Greek Banking: Reflections on the Day Afterthefutureofbanking.boussiasconferences.gr/files/... · Market price equals book value. YE 2010 . YE 2000-09 . 1. On the face of it, global

Greek Banking: Reflections on the Day After

Athens, June 7th, 2011

CONFIDENTIAL AND PROPRIETARYAny use of this material without specific permission of McKinsey

& Company is strictly prohibited

Presenter

Presentation Notes

These are clearly trying times for the country and its banking system. Surely, this conference will discuss questions around the strength and sustainability of the banking system, its ability to support economic recovery and overcome domestic stagnation; and whether the banking landscape will fundamentally change to make that happen. There are no easy answers to these questions. Most of them cannot be answered as long as the fiscal and public debt situation remains unstable. Still, there will be ‘a day after’ for both Greece and its banks. What we will try to do in the next few minutes is to provide some factual context behind the current challenges, but also look beyond Greece, to see what lies ahead for international banks that have presumably turned the corner of the crisis and are facing what we call “The New Normal” in banking

McKinsey & Company | 1

TOP-5 challenges for Greek banks currently

Funding and deposit retention

Shielding from perceived Greek sovereign risk

Preserving asset quality amidst a prolonged recession

Salvaging profitability by acting decisively on costs

Addressing pressure to deleverage

Presenter

Presentation Notes

We have tried to synthesize the major challenges currently facing Greek banks in five headlines. The first – and arguably the most important one – is funding and deposit retention.


The acute funding challenges cannot easily be addressed with tactical discretionary measures

1 Other deposits include Central government deposits and non-domestic residents deposits2 Interbank includes liabilities to BoG

& liabilities to other MFIs

(excl. ECB

funding)

SOURCE: Bank of Greece; Press; McKinsey

0

100

200

300

400

500

MarDecSepJunMarDecSepJunMar

Domestic Retail &Corporate Deposits

Other Deposits1

Interbank2

ECB Funding

2009 2009 2011

EUR

billion

-39

-29

+50

€ bn Change Sept’09-Mar’11

Presenter

Presentation Notes

Since halfway through the crisis in late 2009, approximately 40 billion worth of deposits have evaporated – and apparently they don’t seem to be coming back soon. In parallel, interbank lending lines have been reduced by approximately another 30 billion and access to the interbank market has been practically denied – with few notable exceptions. The majority of the funding gap has been covered by ECB funding, a window that will presumably not stay open forever and definitely at increasing costs of collateral. This is a structural problem that unfortunately cannot be sufficiently addressed by tactical, cost-efficient measures in deposit retention. It is sadly exacerbated by unfortunate commentary in Greece and abroad that draws a lot of publicity almost on a daily basis lately. Unless this trend is reversed (or at least convincingly stabilized), the lending capacity of Greek banks will remain substantially constrained.








Presenter

Presentation Notes

The second equally profound challenge lies in the exposure of Greek banks to Greek sovereign debt – an exposure which is considered almost ‘toxic’ by international market participants


Relative exposure to Greek sovereign debt vs. European peers is creating a substantial handicap in credit counterparty risk for Greek banks

SOURCE: BIS

Report; Bank reports; Press

1 Includes T-bills2 Consolidated foreign claims at immediate borrower basis

Greek government bonds1

€

billion

495143

23

2008 20102009 Q1

2011

+49%

Greek Banks (Top 7 banks)Foreign claims on Greek public sector2

€

billion

International Banks

41

7171

201020092008

-24%

Presenter

Presentation Notes

What’s interesting to note in this case is that as Greek banks have increased their exposure to Greek government debt by almost 50% in the last couple of years to help support the funding needs of the Greek state, international banks have managed to substantially reduce their own exposure to Greek public debt, especially during 2010. They have achieved that either through the secondary markets or through special purpose vehicles set up throughout Europe with state guarantees that seek to shield domestic bank balance sheets from doubtful loans. The point in any case is that a substantial handicap has built up between Greek banks and their international peers with respect to credit counterparty risk, which mostly explains the situation in the interbank market discussed earlier.








