposits in the euro area from firms is also very low (around 6%) and has fallen slightly over the last few years. The level of foreign bank penetration is, overall, relatively low for a banking union.

An Oversized banking system in Europe

The fragmented banking sector across domestic lines leads to overcapacities of the banking sector in many countries; the European Union is particularly concerned by overbanking.

Many indicators point to this excess capacity. For instance, efficiency indicators – such as cost – to -income ratios (around 69% in the euro area, and 60% in the United States) or branches per population (44 per 100,000 inhabitants in the euro area and 26 in the United States) illustrate this overcapacity.

Banks in Europe therefore have to face a much more competitive environment than in the United States and therefore a much stronger pressure on their margins. Moreover, lasting low interest rates have negative consequences on EU banks profitability.

Not concentrated enough

Bank Merger & Acquisition (M&A) transactions within the Euro Area have been on a steadily declining trend, both in terms of number and value, since the year 2000. Cross-border merger and acquisition activity among banks within Europe have practically disappeared. Indeed, bank Merger and Acquisition within the euro area has been on a steadily declining trend both in terms of number and value, since the year 2000.

The EU banking system is much less concentrated that the US one: the market share of the top five US banks within the United States was more than 40% in 2016, whereas the market share in the Eurozone of the top five European banks stands at more or less 20%.

In 2018, there were only $5,0 bn of mergers between European banks, the lowest level for man than a decade and a tiny fraction of the €193,8 bn of such deals done on the eve of the financial crisis in 2007, according to date from Dealogic.

Overall, since 2007, the credit channel (i.e. cross-border lending and borrowing) has been acting in the euro area as a sock amplifier rather than a shock absorber

Whereas they used to be mostly cross-border in the pre-crisis period, they have increasingly become of a domestic type. Furthermore, as unveiled in research by Raposo and Wolff (2017), domestic M&A transactions have become increasingly of a ‘controlling participation’ type, whereas cross-border transactions have become increasingly of a ‘minority participation’ type. Certainly, all of this was, to some extent, driven by the post-crisis inward-looking bank restructuring strategies put in place by supervisors and Member States.

Overall, since 2007, the credit channel (i.e. cross-border lending and borrowing) has been acting in the euro area as a shock amplifier rather than a shock absorber.

Private risk sharing has indeed been impaired in the euro area, and a fortiori in the EU. This should be a concern, as it is through risk-sharing channels that the overall system becomes, at the same time, more resilient and more productive.

What are the consequences of this geographical nationalization of the European Banking system and regulatory framework?

As explained by Jacques de Larosière in a speech delivered in October 2018 at the European Financial Committee, the consequences of this fragmentation are severe and notably mean:

  • Weak profitability of banks (in 2017, the return on equity was 3,9% on average in the European Union as opposed as 9,5% in the United States) at a time of particularly rapid technological innovation. Only banks with healthy profits can invest in technology, talent and scale;
  • Reducing costs through economies of scale is more difficult and in addition, there is much less transfer of technology and knowledge;
  • Competitive disadvantage for Pan-European banks versus US ones, which benefit from a large domestic base;
  • The EU resistance to asymmetric shocks is weaker (in the United States the capital and credit markets absorb alone more than 50% of the consumer impacts; in Europe is only 10% because of the lack of capital mobility and of credit which stay within national borders. In total, including the fiscal element, more than 2/3 of the shocks are absorbed in the US whereas it is only 1/5 in Europe.

Conversely further banking integration would foster resilience against economic shocks. A geographically diversified loan book and deposit base make banks less vulnerable to domestic banks and thus reduce the volatility of their lending and income streams; private risk sharing via the banking channel would thus be made possible by a higher degree of risk diversification enabled by diminishing the domestic bias, be it in the shareholding of banks, in the attribution of credit or in the detention by banks of domestic sovereign debt.

It is evident that «ring fencing » is a significant contribution to explain these consequences. If we continue to condone ring-fencing and hinder cross-border banking consolidation, the risk is to see banking groups split into branches instead of subsidiaries.

Despite remarkable achievements in terms of balance sheets cleaning, regulatory harmonisation, and deepening institutional integration within the Banking Union, where the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) are up and running, financial integration is lagging behind. The Banking Union is failing to provide the degree of financial integration that we would have expected. Rather than smoothing idiosyncratic shocks to individual Member States, the banking sector still operates as a shock amplifier.

If the EU wants to keep up with the US and China economically as well as politically, it must break out this downward spiral and strengthen its banking industry. Only competitive and profitable banks can take on the risks necessary to finance sustainable growth. This is why a financial integration agenda for the Banking Union should rank high among the priorities of legislators and authorities for the next five years.