ESG investment key for banks to beat earnings spiral
European banks have largely improved their cost base at a rate that largely negates falls in revenue. However, if they are to overcome their freeze in the growth of profitability, new research suggests they look to boost their environmental, social and governance credentials.
A new study from consultancy BearingPoint finds that the European banking sector is recovering from the turbulence of the pandemic years. However, if it is to overcome a stagnation of profitability, it is going to need to look beyond the digital modernisation drives championed in the years before Covid-19.
The pre-pandemic transformations of European banking took place in the strategic fields of business model alignment, cost reduction and digitalisation. With the uncertainty of the pandemic affecting both capital markets and among customers, asset quality and risk provisioning soon became the focus of banks during the pandemic – but it was something the previous years had prepared them well for.
As a result, according to BearingPoint, most banks managed to cut enough from their cost bases to compensate for falls in revenue. In particular, UK and Ireland’s banks saw a double-digit reduction in costs. So, despite facing one of the biggest falls in revenue across the continent, UK and Ireland’s financial sector performed relatively solidly. Similarly during the crisis, German banks were able to achieve initial successes in reducing costs through their transformation programs and, at the same time, did not record any high losses in earnings.
New revenue
The problem as stated by BearingPoint’s researchers, however, is that these strict cost reduction programmes are not in themselves a solution for the long-term success of banks. For that, banks need to find new ways to draw increases in revenue. For the banks, this partially means there is a need to be sustainably fit for the future – so a return to overarching digitalisation measures such as the transformation and modernisation of processes and systems seems unavoidable.
At the same time, though, a return to investing is also essential. Although the volume of lending in Europe increased overall, the share of loans in the balance sheet total fell in 2019 by close to 4%. A key reason for this was securing liquidity, which was another driver of the balance sheet increase.
As the economy comes out of the uncertainty of the initial pandemic, though, returns on lending offer a major opportunity for banks to boost their revenues. This is particularly the case in one increasingly important line of service.
This is illustrated by German banks in particular, which BearingPoint pointed to as being on the path to “greater efficiency and increased profitability”. This is partially because these banks have largely placed a greater emphasis on environmental, social and governance (ESG) criteria when it comes to investments.
The researchers explained, “Environmental and social issues have become increasingly important for society in general and financial market players. As a result, socially responsible investing has grown significantly in recent years through the consideration of ESG factors and has become a megatrend. Banks are committing themselves to comply with specific minimum standards and principles, and various ESG instruments and securities have emerged that banks actively promote.”
While it is expected that the ESG market will continue to grow in importance in the coming years In the area of sustainability, banks have a crucial role to play, having a direct influence on companies and, ultimately, on social and environmental issues through investments and the provision of funds. This is already providing banks with a key opportunity to boost profitability.
Banks with a very good ESG rating have a higher net interest income and net fee and commission income than their peers, which have a lower rating. From 2018 to 2020, the general banking sector saw commissions for the market as a whole decline by 2%. Interestingly, though, banks which had the best ESG ratings, according to analysis from MSCI ESG and Sustainalytics enjoyed commissions growth of 7.9% in the same period.
On this basis, the researchers concluded, “As a result, companies that do not integrate ESG criteria into their business operations will be at a disadvantage as they will not have access to this new and rapidly growing investor base. That is why it is vital for banks to unify ESG with their strategy to remain profitable and competitive in the long term and increase earnings.”