Presenter

Presentation Notes

The third important challenge is how to preserve asset quality amidst a recession that drags on for quite longer than initially anticipated.


Asset quality deterioration persists due to prolonged recession despite credit control measures employed by most banks

1 Forecasts by HSBC and Greek press, adjusted by Q1 results

SOURCE: Bank of Greece; NBG; HSBC; Press

0

10

20

30

40

Mar SepJunMarDec SepJune MarDec DecDecSepJune

NPL

Volumes, €

billion

20092008 2010 2011E1

NPL Business

NPL Mortgages

NPL Consumer

5.0% 7.7% 10.4% 14.2%

Total NPL

Ratio

Presenter

Presentation Notes

Many Greek banks have been working very diligently to contain NPLs and restructure doubtful exposures since the early days of the crisis in 2009. Yet, the sheer scale and duration of the recession exerts a continuing drag on asset quality in all asset classes. Forecasts and latest results extrapolated suggest NPLs might climb as high as 35 billion by the end of this year, almost tripling in relative terms since the start of the crisis. Advanced credit control measures need to be maintained and further upgraded – especially in offering smart and appropriate restructuring products that debtholders can live with – yet Greek banks will not be confident that the peak is behind them before they observe a convincing growth uptick in the broader economy.








Presenter

Presentation Notes

The fourth challenge has been around for a while but has become an imperative during the crisis: how to address profitability by working on the cost, rather than the revenue side.


Costs will need to adjust faster to falling income to preserve productivity and earnings health

68

65

6255

60

55

46

66

44

54

67

59

2010

2005-2008 Average

SOURCE: Bank of Greece; McKinsey

Cost-to-Income ratio Percent

2009-2010 Cost Change2009-2010 Income Change

-2%-5%

-2%+5%

+2%+3%

-6%-8%

+2%+1%

-4%-11%

Cost ∆

Income ∆

Greater flexibility and speed required to right- size branch networks and streamline headquarters and operations centers

Presenter

Presentation Notes

The most important thing to note here is that income is dropping much faster than cost in Greek banking, especially in the last year. Less than half of income foregone has been compensated by cost savings. This is unlike other European markets with similar challenges – most notably Spain, where income has dropped by 8% but has been more closely matched by decisive cost savings, helping to maintain very healthy CIR below 50%. For Greek banks to achieve similar adjustment speeds, greater flexibility will be required to restructure branch networks and operating models, right-sizing HQ and creating economies of scale wherever possible.







Addressing pressures to deleverage

Presenter

Presentation Notes

The final major challenge is the need to deleverage, particularly in specific asset classes.


5.2%

Belgium 5.8%

Finland 7.0%

France

Spain 8.4%

Sweden 8.8%

7.5%

9.8%

Netherlands 4.6%

Luxembourg

Germany 9.6%Italy 10.3%

Denmark 10.5%

Austria 12.0%

Ireland 13.6%

Portugal 14.4%

United Kingdom 14.7%

Greece 15.2%

Deleveraging in consumer lending is already underway and may shrink assets by €15-20 billion before stabilizing – other segments also vulnerable

SOURCE: Bank of Greece, ELSTAT, McKinsey

39.0%

Finland 42.1%

Belgium 44.8%Luxembourg 45.6%Sweden 50.0%

Spain

34.6%

Portugal 73.7%

Ireland 85.4%


Denmark 95.7%

Netherlands

52.0%

Italy 27.6%

Austria

Greece

59.3%

34.8%

Germany 35.8%

France

107.3%


Luxembourg 132.9%

Italy

74.6%

Finland 41.8%

Belgium 52.1%

91.4%

55.7%

Germany 58.5%

Greece1 60.7%

Ireland 64.4%

Sweden 66.7%

74.2%70.4%

Portugal 88.4%

Netherlands

France

Denmark 92.0%

Spain 98.1%

Austria

EU-15 average EU-15 average EU-15 average

Mortgage lending/GDPConsumer lending/GDP Business loans/GDP

Presenter

Presentation Notes

Deleveraging is already underway in Greece. It is driven by both reduced demand – especially in consumer lending, where the system has a long way to go to come down from a truly unsustainable peak but also in mortgages, where the real estate market has dried up – and by the need to achieve a more healthy funding profile with less reliance on ECB – which also affects wholesale banking segments. The system is set for a decrease in consumer lending balances by 15-20 billion if it is to rebalance towards more sustainable levels vs. other EU countries in the mid term.








