Are there too many banks? The banking sector after the financial crisis Speech given at the general meeting of the Austrian Society for Bank Research

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1 Introduction

Governor Ewald Nowotny

Vice Governor Andreas Ittner

Ladies and gentlemen

Does the name diplodocus longus mean anything to you?

I won't keep you on tenterhooks – diplodocus longus is a long-necked dinosaur and the mascot of the Senckenberg Museum in my home city of Frankfurt. But between March and June of this year, this mighty beast stood in the entrance hall of a major Frankfurt bank. The actual reason it was moved there was to support a public fundraising campaign for the museum, but the animal's brief change of location did get me thinking about what dinosaurs and banks have in common. Is it some kind of omen warning us of the looming extinction of banks, perhaps?

Even today, scientists cannot agree on why exactly the dinosaurs died out. One of the many theories that have been put forward is that an asteroid struck the Earth something like 65 million years ago, destroying the dinosaurs' habitat. But few doubt that the dinosaurs endured roughly five million years of crisis well before the asteroid is thought to have finished them off for good. That period saw repeated climatic upheavals that disrupted the food chain on Earth. And the dinosaurs that adapted best to this new reality through evolution were the ones that survived the longest.

Of course, we're not hoping that the effects of the recent financial crisis will be felt for the next five million years, nor are we expecting the impact of a heavenly body to threaten the very existence of the banking system as a whole. But just as living conditions on Earth evolved millions of years ago, so, too, has the financial crisis transformed the conditions in which banks today go about their business. A handful of banks are already extinct, others are under intense pressure to adapt, and if there's one lesson we can learn from the prehistoric era, it's this: size alone isn't everything. An individual bank's dimensions don't guarantee that it will survive, and the size of the sector as a whole won't necessarily make it crisis-proof. Quite the opposite, in fact – a far more pertinent question is whether the sector in its entirety isn't actually oversized. This is the topic I would like to delve into in my address to you today. But before I continue, may I thank you most kindly for your very warm invitation to speak here today; Vienna is indeed one of my favourite cities.

2 The post-crisis situation in the banking sector

One need only dip into a newspaper to see that all is not well in the banking sector. Institutions around the world are facing immense headwinds, as the recent plunge in the share prices of mostly European banks so clearly shows.

This malaise can essentially be traced back to the legacy that continues to hang like a millstone around credit institutions' necks – for many years, their success was fuelled by excessive credit growth and an inflated financial market.

When the financial market bubble finally burst, it exposed just how many business models were built on sand. Monetary and fiscal expansion was brought in to buy time for renewal by initially stabilising the system – which it did, and successfully, too. Yet did the banking sector really make the most of that time? Did banks use the credit which society had given them to honour their long-term commitment to rethinking the way they did business?

Let's take stock of the situation.

Germany and Austria are the two countries with the highest number of "less significant institutions", as they are known in the parlance of the Single Supervisory Mechanism. Both systems are highly fragmented. But before I get down to the nitty gritty, there's one point I would like to make absolutely clear: neither of them – neither the Austrian banking sector nor the German one – have done all their homework yet, I'm sorry to say. And interestingly, the situations our countries are facing are very similar indeed.

Let's start with solvency. Since the financial crisis of 2008, Austrian and German institutions alike have improved their resilience, but in terms of their capitalisation, both sectors continue to languish far down the European leader board. On average, Austrian institutions have a tier 1 capital ratio of a little over 12% – that puts them last but one in the euro-area league table. It's certainly not incidental that my counterparts at the OeNB used their last Financial Stability Report to call on financial institutions to boost their capital base. As for German institutions, their tier 1 capital ratio now comes in at 15%, but that's only slightly above the European average. So there's still plenty of upside potential for both countries on this score.

Let's move on to the institutions' cost structure and profitability. In a worldwide comparison, the return on equity in the euro area falls short of the global average.[1] And within the euro area, you could almost say it's par for the course for Germany and Austria to bring up the rear on this count, and sadly, our two countries haven't bucked this trend over the past few years. Austria's return on equity ratio stands at an average level, whereas Germany's is exceptionally low.

At 58.8%, the cost-income ratio in the euro area is roughly mid-table by international standards, just ahead of that of the United States and the United Kingdom. Austria's ratio is slightly above average and has clearly improved since 1996, when a figure of 69.1% was recorded. The average ratio for German credit institutions, on the other hand, has deteriorated from 68.1% to 75.9% over the same period.

