The Single Supervisory Mechanism (SSM) has announced its top priorities for 2016: reviewing and challenging the Business Models of European banks. It will do this through a combination of peer-groupings, quantitative benchmarking and on-site missions. Many directly supervised banks will not have experienced such an examination before. Business Model Analysis means assessing i) a bank’s business model viability (or the institution's ability to generate an acceptable return over the next 12 months); and ii) its business model sustainability (i.e. its ability to generate an acceptable return over 3 years and over a full business/economic cycle).
Danièle Nouy (ECB Chair of Supervision) has consistently shone a spotlight on (below-par) bank profitability over the last 15 months. The EBA’s December 2015 risk report illustrates the problem: European banks reported an average weighted Return on Equity (RoE) of 7.8% in the first half of 2015. While this is an improvement on the 2014 figure (5.7%), it remains below the average Cost of Equity, estimated to be 9% on average and as high as 40% in some parts of the Eurozone.
Were Europe positioned for precipitous growth, or rises in the yield curve, supervisors could afford some optimism that the RoE shortfall is a temporary post-crisis state, that the economic cycle would quickly correct.
The SSM is not allowing itself such optimism, instead asking banks to articulate how their business models will generate sufficient returns even if low yields, sluggish growth and high NPLs become the new normal.
During on-site business model missions, seemingly straightforward questions from supervisors can create deep analytical challenges:
As Danièle Nouy stated: “While some banks may be capable of adjusting to these challenges without having to reshuffle their activities, a number of others have to revamp their business models towards activities that rely less on traditional interest income-generating business.”
The ECB has developed a business model classification tool that the ECB Office has sought to mirror. A toolkit has also been developed to advise banks through four stages of business model analysis:
Banks must demonstrate a thorough understanding of their Business Model. KPMG is working with some clients to obtain the level of granularity and analysis to ensure they are well prepared for this dialogue with the ECB.