The document discusses several challenges facing the European banking industry, including low profitability, high levels of non-performing loans, overcapacity, and prospects for further bank consolidation. It notes that while bank profitability modestly improved in 2015, supported by resilient net interest income, prospects for future profitability remain uncertain given the low interest rate environment and regulatory changes. The document also examines issues like increasing competition from financial technology firms and the growth of shadow banking.

1. Challenges for the
European banking
industry
Conference “European Banking
Industry: what’s next?”
University of Navarra, 7 July 2016
Vítor Constâncio
ECB Vice-President

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Outline
2
» Introduction
» Banks under siege: general challenges
» FinTech threat of unbundling banks
» Uncertainty in the finalisation of the regulatory agenda
» Low interest rate environment
» Regulation of shadow banking and the boundary problem
» The “Alchemy of banks”, the financial crises and structural reform
proposals
» European banking sector: facts and challenges
» Low profitability
» Non-performing loans
» Overcapacity in the banking sector
» Prospects for bank consolidation
» Response by the banks
» Conclusion

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Chart 1: The growth of the non-bank financial sector has gathered pace in recent years,
coupled with a shift towards market-based financing
Sources: ECB and ECB calculations.
Note: MMFs refer to Money Market Funds. ICPFs refer to
Insurance Corporations and Pension Funds. Other financial
institutions (OFIs) refers to non-monetary financial corporations
excluding ICPFs. Non-money market investment funds (non-MMF
IFs) and financial vehicle corporations (FVCs) are included in the
OFI sector.
Euro area total financial sector assets
(Q1 1999 - Q4 2015; EUR trillions)
Sources: Eurostat, ECB, Dealogic and ECB calculations.
Note: Loans from monetary financial institutions to non-financial
corporations are corrected for loan sales and securitisations, while
loans from non-monetary financial institutions exclude loan
securitisations.
External financing of euro area non-
financial corporations
(Q1 2000 – Q1 2016; EUR billions; four-quarter moving flows)
0
10
20
30
40
50
60
70
80
1999 2002 2005 2008 2011 2014
OFIs (incl. IFs, FVCs): 39%
ICPFs: 13.5%
MMFs: 1.5%
Credit institutions: 46%
credit institutions
OFIs (incl. IFs, FVCs)
ICPFs
MMFs
-200
-100
0
100
200
300
400
500
600
700
800
900
2000 2002 2004 2006 2008 2010 2012 2014 2016
total
loans from monetary financial institutions
net issuance of debt securities
net issuance of quoted shares
loans from non-monetary financial institutions

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Chart 2: Estimates of the equilibrium real rate compared to the market real rate
Source: ECB calculations, and San Francisco FED.
Notes: The semi-structural model is very much aligned with the approach of Messonnier and Renne (2007). The BVAR is a
bayesian vector auto regression with minimal restriction that forecasts a five-year ahead forecast of the short-term real interest rate.
The inflation-stabilizing real rate is the real interest rate that would be required to stabilise inflation in the euro area at below but
close to 2% over the medium-term. It is based on the model by Christiano, Motto and Rostagno (2014). For the US, the natural real
rate is based on the publically available data series from the model by Laubach and Williams (2003).
Latest observation: 2016 Q1 for the euro are estimates and 2015Q4 for the US.
4
Euro area US
-3
-2
-1
0
1
2
3
4
-3
-2
-1
0
1
2
3
4
Pre-2009 2009-2013 2013-2015
Laubach and Williams - US natural interest rate

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Euro area banks’ return on equity
(2009-Q1 2016; percentages; 10th and 90th
percentiles, interquartile range and median)
Source: SNL Financial.
Notes: Based on publicly available data on significant banking
groups. Annual and quarterly data are based on a sample of 81
and 49 SBGs respectively.
Chart 3: Bank profitability moderately improved in 2015 and net interest income proved
resilient
-25
-20
-15
-10
-5
0
5
10
15
20
09 10 11 12 13 14 15 Q1
14
Q2
14
Q3
14
Q4
14
Q1
15
Q2
15
Q3
15
Q4
15
Q1
16
median for significant banking groups
-53 -36
Sources: Bloomberg, Datastream, Consensus Economics, ECB
calculations.
Notes: COE is the expected return on the EuroSTOXX Banks index,
estimated by applying the CAPM to the EuroSTOXX market index with
one-year rolling betas. Estimates of the equity premium are based on
I/B/E/S earnings forecasts and Consensus estimates of long term real
GDP growth. Return on equity (ROE) is the trailing weighted average
(by mkt cap) of individual ROEs. Latest observations are for Q1 2016
(ROE) and Q2 2016 (COE).
Return on equity and cost of equity
and for listed euro area banks
(Q1 2000 – Q2 2016; percentages)
-5
0
5
10
15
20
25
2000 2002 2004 2006 2008 2010 2012 2014 2016
COE
ROE

