EMCC European Monitoring Centre on Change

EMCC dossier on the financial services sector

The recent financial crisis has brought to light the serious challenges that the European financial services sector is facing. What are the prospects of a viable, more resilient financial industry emerging from the crisis? To answer this question, we need to look at the economic trends in the banking and insurance industries and examine the results of the debate on the regulation of financial markets. Also, a look at the business models that are applied in the different segments of the financial sector as a response to the crisis can help to map the future of the sector. From the present viewpoint, it appears very probable that different approaches will compete in the near future and there will be no clear decision about which is the superior model. The coming years will be a period of testing at the business level as well as at the level of public regulation.

Financial Services: challenges and prospects

The financial crisis is the most important driver of change impacting on the banking and insurance industry today. Prospects for the sector are moderate, at best, in the medium term. This is the conclusion of the report Financial services: challenges and prospects which looks at the impact of globalisation on the sector. The sector is expected to face comprehensive re-regulation, growing governmental influence, and increasing pressure from investors. Market growth will thus remain limited, and the further rise of equity ratios will constrain profitability.

Return to profitability

However, it is not all bad news: throughout 2009 and 2010 the health of the financial system has improved. With the global economy growing, risks to financial stability have diminished. The capital ratio of the euro area’s banking system rose by one percentage point from autumn 2008 to 7.5% in December 2009, the highest level ever recorded. Continued deleveraging in the banking sector (paying off of debts) has helped to reduce the predisposition to shocks, so normalising markets. With the rise in asset prices, large parts of the banking sector have returned to profitability.

Restructuring

No clear trend of company restructuring in European banking services is visible. Much depends on new regulation, which is still being formulated. Some changes can, however, be discerned. Firstly, trading books will not regain their pre-crisis importance. This can be attributed to the significant reduction of proprietary trading, which was associated with a strong decline in jobs for traders. Secondly, deglobalisation of markets may happen to some degree as national markets become more important. Foreign activities do not always fit the prevailing business model and appear to be risky. Finally, national governments have supported many banks directly or indirectly. This is going to create a strong commitment to the country of residence and may lead to a retreat from international investment banking and trading.

However, the prevailing trends of the last decade may override these tendencies. Firstly, asset trading – proprietary trading in particular – was the most profitable part of the banking business and still provides exceptional profit opportunities. The banking business is therefore partly returning to these activities with great financial success. Secondly, international banking business corresponds with international trade of goods and services, and with an openness of capital markets worldwide. A return to national banking is therefore unlikely. Only the pace of internationalisation may be expected to decelerate. Finally, the influence of economies of scale and scope are still very strong. Information and communication technologies provide an expanding potential for efficiency gains in the operational business, in communicating with clients and internet-based banking services. This may further promote the growth of the big players.

Scenarios for the future

The past is the future – a high risk status quo scenario

Scenario 1 assumes that the big players are strong enough to ensure that no major reform of the financial system takes place. The crisis is generally interpreted as the accumulation of unfavorable circumstances rather than a systemic default. This allows ‘liberal’ banks to continue their profit-oriented strategies while the ‘sustainable’ segment will succeed in holding its position, albeit without expanding substantially. Faced with the growing strength of ‘liberal’ banks, ‘state-owned’ banks will be under stress and governments will try to reduce their involvement in such institutions. The scenario is based on the belief that a further financial crisis can be avoided with only minor regulatory adjustments and that retail and commercial banking will provide sufficient stability.

A new world order for financial markets – the end of the golden age

Scenario 2 sees the G20 governments agreeing a fundamental reform of the world financial system in December 2010. The reform includes higher and risk-based equity ratios, the separation of investment banking from retail and commercial banking, the submitting of resolution plans (‘living wills’) – at least by the big players – and efficient monitoring. Implementing these rules will reduce the competitive advantages of liberal banks and bring the sustainable and state-owned companies into a much better position. Higher equity ratios will be the key to this type of adaptation, which will require a long and difficult transition period.

Divided economies – a worst-case scenario

Scenario 3 assumes that the financial crisis cannot be kept under control. Rising default rates and overburdened public budgets will force some governments in the euro zone to cut liabilities by between 20% and 30% and to liquidate a series of banks. Austerity programmes in European countries will be an additional burden on the real economies and rising inflation in the US and the UK will create further imbalances. The scenario foresees the international regulation of financial markets failing, hence a strongly profit-oriented and growth-oriented group of managers and professionals will continue to engage in short-term speculation and arbitrage, supported by some countries offering liberal financial markets. This approach will be opposed by some sections of society, which will start developing local network-based economies. A fundamental critique of globalised economies will lead to new approaches based on ‘micro-organisms’ rather than macro-institutions.

