What are the long term prospects of the European banking sector, in the light of the ECB’s report on financial structures?
Banks and financial institutions have moved on from the financial crisis, but still urgently need to address the challenges of the current economic and technological environment.
With their profitability under scrutiny (see our article on the profitability of EU‑banks), the ECB identified this as one of its key supervisory priorities for 2017, because of the close link between profitability and capital adequacy (see our article on ECB’s supervisory priorities 2017).
From a creditor’s perspective, profitability is a major issue, as it indicates whether a bank is able to satisfy its liabilities. For regulators, meanwhile, profitability is a main indicator of the viability of the bank. Both creditors and regulators closely monitor banks’ profitability – and banks should be ready to address any concerns on this front. However, they should also consider the bigger picture. How promising are they as an investment prospect from a shareholder perspective? Do they offer sufficient upside potential?
Banks need to offer a viable and sustainable business model, with a persuasive growth story and upside potential, in order to gain access to capital. This allows (non‑state‑owned) banks to operate with sound capital levels and fulfill their role as financial intermediaries.
In this paper, we consider the four overriding factors that determine whether a bank is investable: the real economy, the quality of its balance sheets, operating income and costs.