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To fight the rise of the challenger, European banks must reform

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News Tech: The Eurogroup meeting of finance ministers in Luxembourg in June promised to provide further clarity on integrating European banking and financial markets. As an alternative, it was widely seen as a failure.

The conflict in Ukraine is exacerbating an already inflated situation. Economies are still fighting to recover from Covid-related supply chain disruptions. As a result, concerns about fiscal stability in (southern) Europe are growing, and the European Central Bank is once again being pressed to expand its mandate to deal with the widening of sovereign bond spreads.

While that effort is ongoing, the lack of progress should not have come as a surprise. Priorities shift at times of global conflict.

How bad are things for European banks? At first glance, the global financial services sector appears to be in quite good shape right now, and has been increasing for a number of years. It also demonstrated exceptional resilience during the height of the Covid crisis.

The situation is quite bad for Europe’s incumbent banks.

Annual income at several of the top US banks now exceeds the market value of some of these institutions, which was in the high 20 in 2007. With the financial union failing to offer the hoped-for cure, what should European banks do now to address the value gap?

First, banks should not expect a peerlessly accommodating environment for M&A, but rather should cooperate actively with all relevant regulators to achieve more synergies in cross-border M&A. They must challenge domestic ring-fencing policies within the Eurozone, notably by advocating for cross-border liquidity exemptions that national regulators can provide. Along these lines, banks should lobby local decision-makers not to impose MREL (minimum requirement for personal funds and eligible liabilities) requirements on local subsidiaries of banking groups in addition to the MREL requirements imposed by the Single Decision Board. Longer term, European banks must reconsider their key business models. Yes, we have witnessed several rounds of restructuring and digitization in all European institutions since the global financial calamity. However, at their core, they’re organised in traditional client-oriented silos (similar to retail or wholesale banks or wealth administration departments), with the great bulk of their revenue streams based on risk intermediation. While higher interest rates are helping these businesses, it is not enough to change the fortunes of European banks.

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These additional income can provide more ammo to support a long-term change – that is, to go more fully into skills, particularly knowledge. Value expertise companies (such as payment, banking/insurance-as-a-service models, or digital belongings) have earnings multiples of 20 to 30, whereas related knowledge companies (such as pockets companies, related ecosystem providers for mobility, employment, training, commerce, or local weather danger knowledge) have multiples of 30 to 40. Traditional risk intermediation firms, on the other hand, have multiples of just 10 to twenty. Transitioning to the future will need more than an innovation lab – firms would need to undergo extensive organisational transformation, transforming these platforms into primary or at least equal reporting lines, with future leaders nurtured in these managerial roles.

It will almost certainly be up to European banks to close the growing gap with US firms. Those that demonstrate a willingness to reform are likely to find enthusiastic support from traders, regulators, and prudential authorities across Europe.

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