The 2017 Retail Banking Radar-The Tide of Change …...The Tide of Change Shifts All Banks 1 The...

1The Tide of Change Shifts All Banks

The 2017 Retail Banking Radar

The Tide of Change Shifts All Banks Europe’s banks could have a very promising— if largely new—future, but an open mind and a willing stance will be vital.


Navigating Rough SeasMore than anything, 2016 was characterized by significant change. The world saw a massive political shake-up brought about by right-wing populism. A record number of terrorist attacks were planned, foiled, or carried out. Severe natural disasters—from storms to earthquakes—shook the world and prompted new entries in the record books. The year ended on a bitter note, with hopes for better fortunes in 2017.

European banks were no exception to this trend. Retail banks recorded a decrease in revenues. At the same time, cost-to-income ratios rose, indicating banks were struggling to sustainably reduce costs despite austerity measures. However, there were some bright spots. A few banks managed to revamp their business models and emerge as champions despite a difficult environment. These institutions not only defied the difficult market conditions but widened the disparity in performance from past years and the distance between mainstream banking and excellence.

A few banks managed to revamp their business models and emerge as champions despite a difficult environment.In 2016, the European economy continued its recovery, with a broad yet limited rise in GDP across all countries. Steady improvement in the job market, low oil prices, and rising disposable income created a perfect mix for domestic demand-led growth. Retail banks experienced solid increases in deposits and loans, consolidating the upward trend of recent years. However, the path was not strewn with roses. The European Central Bank’s (ECB) ongoing quantitative easing policy and new regulation, such as on interchange fees, hammered European retail banking profitability, with many failing to adapt their business models to the new digital challenges that affect the industry’s commercial dynamics.

These are among the key findings of the A.T. Kearney 2017 Retail Banking Radar, an annual study that monitors the trends of Europe’s retail banking market (see sidebar: About the Study on page 4). This report begins with our analysis of the current state and recent evolution of the sector. We then outline the biggest challenges the industry faces and how leading players in various markets reinvented their business models to prepare for change and success.

Retail Banking Performance at a GlanceThe 2016 macroeconomic context confirmed gradual but persistent economic recovery in Europe. An increase in domestic private consumption sustained it much more than net exports and investment (see figure 1 on page 2). The evolution that started early in 2013 continued through 2016, reaching 1.9 percent GDP annual growth in the European Union, slightly below 2015 values. Germany led the way with the highest gain in years, making up for the sluggish recovery of other countries such as France, Belgium, and most of the Southern European countries, including Portugal, Italy, and Greece.


Several factors contributed to a consistent rise in real disposable income, which stimulated purchasing power and private consumption. Interest rates reached and maintained historical lows, with the three-month Euro Interbank Offered Rate (Euribor) even turning negative. Oil prices remained low despite their steadfast upsurge from an all-time rock-bottom position in January 2016. And unemployment continued to decline, reaching 8.5 percent on average in 2016, the lowest rate since 2008. In contrast, investment rose slightly less than in 2015, with

Note: Investment includes change in inventories.

Sources: Eurostat; A.T. Kearney analysis

Figure 1Economic growth in the European Union has been gradual but persistent, driven largely by private consumption

–6

–3

0

3

6

2016201520142013201220112010200920082007

Net exports Investment Consumption Real GDP

Note: NII is net interest income.

Source: A.T. Kearney 2017 Retail Banking Radar

Figure 2Net interest income declined despite client deposit and loan volume growth across most of Europe

European retail banking: evolution of business volumes vs. NII (2014–2016; 2014=100)

95

100

105

201620152014

100.0

102.3

102.0

98.8

105.4

104.9

96.4

Client deposit

Client loans

Net interest income


gross capital formation growing by just 1.8 percent and continuing to provide only limited contribution to Europe’s economic growth.

Despite the overall progressive economic recovery, however, the ECB’s extraordinarily accom-modative monetary policy dictated the overall performance of the retail banking sector. On one hand, loan volumes increased 2.6 percent, fueled by historical minimum lending rates, successful corporate restructuring, and an improving housing market. Deposit volumes rose across most European countries, growing by 3.3 percent, even amid low interest rates and flat household savings (see figure 2 on page 2).

On the other hand, banks’ profitability slumped with profits per customer dropping below 2014 levels and profit margins eroding last year’s gains (see figure 3). Except in select countries, the minimal decrease in operating costs did not outweigh the top-line downturn that resulted from a drop in both net interest margins and fees and commissions income. Despite years-long restructuring, headcount downsizing, branch closures, and digitization, operating costs continued to be too high, and the average cost-to-income ratio climbed to 64 percent—three percentage points above the pre-crisis mark. The step-up in risk provision costs, although mainly induced by soaring impairment levels in Italy, also put pressure on the bottom line.

One of the main reasons for the European retail banking industry’s unsatisfactory profits has been the inability of many banks to adjust their business models to the new low interest rate environment. Before the financial crisis, European banks’ strong profitability relied on high leverage, cheap wholesale funding, high interest margins, and riskier real estate lending. Since then, banks have been forced to refocus on core banking activities, deleverage their balance sheets, and increase their capital base. In parallel, many failed to revamp their business model and tap alternative sources of income. The shift toward increased fees and commissions with

Note: Numbers may not resolve due to rounding.


