RISK MANAGEMENT THOUGHT LEADERSHIP

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Does digitalisation increase bank profitability?

Prometeia White paper

 
 

Bank profitability in Italy and in the euro area has improved from the post-crisis lows. However, for many banks, earnings are still below what is required by investors and the recent slowdown in economic growth could threaten the recovery of banks’ profits. Why is this a problem? Why does banks’ profitability matter overall, not only for their shareholders? The reason is that persistently low profitability can limit banks’ ability to generate capital and can make raising capital very costly. Therefore, it becomes harder to build up buffers against unexpected shocks and this can bind banks’ capability to provide financial services to households and businesses.

Weak profitability is one of the key challenges facing the euro area banking sector. Our analysis explores some of its drivers, including digitalisation.

Reducing costs and improving efficiency are necessary steps. Possible strategies to achieve them range from consolidation via mergers and acquisitions, downsizing, as well as branch closures and stuff reduction. But another, not necessarily alternative, way would be to adopt new, cost-saving technologies aimed at digitalising financial intermediation services, in particular those with low added value.

Digitalisation can be an important and permanent cost-saving strategy for banks, particularly in countries with a dense branch network, although depending on structural factors such as labour laws, population density and the level of digitalisation in society. Greater automation and more efficient processes allow cost savings and relieve employees of routine work, allowing them, if appropriately qualified, to take on more demanding tasks. An efficient and modern IT infrastructure is one of the prerequisites to achieve such efficiencies and must, at the same time, be safeguarded against its heightened vulnerability to cyber attacks. In addition, digital ‘leaders’ may also benefit from additional revenues via market share gains. This will require considerable investment by banks in the short to medium term, with cost savings typically likely to materialise in the medium to long term. At the same time, a higher reliance on digitalised forms of financial services may also threaten the stability of revenues, as it becomes easier for customers to shop around and compare banks’ products and prices. This trade off makes it particularly interesting to have a closer look at the overall impact of digitalisation on bank profitability.

Some individual banks have managed to invest large amounts of money in digitalisation in recent years notwithstanding the poor profitability of the euro area banking system as a whole. Figures 1-2 show tech expenses for a sample of European and Italian banks. In terms of IT expenses, Italian banks seem to lag behind: in 2018, IT costs were just 0.12% of total assets in Italy against 0.17% on average for their European peers. In fact, euro area banks (excluding Italian banks) have invested in IT even during the financial crisis or soon after (the ratio increased already in 2013), while it has been at the same level for Italian banks, thus widening the gap with European peers.