G-SIBs emerge from pandemic in good shape but new risks loom

The proactive policies of governments around the world have helped most global systemically important banks (G-SIBs) maintain solid capital and liquidity buffers during the Covid-19 outbreak, according to a recent report, entitled ‘Biggest banks retain competitive advantage, but stiff obstacles loom post pandemic’, by Moody’s Investors Service.

The report, which analyses the underlying metrics of 30 G-SIBs from North America, Europe, Japan and China, has one eye on the looming threat of technological disruption as the world emerges from the pandemic and looks at which G-SIBs may be best placed navigate it.

“The bigger and more diversified banks can generate economies of scale that will help deal with the threat of technological disruption,” says Peter Nerby, a banking analyst at Moody’s. “Stability and strength are enduring sources of competitive advantage.”

Mr Nerby cites US investment bank JPMorgan Chase as a case in point. “If you break down [JPMorgan’s] individual businesses, they perform well by growing customers and delivering operating leverage quarter-on-quarter, which they reinvest. This advantage will be crucial to help them combat the bigger, more existential question of whether basic banking services are about to be technologically disrupted to the core,” he says,

“Technological disruption, to borrow a phrase from Ernest Hemingway, occurs gradually, then suddenly. It will be the G-SIBs that have the ability to invest in new capabilities as the pandemic recedes and that will have an advantage,” he adds.

Operating environments

When comparing the different G-SIBs abilities to invest in new capabilities, a crucial variable to consider is the home-country operating environment, according to Mr Nerby.

To illustrate this point, Mr Nerby cites two Canadian G-SIBs (Toronto-Dominion Bank and Royal Bank of Canada) and compares them with three Japanese megabanks (Sumitomo Mitsui Financial Group, Mitsubishi UFJ Financial Group and Mizuho Financial Group).

“The two Canadian banks display very high and consistent returns on risk-weighted assets, which is a function of their strong franchises, but also reflects the benefit of being anchored in the stable, well-regulated and oligopolistic Canadian market,” he says.  

The Japanese megabanks, however, face longer-term structural challenges to profitability, according to the report.

Economic activity in Japan remains weak as the country’s population ages and shrinks, which further restricts loan demand. Interest rates, meanwhile, are set to remain extremely low for years to come as the Bank of Japan focuses on controlling the yield curve as part of monetary measures to achieve a 2% inflation target. As a result, interest rates on government bonds are likely to remain near zero for maturities over the coming decade.

“Competition among Japanese banks is likely to become more intense as the as the pool of customers shrinks because of demographic changes, further reducing banks’ margins,” Mr Nerby says.

European pressures

Between 2016 and 2020, interest rate pressures, as well as restructuring and litigation costs, hit the cost-to-income ratios of many European G-SIBs. “In Europe, the interest rate environment is tougher than in the US,” Mr Nerby continues. “This has had an impact.”

Deutsche Bank, which made a €1.4bn loss in 2016, stands out in its efforts to address an elevated cost base, according to the report.

Since 2017, the German bank has cut its adjusted cost base by about €2.5bn, solidified its revenue base and raised its underlying profit potential. As a result, the bank’s cost-to-income ratio is now above that of many G-SIBs.

“The strategy execution has been more effective under the current management. They have made hard decisions on what business should focus on and not focus on,” Mr Nerby says.

Santander’s asset quality metrics, meanwhile, remain weaker than those of its international peers, reflecting not only the still-high level of non-performing assets in its domestic portfolio but also its exposure to developing countries, according to the report.

Technological threats

As Covid-19-related risks ebb, most of the G-SIBs in the report have maintained a competitive advantage across the broader global bank universe. At the same time, they face rising competitive challenges and new risks from untraditional sources.

“The threats include disrupters outside traditional banking targeting G-SIBs’ products, services and customers, as well as potential cyber attacks on assets and data,” Mr Nerby says.

As the migration to digital accelerates, four key forces have the potential to dislodge financial incumbents, including G-SIBs, from their dominant role as middlemen in the financial system, according to Moody’s.

These four forces are: big tech firms (such as Google and Facebook); pureplay fintechs (such as Square or PayPal); state finance in the form of central bank digital currencies; and “stateless finance” such as stablecoins.

“The long-term competitive challenge continues to increase for G-SIBs as they look to defend their position against less-regulated fintech and big tech challengers, as well as shadow banks and asset managers, all of which aim to disrupt core deposit-taking, payment and lending services,” Mr Nerby adds.