Figure 3A top-line downturn has resulted in profits dropping to 2014 levels

Profit and loss of European retail banking sector(2008=100)

25302721

1426252223

971118

2214

131612

66666462646361

6163

2016

101

2015

105

2008

100 99103 102

0

33

2 21

103

20112010 2014

104

2013

104

20122009

503

Operating expenses

Totalincome

Risk provision costsOther non-operating

Profitbefore tax


higher off-balance sheet activity or new advisory functions is still far from a reality. Fees and commissions only represent 30 percent of total revenue generation, with a share in total income relatively stable over time. Unlike custodian banks and asset managers, the retail banking business model is still primarily interest income-oriented. The envisioned new commercial paradigm will require much more effort to achieve.

In parallel, a downfall in credit quality after the financial crisis continues to challenge the industry to varying degrees across Europe. Despite positive evolution of the nonperforming loans ratio, which spiked in 2012, most Southern and some Eastern European countries show persistently high levels of credit at risk. Risk provision costs, which affected Italy considerably last year, still reflect 36 percent of total income in Southern Europe and 10 percent in Eastern Europe. This significantly hampers profitability in these regions, as higher cost-of-risk and capital needs will continue to burden banks’ profitability and return on equity.

Still, performance has been uneven across European banks year over year, both between and within regions and countries. Some have been overwhelmed by the record-low interest rates, higher capital and regulatory requirements, and changing competitive landscape. Others have stood out for their strategic acumen in turning challenges into opportunities. The success stories illustrate different transformation journeys that European banks are pursuing to realize future success. Later in this paper, we look more closely at bank champions that have begun to transform their business models.

About the Study

Now in its sixth edition, the A.T. Kearney Retail Banking Radar monitors regional trends in retail and SME banking as well as the performance of individual banks’ retail banking divisions. The study database includes nearly 100 banks from 22 countries that account for 60 to 90 percent of local retail banking markets. In Western Europe, the Radar covers Germany, Austria, Switzerland, Spain, France, Benelux (Belgium and Netherlands), Italy, the United Kingdom, Portugal, and Nordics (Sweden, Denmark, and Norway). Elsewhere, the study focuses on four clusters: Central Europe (Czech Republic, Hungary, Slovenia, and Slovakia), Southeastern Europe (Croatia, Romania, and Serbia), Poland, and Turkey.

The Radar analyzes banks from several dimensions: income per customer, income per employee, net interest income relative to

total income, cost-to-income ratio, risk provision costs relative to total income, and pre-tax-profit per customer. For this year’s study, A.T. Kearney collected raw data from bank financial reports from 2007 through 2016. For each bank, we consider the domestic retail and SME banking segments. Their composition differs from bank to bank, especially in the treatment of business and commercial customers, and the thresholds at which such banks separate their wealth management and corporate-banking activity. A few banking groups are included despite their absence of segment reporting because of their importance to individual markets (for example, savings banks in Germany and Austria). In a few cases, we apply expert assumptions to estimate unreported indicators. Some differences exist among past Radar studies that are explained by changes in the database

sample and banks’ readjustments of figures.

In 2016, many European banks reported gains from selling Visa Europe shares following the acquisition of Visa Europe by Visa, Inc. We excluded this income from our analysis for banks that allocated it in the retail segment in their financial reports.

The annual average exchange rate of the British pound and the Turkish lira against the euro dropped 11 and 10 percent respectively in 2016. Through- out the report, when analyzing changes of retail banking indi-cators denominated in euros, we applied 2016 constant exchange rates to comment on growth in real terms.


Analysis of the Six IndicatorsFor an understanding of retail banking today and what its future may hold, we start by examining the market’s development since 2007, with a focus on the past year. As in previous editions of A.T. Kearney’s Retail Banking Radar, we focus on six indicators that highlight crucial topics for the industry (see figure 4).

A challenging business environment, marked by more regulatory pressure and a lengthy period of low growth and low interest rates, has prompted the industry to conduct a deep strategic review of every major banking area, pushing banks to transform their business and operating model and focus on clients while simplifying and streamlining products and services.

Last year stands out, as five out of six indicators registered a reduction compared with 2015, mainly because of a decrease in total income and the negative effect of Italian banks’ significant risk provision costs. Only income per employee had a significant increase, confirming banks’ execution of restructuring plans.

However, it is crucial to look more closely at each indicator to understand its nuances and potential improvements, as opposed to what might have made headlines (see figure 5 on page 6). A case in point: 2017 first-quarter results for Europe’s biggest banks show a significant increase compared with the same period in 2016 and mark their best performance since early

Retail Banking Radar(Europe; 2008–2016)


Figure 4Five of six key indicators showed a decline in 2016

20152016

Net interestincome relativeto total income

Risk provisioncosts relative to

total income

Income per customer(€)

Profit per customer (€, before tax)

Income peremployee

(€, thousand)

2008

Cost-to-incomeratio

730

670

650

710

690

6%

250

60%

59%

66%

10%8%

64%62%

630

200

16%

70%68%

12%

190

230

170

210

61%

64%63%

62%15014%

60%

250

230

210220

240


2015. They still lag pre-crisis levels by quite a bit, and many industry watchers doubt they can maintain their momentum throughout the year. But there are signals of potential improvement, including hopes that ECB monetary policy can help the sector improve profitability.

