Whether you look at league tables or capital strength, the dominance of the major US banks is clearer than ever.
Following this year’s stress tests from the Federal Reserve, the biggest US firms announced monster buybacks. JP Morgan will buy back $19bn, Citi $17bn and Bank of America $12bn. Morgan Stanley will buy back $5bn.
To put it another way, JP Morgan and Citi together will return more capital to shareholders this financial year than the entire market cap of Deutsche Bank. Throw in Bank of America and Morgan Stanley’s 2017 buybacks and you almost have enough for Commerzbank as well (still a ward of the German state).
Europe’s banks are still at the other end of the cycle. Four of Europe’s global banks, UniCredit, Deutsche Bank, Credit Suisse and Santander, raised €31.5bn equivalent ($37.2bn) of new capital this year, much of it (some €20bn at least) to pay for non-performing assets. UniCredit and Santander ploughed their capital straight into provisions; Deutsche and Credit Suisse are less direct about it but both banks are still working through non-core divisions and selling assets.
Look at the league tables and the story is the same. The top four banks by investment banking revenue in EMEA are all US firms, while in global fixed income, according to Greenwich Associates, Barclays was the only non-US bank in the top five.
The US banks might also benefit further from the deregulation initiatives proceeding under the Trump administration. While much of the administration’s agenda has struggled, the US Treasury’s thoughts on financial deregulation, published in June, seem thoughtful and moderate and so relatively easy to rally around.
The really big question for international banks, though, is whether the US move means any semblance of international regulatory co-operation is over.
“It’s not yet a global level playing field — in particular, the completion of Basel III has yet to be agreed on and there are doubts whether it will ever be fully implemented by the Americans,” says Michael Reuther, head of Commerzbank’s corporate clients business and group treasury. “The next revision… is still in negotiations mainly between US and European standard setters. Investors need to have a firm guideline on capital requirements but I don’t see it being agreed any time soon.”
US and European banking regulators have been deadlocked over where to set the “output floor”, which would limit the capital banks can cut by switching from standardised models to their own internal models. Senior regulators have said that the move isn’t supposed to raise overall capital requirements — but it’s likely to hurt banks with large low risk mortgage books, such as those in northern Europe, the hardest and faces fierce opposition from German authorities.
“What we’re defending is a way of calibrating the capital according to the risk of the assets,” says Frédéric Oudéa, group chief executive at Société Générale. “The work that supervisors are doing at European level, reviewing the modelling by banks, needs to be taken into account by the people who say we have no certainty or visibility into the quality of the models and that therefore we need a floor.”
Without international co-operation, big banks may be subject to a series of tit-for-tat measures. The US introduced “intermediate holding companies” to make sure its foreign banks kept enough capital and liquidity resources onshore. Proposals from the European Commission meanwhile suggest an “intermediate parent undertaking” to achieve the same goal in Europe.
If US government bonds escape the leverage ratio for US banks it’s possible that European government bonds could get the same treatment — though this raises the spectre of the “sovereign-bank doom loop”, which brought down peripheral countries and their banks in 2011-2012.
Olivier Osty, executive head of global markets at BNP Paribas, says: “If the US takes out Treasuries from the leverage ratio, that raises the question of whether Europe will take out sovereign bonds too — European politicians will want to keep a level playing field.”
But others disagree.
Reuther says: “The US Treasury proposals on banking regulations would certainly provide some relief for US banks but in Europe I see little room for an easing of the regulatory framework. I also don’t see the UK switching to a regulation-light regime after Brexit. Given the dominant role of the financial sector for the UK economy there’s a need to make it very safe.”
Grow your own
Though post-crisis policy responses were different across the Atlantic — Europe’s banks weren’t forced to recapitalise and the ECB took until 2015 to unleash monetary shock and awe — there are other reasons why the Europeans fell behind.
Growth has been weaker for one thing. According to the OECD, eurozone GDP grew from $12.06tr in 2010 to $12.75tr in 2016, a 5.7% expansion. In the same period, the US grew from $14.96tr to $16.92tr, an expansion of 12.9%.
