The Single Supervisory Mechanism (SSM) has been scrutinizing EU banks’ business and profitability models since 2016. Among the findings of the review, published in a report, the supervisor shines the spotlight on the factors that undermine bank profitability, as well as the levers that can help boost it, including digitization. However, the report argues that offering digital products is not enough. Banks need to prepare their platforms to migrate from the analogue to the digital world.
With this report, the SSM report aims to first and foremost, help the ECB’s so-called Joint Supervisory Teams, JST, analyze the business models of financial institutions and ensure the consistency of this analysis across all banks. Secondly, to assess banks’ ability to steer strategically their business models and monitor the consequences of weak profitability for banks’ risk-taking behavior.
One of the key findings of the report is that European institutions’ profitability and business models remain under pressure due to low interest rates, the economic environment and increasing competition. While U.S. banks, according to the report, have been quicker to bounce back from the crisis, some European banks are still struggling under the burden of their legacy non-performing loan portfolios. Also, the average ROE of the analyzed institutions remains under pre-crisis levels (6.3 percent in 2017).
The SSM is not expecting banks to go back to pre-crisis profitability levels, but it does consider that they will eventually reach a sustainable ratio. What remains to be seen is whether fintech competition is a threat or an opportunity in this sense for banks.
Another one of the conclusions covered in the report is that insufficient strategic steering capability —with long-term goals— may exacerbate banks‘ challenges, which is why this capability is being closely monitored by supervisors. Lack of strategic vision in some institutions could be detrimental to corporate efficiency and governance, among other factors.
At the same time, the report indicates that the response to the low profitability challenge differs widely across institutions. The weakest banks are focusing on cutting costs and default-prone loans, while best-performing institutions are focusing on growth.
Here, the SSM’s report also focuses on the importance of digitization strategies. The level of technological development greatly differs among banks. For example, it mentions that a number of banks are already investing or entering into partnerships with fintech companies. Also, the report warns about the risk of disruption that the arrival of big-tech competitors could have, although, so far, their forays into the financial sector have been restricted to some segments, such as payments.
Danièle Nouy, Chair of the SSM Supervisory Board. - ECB
How are EU banks supervised?
The SSM is the EU’s banking supervisory system and one of the pillars of the banking union, together with the Single Resolution Mechanism. Its purpose is to safeguard the reliability and resilience of the European banking system, boost integration and financial stability in Europe, and ensure supervisory consistency. After the financial crisis the mechanism was created to “help rebuild trust in the European banking sector and increase the resilience of banks,” as the European Central Bank itself explains on its website.
Currently, the mechanism supervises the 119 significant banks of the participating countries, which hold almost 82 percent of banking assets in the euro area.