As German banks reveal poor interim results, John Rushton and Max Sembach of PA Consulting Group explore why German banks are so much less profitable than UK banks and what they can do about it.
UK banks top the global profitability league. German banks by contrast languish near the bottom of the league and are outplayed on every measure. Return on assets for the main UK banks is over four times higher than for the big German private sector banks; cost income ratios are more than 30% lower. In consequence the market capitalisation of German banks is very low: Deutsche Bank, the world’s third largest, is valued by the market about the same as Halifax Bank of Scotland, of which few Germans have even heard.
Low market value restricts strategic options. German banks are worth so little they are reduced to the status of spectators or targets in the coming consolidation of the European banking industry.
There are both structural and managerial reasons for low German profitability. The structural reasons relate to so-called ‘unfair competition’ by the public sector Sparkassen/Landesbanken, high-cost inflexible labour, and customer behaviour. German banks too often use these structural factors as an alibi for poor strategy formulation and execution. Yet they have plenty of scope to increase revenues and reduce costs significantly within existing structural constraints. By learning from experiences in the UK and elsewhere, German private sector banks can make changes which could quickly double market capitalisation.
On the revenue side, lending spreads are a full 1% higher in UK banks compared to German banks, while domestic fee margin is some 0.4% higher in UK banks. Reaching UK levels on lending spreads alone would generate €5 BN profit for each of the large German banks.
On the cost side, the average German banker costs 40% more to employ than the UK equivalent. If Dresdner Bank’s staff cost the same as Barclays Bank’s staff then its profit would increase by over €1 BN. Treating the UK as a benchmark for branch density, Germany has 8,000 too many branches. The crude saving from this capacity elimination would be in the order of €8.5 BN for the industry as a whole.
In the past, German private sector banks have blamed German labour laws, the under-pricing policies of the Sparkassen and the low customer propensity to borrow for their failure to restructure. Instead of pointing to the customer or the Sparkassen competitor - neither very cost efficient nor customer orientated - management should revisit its ability to innovate new products and services.
As the market punishes their under-performance, German private sector banks follow a defeatist strategy of loss minimisation and capacity reduction, with no clear vision of how to win in their market. What they need to do is:
- Raise income as well as reducing costs. The banks have headline cost reduction targets. Yet without a parallel revenue building strategy, capacity reduction is self-defeating and runs the danger of not reaching the revenue targets necessary for future long-term sustainability of the banking operations. Alongside cost reduction the banks need to re-price credit to raise lending margins. The UK banks have shown it is easier and quicker to charge every customer a €20 annual account fee than to try to close 200 branches.
- Compete on service proposition. The winning formula is not just a lean cost base but also a differentiated proposition. Once they have arrived at a profitable model the private sector banks must position for growth, which means building product, service and brand assets.
- Focus on the back office. German banks seem more anxious to take cost out of the customer-facing branch network than from the overhead areas where the lowest-hanging fruit is found. A decimated branch network cannot sustain growth later: banks are in danger of jeopardising their long-term revenue future through ill-considered and short-term network cuts.
- Industrialise processing. All banks say they believe in collaboratively owned shared service centres. Yet in Germany today every bank wants to insource, few can demonstrate unit cost efficiency, and most will fail to build a commercial processing business. Meanwhile, as banks in other countries increasingly look to locate processing factories in low cost countries such as India or the Baltic states, German banks still think in terms of Munich and Eschborn.
Germany is the only country west of Belarus whose banking sector remains dominated by the public sector. The Sparkassen have managed to impose their banking model on the rest of the industry. The private sector banks need to re-discover the will to win and then challenge the old-fashioned banking model.
