Roland Berger: Profitability of EU banks still too low

03 November 2014

The profitability of European banks has over the past year grown strongly, by approximately€54 billion. Nevertheless, profitability remains too low, in particular in comparison with American counterparts, according to a new research from consulting firm Roland Berger Strategy Consultants. If banks want to boost their profitability, then further reducing their cost levels, more focus on innovation and growth strategies for emerging markets will prove instrumental.

Last year the revenue of the European banking industry stablised at roughly €700 billion*. In comparison, in 2011 (and 2009) the market was valued at €717 billion. Approximately 60% of the revenue is realised in the retail banking segment, while nearly a quarter of the turnover is earned in the investment banking and corporate segment.

Banking Reveues from Core Activities

Profitability has, compared to a dramatic 2012, recovered strongly. In 2012 European banks realised a combined profit of €9 billion, last year the number has grown to €62 billion, two billion more than in 2011.

Profit Before Tax Variation

Despite the improved bottom line results, the industry still struggles with its profitability, say the strategy consultants, in particular when compared to the performance of their American counterparts. The Return on Equity (ROE) – an important baseline for industry profitability – of European banks for example ails at around 1,5%, while U.S. banks on average can rely on 9%. Also on other KPI’s European banks trail their American counterparts.

European vs US Banks

Change of strategy
If European banks want to close the gap with their US rivals, then they should in the eyes of the consultants turn their attention to sustainable profitability. “It is time for a change of strategy,” says Roland Berger, recommending three key pillars. Firstly, continued attention is needed on cost control, through a simplification of the service portfolio and product assortment, pointing at similar successful strategies in for instance the FMCG and automotive sectors. In addition, such changes boost the flexibility of the organisation, the quality of services and the competitive position via a vis competitors.

The second focus area for banking executives is innovation. Easier said than done, in addition to best practice innovation management it requires a change in mentality: banks should change from ‘followers’ into ‘leaders’. Lastly the growth potential of emerging markets should be capitalised, for example through market entry or on-the-ground partnerships.

If executives of European banks mange to successfully deploy the above recommendations, then they can according to the strategy consulting firm more than double their profitability by 2016, to between 9% and 11%. The move will have substantial benefits on market capitalisation – shareholders are forecasted to reward banks with a 30% higher market value.  

Evolution of ROE of European Banks

* In the research report ‘The State of the European Banking Industry’ Roland Berger assesses the performance of the top-100 European banks, representing roughly ~90% of the banking industry in the EU 27 countries.

** Based on the comparison of the top 20 European vs. top 10 U.S. banks (market capitalisation).


The business and operating models of digital-only banks

04 April 2019

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.