Both of our fragmented banking systems have been on a path towards structural consolidation for some time now – fewer institutions, slimmer branch networks, a leaner workforce. Incidentally, Germany has made considerably more progress on this count than Austria – the number of German institutions practically halved from more than 3,400 in 1997 to fewer than 1,700 in 2015. Over the same period, Austrian credit institutions fell in number from roughly 930 to somewhere in the region of 650, which is still a sizeable drop of around 30%.

So there's no denying that a number of reform measures have already been successfully implemented. But a systematic and thorough clean-up is still on the "to-do" list. On this score, banks in Austria and Germany are average at best, though it should be said that the key problems faced by each banking sector are slightly different.

For all the criticism, the situation right now is not yet acutely worrying – and that goes for both Austria and Germany. That said, institutions would be foolish to rest on their laurels. Because they're currently operating in a sound economic setting, and there's simply no way of knowing if things will stay that way. There's one thing I can say for sure, though: the future holds immense challenges in store for the banks.

3 The most pressing problems: debt mountain, demographics, low interest rates and digitisation

These challenges are huge and go to the very core of the matter – they will cause such disruption to the economic equilibrium and today's banking business that it's safe to say that many traditional business models will simply be defunct in future. To continue the metaphor I introduced at the beginning of my speech, just like the dinosaurs, the only banks likely to thrive in the long run will be those agile enough to adapt as swiftly and smoothly as possible to the new habitat.

There is much talk at the moment about whether the era of economic prosperity we have experienced since the 1950s is a thing of the past.[2] This conversation was sparked by a number of challenges, each of which would represent a mammoth task on its own – reducing the debt mountain, getting to grips with demographic change, coming to terms with the low-interest-rate environment, embracing digitisation. Let's now take a look at each challenge in turn, starting with the debt mountain.

The financial bubble that burst in 2008 arose from excessive indebtedness – from living on credit, if you will. The mountain of debt this built up looms as large as ever, and most economies around the world are only now beginning to reduce its size.[3] Emerging market economies, primarily China, have now in fact accumulated an even larger debt mountain. Consequently, households and businesses are preoccupied with running down their debt. For one thing, this curbs their investment, which acts as a drag on the global economy and in turn darkens the outlook for enterprises here. For another, the unredeemed debt puts massive pressure on banks' balance sheets.

As far as discharging debt is concerned, the situation is anything but comfortable for Austria's banks – the share of non-performing loans in Austria is slightly higher than the EU average. Combined with a sub-optimal capital ratio, that's certainly a worrying development. Let's hope we will be able to lower that debt mountain in Europe – and not just here but further afield as well. Until we achieve that, those debts will continue to impede the economy in general and the banking sector in particular.

The second challenge I would like to talk about is demographic change, which is increasingly making itself felt. The ratio of employed persons to non-employed persons is declining steadily – Germany's figures are particularly poor, while Austria fares a little better. But birth rates are low in both of our countries. So what does that mean for banks' business models over a medium-term horizon? A dwindling population, smaller economic growth overall, a higher savings rate and less investment and consumption. Without a doubt, the transformation of investment opportunities and customer expectations will place huge demands on banks and savings banks in Austria and Germany.

Even today, the sector is facing strong headwinds from the third major challenge – the low-interest-rate environment – which is eroding the profitability of interest-heavy business models. That makes interest rates a particularly important factor for German and Austrian institutions, given the rates-driven business models they run.

Narrowing margins in the rates business are crimping profitability. With levels set to remain low over the medium to long term, institutions with interest-heavy business franchises will very probably continue to feel the pinch, and not just in the near future – their resilience will be put to the test on a sustained basis. It would be unwise for these institutions to irresponsibly boost their risk appetite in an effort to compensate for the squeeze on margins in low-risk business.

The fourth challenge is digitisation – a development that most institutions still aren't embracing as much as they should, given that fintech competitors are already carving out market share with their innovative business propositions. Here, it would appear that the dinosaurs are being pushed aside by smaller and more agile mammals. That said, digitisation does bring immense opportunities for credit institutions: just think of the way digitisation can contribute to systematically overhauling business processes and organising them in a much more streamlined fashion.[4]

The combined force of these major challenges is bringing us to a turning point in economic history. And we are currently bang in the middle of this period of transformation. Just like the dinosaurs were.

4 Is the solution a realignment or market saturation?

In this phase, many banks and savings banks face a major challenge to their survival. Institutions are often told that they must realign their strategies in order to avoid becoming extinct. This demand is correct, as institutions will not be able to survive in the long term without bold realignment – or only as government-funded zombie banks.

