Like shareholders and creditors, supervisors are paying growing attention to the strength of banks’ business models. Assessments are becoming more rigorous, and now include pan-European peer group benchmarking. Banks need to understand how demanding assessments can be, and prepare accordingly. That means making detailed, credible projections that align with other internal and external statements about the future.
Recent years have seen European banks’ business models come under increasing pressure from a range of factors including ultra-low interest rates, changing customer behaviour and the emergence of FinTech.
Different stakeholders assess banks’ business models in different ways, but the interaction between business models and profitability is a consistent area of focus. For example, a creditor’s interest in profitability is focused on a bank’s need to service its debt (see The profitability of EU banks). In contrast, a shareholder’s interest is focused on a bank’s return on equity (RoE) and the potential for RoE to rise or fall in future (see Are European banks investable?).
Today, a third group of stakeholders – supervisors – are also paying increasing attention to banks’ business models. The ECB views this as a key area of banking sector risk, and identified business models and profitability drivers as one of its three supervisory priorities for 2017 (and most likely for 2018 as well).
There are clear similarities between the approaches taken by supervisors and other stakeholders (see Figure 1). For example, like creditors and shareholders, supervisors consider a broad range of external factors including geo-politics, interest rates, developments in digital technology, overcapacity in the banking market and the impact of regulation.
However, the supervisory approach to business model assessments (BMAs) is also becoming more demanding and more harmonised as the SSM matures. For example:
These developments make it vital for banks to prepare for the practical requirements of future BMAs. Significant Institutions that have already gone through BMAs under the thematic review or during an On-Site Inspection should expect a similarly demanding process during the 2018 SREP [refer to SREP 3.0 article]. Other banks should ensure that their understanding of BMA methodology – and how it is applied - is up to date. More specifically:
Significant Institutions need to understand that BMAs are becoming a permanent and increasingly rigorous feature of European supervision. They are only likely to become more searching as the ECB develops its understanding of banks’ business models. Clearly, banks are well advised to anticipate ECB’s information requests on banks’ business models to prepare its internal organization accordingly.
1ECB WP 2070 – Business models of the banks in the Euro area, Farnè & Vouldis, May 2017; ECB WP 2084 – Bank business models at zero interest rates, Lucas, Schaumberg & Schwaab, June 2017
2Banks’ business models: Keeping pace? Statement at the Seventeenth Annual Conference on Policy Challenges for the Financial Sector, Washington D.C., 1 June 2017