Next, we look at the six indicators in more depth:

Income per customer. Most European retail banks saw a sizable decrease in income, with net interest and net commission income down 2 percent, while customer numbers remained stable. As a result, income per customer fell 2.6 percent to €633 from €650 in 2015. The current low-interest rate environment and a decrease in commission income drove income down despite a 2.6 percent increase in customer loans.

Spain and Italy saw the greatest decline in this indicator, at 8.6 and 6.6 percent respectively. Both were impacted by the European-wide weakness in net interest income and have seen reductions in net fee and commission income, mostly on asset management products, plus competitive pricing pressure on customer loans. Lower in-branch and counter transaction levels in Spain and Italy have also triggered a decline in fees and commissions associated with current accounts and payment services.

Retail Banking Radar: Country view (2016)


Figure 5Country di�erences within the European retail banking industry remain sizable

–458(Portugal)

513(Switzerland)

164

125(Portugal)

0(Switzerland)

9

70(Germany)

46(Turkey)

64

85(United

Kingdom)

52(Italy)

67

78(Southeastern

Europe)

394(Nordics)

237

116(Turkey)

1.382(Switzerland)

633

Profit percustomer (€)

Risk provision costs relative to total income(%)

Cost-to-income ratio(%)

Net interestincomerelative tototal income (%)

Income peremployee(€ thousand)

Income percustomer(€)

First quartile Second quartile Third quartile Fourth quartile European average


Turkey, Switzerland, and Poland are exceptions to the negative trend. Turkish banks saw a 12 percent increase in income per customer, from €103 to €116, thanks to growing margins both in net fee and interest commissions. This growth came from loan repricing, credit card and merchant fees, and pension commissions, even as consumer prices in Turkey rose 8.5 percent year-on-year as of December 2016. Switzerland showed a slight increase from €1.376 to €1.382, driven by net interest mainly from strong growth in customer transactions. In Poland, income per customer remained flat at €185, despite the country’s biggest banks having seen an increase in customers and strong domestic demand, which drove growth in their loan portfolios, predominantly for housing and consumer loans (up 6.5 percent). Polish banks also increased payment transaction fees and fees from asset management.

Income per employee. Employee productivity is the only indicator in which European retail banks have continuously improved during the past five years. At €237.490, this indicator improved in 2016 by 2.4 percent and is 10 percent above pre-crisis levels. Given the reduction in total income, this indicator’s increase shows that workforce reductions (3 percent from 2015 to 2016) continue driving productivity improvements. The growth of direct banks (with their lower headcount and operating costs) also affects this metric.

Digitalization offers an opportunity for banks to develop new products and services, along with revitalizing core processes and culture.Digitalization has been a primary driver of headcount reduction, both in the back office, thanks to greater automation, and in the front office, as branch closures accelerated. Across Europe, banks are exploring ways to convert to a more digital business model. Digital banking is more advanced in some regions, thanks to regional banking capabilities, customer demands, external market dynamics, and regulations. Beyond automation and cost reductions, digitalization offers an opportunity for banks to develop new products and services, along with revitalizing their core processes and culture.

United Kingdom and Benelux banks made the largest leap in productivity this past year, up 10 and 12 percent respectively, despite a slight reduction in income. Their internal restructuring efforts and digitization of operations have begun to produce financial benefits.

Net interest income relative to total income. The share of net interest income relative to total income has remained generally stable in the past five years, remaining close to 67 percent, despite a 2 percent decrease in commission income.

Different markets, regulations, and strategies affect banks’ ability to generate fee-based revenue. In fact, interchange income associated with international card transactions also fell after the introduction of regulatory caps in December 2015.

In certain regions, such as the United Kingdom and Benelux, net interest income remains close to 80 percent of total income because of reduced current account fees or regulatory changes, and both lower lending volumes and a decrease in commission income in the Netherlands.


Cost-to-income ratio. Since 2007, the cost-to-income ratio has stayed within a narrow band of 60 to 63 percent. In 2016, it rose 1.1 percent, and the average cost-to-income ratio is now closer to 64 percent. There is a large gap between the average and best-in-class ratios, with Spain, the Nordics, and Turkey below 55 percent. Turkish banks have generated a noteworthy 8.6 percent reduction in operating costs—a solid achievement in an inflationary environment.

Drastic cuts in operating expenses that Spanish banks began making seven years ago have led to their current high operational efficiency. Turkish banks, especially traditional ones, have invested considerably in innovation and digitization processes. UK banks have managed a sizable decrease in operating costs of 7 percent year-on-year, and Central Europe banks remain among the top performers with a cost-to-income ratio of about 55 percent.