Presenter

Presentation Notes

So there we have it: the TOP-5 challenges for Greek banks at this juncture – funding, Greek government bonds, loan quality, costs and deleveraging. But how different are these challenges compared to international banks? Have international banks really put such challenges behind them now that the crisis seems to be over in many global markets? What does the day after look like for them?

McKinsey & Company | 1212 SOURCE: Reuters; McKinsey Global Financial Initiative, Datastream

1 Based on a sample of 2 banks only

Although global banking revenues recovered in 2010, valuations remain depressed mostly below book valuesAverage bank price-to-book multiple

1.8

1.1

0.9

2.1

1.2

1.2

1.6

1.7

0.6

0.5

0.5

0.6

0.8

1.0

Market price equals

book value

YE 2010

YE 2000-09

1

Presenter

Presentation Notes

On the face of it, global banking revenues recovered nicely in 2010 in many parts of the world, reaching at least 2008 levels. Still, valuations remain depressed. Most shares of international banks still trade below book value, way down compared to the multiples of the growth years of the past. There are some very important market expectations and forward-looking challenges hidden behind this observation.


Valuations reflect the need to generate enormous extra profits by 2015 to find and remunerate the additional capital required in the ‘new normal’

820 2,610

1,790

660

2015F

5,600

2,990

2010E

4,120

2,330

SOURCE: McKinsey Banking and Risk Practice; McKinsey Global Financial Initiative; Reuters

Adding additional core tier 1 capital needed to

comply with Basel lll

Europe

U.S.

Expected capital build up for global banking system YE 2010 to YE 2015

Bank common equity, $ billion

Required improvement of individual bank profitability drivers from 2010 levels to reach a 12% RoE in 2015

Bank profitability driver

Percentage change

Required improvement

Cost-to-income ratio -18%

Revenue margin +60%

Risk-weighted assets/ total assets -121%

Annual provisions for loan losses

11 p.p.

192 b.p.

52 p.p.

11 p.p. -57%

To reach 12% ROE, an additional ~US$310-350 billion in bank profits needed above projected trend levels

Presenter

Presentation Notes

This is where the so called “new normal” kicks in. Simply put, markets are discounting a new era of depressed profitability for banks, where achieving the RoE of the recent past will be less than straightforward. New regulation commonly referred to as Basel III demands vast amounts of excess capital to be held, especially in the form of common equity. This excess capital adds up to almost 1.5 trillion US$ for US and European banks. To give a practical measure of the implications on profitability of complying with Basel III, let’s look at what it would take to achieve a RoE of 12% which was pretty common before the crisis. It would take: A reduction of the CIR by 11 pp or 18% An increase in NIM by almost 200 bps or 60% A reduction in RWA over total assets by 52 pp Or a reduction of provisions through better asset quality by 11 pp or 57% This all adds up to as much 350 billion US$ in profits, over and above current trend levels.


Five resulting priorities for international banks also very relevant for Greek banks

Massive changes in consumer attitudes and behavior driven by technology enablement

Reshaped regulatory environment for banks

leading to higher capital and funding requirements and significant profitability pressure

Massive rebalancing of economies with vibrant emerging-market growth, resulting in shifts in banking profit pools between markets and sectors

Continued social scrutiny and need for banks to find ways to justify their value-added role in society and the real economy

Funding as key competitive advantage

Earnings growth through thoughtful pricing in the right sectors

The next productivity frontier

The new/old risk paradigmFrom models to models and

judgment

Banks’ responsibility to society

Presenter

Presentation Notes

This reality helps frame five priorities for international banks to compete in the “new normal”, which as you will see are not fundamentally very different from the challenges faced by Greek banks, although admittedly under different circumstances.


