14 November 2019

LSE: Post-crisis banking in the euro area and Greece: How can a pan-European banking sector be created?

With the post-crisis macro-economic environment now deteriorating, Eleni Louri-Dendrinou and Petros Migiakis argue it is vital policymakers focus on the creation of a genuine pan-European banking sector.

Although euro area banks have become much more resilient since the global financial crisis, with capital buffers exceeding 18% of their risk weighted assets and close to those of US and Nordic banks, their profitability has suffered. The question is what are the drivers of this limited improvement? Have structural advances within the banks taken place or was the improvement only due to the positive post-crisis macro-economic environment, which is fast deteriorating now?

If there are structural improvements, they should be mirrored in the net interest income of banks which reflects better management, better allocation of available funds and higher cost efficiency. A careful look at a net interest income index taking the value of 100 in 2008 reveals that only three countries in the euro area (France, Spain and the Netherlands) showed an improvement in 2018. The index for the rest was below 100, while the index for Greece stood at 60. Furthermore, the average net interest income to total assets has stabilised to low levels after 2010 with no special reaction to the low interest rate environment introduced by the ECB’s monetary policy.

Hence, it is possible to draw the conclusion that the relative increase of return on equity was not due to structural improvements (which would show in the net interest income) but the phase of the cycle, as both macro-economic and financial conditions improved substantially, in association with the ECB’s unconventional monetary policies that managed to support investor and business confidence. Greek banks seem to have lost this window of opportunity, at least for now, as Greece was not in a position to benefit due to its low (below investment grade) rating.

The main reason for the low net interest income of banks in crisis-hit (periphery) countries is the existence of non-performing loans (in an econometric analysis they are found to explain almost half of the variation of net interest income). In non-crisis-hit (core) countries, bad assets explain very little, while studies reveal the role of low interest rates. The different financial conditions banks face in the euro area reveal persistent fragmentation.

In spite of rapid bank consolidation, most of the mergers and acquisitions between banks were within-country and not cross-country. Consolidation has been either precautionary in order to improve resilience or necessary due to bank failures. Bank consolidation has facilitated deleveraging and improved the resilience of banks in the euro area. But it has also meant that in several countries banking has become much more concentrated, causing problems of market power (higher prices, higher fees, reduced efficiency).

Concluding, we can argue that the profitability of European banks has improved in the years since the financial crisis, although to a much lower extent than their US and Nordic peers have experienced. However, this seems to be a development attributed more to juncture than to structural reasons. The fragmentation of the euro-area banking sector is still an important barrier to a true economic union. Policymakers should focus on supporting the creation of a pan-European banking sector, while banks should focus on improving efficiency. The immediate way to go, in order to strengthen the existing banking institutions ahead of the turning macro environment, is consolidation across the euro area by introducing suitable incentives and regulation. Greece could benefit immensely from such developments.

Full article on EUROPP blog

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