Cost efficiency is not about cost-cutting alone, but must include a profitable and sustainable banking model, where income improvement and operational efficiency go hand in hand.Despite cost improvement by some institutions such as Bank Austria or BAWAG in Austria and Deutsche Bank in Germany, the European countries with the highest cost-to-income ratio are Austria, Germany, and France. Those more fragmented markets have been slower to adapt branch footprint and drive operational efficiency. However, the cost-to-income ratio is high not only because of their relatively heavy cost structures but also because of struggles to sustainably increase income per customer. This only reinforces our view that cost efficiency is not about cost-cutting alone, but must include a profitable and sustainable banking model, where income improvement and operational efficiency go hand in hand. (See the “Cost Champions” section for examples of banks that have launched structural cost improvement programs in recent years, the results of which are already paying off.)

Risk provision costs relative to total income. After declining for several years, risk provision costs relative to total income rose from 7.5 to 9 percent in 2016. Much of this was driven by the signif-icant increase in Italy and Portugal. Italian banks have doubled their overall risk provision costs to address their credit-portfolio legacy and accelerate the rundown of their non-core portfolio. They have also increased coverage levels to support the progressive decline in the cost of credit.

There are also big differences between countries. Germany has risk provision costs relative to total income of 0.4 percent, while France is above 6 percent, and both Italy and Portugal remain well above 40 percent. East European countries show a wide spectrum from 3 percent lows in Central Europe to more than 10 percent in Poland, Turkey, and Southeastern Europe.

Looking at the combined total efficiency ratio, the sum of operating costs and risk provision costs provides a different perspective on stand-alone ratios (see figure 6 on page 9). The Nordics remain the leader on total efficiency at 50 percent and have continued to generate improvements since 2015. Turkey’s remarkably low cost-to-income ratio (45.6 percent) is offset by a relatively high 12.5 percent loans impairment ratio. Italy’s 49 percent loans impairment


Total e�iciency ratio(2016)

Cost-to-income ratio(2016)

Loans impairments-to-income ratio (2016)

Figure 6The Nordics, Switzerland, Central Europe, and Turkey continue to post strong totale�iciency numbers

1 Central Europe includes Czech Republic, Hungary, Slovakia, and Slovenia.


Nordics and Switzerland Western Europe Eastern Europe Southern Europe

Portugal

Italy

France

Austria

Southeastern Europe

Germany

United Kingdom

Poland

Spain

Benelux

Switzerland

Turkey

Central Europe1

Nordics

191.2%

116.4%

74.8%

74.2%

71.2%

70.4%

67.6%

67.4%

64.9%

64.2%

61.2%

58.1%

57.6%

50.3%

66.2%

67.4%

68.5%

69.6%

55.9%

70.0%

63.2%

56.8%

54.5%

62.4%

60.8%

45.6%

54.7%

49.0%

125.0%

49.1%

6.3%

4.6%

15.2%

0.4%

4.5%

10.6%

10.3%

1.8%

0.4%

12.5%

2.9%

1.3%

ratio, combined with a high cost-to-income ratio, results in a significant downturn in the country’s efficiency ratio.

Profit per customer. At €164, profit per customer has dropped by 14.3 percent but is heavily influenced by Italian banks’ substantial and growing risk provision costs. In fact, if we reconsider this number by keeping Italian risk provision costs constant at rates from previous years, the overall European profit per customer jumps to €182—a more modest 5 percent decline from €191 in 2015.

However, looking at the average obscures big differences between countries. With €59 profit per customer in Eastern Europe, well above that of 2008 (a double-digit increase), the region is becoming more attractive again. Nordic and Swiss banks remain above €300 and €500 per customer respectively, mainly because of higher income per customer and lower risk provision costs compared with the average for Western European countries. In those countries, profit per customer remains below €150 as a result of heavy operating costs. In comparison, Southern European banks show a profit per customer at –€17 (or €52 without inclusion of Italy’s increase in risk provision costs).


Individual Bank PerformanceRevenue champions

It has been challenging for European banks to improve revenues. On average, income-per-customer levels have dropped 2.5 percent since 2014. Even so, we see a significant difference in revenue performance across Europe (see figure 7).

Market environments and macroeconomic factors play a key role, impacting two-year revenue trends. Take, for example, the contrasting housing markets in Italy and the United Kingdom and Turkey’s significant price inflation, all of which significantly influence income-per-customer ratios.

To offset the impact of local factors, we have measured each bank’s performance against its own market. Our analysis reveals four types of performance:

• Struggling incumbents. Income per customer above the market average in 2014 but market underperformance between 2014 and 2016

• Tail-end banks. Income per customer below the market average in 2014 and market under-performance between 2014 and 2016

• Revenue challengers. Income per customer below the market average in 2014 and market overperformance between 2014 and 2016

• Revenue champions. Income per customer above the market average in 2014 and market overperformance between 2014 and 2016

Figure 7There is a large revenue performance spread across countries

1 Growth in Turkey is partially driven by inflation. Prices in Turkey increased 8.5% year-on-year in December of 2016.


Income per customer development(2014–2016)

Italy

Spain

Poland

Benelux

Nordics

United Kingdom

Germany

Central Europe

Southeastern Europe

Switzerland

Austria

France

Portugal

Turkey1

–11.1%

–8.9%

–6.9%

–4.7%

–2.9%

–1.2%

–1.0%

0.2%

0.7%

2.3%

3.1%

7.0%

7.9%

31.5%

Nordics and Switzerland

Western Europe

Eastern Europe

Southern Europe


In measuring each bank’s performance against that of its market, we observed mixed outcomes during the past two years (see figure 8). Nearly 19 percent of banks are revenue champions, while around 29 percent are revenue challengers.

