Bank business models and regulation

2 October 2013

Séminaire IEP-Banque de France

Respondant : JB Bellon

1. Evolution of Bank Business models after regulation

2

World is changing again…

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… and market darlings too

Changing mood of investors from mega banks in the late 80’s (HSBC, Citigroup, …) to specialized one’s in

the late 90’s (Lloyds TSB, GS, …). Investors hated commercial bank moving to investment bank, e.g.

Deutsche Bank (quantity over quality ?).

Up to the crisis, ‘growth plus’ was the key attribute for bank preference, including growth through acquisition (RBoS, Santander,…).

Following the crisis ‘old’ banking style revaluated with RBC or SHB as the good bank favorite names.

4

Bank support ‘trauma’ was different … (support 2008-2012 as a % of GDP)

22% 22%

19% 19% 19% 17%

12% 11% 11%

8%

2% 2%

0%

5%

10%

15%

20%

25%

30%

35%

Irla

nd

e

Esp

agn

e

GB

Dan

emar

k

Po

rtu

gal

Grè

ce

Be

lgiq

ue

Pay

s B

as UE

Ch

ypre

Alle

mag

ne

Fran

ce

Ita

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106%

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…which explains fragmented rules…

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…and investors uncertainty

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Crisis challenged leverage

Leverage and Liquidity crisis

Dependence on short term (less than 1 year ?) and wholesale funding is dangerous either for Investment banks (what is the market value of non liquid assets ?) or for retailers with a low or weak deposit base (N Rock, CIF, …)

Trading is using too much liquidity.

Loan to Deposit ratio should be much lower, but it seems that low LTD (below 100%) are not an insurance for safe behavior : Benelux banks, JP Morgan London CIO, …

8

Deleveraging is still an on going process

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…and asset reduction will cut revenues…

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2,10%

2,15%

2,20%

2,25%

2,30%

2,35%

0

20

40

60

80

100

120

140

160

180

200

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Global CIB revenues in bn $ (ex write downs and DVA)

revenues REVoA

… on the top of regulatory changes…

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…reducing high margins in ‘opaque’ areas

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Banking intermediation is also under scrutiny

Banking intermediation is based on a certain balance of maturity and quality.

Temptation to increase intermediation margins (i.e. risk) to offset decline of revenues in a more competitive environment (Dexia example less client margins more portfolio revenues) or to increase returns. Carry of ‘A-AAA’ security (ABS, CDO…) at most of the bank was a nice short term sweetener of revenues…until 2007.

Flexibility of portfolio “capex” was too large (UBS 100bn CHF, RBoS > 50bn£).

13

Retail was growing in the wind of credit volume in southern Europe

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Italy

Spain

Portugal

PolandRomania

NL

UK

Finland

Czech Rep

SlovakiaAustria

Germany

France

Sweden

DK

Belgium

0,0

20,0

40,0

60,0

80,0

100,0

120,0

140,0

160,0

180,0

200,0

2 4 6 8 10 12 14 16 18 20

GD

P in

EU

R M

pe

r b

ran

ch

Staff per branch

Bank networks in EuropeBuble size proportionated to the number of branches

MS

Bar

Creating excess capacity

15

-4000

-2000

0

2000

4000

6000

8000

10000

12000

14000

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

E

Spain : cumulative changes in branches1990-2012

branches banks cajas

Networks will be more balanced

80%

90%

100%

110%

120%

130%

140%

150%

160%

170%

2004 2005 2006 2007 2008 2009 2010 2011 2012

Retail bank : Loan to Deposit

4 groups BNP Paribas SocGen

LCL CR CA

16

Pricing is only reflecting rising credit risk

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Questions on Bank Business models

Useful, Useless or Utility ?

Debate on structural issues not over.

Reduce the scope of activities allowed ?

Utility bank an oligopoly regulated at cost plus a margin in order to fund maintenance capex and growth ?

Even if not facing extreme changes, more transparency and margin could be required to be socially acceptable.

Capacity to move out of banking regulation scope, more shadow

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2. Is M&A part of the answer ?

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Concentration already increased

0

100

200

300

400

500

600

700

800

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

France

Germany

UK

Spain

Italy

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Expected RoE matching CoE consistent with P/TBV = 1x

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The main driver to increase RoE is cost cutting

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However current valuation does not incorporate any goodwill at P/TBV = 1x

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Goodwill used to be an issue despite regulatory deduction

Goodwills 2010 2011 chg as a % of Market Cap

% market cap in €M

Santander 22865 24622 8% 43% 56902

Intesa SP 19217 8984 -53% 37% 24009

Crédit Agricole SA 18960 17528 -8% 149% 11741

HSBC 17232 17616 2% 15% 116001

RBS 16856 17153 2% 89% 19364

Unicredit 20428 11500 -44% 52% 22254

BNP Paribas 11324 11406 1% 26% 44220

Deutsche Bank 10762 10800 0% 33% 32607

UBS 7117 8049 13% 20% 39505

Credit Suisse 6221 6985 12% 29% 24030

SocGen 7431 6973 -6% 37% 18766

Barclays 7256 6124 -16% 18% 34361

BBVA 6949 5900 -15% 18% 33097

Lloyds BG 6071 5329 -12% 19% 27643

ING 2765 2750 -1% 11% 25881

Top15 181454 161719 -11% 30% 530381

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Management claim on M&A relevance

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Regulators hesitate to back large M&A, afraid from abuse of market power…

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…but do not bar smaller operations which increase efficiency of the industry

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Jury is not out, but past experience is not too impressive

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Investors are not very supportive of M&A

• Statement 1 : M&A serves management not shareholders, ABN-Amro bid as a good example

• Statement 2 : aggressive cross border acquisition strategy is a good recipe for disaster, usually at high entry prices (see exit from Greece, Russia…). Good banks do not need help and bad banks are really bad and difficult to turn around.

• Statement 3 : acquisitions in downturn (vulture) could create value, thanks to low P/BV.

• Statement 4 : in-market acquisition are more attractive.

• Statement 5 : Large banks are nevertheless the product of M&A, good risk culture is key.

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