Risk and Regulation in Euro Area Banks

Completing the Banking Union

Francesca Arnaboldi

• Publisher: Palgrave Macmillan
• Year: 2019
• ISBN:
  9783030234294
• Topic: Business
• Subtopic: Servizi finanziari
• Index: Business

Since the last financial crisis, much work has been undertaken to strengthen the ability to respond to distress in the EU financial system. However, reforms enacted since the Single Resolution Mechanism was created in July 2014 as part of the Banking Union initiated in 2012 mainly focused on non-performing loans, and the third pillar of the Banking Union, namely a European Deposit Insurance Scheme, has not been completed.

Against this backdrop, this book focuses on the reasons why the EU banking system continues to remain fragile. In particular, high stocks of non-performing loans in some countries, the Level 3 assets evaluation and high exposure of many banks to the debts of their own governments are among the major concerns. Secondly, the book discusses the completion of the public safety net for banks, including deposit insurance, which remains primarily at the national level. This creates scope for contagion from banking sector fragility to national sovereign debt distress. Of interest to banking researchers, academics and students, this book combines rigorous analysis of the regulatory framework and empirical investigation on EU banking system data to prove that market discipline and risk sharing should be viewed as complementary pillars of the Euro-area financial architecture rather than as substitutes, requiring a reformed institutional framework.

© The Author(s) 2019

F. ArnaboldiRisk and Regulation in Euro Area BanksPalgrave Macmillan Studies in Banking and Financial Institutionshttps://doi.org/10.1007/978-3-030-23429-4_1

Begin Abstract

1. The Euro Area Banking System: Where Do We Stand?

Francesca Arnaboldi¹

(1)

Department of Law Beccaria, University of Milan, Milan, Italy

Francesca Arnaboldi

Email: [email protected]

End Abstract

1.1 Introduction

Banks across Europe have been through a significant restructuring process in response to weak profitability and to meet the new laws and regulations that have been approved in the wake of the financial crisis. Euro area banks have spent the last decade recovering from the global financial crisis. They have been fixing their balance sheets, adopting new regulations and exiting structurally unprofitable businesses in a low-growth environment. While the performance of European banks has improved since 2008, the average return on capital is still low. This average covers large geographic differences: banks in some European markets have completed this restructuring process, while other markets continue to struggle. First, the chapter analyses the process of restructuring that euro area banks have been facing. Then it investigates the European banking system, presenting structural developments in the euro area, providing a broad set of structural information from both a cross-sectional perspective, that is, different ownership structures and geographical areas, and a time perspective, and setting the context for the investigation on non-performing loans (NPLs) in Chap. 2.

1.2 Euro Area Banking System Restructuring Process

Much has been done in the past ten years to enhance the resilience of the euro area banking sector. A sample formed by all banking groups in the European Central Bank (ECB ) supervisory reporting framework indicates that the performance of euro area banks has recovered from 2008 (Fig. 1.1). Both the return on equity and return on assets of domestic banking groups and stand-alone banks have increased over the last decade.

Fig. 1.1

Return on equity euro area domestic banking groups and stand-alone banks (%). Source: Author’s elaboration on ECB (2018c)

The average return on equity in 2017 was 6.2 per cent, compared to 0.4 per cent in 2008. Figure 1.2 presents data for the return on assets for euro area banks. The picture is quite similar, with the average return on assets being 0.6 per cent in 2017, which was double the 0.3 per cent of 2008.

Fig. 1.2

Return on assets euro area domestic banking groups and stand-alone banks (%). Source: Author’s elaboration on ECB (2018c)

The process of restructuring varies with country, but most banks are now nearing completion of their efforts to close unprofitable lines of business, reduce the stock of non-performing loans on their balance sheet and meet the higher capital requirements and liquidity ratios. Despite this progress, profitability is still below the hurdle rate for many banks. In some countries, such as Cyprus, Greece and Portugal, the average return on equity is still negative.

The European Central Bank has indicated that low bank profitability is one of the key systemic risks to euro area financial stability (ECB 2018b). Low profitability leaves banks vulnerable to a possible turnaround in the business cycle. The ability to generate adequate profits is a key element for banks to avoid losing shareholders, diminishing market capitalisation and gradually decreasing their solvency. In other words, a bank that is not adequately profitable cannot guarantee its sustainability over time. The low profitability issue and the need for euro area banks to adjust their business models have also been highlighted by the ECB and the International Monetary Fund (IMF) in recent publications (ECB 2018d; IMF 2018). The introduction of stricter capital and liquidity requirements, which is described in the next chapters, and the higher compliance costs associated to the new regulatory framework, inevitably affects the ability of banks to being profitable (Sironi 2018).

Profitability differs across institutions like the ability to face a changing environment. Not all banks are affected to the same extent: the evolution of banks’ core banking revenues varies substantially. For example, from a sample of 380 euro area commercial banks, 137 (36 per cent) managed to increase both net interest income and net fee and commission income from 2013 to 2017, while 111 (29 per cent) managed to raise core banking revenues by substituting net interest income with fee and...

Table of contents

• Cover
• Front Matter
• 1. The Euro Area Banking System: Where Do We Stand?
• 2. The Main Challenges Facing the Euro Area Banking System
• 3. Non-performing Loans in the Euro Area
• 4. Level 3 Assets and Sovereign Exposure
• 5. Progress on the First Two Pillars of the Banking Union
• 6. The Third Pillar of the Banking Union: The European Deposit Insurance Scheme
• 7. The European Deposit Insurance Scheme
• Correction to: Risk and Regulation in Euro Area Banks
• Back Matter