Funding has become a strategic differentiatorKey elements raising the strategic importance of funding

SOURCE: BIS; Basel III amendments, Oct. 2010

1 EU-27, plus Switzerland, estimates before balance sheet restructuring

Key elements

OUTSIDE-IN ESTIMATE

Higher and more differentiated cost of funding

Massive refinancing needs

Additional funding shortfall due to Basel III regulation

Impact of full implementation for Basel III LCR and NSFRon funding requirements for the EU banking sector1

Short-term liquidity shortfall due to liquidity coverage ratio

~ 1,300

~ 2,600

Long-term funding shortfall due to net stable funding ratio

Estimated shortfall EUR billion

Imple- mentation

by 2015

Imple- mentation

by 2018

Amount equi-

valent

to

all outstanding US T-Bills US$1,782 billion as at 6/30/2010)

Amount equi-

valent

to

~25% of current long- term EU debt

Presenter

Presentation Notes

Another major compliance requirement from Basel III is around funding, designed to ensure resilience in short-term liquidity shocks through the so-called LCR that concerns immediately available funds and the NSFR that regulates the long-term stability of the funding profile. Though these regulations will not immediately come into effect (especially the NSFR) they do represent a massive deviation vs. current funding profiles in most balance sheets. The shortfall has been calculated at 1.3 and 2.6 trillion EUR respectively to comply with both ratios. Once implemented, these regulations will effect a tectonic shift in competitive dynamics and business models in global banking.


Market dislocation is leading to the emergence of two different funding challenges

SOURCE: Bloomberg, quarterly reports

555962626670757677777878808181

9396101107107

114115121127129133

143144148154

Mitsubishi UFJ Financial GRO Royal Bank of Canada

JPMorgan Chase & Co. Bank of China Ltd-H

Bank of Communications CO-H

Bank of Nova Scotia UBS AG-REG

Agricultural Bank of China-A

Toronto-Dominion Bank IND & COMM BK OF CHINA-A

China Construction Bank-H

Westpac Banking Corp Commonwealth Bank of Australia Banco Santander SA

Itau Unibanco Holding SA Banco Santander (Brasil) SA Lloyds Banking Group PLC

Standard Chartered PLC HSBC holdings PLC

National Australia Bank Ltd

Bank of America Corp

BNP Paribas

Sberbank

Aust and NZ Banking Group

Citigroup Inc

Banco Bradesco SA-Pref Banco do Brasil S.A.

Wells Fargo & Co

Royal Bank of Scotland Group Barclays PLC

Loan – deposit ratio for top 30 global banks, 2010 Percent

Return Seekers – banks with strong deposit bases▪

Meeting own funding needs, with long-term stable bases

▪

Deleveraging and low interest rate environment make returns more challenging

▪

Key priority sustainably improving returns on deposit bases, whilst retaining base

Deposit Seekers – banks with significant funding gaps▪

Increases in funding costs and risk have made "lending-heavy" model unsustainable

▪

Deposit-raising initiatives very important for many of these banks, particularly for long-term money

Presenter

Presentation Notes

These changes will create a dichotomy between different banks, depending on their liquidity profile and asset intensity. Lending-heavy banks with high LDR will need to become competitive deposit seekers, particularly for long-term money. They will need to match the funding profile and the asset intensity at a segment- or even customer-level, which deviates substantially from their traditional model. On the other end of the LDR spectrum, deposit-rich institutions will become return-seekers in an era of constrained asset growth, forced to look for profitable returns in uncommon places and – at the same time – defend their deposit base from increased competition by deposit-seeking banks.


