BCG: Banks regaining their economic profitability

08 January 2015 4 min. read

The financial crises had a substantial effect on the economic profit (EP) generation of banks, especially in North America and Europe, concludes consulting firm The Boston Consulting Group. Six years after the crisis, North American banking institutions are coming out of negative profit, buoyed by cheap refinancing costs and lowered risks. In Europe however, negative economic profit continues.

The positive basis of banking
The Boston Consulting Group (BCG) recently released its fifth annual assessment of the state of the global banking industry (‘Global Risk 2014–2015: Building the Transparent Bank’). For the report, BCG assessed the economic profit (EP) generated in 2013 by more than 300 retail, commercial, and investment banks, which according to the firm accounts for more than 80% of all banking asset worldwide. EP —which weighs refinancing costs, as well as operating and risk costs,  against income — provides a comprehensive measure of the financial conditions that banks face in an era of risk and overarching regulation.

Building the Transparent Bank

The EP assessment for banks in 2013 shows a regained economic profitability for banks with a net positive of €18 billion, or 3 basis points, as a percentage of total assets, compared with negative EP ranging from -6 to -23 basis points during the previous four years. In the regional performances however, there are substantial differences in EP value added and the global increase in EP was driven by the positive regional performance of banks in North America, the Middle East and Africa.

North America finally managed to bring its banking sectors into positive basis point territory, coming up from -80 in 2009 to 19 in 2013. In the Asian-pacific region the banking sectors continue to trend in positive territory, increasing their EP from 20 basis points in 2009 60 points for 2013, although slightly dropping from 2012. Banks in South America, while continuing to perform well, are trending downwards from a 2011 high of 92 basis points, to 59 in 2013. Only in Europe is the banking sector stuck in a continuous negative EP, from -22 in 2009 to -40 in 2013.

Economic profit global banks

For the global banking sector, the six years since the financial crisis have been turbulent, buffeted by continued market uncertainties and compliance to stringent regulatory tests and demands. Especially mature markets, in North America and Europe, the consequences of the crises played havoc with bank balance sheets.

Regional differences
An assessment of the components of economic profit reveals the basis for these differences in regional performance. In North America for instance, while the income component of asset value generation has decreased with 166 basis points between 2009 and 2013, this has been offset by considerable cutting in risk and refinancing costs, decreasing 178 basis points and 57 points respectively. The decrease in risk costs was due to an improved macroeconomic environment, the report found. While quantitative easing by the US Federal Reserve helped reduce refinancing costs substantially in North America. With the quantitative easing programme being ‘tapered off’ in the coming years, this aspect of the assets balance sheet may come to change. In total, the reduction in costs has driven the creation of the total positive value for North American banks.

In contrast, the European banking sector’s decrease in income isn’t as sharp as in the US markets, decreasing 53 basis points in the period 2009-2013. Yet during that same period, not much has been gained in the reduction of costs, with a total decrease of 34 basis points. While the refinancing costs have stayed relatively flat on the back of low interest rate loans offered by the ECB, this environment is not expected to persist indefinitely. BCG suggests that reducing operating costs or improving the top line are the best way forward to return the European banking sector to positive value creation on their assets.

Income and costs of global banks

Despite the positive overall development of the global banking industry, regional differences are clearly evident. Worldwide, the new era of regulation will have, BCG report predicts, an uneven impact on the various components of bank EP. As a consequence, some regions are in better shape than others for addressing the shifting regulatory environment.