Stagnation, fines and regulation leave European banks struggling

Are European banks in terminal decline? The global status of the continent's banking sector has been steadily weakening for years. Tough regulation on capital and pay, fines for past misdemeanours and economic stagnation in home markets have hit Europe's biggest banks hard, leaving them struggling to keep up with their transatlantic rivals.

Over the past week, the trend has seemed to accelerate. Consider the latest quarterly results from Credit Suisse, a strategic plan from Deutsche Bank and HSBC's threats to relocate its headquarters from London to Hong Kong amid growing unease about fiscal and political uncertainties. They are hardly an advertisement for the future of European banking.

In investment banking, the basis for the global strategies of most international banks, the first three months of 2015 was the best quarter for years. Wall Street's finest hailed levels of profitability not seen since the financial crisis. European banks have been buoyed along too. But there is a wide gap. Goldman Sachs made a 15 per cent return on equity. Credit Suisse and Deutsche, the only big European banks to report so far, made 10 per cent and 3 per cent.

The weaker performance is evident across the board. Though Deutsche's sales and trading revenue was up 14 per cent, and Credit Suisse's 10 per cent, the equivalent number at Goldman was nearly 25 per cent.

In the underwriting and advisory wing of investment banking, the Europeans are lagging, too. European banks have had their worst showing for a decade in M&A and equities, according to league table data from Thomson Reuters. There were only two Europeans (Barclays, ranked four, and CS, 10) among the top 10 deal advisers so far this year. A decade ago, UBS and Deutsche were in there, too. In equities, Barclays has tumbled down the rankings, leaving only three banks (Credit Suisse, UBS and Deutsche) in the top 10.

There are a few obvious drivers. In M&A, US banks are winning the advice mandates in part because US companies are dominating the deals. The trend for companies to take advice from independent boutiques is an extra squeeze.

In trading, most of the big European players have a strong fixed-income bias and are the most exposed to the impact of steadily toughening regulatory capital requirements. That risks spilling over into the one main bright spot for Europe's banks - debt capital markets issuance, where Barclays and Deutsche and to a lesser extent HSBC, Credit Suisse and BNP Paribas are giving the US banks a run for their money.

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Deutsche is the last red-blooded investment bank left in Europe. Its new strategy involves cutting €200bn of assets from its investment banking division. But put that in context. The cuts will still only reduce the investment bank's balance sheet to €1.2tn, the same as it was last September.

The trouble is that, like Credit Suisse, Deutsche is stretched to the limit on capital. It is now aiming for a leverage ratio of equity to assets of 5 per cent (up from 3.4 per cent now).

Deutsche's shift away from retail banking (through the sale of Postbank) and redoubled commitment to investment banking is unusual in a regulatory environment that punishes many core investment banking activities.

If the bank is lucky - the European economy turns up, regulators back off and the punishment of past misdemeanours abates - it could be a winner among European peers. But even then, it is hard to see even Deutsche keeping pace with a Goldman or a JPMorgan. If Deutsche is unlucky - the regulatory pressure continues, the European economy stagnates and costs prove stubborn - it is stuck. Like Credit Suisse, its name binds it to its domestic economy and all the attendant regulatory pressure. And unlike some European rivals, it has few other strings to its bow.

How different a situation HSBC finds itself in. Despite past scandals that look as bad as any rival's, and an investment bank that like Deutsche's has been growing, its biggest and best franchises are in Asia. Only its London headquarters earn it the tag of Europe's biggest bank. No wonder it is threatening to up sticks for Hong Kong.

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