Strategic pricing positioning becomes an imperative to micro-manage profitability in the ‘new normal’

Re-pricing actions to be calibrated based on 3 key elements determining the strategic attractiveness of the different sectors/sub segments

Drivers for sector/sub-segment pricing positioning Strategic objective

1 Profitability over employed capital/EVA

Maximize overall return

2 Funding imbalance of the segment (LDR)

Minimize funding need

3 Sector growth projections Focus on healthy customers

Presenter

Presentation Notes

Profitable returns will rely much more on superior pricing skills than before. Banks will need to be able to price against expected profitability over capital employed even at the individual customer level, calculating EVA at a very granular level. They will have to minimize the funding need by adjusting funding balances at least at a segment level – and they will have to look for growth beyond their traditional ‘cash cows’, in emerging markets, segments and sectors. We believe this last point will be especially important for Greek banks going forward.


Use of online banking

1 Includes Management, Training and Other

51

-49%

OtherBack-office

1020

30Teller service

Customer service Sales and advice

Direct first

1059

14

100

10

78

6 12

37

Brick & mortar10

30211319

Online adaptors

Branches are transforming into a sales and advice outlet, with decrease in overall staff required

SOURCE: McKinsey Multi-channel survey 2010, EFMA

Percent

Branch staff time spend per activity

Presenter

Presentation Notes

On the cost side, the “new normal” will signify the more decisive shift yet towards non-branch based distribution. This is already happening in many markets like in Scandinavia or the Netherlands. A fundamental shift to a ‘direct first’ model, away from the bricks & mortar models prominent in countries like Greece can decrease total branch staff requirements by as much as 50%, while increasing time allocated to pure sales and advice offering – the most value adding activities of the bank. In doing so, the underlying technological enablement will transform the entire business model also in the back end, causing a fundamental operational disruption that will reset the cost base.

McKinsey & Company | 19SOURCE: New risk paradigm, McKinsey Risk practice

What went wrong in risk management? Analysis of risk management breakage points

Over-reliance on complex “black box” models and Inadequate MIS

Lack of understanding of risk at board level

No clear risk responsibilities for key topics around capital and liquidity

Incentive for risk taking and market conformity

▪

Develop foresight –

early warning KPIs for structural risks

▪

Stress test the resilience of the business against specific scenarios

▪

Assess “natural ownership”

of key risks

▪

Stick to areas of “core competence”

and avoid growth in “peripheral”

areas

▪

Make board/top management re-appropriate risk management

▪

Ensure soundness of risk culture▪

Openness▪

“First line of defense”

mindset▪

Clarity on who owns risks

Fundamentally better data supporting flexible and integrated risk MIS will be needed

Presenter

Presentation Notes

The “new normal” will also nurture a different risk culture, based on better understanding of risk undertaken and allocating clear risk accountabilities within organizations.


Key demands of society vs. the financial system

Put in place the right incentive and compensation structure to encourage quality underwriting without compromising their ability to fight for talent

Fulfill their intermediation role, in particular to SMEs with a view to facilitate economic recovery and growth after the

crisis

Provide Trade Finance –

despite proposed changes in

regulations –

to encourage international trading activity

Treat customers fairly, protecting them from buying products they do not understand or from excessive

leverage

Allocate funding efficiently among businesses and economic sectors

▪

Not all of these should be imperatives for non- state-owned banks

▪

Focal role of banks in economy and recent market failures are attracting additional monitoring and regulation on–

Consumer protection

–

Risk mitigation–

Economy support

Presenter

Presentation Notes

Finally, in the “new normal” banks will have to become much more socially conscious to overcome the backlash of the global crisis on the reckless conduct of the past.


Concluding remarks

The unprecedented challenges in Greek banking are driven first and foremost by the fiscal and public debt crisis and they cannot be addressed in isolation

Opportunities for sustainable growth will have to be sought in a new extrovert national economic model, with a leaner operating model and a prudent and socially responsible risk culture

The Greek crisis will be over sooner or later and Greek banks will be part of the solution; in the day after, they will face very similar – yet milder – challenges to compete in the ‘new normal’

Documents

Greek Banking: Reflections on the Day Afterthefutureofbanking.boussiasconferences.gr/files/... · Market price equals book value. YE 2010 . YE 2000-09 . 1. On the face of it, global