Banking for the Future - Nicolae Dănilă, membru al CA al BNR

Intervenție cu ocazia lansării Raportului Oliver Wyman asupra sistemului bancar European: “The Shape of Things to Come – What recent history tells us about the future of European Banking”, 27 noiembrie 2013

Discurs disponibil numai în limba engleză

Good evening ladies and gentlemen and thank you for inviting me as a speaker at this prestigious event. It is an honour for me to share some of my views on the future of the banking industry in front of such distinguished audience. Although I currently hold a position with the Romanian central bank, the opinions I will express here do not represent the official view of this institution. They are merely the thoughts of a banker who had the chance to witness over the past 30 years the development and integration of the financial sector across US, Europe and Eastern Europe.

The main trends in the European environment are focused on growth, job creation and competitivity, all within the unique global transformation era, having as central event the great convergence. Speaking about Europe please keep in mind that it is still a credit related economy and will stay like this for the next few years. In this respect let’s not forget that banks play a fundamental role in financing the real economy.

I will not dwell on the recent past (the financial crisis). We need to prove a long term thinking. In my view, the critical issue for the future of the banking industry is to wisely use the opportunity brought by the financial crisis in order to perform a major overhaul to ensure its efficiency and performance over the next decades.

In order to achieve this is necessary to have as many informed views as possible. I am encouraged by the fact that there are many high quality analyses available. The Report “The shape of things to come” we talk about at this major event is a practical contribution to the debate. I consider that this Report is highly important for Romania within the current trends of deleveraging and disintermediation, when the country is facing the negative impact of the structural vulnerability of its banking system, a system having more than 90 pct foreign capital mainly from Euro-zone. The Report is an invitation for a serious analysis and more “action now” on behalf of Romanian authorities, banks and businesses, including National Bank of Romania. Euro area banks are going through a major transformation process which will have a great impact on Romanian convergence efforts.

In my view the future of the banking sector is outlined by the present discussions on the following areas that I will elaborate on: the challenges on short term; the business model that banks will adopt over medium term; and the contribution of the banking sector to growth over long term.

Challenges on the short term

I consider there are three challenges on short term for the banks around the world and these elements will weigh on the business model and on their contribution to growth.

First, the most obvious test for the banking industry is how to survive the deleveraging process. (ECB statistics are showing that outstanding loans to non-financial sector remains negative on annual growth rates, i.e. -2.3% in 2012, -3.4% mid 2013, -3.8% August 2013). The prospect for an accelerated and chaotic disintermediation is heightened by the fact that Basel III will soon impact the banks worldwide while the banks in the European area are also going to be submitted to the AQR in the next 12 months.

Obviously, emerging countries like Romania are among the first ones to receive the full blow in case of a messy deleveraging. Until now foreign banks have repatriated around 26.2% of their exposure, amounting to around EUR 5 billion. Nevertheless, this move was more than offset by raising deposits on the domestic market.

Second, banks in the euro area have to sever the links with public funding established during the various crisis episodes since 2007. This factor impacts the future of the banking sector for two reasons. On one hand, the capital injected through public spending saved the day but also had perverse effects because it postponed the cleaning up of the balance sheets. Therefore, in the very near future banks will have to shed assets while returning public capital. The data is showing a shrinkage of 9pct between 2008 and 2013 in the balance sheets of the banks. On the other hand, banks will need additional capital to cover for the public funds and also to prepare for the final phases of Basel III. They will start looking for capital in an unforgiving environment where capital is still very scarce and shy of investing in banks (to note that between 2009 and 2013 banks’ capital and reserves have gone up by 35% amounting to Euro 2.4 trillion). A vicious cycle might start under these circumstances as the meagre economic growth generated by the real economy is not enough to feed banks which in turn diminish non-financial sector’s chances to generate growth. In fact Basel III has aggravated the situation exactly when the euro-zone economy was moving into recession.

