German banks' return on equity not even global average
In 2023, the global banking industry is expected to attain a 13% average return on equity, according to McKinsey's recent global study. It places the industry significantly above its 9% long-term average. However, for the German banking sector there is no cause for celebration, since with an average return on equity of 5.4%, it lags behind the global average.
Despite the interest rate turnaround, German banks struggle to achieve a satisfactory return on equity due to intense competition in an overcrowded and overbanked market. They face a dual challenge compared to international peers, contending with fierce competition among banks for market shares and encroachment from non-banking entities. In recent years, financial specialists, such as stock exchanges, asset managers, and payment providers, have progressively assumed a greater share of traditional banking functions. Based on McKinsey's study, just under one-fourth of the euros end up in bank balance sheets – interestingly, this does not occur in the traditionally capital market-oriented USA, but in Europe, which has been known for its reluctance towards capital markets.
As assets leave the banking system, so do risks
The increasing use of off-balance-sheet financing and investment instruments is not a novel development and is politically accepted, maybe even intentionally encouraged. Strict post-financial crisis banking regulations have driven financial institutions to fill gaps left by banks, leading to the transfer of significant risks as well as assets and customers away from the banking sector. Nevertheless, the risks haven't disappeared, but have merely been redistributed – at best, they are equally spread onto broader shoulders, at worst, new concentration risks emerge.
As non-banks take over more traditional banking functions, it raises the question of whether the industry should also face stricter regulation. Some areas, like money market funds, are already under consideration for tighter regulation. But is a global asset manager with over $10 trillion in managed assets equally systemically relevant as a bank with a comparable balance sheet? Probably yes, but as the industry has not yet triggered a global financial crisis, the associated risks are, for now, reasonably contained.
