European banks see €110bn profitability swing. But KPMG report finds that it may mean that difficult times are looming.
The leading 15 European banks made collective profits of €85 billion in 2010, double the amount recorded in 2009 and up from losses of €25 billion in 2008, and look well-placed for recovery in normal conditions – but sovereign debt concerns may mean that difficult times are looming again according to a new report from KPMG.
“Our survey revealed that there are three main components to the present strategy of many major banks: a focus on the main banking business and a reduction in volumes of non-core assets, as well as improving client services and continuing to cut costs.” said Alexander Sokolov, Partner, Head of Financial Services, KPMG in Russia and CIS. “In this respect, I see much in common with trends in the Russian banking market.”
KPMG’s report "Focus on Transparency" finds that retail and commercial banking performance has improved amidst growing emerging market activity and economic recovery, while investment banking revenues were off very slightly by 2% to €121 billion. A substantial amount of the banks’ increased profits is the result of a significant decrease in loan impairment charges. Impairments in retail and commercial banking fell 27% to €79 billion while in investment banking they fell by 29% to €80 billion. These decreases enabled banks to largely offset the effect of reduced revenues in investment banking, and contributed to the increased revenues reported in retail banking. This means that, from losses of €25 billion in 2008, there has been a €110 billion profitability swing in European banking in just two years. But KPMG warns that this trend is unlikely to continue.
Bill Michael, UK Head of Financial Services at KPMG, said: “Banking remains at the cross-roads. Having made strong progress since the dark days of the credit crisis, rising concerns over sovereign debt could put them right back into difficult territory. There are some large potential exposures amongst European banks. Looking forward, the real impact of the wave of regulatory change will begin to bite. The debt problem has not gone away, it has shifted from banks to governments. Many believe the future looks ominous as we enter an age of financial austerity.” Regulatory capital requirements under Basel III will be challenging and will affect profitability and return on equity of banks. All the banks in KPMG’s survey have disclosed their Basel II capital adequacy ratios which in general have gone up, with an average rate of 14.83% in 2010 compared to 14.41% in 2009. A third of banks indicated their ability to meet the new Basel III requirements in 2013 but many highlighted areas of detail that need further development and implementation by national supervisors. Nevertheless banks are moving to improve the quality of their capital, reporting an increase in Core Tier 1 capital in 2010, with first quarter 2011 statements tending to confirm an ongoing trend. Tighter regulation brings higher costs but beyond the cost issue a concern for many banks is the disparity of regulation around the world. Some countries are making strident changes to their regulation – while other jurisdictions, seeming to regard the credit crisis of 2007/08 as a European and US issue, are not. This could put some banks at a competitive disadvantage and create uncertainties. It is sovereign debt, however, that is the greatest current concern. Much more space is devoted to sovereign debt in 2010 annual reports compared to 2009 – but the speed of developments could not have been foreseen at the time the annual reports were prepared. The potential impact on the banking sector has become an issue of growing concern. The latest round of European Banking Authority stress tests require the banks to disclose sovereign debt exposure by accounting portfolios, maturities and countries. The banks also have €92.5bn of deferred tax assets (broadly, losses held against tax liability) on their balance sheets, equating to around €334bn of probable future taxable profits that need to be generated to recover them. In these uncertain times, the view on availability of future profits could change quickly, resulting in the potential write down of some balances.
Colin Martin, partner in KPMG’s Financial Services practice, said: “Our report highlights a trend of banks returning to core banking activities by focusing on customer relationships and cutting costs. The question remains as to whether tumultuous markets allow them to continue this trend.”