Revenue champions managed to outperform their markets in net interest income per customer by 10.5 percent and net commission income per customer by 5.4 percent (see figure 9). In comparison, revenue challengers’ performance was fairly in line at 11.6 and 4.2 percent respectively.

Figure 8Almost two-thirds of banks are either “revenue challengers” or “struggling incumbents”


Total income 2016

Perf

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ance

201

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ank’s

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ints

)

Market position 2014(deviation of income per customer to local market average)

18.5% 33.7%

Revenue challengers: Lower than market average 2014 + market overperformance 2014–2016

Tail-end banks: Lower than market average 2014 + market underperformance 2014–2016

Revenue champions: Higher than market average 2014 +

market overperformance 2014–2016

Struggling incumbents: Higher than market average 2014 +

market underperformance 2014–2016–40%

–35%

–30%

–25%

–20%

–15%

–10%

–5%

0%

5%

10%

15%

20%

25%

30%

...%

85%

–80% –70% –60% –50% –40% –30% –20% –10% 0% 10% 20% 30% 40% 50% 60% 70% ...% 300%

18.5%29.3%

Figure 9Revenue champions and revenue challengers fared best when compared to their markets


Average development per cluster compared to market performance(2014–2016)

Tail-end banksStruggling incumbentsRevenue challengersRevenue champions

10.5%

5.4%

11.6%

4.2%

–10.5%

–4.2%

–11.2%

–1.7%

Net interest income per customer

Net commission income per customer


The banks in the remaining two groups performed worse than their market average both for net interest income and net commission income.

We do not see a significant shift in the mix of revenue-component interest income and commission income. Net interest income remains the most important. (Cluster averages ranged from 65 to 73 percent of total income in 2016, with a 2-percent variance compared to 2014.) Because of high dependency on interest income, growth in client loans per customer and an increase of net interest income per client loan were vital for outperforming the market (see figure 10). Revenue champions and revenue challengers outperformed client loans per customer in their markets by about 7 to 9 percent. The difference between these two clusters is the level of outperformance in net interest income per loan, with revenue champions generating a bigger increase than revenue challengers.

Each bank uses a strategy that suits its specific situation. Next, we take a look at two outstanding examples of banks that outperformed their markets.

As a revenue challenger, ING-DiBa’s strategy is one of aggressive organic growth. Centered around a free current account without branches, ING-DiBa released its internal restrictions on mortgages in 2015. It managed to transform nearly all of its deposit growth (€10 billion) into additional mort-gages and consumer lending by attacking third-party volumes through its mortgage platform, which accounted for a third of new business in 2015. Furthermore, its 10 percent increase in income per customer is backed by strong growth of its deposits business and the benefits of a strongly rising wholesale banking division to balance its loan-to-deposit ratio.

A revenue champion, Banca Transilvania focuses on inorganic growth to strengthen its market position. In 2015, it acquired and integrated Volksbank Romania in a record eight months, from deal closing to operational integration, adding a large portfolio of retail loans and other clients. The bank is the clear leader in Romania’s micro and small and medium-size enterprise (SME) segments, which are highly profitable and growing at a healthy rate. These segments enabled the bank to grow average income per customer 23 percent from 2014 to 2016.

Figure 10Revenue champions lead the way in net interest income per client loan andrevenue challengers in client loans per customer

Average development per cluster compared to market performance(2014-2016)


Tail-end banksStruggling incumbentsRevenue challengersRevenue champions

6.8%4.8%

9.3%

3.2%

–7.9%

–2.9%–6.7%

–3.2%

Client loans per customer

Net interest income per client loans


Cost champions

The ongoing tensions and tough conditions that have hit the financial sector in recent years have prompted the resurgence of a fundamental axiom: efficiency is essential to profitability.

The efficiency ratio (cost-to-income) has again become one of the most relevant performance indicators. Reaching as low a cost-to-income ratio as possible is now imperative for sustained profitability. Increasing equity and capital requirements and the gradual stabilization of loan-loss provision (LLP) levels have further driven efficiency to the top of management agendas. In fact, our simulations show that, depending on market LLP levels, cost-to-income ratios below 50 to 55 percent will be crucial if banks are to generate attractive returns for their investors above cost of capital.

Only 38 percent of banks in our study achieved the 55 percent target ratio (see figure 11). This reinforces the need for most banks to prioritize efficiency measures to significantly improve or protect their cost-to-income position. In this context, given current record-low interest rates, fierce competition, and changing customer demands, cost optimization emerges as the best way to achieve strategy excellence in efficiency.

