Large European banks’ ability to modernise their banking platforms and improve digital services will be critical to remaining competitive in the long term, Fitch Ratings says.
But the cost of these new systems is high and comes at a time when record low interest rates are weighing heavily on earnings and burdensome regulatory changes are eating up time and resources. Banks that take too long, or which cannot afford to invest on a continuing basis, may see their franchise fall behind.
Banks are investing to ensure their support systems are compatible with their product offerings so they can service clients’ needs as seamlessly as possible. This is part of a wider shift from product-focused to client-focused business models, which we believe perform better over time. They are also responding to smaller, digitally focused challenger banks.
These challenger banks have shown some success in retail banking niches, but we believe economies of scale should give Europe’s large banks an advantage once they have successfully updated their infrastructure. The costs of compliance, credit risk management, and regulatory systems and staff will weigh particularly heavily on challenger banks as they develop. Small retail banks, like their larger rivals, also need to invest to address the threats of digitalisation, such as cybercrime, which we see as one of the greatest risks facing banks and one of the hardest to control.
As banks plan these investments, they are also having to adapt their business models to cope with a lower-for-longer interest-rate environment and regulations that are heightening capital and liquidity needs and, in some cases, driving changes to their legal structures.
The clearest impact of low rates is in traditional retail banking, where even interest-free deposits are no longer attractive and very low interest rates on mortgage loans are hurting net interest margins. Low rates are also making it harder for Europe’s banks to generate revenue from corporate lending and fixed-income products as investment demand is very low. Wealth management operations are feeling pressure due to the disappearance of risk-free returns on client deposits and a reduction in client activity.
The ability to adapt business models to meet these challenges can be critical for ratings. Over the past year we have downgraded Credit Suisse Group and Deutsche Bank based on our view that their capital markets-focused business models have become less resilient to changes in regulation and their business environment, especially as the banks are undergoing costs of implementing turnaround strategies, in Deutsche Bank’s case including substantial IT spend.
Successful execution of the strategies introduced by new chief executives of both banks in 2015 depends on building up stronger core client franchises. For Deutsche Bank, this is primarily with European corporates, for Credit Suisse it is largely with Asian high-net-worth individuals.
