Swiss banks must cut costs despite healthy 2016 performance

26 July 2017 Consultancy.uk

Swiss banks have managed to generate healthy gross operating profit margins, outperforming Western and Southern neighbours. However, the Swiss still trail their Nordic counterparts, and are advised to leverage innovative new techniques to cut costs and keep pace with their rivals. Institutions may face an increasingly tight environment as investors become weary of traditional business models and low interest rates and competition bit into net income from interest. Diversification and cost control are ways in which the region’s banks may be able to improve margins further.

The private banking landscape in Switzerland remains unmatched. The country has the most private banks in the world, while the sector itself remains diverse in terms of the size of providers – from banks with hundreds of millions under management, to banks managing trillions. However, recent analysis had suggested that while the Swiss private banking scene remained relatively stable, trends in the sector suggested profitability was becoming harder to book.

Despite such worrying projections, a 2017 study from Oliver Wyman has since found the Swiss financial services sector to be continuing to perform well. One of the larger parts of the wider Swiss economy, representing 10% of the economy in 2014, with the banking sector representing more than half of the amount. The report, titled 'Swiss Banking 2017: Room for Improvement’, shows that the country’s banking system remains relatively robust, with return on equity even in light of the continued low interest rate environment.

Profit and returns

The research focused on the largest domestic banks in the country, including the Swiss units of UBS and Credit Suisse, Kantonalbanken, Raiffeisenbanken, regional banks and other retail-focused banks, and the most recent results shows improvement in the industry’s gross operating profit margin. Margins remain down slightly on 2011 however, when they stood at 44.8%, along with return on equity, which fell from 7% to 5.7% in the same period. The risk adjusted return on equity, which takes into account overcapitalisation – where the valuation of an asset is superior to its 'real' value, putting a strain on attempts to obtain a reasonable return on investment – was actually slightly higher at 7.8% though.

The firm notes that, if the change in interest rate is taken into account, the difference between the two years is the same, which, given the change in conditions within the wider banking sector, from capital buffer requirements to regulatory requirements, highlights considerable operational improvements.

Regional comparison

In terms of a regional comparison, Swiss banks have outperformed almost all of their European peers. In terms of gross operating profit, only the Nordics have performed better, with an increase in margin of +11% to 53% while Southern Europe has fallen further behind to 31%. German banks meanwhile continue to face a tough environment, even if margins have softened a little, improving from 28% to 30%.

According to the consulting firm, the Nordics have managed to improve margins in part on the back of various transformations and a continued focus on cost cutting. However, the firm also notes, that regional factors, relating to macroeconomic conditions played their part as well.

Operating revenue and costs

While the Swiss banking system has managed to perform relatively well with respect to its regional counterparts, the research highlights a number of areas in which there is apparent weakness. Banks in the region have seen their price-to-book ratio (P/B) by around 25%, to a value of 1.3 on average. The decline highlights investors’ reluctance to pay a ‘premium’ for stock in the segment.

The institutions too have seen moderate increases in costs, at around 2.2% per annum between 2011 and 2016, with the larger share of costs going to general administration increases. Revenues meanwhile were up only slightly, at 1.3% per annum on average, largely due to improvement in fee and commission net income increasing and trading net income, which saw 3.8% growth. Net interest income, given the current environment, saw a slight increase of 0.2% per annum.

Future view, expected operating revenue 2022

The study suggests that operating revenue will shift slightly as low interest rates continue to affect the market, driving banks to explore other revenue streams, while highlighting that net interest income is set to grow below Swiss GDP growth (2% between 2016 and 2022) at around 1.2% between 2016 and 2022. Traditional fee and commission net income will meanwhile stay relatively stable.

Diversification may provide institutions with a way forward however, with ‘other income’ and trading net income each set to increase by around 5% per annum. In addition, banks may be able to supplement their income with a move into new fee and commission net income areas from various additional sources. Globally, banks are facing increasing competition from new market disruptors. Leveraging new technology as a means of diversification, along with cutting costs and maximising profits, is being seen throughout the global financial market as key to any bank’s survival. This process has even seen long-term market incumbents put under pressure.

In their conclusion, the authors of the report recommended, “a focus on capturing additional revenue pools which are independent of the interest rate business. While being challenging, we believe that most players should be able to increase revenues through wealth management, insurance business, SME business, asset management and trading income. Cost reduction initiatives need to be performed, but are unlikely to be a source of a long-term sustainable advantage. However, cost mutualisation initiatives, especially when responsible for new revenue, could be carried out more vigorously.”

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