David T' Llewellyn

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STRUCTURAL CHANGE IN THE EUROPEAN BANKING INDUSTRY

• David T. Llewellyn
• Loughborough University
• President, SUERF The European Money and Finance
  Forum
• SUERF/NIESR Seminar
• London, 24 March 2006

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PRESSURES FOR CHANGE IN EUROPEAN BANKING

• Combination of Pressures
• Global
• Country-specific
• European Integrationist

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STRUCTURE OF PRESENTATION

• Current structure of European Banking
• SHV v. STV strategies
• Bank- v. Market-based models
• UK case study
• Convergence v. Diversity in European Banking
• Corporate Governance issues

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FOUR KEY ISSUES IN EUROPEAN BANKING

• Will current national structures remain?
• Will there be a convergence of national financial
  systems?
• If convergence, will it be on the Anglo-Saxon
  model?
• Governance implications

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THE CURRENT POSITION

• European banking highly atomised
• European banking populated by a variety of
  different types of banks varying mix of Public,
  State, Co-operative, Mutual, and Private banks
• Differ Substantial differences between and within
  countries bank efficiency, profitability, size
  of banks, business models, business profiles of
  banks
• Different business objectives SHV v. STV models
• Competitive conditions vary within/between
  countries

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THE CURRENT POSITION

• In some countries, banks have been earning
  negative Economic Value Added
• Differences between countries bank-based v.
  market-based
• Corporate governance arrangements and structures
  vary between countries
• Disciplining power of the capital market and the
  market in corporate control (the take-over
  market) vary between countries
• Wholesale v. Retail banking

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BANK BASED MODEL

• Bank financing dominates
• Insider control
• Close bank relationship
• Internal corporate governance
• Low capital market discipline

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MARKET-BASED MODEL

• Diffused ownership
• Capital market discipline
• SHV
• MCC
• Greater access to capital market financing
• Arms-length bank relationship

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NO STRICT DICHOTOMY

• Always a mix
• Securitisation
• Use of derivatives by banks
• Trading in credit risk
• Loans in tradeable form
• Underwriting by banks
• Banks securities trading
• Risk management by derivatives trading

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SHV v. STV MODELSThe STV/SHV mix varies between
countries

• view of the company social institution
• who are stakeholders
• stakeholders v. shareholder
• bottom-line business objective
• exclusivity of objective
• strategy implications
• capital market pressure
• market in corporate control

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Table 1
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THE THESIS ON BRITISH BANKS PROFITABILITY

• Banks are profitable because they choose to be
  profitable
• Focus on sub-markets
• Pressures on British banks capital market
• Structural conditions are supportive
• Benign business cycle
• A convergence is likely in European bank
  profitability

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EVA STRATEGY

• ROE exogenous
• Raise rate of return
• Cost strategy
• Revenue strategy
• Capital-free business
• Remove assets from balance sheet
• Disengage
• Sell business
• Securitise assets
• Return capital to shareholders
• Organisational structure

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EVA STRATEGY OF UK BANKS

• Substantial cuts in cost-base
• Rationalise branch network
• Low branch penetration
• Sell businesses
• Reduced employment
• Disenfranchise
• Securitisation programmes
• Repay capital

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EVA STRATEGY OF UK BANKS

• Off-balance-sheet business
• De-diversification
• Outsource
• Dual pricing
• Cross-subsidies

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EVA PRESSURES

• Power of capital market
• Market in corporate control
• Culture SHV v. STV
• Legacy effect
• Legal position securitisation and capital
  repayments
• No STV banks
• Limited mutual sector
• Institutional shareholders
• Governance
• MCC

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HAZARDS WITH SHV MODEL

• Short-termist
• Costs cut too much
• Exploit semi-monopoly powers
• Market expectations vicious circle
• Indeterminate
• Other stakeholders
• Vagaries of the stock market
• Limitations in MCC
• Social exclusion

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SCHOOLS OF THOUGHT ON CONVERGENCE

• Convergence in Europe
• Convergence on Anglo Saxon model
• Plurality of financial systems
• Hybrid convergence

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HYBRID CONVERGENCE

• SHV in ascendancy
• governance arrangements within SHV model
• erosion of Universal Bank
• greater role of capital market financing
• capital market discipline
• more arms-length bank relationships
• Securitisation
• SH activism

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HYBRID CONVERGENCE

• more institutional shareholdings
• more international shareholdings
• range of financial instruments
• increased shareholder rights
• corporate governance
• shareholder rights
• Accountancy rules
• MCC

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MARKETS IN ASCENDANCY

• Globalisation of markets
• Euro capital market
• Institutionalisation of fund management
• Regulation arbitrage
• IT/communications technology
• Financial innovation
• Competition and margins
• SHV ascendancy
• Universal Banking model (?)

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SHV ASCENDANCY

• Global competition
• SH activism
• International SH base
• Institutional SH from SHV ethos
• Legal changes
• Corporate governance laws

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NO CONVERGENCE

• size of banks
• business mix
• organisational structure
• geography
• distribution v. production
• monoliners v. multi-channel
• business models
• institutional structure

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CORPORATE GOVERNANCENo corporate governance
convergence

• rights of shareholders
• rights of minority shareholders
• extent of cross-share-holdings
• concentrated v. dispersed ownership
• institutionalised shareholding
• SHV shareholders
• ownership/voting rights
• disclosure regime
• outside monitoring
• Take-over defences

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GOVERNANCE CONTINENTAL

• Insider control
• Limits to SH rights
• Close ownership
• Lower SH rights v. creditors
• Management power
• STV focus
• Less active MCC
• Take-over defences

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GOVERNANCE CONTINENTAL

• Less transparency
• Cross share-holdings
• Voting rights not always 11

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GOVERNANCE ANGLO-SAXON

• MCC external influence
• Diffused ownership
• SH rights
• SHV focus
• High disclosure
• Voting rights

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SOME CONCLUSIONS

• Increased emphasis on SHV
• Corporate governance implications
• No convergence on a single model
• Hybrid convergence in Europe