ECB Report on financial structures: importance of non-banks increasing

Yesterday, the ECB published its annual report on financial structures in the Eurozone. In it, the central bank identified both short-term and long-term trends, some of which seem intuitively obvious while others are surprising.

In its consideration of the financial sector as a whole, which alongside banks includes insurances, pension funds, investment funds and other financial corporations, the interesting finding is that the relative importance of the banking sector is on the wane. While the share of the non-bank financial sector prior to the 2008 financial crisis was 43%, it has since risen to as much as 55%. In this context, the financial sector as a whole has continued to grow. While its total volume in 2008 was EUR 55 trillion, by the end of 2015 the figure had climbed to EUR 71 trillion, and by the beginning of 2017 to as much as some EUR 76 trillion. The growing significance of the non-bank sector is also attributable to the fact that since the financial crisis the rate of change in net bank loans to corporations has been negative most years, and didn’t return to the positive zone until 2016.

The financial crisis also triggered a strong wave of consolidation. Thus, the number of credit institutes in the Eurozone dropped by a quarter between 2008 and 2016, namely from 6,062 to 4,385. In 2016 alone, the figure fell by 401. It comes as no surprise that in the wake of cost-cutting measures, the number of bank branch offices declined steadily between 2008 and 2016, by a total of one fifth or 36,902 branch offices. Roughly half of those closed were located in Spain. All in all, in the EMU there is now one branch per 2,278 inhabitants, while the figure is 2,575 in Germany; in other words, relatively speaking Germany has fewer bank branches than the EMU average.

The consolidated balance sheet total has slipped 14% since 2008 to EUR 24.2 trillion. The volume of loans within the Eurozone edged up by about 1% in 2016. By contrast, the volume of government bonds held by banks continued to fall. The ECB attributes this to the reduction in holdings in national government bonds on the heels of the financial crisis and to the ECB’s bond buyback programme. This phenomenon was to be observed in many parts of Euroland, with the exception of Finland, Luxembourg and Portugal.

In 2016, the profitability of the Eurobank sector held steady on the previous year and remains very low. Compared to the already low level, it dwindled even further in Italy and Portugal. The median level in non-performing loans (NPLs) continued to fall in 2016, but remains high in some countries.

Structural inefficiencies continue to hinder profitability measured in terms of the usually stable, in part even rising cost/income ratios. Thus, the cost/income ratio in the Eurozone ran at 58% in 2016. Far higher ratios were posted by the banks in Germany, France and Italy. This is in part the consequence of a higher exposure to the capital markets in these countries, but also the result of greater fragmentation in the banking sector.

In the final instance, many of these developments have already been observed and noted. For example, the fact that owing to cost factors banks are increasingly rationalising operations and thinning out their branch networks to offset the rising outlays for constantly new regulatory stipulations can be seen day-in day-out, as an increasing number of bank branches are being closed. The banking world is in the throes of change and digitisation; blockchain technology and so-called FinTechs are posing ever new challenges for banks, which need to react swiftly to this changing environment if they are not to lag far behind the PayPals of this world. On the other hand, it is important in this regard that the same competitive conditions apply to all. The increasing significance of the non-bank financial sector, only parts of which are to date regulated (e.g., the insurance trade), makes it clear that this sector could possibly trigger the next financial crisis if a functioning and comprehensive supervisory regime analogous to that for the banking system is not put in place in due time.

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