Our analysis shows banks have a long way to go with cost transformation. The following prior-ities will be important:

Figure 11Only 38 percent of analyzed banks achieved cost-to-income ratios below 55 percent

Note: Excludes banks with less than 1.5 million customers


2016 cost-to-income ratio (%)

2014–2016 operating cost evolution (%)

Total income Percentage of analyzed banks%

40% 22%

CIR < 55% without additionalcost reductions since 2014

CIR > 55% without additionalcost reductions since 2014

CIR < 55% with additionalcost reductions since 2014

CIR > 55% with additionalcost reductions since 2014

110%

100%

90%

80%

70%

60%

50%

40%

30%

20%

+90% ...% +30% +25% +20% +15% +10% +5% 0% –5% –10% –15% –20%

14%24%

Western Europe Eastern EuropeNordics and Switzerland Southern Europe


• People transformation. Introduce new ways of looking at employees’ dedication, capabil-ities, and value-added skills to enable a longer-term and proactive approach to workforce planning, resource allocation, talent management, and productivity optimization.

• Branch and distribution model transformation. Adjust the role of the branch, integrating various channels in a more omnichannel and seamless way. Embrace digital opportunities to maximize sales and migrate transactions to alternative channels to reduce the cost to serve.

• Operations model transformation. Broaden the scope beyond traditional boundaries to include all operational activities and resources across the bank and maximize operating process centralization, industrialization, automation, and rationalization.

• IT model transformation. Leverage new and more efficient technologies to ensure a fast legacy-to-digital transition.

• Simplification. Reduce bank-wide organizational, product, technological, and operational complexity.

• Advanced procurement. Maximize third-party savings generation, and secure its material-ization in the bank’s bottom line.

Several banks have made significant cost improvements over the past couple of years, allowing them to partially compensate for revenue declines and prevent efficiency erosion or even improve already acceptable efficiency levels (see figure 12).

Figure 12A number of banks have made significant cost improvements in recent years

Note: Excludes banks with less than 1.5 million customers


2016 cost-to-income ratio (%)

2014–2016 operating cost evolution (%)Total income

90%

85%

80%

75%

70%

65%

60%

55%

50%

45%

40%

35%

0% –2% –4% –6% –8% –10% –12% –14% –16% –18% –20%

Western Europe Eastern EuropeNordics and Switzerland Southern Europe

Nordea

Československáobchodní

banka (CSOB)

Slovenskásporiteľňa

Českáspořitelna

UBS

Intesa SanPaolo IMI

CreditSuisse

DanskeBank

VÚB Banka Akbank

BAWAGMillennium

BCP

Swedbank

Bank PekaoBanco BPI

Caixa GeralDepósitos (CGD)

BarclaysBank Plc

La BanquePostale

RBS Group

Postbank

HSBC

ING Group(Net’lands)

LloydsBankingGroup

Bankia

Santander


The results of such cost-improvement initiatives are evident with the following banks’ stories:

The turnaround of Austria’s BAWAG since its acquisition by Cerberus in 2006 has been remarkable. The bank reduced operating costs by 42 percent, with a 20 percent drop in the past two years alone. In parallel, BAWAG increased revenue by 30 percent during the past decade, with 10 percent of this gain since 2014. The bank has cleaned up its balance sheet, divested non-core assets, and optimized its scale and capacity. Reducing product and distribution complexity has been a key focus, while encouraging use of digital channels has reduced costs per customer. Employee productivity has also increased, in part because of a strong perfor-mance culture. Overall, this strategy has enabled BAWAG to improve its efficiency ratio from 99 percent in 2006 to 49 percent in 2016.

In Denmark, Danske Bank has succeeded by adjusting branches and simplifying the organization.In Denmark, Danske Bank has reduced its costs by 12 percent despite difficult market conditions and revenue that has fallen 17 percent since 2014. The company has succeeded by adjusting branches and simplifying the organization. Deploying strategic teams—including outsourced work—throughout Denmark, Lithuania, and India has also been essential. These measures have allowed Danske Bank to significantly reduce costs. Yet it still faces a gap in reaching a cost-to-income ratio comparable with its main competitors in the Nordics, such as SwedBank and Nordea. Going forward, Danske Bank will need to continue cost optimization by increasing digitization, improving processes, and working on its organizational setup.

In Portugal, Millennium BCP has executed a profound restructuring plan approved by the European Commission following a €3 billion state bailout in 2012. Since then, the bank has focused its domestic activity on its core banking business by selling asset management and property-and-casualty insurance businesses. It has adjusted staff levels by more than 25 percent, reduced the number of domestic branches by 30 percent, redesigned and simplified its organizational and operational models, and drastically challenged and rationalized external spend by 30 percent. These measures have reduced operating costs by more than 30 percent, bringing the cost-to-income levels below 50 percent. The bank also fully repaid the state earlier this year. Yet, the journey to efficiency is not over. In two years, the bank plans to reach cost-to-income levels below 43 percent, positioning it as one of the most efficient banks in Europe.

In the United Kingdom, Lloyds Bank has made cost leadership a core strategic pillar. Lloyds is undergoing a three-year cost restructuring with the objective of generating €2 billion in annual savings. So far, the bank has reduced costs by 6 percent since 2014, maintaining an efficiency ratio of 55 percent. The bank made significant digital investments, focusing on simplifying and streamlining operations, digitizing its branch network and associated distribution channels, and simplifying and downsizing its organization. (Final staff reductions are projected at 9,000 employees.) The bank is also focusing on the sale of non-core assets, such as TSB Bank. Overall, Lloyds Bank has gone from a very complex organization, after the integration of TSB and HBOS, with significant legacy challenges, to a much more streamlined operation that can focus on its future without constraints.


