Greater regulatory scrutiny in Europe is compelling banks to better understand their data and consider tough strategic decisions. 

With the results of the European Central Bank’s (ECB's) comprehensive assessment due in October 2014, some banks have sought to shore up their defences by bolstering capital reserves. Deutsche Bank recently tapped its shareholders for more than €8bn. Banks are estimated to have strengthened their balance sheets already by more than €100bn in a series of pre-emptive strikes.

The stress testing will present banks with a range of scenarios – purported to be much more rigorous than previous ones – ranging from plunging property prices and spiralling interest rates, to soaring bond yields and catastrophic increases in unemployment rates. But while the stress tests will grab the headlines in the next few months, culminating in the publication of the ‘pass or fail’ test results in October, the wheels of the EU’s asset quality review (AQR) continue to turn purposefully in the background. 

In the most ambitious project of its kind, the ECB is probing the quality of nearly €4000bn-worth of assets sat on the balance sheets of 128 banks across the region. An army of regulators is currently scrutinising mountains of data spewed out by banks – a large part of the estimated 2.5 billion gigabytes of data generated globally every day – in an effort to avoid the sins of the past and accurately assess and understand the relative riskiness of banking institutions.  

As with the stress tests, banks will be given a gladiatorial thumbs up or thumbs down when the results of the AQR are revealed later in the year. While the minutiae behind the successes and failures are dissected in the months following the announcements, there are already a number of acclaimed successes. AQR will have a profound effect on the way banks do business.

Practical applications                                     

There can be no doubt that the sheer breadth and depth of the EU’s investigation has helped to inject a much-needed bout of confidence back into a once-fragile banking system. But AQR is more than just a confidence play; it is forcing Europe’s banks to bring consistency to their collection, management and ultimately understanding of data that simply did not exist in the past.

This ‘common ground’ principle will bring European banks a step closer to being somewhat comparable, lowering the threshold for international investment and preparing portfolios for securitisation programmes so desperately desired by the ECB.

Banks have generated data piles unrivalled by pretty much any other sector. But they have been inefficient in getting to grips with this data, using it to their benefit and managing the risks lurking in their operations effectively. It is interesting to note that very few bank chiefs fear the outcome of the AQR; however many complain about the impact the exercise has on their resources.

If finding and reporting the required information for AQR has such a large operational impact, obtaining information that is helpful in making strategic decisions will be equally burdensome. This should be worrying bank chiefs and investors. The exercise shows that the costs and opportunity costs of bank activities are often educated guesses. Hopefully AQR is changing this.

Structural shake-up

Banks are being pressured into gleaning a better understanding of their data. And by understanding the true costs involved in running their operations, banks will be much better placed to assess what are core and non-core activities for the business.

For this reason, a by-product of AQR will undoubtedly be a steady stream of sale processes, with many banks exiting from activities they realise to be unprofitable. They will be free to put any monies raised into activities that generate higher levels of return on investment.

Of course, other banks are likely to enter the bidding fray when the 'For Sale' signs are hoisted on banking assets. But increasingly, traditional buyers will face competition for assets from organisations and institutions that understand their own data and corresponding cost structures more readily than banks.

The titans of retail, the likes of Amazon, Tesco and Wal-Mart, have long understood the value of effectively mining and managing their own data. Over the course of the past few decades, these organisations have collectively invested hundreds of millions into their own data-mining processes to help better understand their own organisations and the demands of their customers.

These retail giants have long realised that data can be an effective offensive weapon. Banks will have to take a leaf out of their book or run the risk of seeing business disappear while struggling with inefficient legacy portfolios. The real benefits of the comprehensive assessment will be felt well beyond October 2014. When it comes to AQR, sometimes the journey is more important than the destination.

Peter Meijer is a managing director at Moelis & Co.

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