A shrinking banking sector

9 December 2013

Ever-tighter regulations and an uncertain financial climate led to a decline in the total assets of the European banking sector in 2012, along with a fall in lending. A credible growth agenda is needed to get things moving again, writes Guido Ravoet, chief executive of the European Banking Federation.

The European banking sector is shrinking. Leading indicators are all pointing at a contraction in size (deleveraging) and a retraction into national borders. There is also greater focus on compliance with the new wave of financial regulation, stronger risk management and the building up of capital and liquidity buffers.

The total number of EU credit institutions in 2012 decreased by 199, of which the biggest changes were recorded in Italy, Germany, Spain, France and the Netherlands. This trend continues into 2013: from the beginning of the year to October, the number of credit institutions fell by 113. These changes reflect banks' efforts to consolidate.

As a result of bank closures, some 5,500 branches were closed in 2012, mainly in Germany, Spain and Italy. In line with that, the number of staff employed in the banking sector fell by over 51,000 or 1.7%, not least on account of Spain, Italy, France, Germany, Poland and Romania.

As a consequence, the assets of banks operating in the EU fell by €863 billion, or 1.9% of total stock. From a geographical perspective, the largest contribution to the fall in the stock of assets is attributable to the eurozone (-2.5%), while the non-eurozone countries' asset stock remained broadly unchanged.

The economy's funding sources

When total assets shrink, so do loans. Throughout 2012, the eurozone banks' stock of loans decreased by €518 billion. At the same time, the non-eurozone banks' loans increased by €312 billion. The cumulative result for the EU27 is a -0.8% decline in the loan stock in 2012. These figures are a tangible manifestation of the impact of financial regulation, which eventually leads to the deleveraging and restructuring of the banking sector. Most banks' counterparties saw the situation worsen in 2012 as far as bank lending was concerned, and some economic players turned to alternative funding sources.

Inter-bank lending was the EU banks' counterparty that saw the biggest decline in loans: it shrank by over €440 billion, or 6%, in 2012. Introduced two years ago, the ECB's long-term refinancing operations (LTRO) are gradually being phased out, and that has direct implications for inter-bank lending positions. In addition, ever scarcer collateral (which has become a very important factor for loan provision) creates a negative impact on market making, not least for the inter-bank market.

"The figures are a tangible manifestation of the impact of financial regulation."

The second largest decline in the stock of loans in absolute terms was registered for loans to non-financial corporations (NFCs), which fell by over €175 billion, or 3.2%, in 2012. Such a figure may sound alarming; however, this fall in bank lending to NFCs was dwarfed by what corporations received in non-bank financing over the same period. The outstanding amount of NFC quoted shares grew by €783 billion, and, combined with the €387 billion in securities issued by NFCs in 2012, the non-bank financing acquired by EU companies totalled €1.1 trillion. It could thus be said that, in 2012, large EU companies did not suffer from a lack of funding sources.

Finally, total stock of loans to governments in 2012 reduced by some €100 billion. This was compensated for by a growth of €311 billion in the stock of debt securities issued by general governments.

The stock of loans for house purchase, and loans to other non-monetary financial institutions (MFIs) grew in 2012 by 1.2% and 5.5% respectively.

The decline in EU banks' loan stock is a result of several phenomena, such as the necessary deleveraging (imposed by new EU financial regulations) and loan-sale programmes of banks. This is particularly important in countries where target loan-to-deposit ratios are imposed. Other reasons for the decline in loans are that the rate of return for lending to businesses is simply not high enough, pushing some banks to buy government bonds instead. That said, real lack in demand is yet another explanation to the observed SME-lending trend.

Banks' funding sources

One of the most important funding sources for banks is deposits. The total stock of deposits in the EU grew by 0.5% in 2012; however, growth is only attributable to the non-eurozone EU countries (€232 billion or 4.7% for the region), while eurozone banks' stock of deposits declined by €115 billion, or 0.7%.

Analysis of the EU banks' major counterparties shows that the biggest decline in banks' deposit base took place within the inter-bank deposits: they dropped by €283 billion, or 2.2%. The only other counterparty whose deposit base shrank was central governments: a fall of €16.5 billion or 7.2% in 2012.

