Overbanking?: Too Much Banking Or Too Many Banks?

Overbanking in Europe?ECB at dusk

Europe is excessively banked. That creates weaknesses in the system (weak banks). That’s the argument put forward by Danièle Nouy, Chair of the Supervisory Board at the European Central Bank, as well as by a lot of other experts in the European Union. The current postcrisis debancarisation is not enough. We need to let the banks which need to fail do just that, using the Banking Union’s resolution mechanism. Furthermore, we need to strengthen the process of mergers amongst healthy banks. It would be desirable for these mergers to be cross-border. This argument throws up lots of questions which don’t have clear answers.

The first problem is the starting point. There are two possible versions of ‘overbanking’: a very high proportion of banking intermediation in financial flows, which we will refer to as too much banking; or a very large number of lenders of groups of banking institutions, which we will refer to as too many banks. Both these excesses would need different formulas: but the critics of ‘overbanking’ jump between the two without any warning.

Too much banking?

If we are talking about an excess of banking, the main argument that everyone comes up with is the fact that in the US banking intermediation is less important in comparison with the stock market. And as the US is the leading world economy, we need to copy it. But the US is more of an exception, justfied by idiosyncratic and historical reasons. Its situation is a fact, not necessarily a model to imitate. Other countries in the western world have achieved similar levels of development with economic structures which are very bancarised.

So as not to look gullible, we provide some other reasons. They say that banking absorbs too much business and human talent, which would be better used making things which are tangible instead of financial products. Although in one respect this argument would be acceptable. Some of this talent is dedicated to managing the sophisticated techniques which are now indispensable thanks to, amongst other things, Basel II.

There are societies where savers prefer the relative tranquility of bank deposits much more than risky financial instruments. It seems some regulators don’t want this “excess” of deposits to exist, but it does. The academic dreams of giving risk back to deposits by withdrawing the Deposit Guarantee Funds have flown in the face of the socio-political reality. The attitude of European civil servants on this specific point is that the European DGF should be established. This would boost the attractiveness of deposits even in those countries which have difficulties in honouring their DGF’s guarantees. So, more ‘overbanking’.

The other side of the excess of deposits is an “excess” of bank lending. In the developed economies, the beneficial or prejudicial influence of more or less credit in the financing of the economy is a matter for discussion amongst academics and econometric analysts, without there being any definitive conclusions.

Another line of argument, espoused by Ms. Nouy, alleges that an economy with more lending performs a bit better during the economic cycle. But it suffers more after a crisis, taking time to recover. It is more likely to get into situations of over-indebtedness, with the consequent high levels of NPLs and a need for provisions which is a burden for the banks’ profit and loss accounts.

Too many banks?

But Ms. Nouy, based on her recommendations, insists more on there being too many banks than an excess of banking. She says that in Europe there are too many banks, particularly weak banks. Their performance, hopeless competition in the loans and deposits markets, may be seriously destabilising for the system. Not to mention banks with very high operating costs and those which are unable to deal with the new technological challenges. The banks’ current low profitability  is also mentioned here, although this is more arguable. A good part of the blame corresponds not to the structure of the market but to the anomolous situation of interest rates (and another part to the utilisation, as a comparative term, of an intended cost of capital which is conventional and arbitrary). Corrolary: there are too many banks.

Before continuing, we should define the playing field in which this problem is being considered. Ms Nouy, predictably given her job, is referring to a unified European banking space. It’s true that a good 25 years ago a banking Common Market was formally created. Now, in addition, the supervising system and the euro area resolution mechanisms are being centralised. But in many important aspects, starting with retail activity, this common banking space breaks up, following national frontiers. Each country has its own national banking structures, with obvious differences and peculiarities, and the level of inter-penetration amongst countries is generally low in the majority of cases. So should we be talking about European ‘overbanking’ or would it make more sense, say, to talk about German ‘overbanking’.

The claim that there are “too many weak banks” begs the question: if that is the case, how have we arrived at that situation? There are institutions with problems struggling to survive in every sector of the economy. In other sectors, the old  Schumpeterian way works. But the banking sector, on the other hand, is subject to strict and intrusive regulation and supervision. Firstly, these should reduce the emergence of problems and, secondly, identify those which arise early on, in order to rectify their course and avoid shipwrecks. Useful policies, but difficult to measure in terms of efficiency because discretion is essential in this game: the names of those banks saved in the supervisory backroom will never be mentioned.

So now what?

With respect to an excess of banking, the banks are subject to an extremely strict, cautious policy in exchange for the regulatory privilege of capturing deposits. Basel has tightened its policy a lot as far as solvency is concerned, creating new regulatory restrictions (liquidity etc). Then there are the additional requirements of TLAC and MREL.

The excess may even be changing sides. The prudent restraints imposed on the banking sector indirectly lead to the development of other activities and financial institutions which are less monitored (shadow banking, fintech), which invade banking activity’s typical areas. This begins to worry the authorities because it can make investors vulnerable. And it also bothers the banks, which want the same treatment or less regulation.

So perhaps we are going from ‘overbanking’ to ‘overshadowbanking’, which doesn’t make the financial authorities happy either.

And the excess of banks?

There is still the issue of “fewer banks”, central to Daniel Nouy’s proposal. Banks’ resolution processes tend to lead to an increase in banking concentration. That’s because the formula most used by the banking authorities is to organise the unviable bank being absorbed by another with adequate size and solvency. Or at least the sale to other banks of the useful parts of the former, already restructured. But Ms Nouy is also proposing mergers for banks which are in a normal situation, in other words, cross-border deals, or what amounts to more Europe!

The problem is that the reality is different. In the last few years, the pace of mergers has decreased. Cross-border operations are conspicuous by their absence. Why is that? Mergers are complicated transactions, expensive and risky. They require a spirit of adventure and confidence in the future, virtues which apparently have not been recovered after the crisis. There is no certainty about mergers creating value, nor is there is confidence in the quality of the other side’s assets. And why buy branch networks when digitalisation allows you to operate with fewer counters. Whatsmore, there are still regulatory uncertainties…Faced with this, the banks prefer to put their own houses in order. Other forms of interbank cooperation (cooperatives) are not even mentioned.

 

*Photo: Flickr /Christian Dembowski