But this demand is merely half the truth. It is also true that the necessary market consolidation is probably nowhere near complete.

I am firmly convinced that we are sending the wrong political message by saying that banks and savings banks merely need to adapt and everything will be back to normal. This statement neglects the fact that the sector continues to face considerable structural problems. Consequently, the political message needs to be a different one. Yes, institutions must update their business models, but structural reforms in the banking and savings bank sectors are likewise needed.

The question that follows on from this is: do we still have too many banks? Incidentally, this question is not new, neither at the European level nor in terms of Austria and Germany; academics, politicians and supervisors have been looking into this matter for many years now.[5] It has merely been placed on the agenda more frequently again of late. In his speech last week, ECB President Mario Draghi linked overbanking to the current low level of profitability amongst European financial institutions. He said that overcapacity and the ensuing intensity of competition exacerbated the squeeze on margins.[6] I, for my part, fully agree with this assessment.

I believe it is important to stress that the question "Are there too many banks?" is a simplification. Maybe we don't need fewer banks but simply smaller ones. Or maybe only trading needs to be scaled back. Or maybe we need other business areas. Or maybe there is just a bit too much of everything.

The question should therefore be this: is Europe and are Austria and Germany overbanked? Banking systems are referred to as overbanked if their banking services exceed real economic demand. The following three versions are frequently discussed.

  • The first is that there are too many institutions, rendering competition too fierce. This, in turn, causes very low margins and triggers a dangerous search for yield.

  • The second version is a market without pressure from new competitors from outside. In such an environment, it is impossible for new institutions to enter the market because barriers to entry are insurmountable – eg in the form of high licensing requirements. As a result, even uncompetitive banks will be able to survive, meaning capacity exceeds demand.
  • The third is an overbanked banking system riding a credit or financial bubble where transactions which do not make sense from a real economic perspective nevertheless generate a profit.

Can such effects currently be identified?

Let's begin with the matter of competition, which is typically analysed in two ways. First, competition is analysed based on concentration in the banking sector. In the EU, we often encounter strongly oligopolistic structures. In many member states, a small number of banking groups control the market.[7] Since 2009, this concentration has increased even more. By contrast, Germany and Austria have relatively fragmented systems. In 2015, Germany was the country with the lowest and Austria the country with the third-lowest concentration of market power in the EU. However, whereas the concentration in Germany has increased since 2008, it has fallen slightly in Austria.[8] Yet both systems remain fragmented – without a doubt.

As I said earlier, consolidation is ongoing but has yet to be completed, both in Germany and in Austria. However, the consolidation pressure on institutions is probably greater here in Austria than it is in Germany.

Does this mean that our banking sectors are too protected or too competitive? To answer this question, we should first take a look at other measures of competition.

Because, second, the level of competition can also be analysed on the basis of institutions' ability to set prices. And here Germany exhibits an above-average intensity of competition by international standards, although it has declined since the early 2000s.[9] By comparison, competition in Austria was somewhat less fierce before the financial crisis. Since then, the level of competition has also decreased and therefore remains below that of Germany.[10]

Ultimately, it is difficult to ascertain from the various measures of competition whether there is a deficit or a surplus of banks. Fragmentation is not necessarily a bad thing; quite the opposite, in fact, as it can guarantee a dynamic market. The low pricing power and structurally low margins in Germany could also be interpreted in this way. That said, these observations could also be a sign of inefficiency – a possibility that cannot be ruled out for Germany and Austria, too, when looking at the lousy cost-income ratios. However, it is important to be aware that inefficiencies may equally occur in oligopolistic markets with just a few large institutions.

As you can see, answering the question of whether there are too many banks is anything but easy. While the strong fragmentation of the banking sector in Austria and Germany may be an indication that the level of competition and capacities are too high, a more in-depth analysis does not bear out this simple statement. Considering the limited pricing ability, the intensity of competition in Germany is above-average by international standards. In Austria, however, competition in the market appears to be less fierce and market power more pronounced.

A certain degree of additional consolidation can be expected for Germany and is probably inevitable for Austria. Institutions in both our countries will also have to improve in terms of their cost structures.

Let us now shed some light on the third and final version of overbanking. A banking system can be overbanked and nevertheless lack competitive edge if it is, as it were, riding a financial or credit bubble. This becomes particularly apparent when credit volume increases substantially in relation to gross domestic product. A further indicator of an inflated system is an excessively rapid expansion of bank balance sheets in relation to national GDP.