Third, if banks need additional capital they must show some profits and in order to obtain profits they must cut costs. The industry has already been through several waves of cost slashing since the start of the financial crisis in 2007. Nevertheless, there are two factors that will continue in the short run to contribute to the increase in costs which makes reducing costs even more necessary and challenging. Authorities at international and European level are nowhere near the end of regulation of this sector (in addition to capital we are talking about liquidity requirements, bank recovery and resolution directive requirements, the leverage ratio) and this will create additional costs for the banks. Moreover, the costs of provisioning the NPLs will continue to grow in Europe as long as banks can still operate on public money support. The results: limiting bank lending and maturity transformation role which will be detrimental not only to short term financing, but especially to long term investments. We have to bear in mind that the long term financing is becoming a priority for Romania and all EU member countries. I hope that the authorities will take into consideration the diversity, the business model and the risk profile of each bank and the specific situation in each country when observing and implementing the new regulations.

The way banks will choose in the next 12 months to react to these challenges will impact the business model in that it will decide which banks will preserve their place in this market and which will be absorbed by other players or will disappear altogether. To the same extent there will be an effect on banks’ participation in the next economic growth because some might miss the boat.

The business model

The academic discussion over the business model of the banking sector is at least as old and as divisive as is the subject of the Great Crisis of 1929 – 1939 and is largely related to the saga of the 1933 US Glass-Steagall Act since its adoption, implementation, functioning and abolishment in the late 1990s.

Profitability is one of the main reasons making necessary the change of the banking business model. The financial system has as main function the allocation of financial resources and the limits of its activity are set by the capacity to manage risk and debt.

The banking sector in Central and Eastern Europe (CEE) moves towards a new paradigm. In the past few years the performance of the CEE banking system decreased under the pressure of volatility and uncertainty from the EU area. The banks had to tackle with the challenges of offsetting this volatility. The average capitalisation of the CEE banking sector has shrunk by 67% in the aftermath of the crisis after it surged by 52% between 2000 and 2007.

In spite of all these changes I believe that a bank as an enterprise can navigate through crisis periods by combining good risk management with finding solutions that satisfy the principle of “on-going concerns”. In my opinion a successful bank in Romania and in CEE is one being able to effectively manage the new regulations, increased risks and volatility, higher funding costs, qualitative changes in customer behaviour, high competition from non-traditional players. They are in need of deep changes to prepare themselves for the future, however this cannot be achieved without entering and finalizing a transformation process, starting with mentality and banking culture.

Their business must become strong and sustainable to the benefit of all stakeholders. We need to identify in the case of each bank its new philosophy in connection to corporate behaviour, product development and marketing, customer relationship, reputation, collective and social responsibility, and for sure I am not forgetting the credibility. In fact gaining and/or regaining the credibility is probably the core challenge facing the banking industry. I have made reference to risk. Please allow me to revisit in few words this concept. Risk cannot be eliminated, “ and without risk there can be no reward, no progress and no economic growth” (KPMG Sept 2013).Risk management is one of the core capabilities of the financial services institutions. Risk taking and risk mitigation are sides of the risk culture. It is my opinion that exaggerated “protection” and “prevention”, and too much risk aversion are detrimental in a long run to the economy and living standard, and to the banks future as well. Think of it.

More words about the banking model. I expect to see the implementation of a transition from “transaction banking” to a more solid and sustainable model of “relationship banking” - placing the customer first, focussing consistently and continuously on satisfying customers’ needs. Probably this is the fundamental theme on banks management response to the current and emerging challenges. The crisis has eroded customers’ confidence in financial services institutions. Therefore, restoring trust and credibility in banking sector is a key priority. Rebuilding trust is not just with customers, but the process includes trust in front of stakeholders, regulators, rating agencies, own employees. In this respect we have to concentrate on effective and efficient competence and integrity. It will be impossible to continue business as usual. When building the bank of the future sometime is necessary to revisit the traditional ways of doing banking, not to forget that simple is probably the best, and to bring all models to updated, modern and innovative forms. At this stage of writing my speech my own initial years in banking came to my mind. In particular those days with Manufacturers Hannover Trust Co New York, accompanied by the saying that “we are not manufacturing anything, we are not from Hannover and we do not trust anybody”. How can I forget our first commitment in front of our customers, including three key words : “Quality, Loyalty, Consistency”. We were able to prove this many years ago and today I strongly invite you to do the same in your partnership with customers.