Future-Looking ScenariosRetail banking is in the midst of a period of unprecedented change as economic, regulatory, and competitive pressures combine to create an era of high uncertainty and significant oppor-tunity. How today’s retail banks will be impacted is not clear, but several scenarios may play out over the next few years as banks plan and take action to put themselves in the best possible position to succeed.

We see three potential scenarios:

• Open banking. A new third party enters the ecosystem and manages to disintermediate a significant volume of retail banking customers across Europe.

• Global shocks. The political upheaval from Brexit and recent US elections extends into a contraction of investment and confidence across the continent.

• Rise of the giants. One of the digital giants harnesses its potential by materially disrupting the financial services market.

Open banking

The revised Payment Services Directive (PSD2) and open banking are a reality that all European retail banks are dealing with, yet how this legislation will shape the payments and banking landscape is highly uncertain. Banks within the European Commission are required to give third parties access to customer data and to process payments if a third party requests it on behalf of an account holder. There is every opportunity for a new third party to leverage these changes to disrupt the market. Consequently, this scenario offers the greatest potential impacts arising from PSD2 and serves as an interesting bookend when considering the strategic options. In this scenario, we see two main impacts on European retail banks:

Disintermediation of end consumers. Acquiring new customers for banks is expensive, and when possible, banks would rather retain an existing customer than acquire a new one. PSD2 and access to accounts provision could make customer retention much more challenging. Depending on third parties’ user experience, they could become the de facto interface between a bank and the end consumer. To protect against this disintermediation, we could see the start of a new user experience “arms race” between banks, fintechs, and digital giants to determine which stakeholders capture the end-customer interaction (see sidebar: Fintech for the Future on page 17).

Competition for best services. Existing competition for products such as accounts will be transformed into competition for services such as transaction initiation or account aggregation. PSD2 and access to accounts will likely be only a first step in this journey, and other product areas will follow. In this context, services will be far more than data APIs, and the banks’ target groups will be broadened, for example toward merchants and OEMs. Banks will need to rethink their value chain and identify which services are marketable from both a sourcing and a selling perspective. Open banking might be a paradigm change with significant influence on cost and revenue.

Global shocks

In many ways, this scenario is already under way. The surprise election of Donald Trump as US president, the United Kingdom’s vote to leave the European Union, and the hung-parliament


result of the election called by UK Prime Minister Theresa May took most people by surprise. The banking world is still trying to understand the implications, let alone reflect these develop-ments in its business strategies.

It is beyond the scope of this paper to analyze the specific impacts of these changes to the geopolitical landscape, but it is relatively easy to foresee that they may in fact only be the beginning of a series of major geopolitical shifts that business leaders will have to address. The French election has taken place, but upcoming elections in other countries may result in an additional threat that the European Union cannot ignore. At the very least, we will likely see changes in policies for the countries involved. Threats related to the euro crisis may have died down since 2015, but the underlying issues have not gone away. Migration remains a major challenge, especially politically. Looking further afield, escalating tensions with Russia and North Korea may destabilize the outlook even more.

In a scenario where one or more of these situations come to pass, what will the impact be on banks, and how can they protect themselves from the implications? We see three possible outcomes:

Business and consumer confidence fall. The first victim of uncertainty is consumer and business confidence, which would significantly affect the retail banking market. Decreasing business investment would clearly impact retail banks that service the SME and corporate banking markets. A corresponding effect on the economy would also have a wider impact.

Fintech for the Future

The fintech story has grown rapidly over the past three years and is appearing more often on banking CEOs’ radar. New technologies have started to emerge as significant challengers to the way banks deliver services. Chatbots driven by artificial intelligence are becoming a popular way to improve the customer experience and reduce call-center costs. Blockchain could be a nirvana of technol-ogies, and as knowledge of it spreads, commercial applications are emerging, mainly in capital markets by JP Morgan Chase, Citibank, and others.

We expect use cases and proof-of-concepts in banking to gain more attention in the coming year. We also see three kinds of fintech evolving:

Challenger fintech start-up banks such as N26 are gaining traction,

and some markets face a wave of new competition. For example, Monzo, a UK start-up bank has grown to almost 200,000 users in the 18 months since launching.

As partners to incumbents, some fintechs could augment or accelerate established banks’ digital transformation and improve customer experiences, such as Onfido's use during onboarding for streamlined KYC and AML checks or Mambu with its Core Banking as a service offering. We believe this trend will be the big fintech news story for 2017. Fintechs will want to collaborate, rather than compete, with incumbents because of the hard realities of regulation and the challenge of acquiring customers. Entrepreneurs will find it easier to mine the large customer bases of established banks by working with them rather than starting from scratch.

Other fintechs compete in the transaction banking space, such as Klarna, Transferwise, and Revolut. They are now looking to move into full-fledged banking.

