Few know the European and U.S. banking industry from the inside as well as Ermotti. He retires from banking after a four-decade career spanning a stint at Citibank; 16 years at Merrill Lynch, where he eventually ran the equities unit; the de facto No. 2 job at Italy’s UniCredit SpA; and finally UBS, where he was promoted to chief executive officer after a rogue trader cost the bank billions.
I caught up with Ermotti to discuss what lies ahead for banking. In the past, he has worried about too much regulation stifling banks. Now he’s not sure lenders will be able to endure another economic downturn, especially in Europe where they remain “quite vulnerable” to the low interest-rate and growth environment.
After arguing that banks could merge their back offices to cut costs, lately he thinks they are more predisposed to doing outright mergers. As for the longer term, he says that London’s star status as a financial center has already faded and that growth in China will remain primarily in local hands.
What follows is a lightly edited and condensed transcript of our conversation.
Elisa Martinuzzi: As the pandemic heads into a second phase of lockdowns, how do you think the banking industry will survive and emerge from it?
Sergio Ermotti: The fact that we were able, as an industry, to come out solidly is testament to many of the regulatory and strategic actions taken by banks over the years.
Most likely you will see very modest growth, if any at all in some economies, in the next few years. The structural overcapacity that we have right now in the system, coupled with the lack of profitability in the vast majority of banks in Europe particularly, makes our sector quite vulnerable should another more profound slowdown come in the next few months or years. We need to acknowledge that the fact that we managed this crisis well so far is not yet a solution to the problem.
EM: Do you think that the vulnerabilities the European banks had going into the pandemic further widen the gap with U.S. firms, particularly those that have been benefiting from very strong trading figures?
SE: Yes, some of [the U.S. firms] have benefitted from trading, but others are well below their average returns of the last few years in terms of returns on capital. Still, they have a decent position with a 7 or 8% return on tangible equity, which is not so bad considering the environment.
In Europe, even if you take out credit losses, banks struggle to get into positive territory. So I think the gap is likely to stay there unless two or three factors come into play.
First, you need an improvement in the macroeconomic situation in Europe to drive sustainable credit growth. Second, you need to re-establish a decent return for banks also on the liability side of the balance sheet. Last, but not least, you need to allow for the creation of a truly integrated banking market, through a banking union, and the ability to create capital and liquidity synergies within banking groups. This would help with or without further industry consolidation.
UniCredit [when I was there] already had a pretty good European business mix with a vision that Europe would one day be a common banking market. And actually the opposite happened. Europe has reversed and is still very parochial and de facto a sum of standalone jurisdictions.
EM: How much room do you think there is in Europe for some of the larger banks to pull out of certain businesses, reducing their footprint?
SE: The next level could be that, in some cases, they need to get out of certain geographies. So for example, buying the retail business of Bank A because you as Bank B already have critical mass in the country, and then selling your corporate SME business to Bank C because you don’t have a critical mass in that sector.
That, of course, and ongoing domestic consolidation will continue.
EM: How close are we to seeing mergers of back offices?
SE: Not to the full extent possible, but we see good developments in some areas. For example, we are developing our U.S. infrastructure with Broadridge. This is allowing us to reduce development and maintenance costs, as our partner will then sell to third parties. So through that we can all benefit from the economies of scale.
In Europe, I guess that probably the easiest way to create synergies right now is going to be more through consolidation in the way I just described or through broader outright M&A.
EM: As China opens up its markets to foreign players, how much does that change the global landscape of big finance?
SE: There is no doubt that the opening of the China market is a great opportunity. It is also clear that Chinese institutions will probably capture the vast majority of the growth. Still, the opportunity for foreign institutions is significant. That would also be a positive situation for China because they would have to create a healthy and competitive market place.
EM: Will Brexit ultimately reshape London and Europe as financial centers?
SE: London will continue to be an important center, I have no doubt. But you will find out in 5-10 years if this was a good or a bad decision. Most likely Britain will try to regain some of the lost attractiveness across the board, not necessarily just in capital markets activities but also in asset management and wealth management.
But, of course, even before Brexit, the financial crisis had slowed down the trend of London being the financial center of the world — in favor of, for example, New York and Shanghai and Hong Kong and Singapore all gaining momentum.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.
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