Contribution to growth

The most important client category for retail banking is the SMEs sector both in the US and in the EU. The difference between the two regions is that bank loans account for around 50% of firms’ external financing in the EU, while in the US 80% of firms’ financing is generated through the capital markets. This also gives a higher share of the banking sector in the euro area (270% of GDP) than in the US (72% of the GDP)1.

In spite of this impressive size the European banking industry is comparable with the US peers in terms of capital positions. Euro area banks have higher median Core Tier 1 ratio (12.7%) than the US ones. Median leverage ratios, considered on equal accounting standards, are similar in the two regions. The big difference is represented by the lower profitability and lack of investor confidence in the European banking sector2. Lending to non financial institutions in EU over the last 3 years period has dropped heavily, only in euro-zone the drop has reached almost Euro 700 billion. The trend is present in Romania, underlining the fragility of the country’s tentative economic recovery.

The SMEs sector is the pillar of the European economy since more than 99% of the companies in the EU are SMEs and they employ almost 70% of the entire workforce3. Hence, this sector is essential for generating economic growth and their financing needs are of utmost importance for the banking industry. Banks will remain the main contributor to the financing needs of the real economy and especially SME’s and households. Taking into consideration the complex transformation process the banks have to accomplish, the European authorities, including Romanian authorities, have to think of financing alternatives by effective “action now”.

In very simple terms this tells us that Romania and the entire EU area have an opportunity in developing its capital markets, maybe in products co-generated with the banking sector, and deliver higher economic growth by targeting the needs of the SMEs sector and long term financing for infrastructure, agriculture and industrial projects.

However, the relative health of the banking sector in EU vis-à-vis the US is not the main cause for its reduced role in the economic growth. The problem lies in the fact that banking has not upgraded to today’s world and certainly not to that of tomorrow’s both in the US and in EU.

In order to prepare for this avenue of economic growth the banking industry has to start to invest today in this reinvented business sector and most important they have to invest in human capital with the appropriate set of skills.

The Romanian banking sector has seen during the past years an accelerated decline in branch numbers and employees, a move mirroring the scaling down of business in the real economy. In fact we have seen an austerity type of approach at all major levels: banks, clients and authorities. We all need to avoid a wrong growth model which will not be sustainable. Nevertheless, Romania like many other countries in this CEE region has a huge potential for financial services increase and the profit margin will certainly be in others’ yard if on medium term foreign bank groups and their local representatives will continue to think only in terms of retrenchment.


I would like to conclude by saying that my experience in this sector tells me that there is a future for the banking sector in allocating capital and resources. Yet, the banking industry has to reconsider its place in the economy. It is no longer the real economy that revolves around the banking sector because the banking sector has the monopoly on the financial resources. Instead, it is the banking industry that has to chase the new competitors, the non-financial entities. Romanian banking system is turning now towards raising most of the funding from local market. In this new context it is fair to say that local customers engaged in savings have natural, normal expectations that their bankers contribute to growth and improving their living standard, proving responsibility towards local market, local customers, local stakeholders. This clearly represents an important contribution to the sustainability of a bank business model and to the bank’s existence on a market.

I wish you all the best. Thank you for your kind attention.

1 Yves Mersch “SMEs, Banking Union, and securitization – exploring the nexus”, Keynote speech, Luxembourg, 13 November 2013
2 Vitor Constancio “Banking Union and the European crisis”, Opening remarks, Madrid, 5 November 2013
3 Mersch