Europe’s banks are also sub-scale compared to their US equivalents. If you compare outright balance sheets, BNPP’s €2.14tr of assets looks very comparable to JP Morgan’s $2.58tr but JP Morgan achieved that size after selling most of its good quality mortgages to Fannie and Freddie.
The absence of European megabanks is because of their history. The US giants mostly emerged out of a series of rollups in the 1990s and another crisis consolidation wave in 2007 and 2008.
The European firms, meanwhile, still have to contend with wide variations in national legal systems, making it difficult to get mergers to pay — despite the creation of a “Banking Union” from 2013.
“There are supervisory barriers in Europe, banking systems in Europe are ring-fenced and we need to advance in terms of legal harmonisation,” said José García Cantera, chief financial officer at Banco Santander, speaking at a conference at the European Central Bank. “There are many different laws today despite Banking Union and Capital Markets Union.”
Ever closer Union?
European authorities, however, are trying to finish the work on Banking Union — but events keep getting in the way.
The European Central Bank’s Single Supervisory Mechanism took over big bank supervision in 2014 explicitly to avoid national supervisors favouring their own institutions or trapping capital behind national borders.
It was a slow start following an immense “asset quality review” examining the balance sheets of every European firm. This year, the SSM has been working on examining bank capital models in great detail through the “TRIM” exercise, which is expected to increase capital costs for some firms.
The final item on the agenda, though, is the most controversial. European officials have been pushing for a “Single Deposit Insurance” scheme for years against implacable opposition from certain countries in northern Europe. This would share the risks of bank failure across Europe since retail depositors would be able to claim their funds back not from national governments but from a European pool.
But confidence in the potential scheme is not high following a string of bank failures.
Banco Popular gained a clean bill of health before being sold for €1 to Santander in June, while Monte dei Paschi di Siena was forced into the arms of the state when its rescue plan, concocted to satisfy the ECB, fell apart.
“If you had a European deposit scheme three years ago it would quite likely have resulted in French and German taxpayer money to go into MPS and Banco Popular,” says Reuther. “There will only be acceptance for such a scheme once the banking system is perceived to have again reached a safe and stable state. But proving safety is difficult. The trust of markets and investors in the stress tests is limited when you have banks almost failing just six months after getting a positive mark in a stress test.”
The bank of the future
The deposit scheme would only unite banks when they fail — and not necessarily help Europe’s banks to bulk up and regain their swagger. That will take time and technology and far more European integration.
“Consolidation is not just a question of regulation,” says Oudéa. “It’s also a question about the profound challenges taking place in banking, resulting in particular from the new technologies. The regulators themselves have expressed their views that given all these challenges the market is overbanked and there’s a need to have a minimal scale in each business. Domestic consolidation could make sense where there is the capacity to extract synergies in terms of systems and branch networks.”
He continues: “When you have more integrated markets you can imagine the benefits of cross border merger but you need to be realistic about the timescale: it is not for tomorrow, it’s probably in 10 years’ time. Right now, management energies are concentrated on transforming existing businesses so any such transactions will likely come later on. In the long run size does matter, both for retail and wholesale.”
Santander’s Cantera also points to technology as a driver for consolidation and says that his firm’s annual tech spend is “more than equity capitalisation of 95% of European banks”.
For banks which can afford the entry price technologies such as distributed ledger and artificial intelligence will transform their offering — and their earnings potential — by uniting disparate systems and making it far easier to bank clients across borders. US firms will benefit from the same technologies but in a fragmented market the Europeans have far more to gain.
European policymakers have also set a course that ought to help the region’s banks in the long term. A speech from French president Emmanuel Macron at the end of September laid out a vision for the future of the European Union that included a European finance minister, a European equivalent of the IMF and a big step forward in integrating financial rules across the continent.
So, far ahead on the horizon, there is a chance for European banks to compete again — it just depends on the politics.