On balance, EU deposits from non-MFIs grew by a steady 2.2%, of which deposits from corporates increased by a healthy 5.1% (or €108 billion).

It is clear that stalling in the growth of deposits limits banks' capacity to finance the economy, especially given the current economic and regulatory environment. With the new wave of financial regulation, banks have been strengthening their compliance departments. Staying above sea level is what 2012 was all about.

Overall decline in volume of loans

A glance at the performance indicators of banks will reveal the story behind the poor lending performance. The mean of total gross doubtful and non-performing loans (NPLs) across the EU member states has been steadily increasing over the past five years (see Figure 3, page 10). As a share of total debt instruments and advances, it has grown from just over 2.0% in 2008 to 5.1% in 2012. For the eurozone, the figures stand at 1.7% and 4.4% respectively.

This reflects the fact that the socio-economic situation is weak, thus preventing an ever-larger share of borrowers from repaying their loans, be they private, institutional or corporate clients. This is part of the reason for an overall decline in the total volume of loans: banks are more prudent with their clients. Certainly, the situation across the EU member states varies. While the share of NPLs increased in more or less all countries in Europe, in some, like Bulgaria, Cyprus, Greece, Hungary, Italy, Latvia, Lithuania, Portugal and Spain, it exploded over the past few years.

"The fall in bank lending to NFCs was dwarfed by what corporations received in non-bank financing."

NPL ratios of over 10% are certainly unsustainable, and need to be brought back to lower levels. This will be possible when the economic situation stabilises, and the full set of new financial-sector regulations has been phased in. The process is complex and the current economic environment is not favourable, so it may take a few years before all EU member states bring their NPL ratios down.

The ratio of loans to deposits in the sector of non-MFIs has been gradually falling during the past five years, reaching 113% in 2012 (see Figure 4, right). In other words, the non-financial sector has been reducing its balance-sheet leverage. On the other hand, the inter-bank loan-to-deposit ratio has been less steady. As the inter-bank loan base fell much more rapidly than the deposit base in 2012, the ratio dipped to 99%.

Need for a credible growth agenda

It can be concluded from the above that 2012 was a year of reduction in the on-balance-sheet banking-sector leverage. This is in line with the general aim of the regulators, although lending to SMEs being in decline in 2012, a year of negative economic growth, is not quite the perfect outcome, no matter which way one looks at it. Following a number of academic studies, bank lending lags behind economic growth by anywhere between 12 and 18 months, which means that economic expansion must be led by a strong and sustainable non-banking stimulus (such as innovation, new trading partners or external demand) in order to get companies to start borrowing again to cater for new orders. This will spur new employment and help households consider taking on new loans. For this to happen, a credible growth agenda needs to be put in place by national and EU policymakers.

European banks having been endeavouring to strengthen their tier-1 capital bases over the past year. With the exception of Cyprus and Greece, every other country's banks have improved their tier-1 capital ratio, according to the European Central Bank's consolidated banking figures. In 2012, the calculated median of the national tier-1 ratios of all banks operating in the EU27 member states was 13.8%, a vast improvement compared with the 9.6% in 2008.

"Staying above sea level is what 2012 was all about."

Owing to continued business-related and regulatory challenges, banks have been struggling to improve their efficiency. As a result, the calculated median of cost-to-income ratio of all banks operating in the EU27 at the end of 2012 inched up to 58.6%, from 58.3% in 2011. The most remarkable improvements were registered in Luxembourg, Denmark, Malta and Austria. The efficiency ratio notably worsened in Ireland, Hungary, Greece and Slovakia (although it should be noted that costs here include provisions).

European banks' figures on return on equity remain weak. In 2012, the calculated median value of return on equity for all banks operating in the EU, as registered by the ECB, was a meagre 3.4%.

In conclusion, European banks have been going through difficult times. An overwhelming amount of regulation is not helping, in these times of economic weakness. Once the economy starts picking up, however, banks will be able to get back in business again.
This article is a summary of 'European Banking Sector Facts & Figures 2012', published by the European Banking Federation.

This article is a summary of 'European Banking Sector Facts & Figures 2012', published by the European Banking Federation.


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Since January 2005, Guido Ravoet has been secretary-general of the European Banking Federation.