A decade or so ago, mBank started a trend: establishing a new bank free of legacy technology, processes, and culture. The idea has gained speed as BBVA acquired Simple and Holvi, and Société Générale developed Boursorama. Our own engagement with banks indicates many incumbents are considering acquiring or creating a new bank to create a leading, differentiated, and fully digital proposition that can be compet-itive. It also could be a way to innovate at a much faster pace that is nearly impossible to achieve given banks’ current technology and culture. The challenge will only accelerate as PSD2 and open banking evolve.


Although consumer confidence is hard to predict in the current environment, it is safe to assume that spend on borrowing would be cut as consumers prepare for the worst. While we would expect to see greater demand for savings, in the current low-interest environment it will be harder for banks to take advantage by reducing rates when there is little room to go lower. With revenue from liabilities reduced and that from assets at a similar level, profitability will suffer unless banks can address the cost base to compensate.

Interest rates continue to remain low. The most immediate central-bank reaction to uncer-tainty in recent years has been to reduce interest rates to their current, historically low levels. We expect little drive for interest rates to increase quickly, especially if inflation remains low overall. Even in markets where inflation may rise (in part because of increasing energy prices or shifting exchange rates related to Brexit), we do not expect to see increased wage growth. Consequently, we anticipate continued constrained income levels for banks.

Several scenarios may play out as banks act to put themselves in the best possible position to succeed.Trade is reduced. The political movement away from globalization is already coloring corporate investment decisions. In this scenario, we might expect to see a reduction in benefits of a globalized business model. With tariffs and other trade barriers reintroduced, not only will the top line be affected as markets become less accessible, but pan-European or global banks will have a diminished ability to reduce costs by centralizing operations across markets.

Rise of the giants

Retail banks across Europe have historically held a high position in terms of influence and scale compared with other institutions. However, this influence has been eroded by the progression and growth of digital giants, which now have unsurpassed reach and scale. This final scenario considers the rapid progression of one of these giants into the consumer banking arena, in the same way that giants moved into the telecom sector in the late 2000s. This is a purely hypothetical scenario, based on our view of how a giant could enter the market and profoundly change it.

In line with most new banking entrants, we would expect a giant to follow the standard road map, from an initial product roll-out strategy for pre-pay to credit cards, loans, current accounts, and then mortgages. It would likely occur on a country-by-country basis, starting in the United States or the United Kingdom.

This scenario could play out across three dimensions:

Efficiency. Unlike incumbents, the giant would not face the challenges of legacy infrastructure or processes, freeing it to compete on a very low cost-to-income ratio and keep the net interest margin of their products very low. In the markets it chooses to enter, we would likely see signif-icant reduction of the new lending spread and a significant impact on funds and fee income. This scenario would likely accelerate the transformation that we are seeing as banks move off legacy platforms onto more agile, digitally ready solutions.


Authors

Daniela Chikova, partner, Vienna [email protected]

Peter Hewlett, partner, London [email protected]

Roberto Freddi, principal, Milan [email protected]

Pedro Castro, partner, Lisbon [email protected]

Jaime Rubio Donze, principal, Madrid [email protected]

Mischa Koller, consultant, Munich [email protected]

Growth not income. Customer numbers and their associated growth would likely be a core metric that a giant would consider. This factor would increase costs for acquisition and retention for all other banks in the markets they operate in. Using its vast data resources, the giant would target customers more accurately than existing retail banks and provide more personalized products and services. Incumbent banks would need to carefully consider how they compete in this scenario to ensure they do not partake in a race to the bottom but instead focus on their own strategic capabilities and associated customer value proposition.

Customer experience. Customer experience and focus would be core to the giant’s values. If it entered retail and consumer banking, we would likely see it innovate on the customer experience front and challenge current product origination and servicing. Almost certainly, this would be a mobile-first journey. Many banks would probably keep pace with this innovation, but others would be forced to invest heavily to survive. In the short term, they would see operational costs rise and then taper off in the long run.

How Should Banks Respond?What the future holds for banks is, of course, our central question for this edition of the Radar report and future editions. Income could be challenged by new open-banking entrants, economic uncertainty will continue, digital giants could stride across the landscape, and economic realignments could pressure costs as incumbents struggle to compete.

Banks can best protect themselves from these threats and take advantage of the opportunities they bring by understanding these changes and the responses they will make. Where can banks play in the new disintermediated value chain? What are their differentiators to customers? What income streams will be significant in the changed global environment? What skills and capabil-ities do incumbents have that digital, nonfinancial services firms cannot replicate? These are all important questions. An open mind and a willing stance are part of the answers as Europe’s banks look to what could be a very promising, if largely new, future.

The authors wish to thank Andreas Pratz, Ettore Pastore, Andrew Lloyd, Olga Wittig, Simon Horner-Long, and Simone Doro for their valuable contributions to this paper.

A.T. Kearney is a leading global management consulting firm with offices in more than 40 countries. Since 1926, we have been trusted advisors to the world’s foremost organizations. A.T. Kearney is a partner-owned firm, committed to helping clients achieve immediate impact and growing advantage on their most mission-critical issues. For more information, visit www.atkearney.com.

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