Employment in the financial sector

All scenarios see a further reduction of employment in the financial sector. This will be most severe in the third, ‘divided economies’ scenario. However, the pressure to achieve cost savings will be strong in all scenarios, while information and communication technologies will provide scope for continuous productivity increases.

Case studies

The research drew on a number of case studies. Information on the approach taken in conducting the case studies is available in a methodology report.

Generali

Generali is the third-largest insurance group in Europe after Axa and Allianz, represented in 65 countries throughout the world. The group managed to pass through the financial crisis with a continuously rising turnover. Generali France introduced a new model for work organisation – Empowered Work Organisation (OTR). Even though this new organisation is a response to fundamental changes in the insurance business rather than an answer to the crisis (experiments started in 2007), the reorganisation of work processes has contributed considerably to the resilience of the company against financial and economic risks.

Building Societies in the UK

UK building societies are an excellent example of traditional mutual banking that went out of fashion during the liberalisation of banking markets. The study examines the case of Leek United. The business strategy of Leek United has been stable in recent years, the building society being committed to traditional values. Credit exposures are predominantly financed by savings accounts, and the decline of deposits has prompted the bank to decrease total assets. With shrinking overall activity, Leek United aimed to improve cost efficiency and productivity. This resulted in a 5% job cut in 2009 and a 16% decline compared with 2007.

Companies with a ‘liberal’ approach

A broad group of financial institutions follow a ‘liberal’ approach, based on the free movement of capital and unrestricted innovation in capital markets. Investment banking is an important part of the business while retail banking is its basis. For this case study, three representative companies were selected: Barclays, Deutsche Bank and Unicredit. Companies in this segment will be adapting their business models in response to the financial crisis. Many raised equity ratios during 2009, improved risk assessment tools, reduced costs by cutting jobs, and revised their bonus systems. These adaptations – however – do not address the core business, which includes a strong investment segment in addition to retail and commercial banking.

Companies with a ‘State-ownership’ approach

Over the course of the crisis, a number of banks had to take advantage of state guarantees and public capital support, leading to state-ownership. These financial institutions suffered from the devaluation of financial investments during the crisis either because they were heavily engaged in this business or because they were among those that could not exit the markets early enough. For this case study, three representatives were selected: RBS, the bank in Europe with the highest level of governmental support; Commerzbank, the second largest credit institution in Germany; and Fortis, which was a large financial service provider for insurance, banking and investment management before it encountered severe problems in 2008.

Companies with a ‘sustainable finance’ approach

Banks which follow a ‘sustainable finance’ approach are characterised mainly by a conservative and risk-sensitive business approach. Their key segment is retail banking and a focus on good customer relations is a high priority. Some, such as Santander and Rabobank, are also active in the area of asset management, investment or insurance. This group of banks was not seriously affected by the crisis. This case study examines the reasons why institutions with a ‘sustainable finance’ approach have not been as badly affected by the crisis as their competitors.

Further case studies

Dexia Bank

Dexia, the world’s biggest lender to local authorities, has faced serious financial challenges in the past two years, mainly linked to unsound financial investments. This report focuses on how Dexia Bank Belgium has responded to the considerable challenges resulting from the financial and economic crisis, and how the transformation of its workforce has been managed under these circumstances. It specifically emphasises the role of the social partner organisations at different levels (European, national, local), their role in the change management process and the impact of restructuring on employment.

Danske Bank

This case study demonstrates how Danske Bank, market leader in banking services in Denmark and one of the largest banks in northern Europe, has dealt with the impact of the financial crisis, and with longer term restructuring requirements arising from rapid expansion and internationalisation of the bank, the integration of IT systems and the relatively high employment density in the sector in Denmark, compared with other European countries. The bank was able to draw on its well developed structures for social dialogue at national level, as well as the company’s relatively new European Works Council in the discussions.

Further scenarios

Long-term scenarios for the skill needs of the European financial sector were developed by Economix Research & Consulting on behalf of the European Commission in 2009. The study is part of a comprehensive analysis of future skill needs in the European Union launched by the Directorate General for Employment, Social Affairs and Equal Opportunities. The scenarios identify different development paths up until 2020 and draw conclusions for human resource policies in the EU Member States. They take the strategic responses to the challenges of the financial crisis as their starting point.

Related research

The number and importance of new investment funds (private equity (PE), hedge funds (HFs), and sovereign wealth funds (SWFs) has increased sharply in recent years. This increase has generated heated debates on the impact of these funds on restructuring practices, employment levels and industrial relations. Fund managers have claimed that they play a valuable role in rejuvenating underperforming companies, thereby contributing to long-term employment growth. By contrast, many employee representatives and those on the political left have argued that these new funds secure returns at the expense of labour. This report presents the results of a project that assessed the effects of investment funds on labour outcomes.

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