Back in 2014, the European Systemic Risk Board, or ESRB, stated that the European banking sector had ballooned since the 1990s and that the majority of this unhealthy growth was concentrated in the largest banks.[11] Europe was and remains highly dependent on banks by international standards, while capital market orientation is relatively weak by comparison.

Until 2008, for example, we observed in Europe both a speedy increase in credit and an expansion in balance sheets, which progressed just as quickly.[12] The figures for Germany are astounding: the German banking sector's balance sheet total tripled from just over €3 trillion in 1993 to more than €9 trillion in 2008. In other words, from less than 190% of GDP – which is not exactly a small figure either – the German banking sector's balance sheet had become inflated to more than 360% of GDP by 2008.[13]

Bearing this in mind, the balance sheet reduction since 2008 has been rather modest. Between 2008 and the end of 2015, euro-area banks have only trimmed their balance sheets by a little over 15%. German institutions reduced their balance sheets by around 30% – representing a decrease in the share of German GDP from the above-mentioned 360% in 2008 to just under 230% in 2015. In Austria, however, the reduction only amounted to around 10%. Against the backdrop of the rapid increase since the early 1990s, the reduction was absolutely necessary and is probably far from being completed.

Hence, the picture is clearer in terms of the excessive size of the banking sector than when it comes to the question of whether competition is too high or too low. Europe remains overbanked. Although Austria and Germany are not among the countries to have seen strongest growth in the banking sector, both have recorded fairly large expansion.

Now, you might argue that this growth is economically justified as it is the response to heightened real economic demand. The higher volume would then cause economic productivity to increase.

Recent studies do indeed grapple with this difficult issue.[14] They ask whether a financial sector has grown too large or whether its size is efficient in that it meets sustainable real economic needs. In the US sector, there are initial signs that the massive growth since the 1990s is actually attributable to secondary trading activities that are of little use to the economy.

What's more, the productivity of financial services seems to have improved only marginally since 1900. This means, therefore, that the increases in efficiency made possible by the IT revolution were primarily used to make such trading activities more profitable. Increases in the efficiency of simple bank services, on the other hand, were fairly small.

In other words, while large-scale proprietary trading was carried out profitably until 2008, the simple issuing of new bonds is not much more efficient today than it was in John Pierpont Morgan's days at the start of the last century …

Let me summarise my thoughts: it is not up to the supervisory authorities to class individual transactions or business areas as unprofitable – that is market players’ duty. It is rather a question of guiding the light of the streetlamp under which we are searching to the right place, or in this case, to light a broader area – we are searching for the reasons behind the malaise of our banks and savings banks. Until now the beam has been too focused upon their failure to adapt their business models. But maybe we won't find the key under this beam of light at all, because we lost it much earlier somewhere else. Maybe the answer is that the banking sector has simply grown too large.

This is what I think is important: market consolidation does not necessarily mean that there should be fewer small banks and fewer savings banks, or that there should be no more branches. It may indeed be the case that many smaller institutions cannot hold their ground, or even that some branches prove unsustainable. But it may equally be the case that downsizing is healthy for some larger institutions, and that a fintech competitor provides some services more efficiently and better. To put it simply, competition between institutions will establish which business areas and what structure will no longer be needed in the long term.

In this context, fixating on high profitability rates constitutes a problem. Was this not the exact problem we encountered prior to the financial crisis? May I remind you of overly ambitious return on equity objectives of more than 25% per year – profitable, admittedly, but not sustainable.

I think that we must make a distinction.

On the one hand, I assume that the times when the target was a return on equity of 20% or more are over for the foreseeable future.

Higher yields through aggressive balance sheet expansion, which is the strategy some institutions choose, seems questionable to me. In the past, such fast growth has not been of a sustainable nature, and to me it is, in fact, an expression of strategic perplexity.

On the other hand, the situation is different when it comes to conservative returns. As a supervisor I am keen to see that an institution is capable of surviving in the long term. This means that an institution must have reserves for hard times. These must, of course, be generated when times are good.

Thus for me, it is not a question of having especially profitable institutions. Profitability is only a means to an end. Returns must, however, be sufficient to assure future resilience, in other words to meet capital requirements and to cover the cost of equity. To this end, banks must also improve their market funding. Summed up, the ratio of yield to risk must be right. This is what interests supervisors; everything else is up to the market.

5 The to-do list

So where do Europe's banking sectors stand in general terms, particularly Austria’s and Germany’s? Have we taken the lessons learned from the financial crisis seriously, and have we been rigorous enough in our interventions? What more do the individual market players need to do?