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Chart 4: Deterioration in market sentiment largely reflected a re-evaluation of banks’
profitability prospects
Sources: Bloomberg and ECB.
Bank equity indices for key regions
(1 Jun. 2015 - 5 Jul. 2016, daily data)
Sources: Bloomberg, Datastream and ECB.
Banks’ price-to-book ratios in key
regions
(1 Jan. 2015 - 1 Jul. 2016, weekly data)
50
60
70
80
90
100
110
120
Jun-2015 Aug-2015 Oct-2015 Dec-2015 Feb-2016 Apr-2016 Jun-2016
S&P500 Banks
FTSE 350 Banks
Nikkei 500 Banks
Eurostoxx Banks
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
Apr 15 Jun 15 Aug 15 Oct 15 Dec 15 Feb 16 Apr 16 Jun 16
US
UK
JP
Euro area

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Chart 5: Scope for efficiency gains in the banking sector
B
Market concentration and efficiency ratio in euro area
countries
x-axis: Herfindhal index; y-axis: cost-to-income ratio
Source: ECB.
Change in the number of bank branches/employees
versus the change in cost-to-income ratio in euro area
countries
2009-2014; percentage changes (x-axis); percentage point
changes y-axis
Sources: ECB and ECB calculations.
 Branch network rationalisation and headcount reductions brought efficiency gains in some,
but not most, euro area banking sectors
 Low market concentration and higher cost inefficiency suggest there is scope for efficiency
gains from consolidation
-40
-30
-20
-10
0
10
20
30
40
-60% -40% -20% 0% 20%
change in the number of branches (blue) and employees (yellow)
chnageinthecost-to-incomeratio

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Chart 6: Banks’ adjustment to new business models
8

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Chart 7: Market concentration has increased since the crisis but cross-country differences
remain significant
Source: EU structural financial indicators.
Market concentration in the euro
area/EU banking system
(2005-2014; share of 5 largest CIs; Herfindahl index)
Source: EU structural financial indicators.
Note: Horizontal line represents market concentration in the euro
area in 2014.
Market concentration in euro area
countries
(2008-2014; Herfindahl index)
500
550
600
650
700
750
800
38
40
42
44
46
48
50
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
EA-share of the 5 largest CIs in total assets (left-hand scale)
EU-share of the 5 largest CIs in total assets (left-hand scale)
EA-Herfindahl index (right-hand scale)
EU-Herfindahl index (right-hand scale)
0
500
1000
1500
2000
2500
3000
3500
FI EE GR NL LT MT CY SK PT SI LV BE ES IE FR IT AT LU DE
2008
2014
euro area (2014)

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Chart 8: M&A activity in the EU banking sector has declined since the high values recorded in 2007
Source: Dealogic M&A Analytics.
Notes: M&As include both controlling and minority stakes. The value of some of the transactions is not reported. “Cross-border”
M&As refer to intra-euro area transactions involving a non-domestic acquirer. “Inward” refers to M&As by non-EU or non-euro area
EU banks in the euro area and “outward” indicates M&As carried out by euro area banks outside the euro area.
Bank M&As – number of transactions
(2000 - 2015)
Bank M&As – value of transactions
(2000 - 2015; EUR billions)
0
20
40
60
80
100
120
0
20
40
60
80
100
120
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
domestic cross-border
outward EU inward EU
outward non-EU inward non-EU
0
20
40
60
80
100
120
140
160
180
200
0
20
40
60
80
100
120
140
160
180
200
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
domestic cross-border
outward EU inward EU
outward non-EU inward non-EU