A debate that is attracting a fair amount of controversy is whether Europe is overbanked. This debate is made even more contentious as overbanking can have two distinct meanings: is there too much banking in Europe, or is it a case that there are too many banks?
An obvious first point of reference in this debate is a comparison between the EU and the US banking systems. The comparison of the 2018 indicators gives some impressive results.
In the eurozone, the size of the banking system is 280 per cent of the euro area GDP. In the US, banking turnover accounts for a mere 91 per cent of GDP. The return on equity of eurozone banks is 4.5 per cent while that of US banks is nine per cent. The cost-to-income ratio of European banks is 69 per cent while that of US banks is 60 per cent. For every 100,000 inhabitants, there are 44 bank branches in Europe while a mere 26 in the US. Banks quoted on the European stock exchanges have 52 per cent of total banking assets, while in the US publicly quoted banks have 78 per cent of total banking assets. European banking supervisors and some banking analysts agree that these figures confirm that Europe should adopt the US model because there are far too many banks with some of them performing quite badly.
Daniele Nouy, former chair of the Supervisory Board of the European Central Bank, argues that Europe is excessively banked and this creates weaknesses in the system. The post-crisis debate on banking supervision has created an ugly neologism – debancarisation. This term essentially means that weak banks should be allowed to fail by following the Banking Union resolution mechanism. Another option is to encourage healthy banks to absorb weaker banks by making cross-border mergers a reality.
Before deciding on whether the preferred strategy of EU regulators is the best available, we need to understand what the real problem is. Overbanking can mean a very high proportion of banking intermediation in financial flows which can be termed as ‘too much banking’. Undoubtedly in Europe banks have a much more significant role in the economy than is the case in the US.
Overbanking in Europe is unlikely to be eliminated anytime soon
Banks are subject to increasingly strict regulation in exchange for the regulatory privilege of capturing retail deposits. The restraints imposed on the banking sector is leading to the development of other activities and financial institutions, which so far are less monitored and even less regulated.
Shadow banking and fintech activities are invading banking activity areas. This development should be a cause for worry to regulators as they may soon have to deal with ‘overshadow banking’ which may be as challenging to address as ‘overbanking’. I am particularly concerned about the ease with which small retail investors can buy sub-investment grade paper when they probably do not understand the risks involved.
Nouy, like her successors at the ECB, is keen to see fewer banks operating in the EU as they believe that the problem of overbanking is more related to having too many banks rather than having too much banking. In the last few years, national banking authorities have preferred to adopt a strategy of stronger banks absorbing weaker ones. This approach is inflating the already existing problem of having some too-big-to-fail banks. In a financial crisis, this creates more challenges for regulators who would have to resort to the much-hated bail-in solutions.
Some regulators may also be affected by the ‘more Europe’ syndrome when they promote the cross-border mergers to strengthen the banking system. The current social-political environment will certainly not encourage more cross-border cooperation in banking. Financial services are considered as ‘high politics’ by member states. This implies that they will not give up easily their sovereign rights to promote more European integration.
Cross-border operations in the banking sector are conspicuous by their absence. Mergers are complicated transactions, expensive and risky. Mergers require a spirit of adventure and confidence in the future.
These are sentiments that so far are not prominent in European bankers’ sentiments.
Stricter regulation and digitalisation make the cross-border merger solution to the challenge of overbanking an unattractive option. At member states levels, local regulators will keep pushing for local solutions in order not to see any of their banking champions going under even when their business models are not feasible.
Overbanking in Europe is unlikely to be eliminated anytime soon because the political realities in Europe are so much different from those in the US.