I am convinced that institutions must develop business strategies which generate income without inflated balance sheets. Thus they need to become more efficient in order to eventually increase economies of scale on the cost side. On the revenue side, core competencies should be identified and utilised to earn money. For institutions with interest-heavy business models this means, first and foremost, finding strategies to adapt to the low-interest-rate environment, which is likely to continue for some time to come.

For policymakers and supervisors, it means that the political support for the banking sector must finally end – unfortunately, I see only limited signs of this so far.

This makes it all the more important to push ahead with concluding the post-crisis reforms. We should finish implementing Basel III by the end of this year, and end the preferential regulatory treatment of government bonds in the medium term. Much speaks in favour of advancing the capital markets union in order to strengthen the capital markets as an addition to the banking system. Most importantly, we cannot deny the existence of structural deficits in the banking sector.

6 Conclusion

Ladies and gentlemen, the credit institutions of Europe as well as those of Austria and Germany have made considerable progress since the financial crisis. However, they are insufficiently armed at the current juncture to survive the challenges of the new economic age.

As this age dawns, banks and savings banks must adapt their business models to the prevailing conditions if they want to avoid suffering the same fate as the dinosaurs.

Addressing legacy problems and realigning business models will not be enough. The sector must, in fact, prepare for its share of national accounts to shrink further. The systemic clean-up process, unavoidable following the bursting of the financial bubble, is not yet complete.

However, we should not confine this discussion to simply saying "there should be fewer institutions and fewer branches". A further increase in the market power of large banks is not the perfect solution. Instead the focus should be on shrinking the sector to a size required by the real economy, a sustainable size. Market players must decide on how to eliminate overcapacities.

Provided we deal with these major challenges, I see a good chance of us exiting the current crisis before the next five million years are over and I don’t believe banks are likely to be relegated to the museum even a long way down the road. 

7 Literature

Claessens, Stijn and Laeven, Luc (2004): What drives bank competition? Some international evidence. Journal of Money, Credit and Banking 36(3): 563-83.

Dombret, Andreas (2016): Digitalisation – repercussions for banks and their supervisors. Speech delivered at the 16th Norddeutscher Bankentag at Leuphana University Lüneburg, 8 June 2016

Draghi, Mario (2016): Welcome address at the first annual conference of the ESRB, Frankfurt, 22 September 2016

European Systemic Risk Board (2014), Is Europe overbanked? Report of the Advisory Scientific Committee, No 4/June 2014.

Gordon, R J (2016): The rise and fall of American growth: The U.S. standard of living since the Civil War. Princeton.

Koetter, Michael (2013): Market structure and competition in German banking. Modules I and IV. German Council of Economic Experts, Working Paper 06/2013.

McKinsey & Company (2015): Debt and (not much) deleveraging.

Phillippon, Thomas (2015): Has the US finance industry become less efficient? On the theory and measurement of financial intermediation. American Economic Review 105(4): 1408-1438.


  1. See World Bank, Global Financial Development Database (

  2. R J Gordon (2016) The rise and fall of American growth: The U.S. standard of living since the Civil War. Princeton.
  3. McKinsey (2015), Debt and (not much) deleveraging.
  4. Dombret, Andreas (2016), Digitalisation – repercussions for banks and their supervisors. Speech delivered at the 16th Norddeutscher Bankentag at Leuphana University Lüneburg, 8 June 2016.
  5. See, for example, S Claessens and L Laeven (2004) "What drives bank competition? Some international evidence. Journal of Money, Credit and Banking 36(3): pp 563-583.
  6. Draghi, Mario (2016): Welcome address at the first annual conference of the ESRB, Frankfurt, 22 September 2016.
  7. Unless otherwise stated, the analyses are based on data from the ECB's consolidated banking data statistics.
  8. Measured by the share of the five largest institutions in total assets.
  9. M Koetter (2013), Market structure and competition in German banking. Modules I and IV. German Council of Economic Experts, Working Paper 06/2013.
  10. See World Bank, Global Financial Development Database (
  11. European Systemic Risk Board (2014), Is Europe Overbanked? Report of the Advisory Scientific Committee No 4/June 2014.
  12. European Systemic Risk Board (2014), Is Europe Overbanked? Report of the Advisory Scientific Committee No 4/June 2014.
  13. M Koetter (2013), Market structure and competition in German banking. Modules I and IV. German Council of Economic Experts, Working Paper 06/2013.
  14. T Phillippon (2015), Has the US finance industry become less efficient? On the theory and measurement of financial intermediation. American Economic Review 105(4): pp 1408-1438.