European banking at a crossroads

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Major disruptive forces including technology, regulation, competition and now Brexit likely to set the direction for the next decade, says PwC report

The banking industry in Europe is in need of a major shake-up, according to a new PwC report, "The future shape of banking in Europe - how disruptive forces will drive the evolution of a new banking ecosystem”. 

A new array of challengers, including fintech start-ups, non-bank finance firms, technology giants and high-street retailers is soliciting bank customers with new propositions and ‘cherry-picking’ other parts of the banking value chain, according to the report. This presents a major opportunity for all market participants to evolve, says PwC. 

Colin Brereton, EMEA Financial Services Risk, Regulation and Crisis Leader at PwC, said:  

“While banks may have strengthened their balance sheets, less has been done to address their core business fundamentals, and investors are getting impatient. 

“Incumbent banks are struggling to perform under the weight of their legacy; a still packed regulatory change agenda; and weak and increasingly volatile economic conditions – now exacerbated by the Brexit vote.” 

Europe’s banks have consistently failed to cover their cost of capital since the global financial crisis, and they are currently operating at an economic spread (return on equity less cost of equity) of about minus 6%*, net of fines, restructuring costs and other transitory items. Market price-to-book ratios (actual stock market value vs book value) reflect this. 

The problems are not confined to investment banking, which some regard as the ‘problem child’ of the banking industry – they extend into core retail banking which, globally, missed its cost of equity threshold by about 3% in 2015, PwC says. 

While the traditional barriers to entry may sustain incumbents for a while, it is not hard to see  them being progressively broken down or turned to challengers’ advantage: brands are likely to be a major battle ground, but not necessarily to incumbents’ advantage as major technology players encroach in the market; privileged access to prized customer data is being bypassed or intermediated by technology firms; the lock on cheap deposit funding comes with an increasing compliance cost, is no longer such an advantage these days with interest rates on non-deposit funding being so low, and is also vulnerable to disruption through peer-to-peer and crowd finance. The control over banking infrastructure is potentially vulnerable to the emergence of blockchain technology; and general banking know-how can always be poached or even replicated through artificial intelligence. 

PwC’s report sets out three possible scenarios for a future banking system in Europe: 

  • The trend of multi-paced transformation continues: banks gradually adapt and consolidate but not fast enough to prevent challenger organisations of various forms from taking a sizeable - perhaps 20% - and permanent share of the market.

  • The trend quickens, and a tipping point is reached beyond which the challengers become the new incumbents and the present incumbents either fade away or are reduced to playing a utility role. In this scenario, it is possible that a new banking crisis, and a new round of public intervention, could precipitate the transition.

  • The third more optimistic scenario sees the banking industry – together with other financial services and technology sectors – move on from vying for who gets what share of the payments, deposits, loans and securities market. Instead, it addresses itself collectively – through amalgamations, alliances and other business-to-business commercial arrangements - to customer service innovation, solving contemporary societal challenges and getting back on the growth agenda.

The third scenario is the most likely outcome, says PwC partly because the market is already evolving in that direction, naturally rather than by design. The parallel is drawn to the emergence of the so-called ‘sharing economy’ which has come into being through developments in the socio-economic environment, rather than being institutionally driven.

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