BEYOND RESTRUCTURING: THE NEW AGENDA

1 BEYOND RESTRUCTURING: THE NEW AGENDAEUROPEAN BANKING 20172 The primary authors of this report were:Neil Reid, Partner & Head of financial Services Practice Group in EMEA, FrankfurtLindsey Naylor, Partner, LondonChris Allchin, Partner, LondonVicente Vazquez Bouza, Partner, MadridThomas Schnarr, Partner, FrankfurtRobert Rogers, Engagement Manager, LondonSofia Gardefjord, Engagement Manager, StockholmThe authors drew on the contributions of many people across the firm, but in particular wish to acknowledge the help of Matt Austen, Anthony Bice, Pablo Campos, Simon Cooper, Sean Cory, Bruno de Saint-Florent, Christian Edelmann, Andrea Federico, Philip Gudgeon, Astrid Jaekel, Simon Low, Thierry Mennesson, Ted Moynihan, Alexander Peitsch, Emmet Rennick, Ted Rudholm-Alfvin, Michael Smith, Robert Urtheil, Giovanni Viani, Tobias W rgler, Michael Zeltkevic, and Markus BANKING 2017 CONTENTSSTATUS OF RESTRUCTURING 4 Balance sheet clean-up 9 Regulation, capital.

2 And risk 11 Exiting unprofitable businesses 12 Operational efficiency 13 Concentration and consolidation 14 Regional differences 17 THE NEW AGENDA 18 Responding to changing buying behavior 21 Upgrading and replacing infrastructure and processes 22 Delivering higher financial resource efficiency 24 Consolidation opportunities 26 Building a workforce of the future 28 Delivering for our societies 29 CONCLUSION 30 EXECUTIVE SUMMARY 22 Europe s banks have spent the last nine years working hard to recover from the financial crisis. They have been repairing their balance sheets, making the changes demanded by new regulations, and exiting structurally unprofitable businesses, all in a low growth the performance of European banks has recovered from the lows of 2008 the average return on capital of percent remains well below the hurdle rate. This average masks large geographic differences; banks in some EU markets have completed this restructuring process, while other markets continue to all of Europe s banks now also find themselves having to deal with a rapidly changing environment.

3 New customer preferences, digital interfaces and platform businesses are changing how customers bank a trend that will be accelerated by regulators push for open banking . Automation and data tools are creating the opportunity and imperative to significantly cut cost short, Europe s banks are emerging from the crisis only to face a whole new set of challenges. The new AGENDA is going to require boldness of a kind: going BEYOND restructuring and making changes to the banking business model itself. To date, only a few organizations are taking action to fully address these new believe the incumbents in the sector still have major structural advantages and can thrive if they make the bold moves BANKING 20171. STAT US O F RESTRUCTURINGB alance sheet clean-up: Europe s banks have spent significant time and resources to streamline their balance sheets. In some EU markets this is completed but the process of restructuring, writing off and selling off non-performing loans will continue in markets such as Greece, Italy and , capital, and risk: Banks have been forced to increase capital and shrink balance sheets, resulting in average capital ratios increasing from to percent (Tier 1 capital/ (IFRS) assets).

4 Further work is now in train to strengthen oversight and control such as MiFID II. Planning for structural reform such as Brexit and Recovery and Resolution planning continue to take up management unprofitable businesses: Good progress has been made here both from a business line perspective, for example exits from wholesale banking and real estate lending, and a geographic perspective as banks have moved away from non-core markets. We estimate that in wholesale banking, European banks have exited lines of business that generated annual revenue of 10 billion in efficiency: Waves of cost savings programs have been announced; nevertheless, nominal bank expenditure grew at one percent per year from 2008 to 2016, and cost-income ratios barely moved as revenues shrank in the same time frame due to an environment of low interest rates and squeezed margins. No European bank is done with cost cutting. Managers at two-thirds of European banks are still initiating new cost-cutting work, and the rest have efficiency programs in and consolidation: While some European markets have been transformed by a consolidation wave, others have barely moved in this period.

5 Greece and Spain have seen concentration double since the crisis and Italy has seen significant activity over the past year. Cross-border consolidation remains THE NEW AGENDAR esponding to changing buying behavior: The growth of aggregator platforms on which customers can compare, buy, and use a variety of suppliers in a much wider range of products is forcing banks to make critical strategic choices around participation, investment, and partnerships in this and replacing legacy infrastructure and processes: The pace of change of technology, combined with a desire to reduce cost will see continued work to replace legacy systems with greenfield infrastructure, and the use of application programming interfaces (APIs) to allow a modular approach to systems build and higher financial resource efficiency: In light of the increasing complexity of constraints on financial resources, banks will deploy advanced financial resource management tools that aid decision-making by modelling the comprehensive financial resource opportunities.

6 In light of ongoing challenges to economics, we believe consolidation is likely to be accelerated in some markets, for example in Italy. However, it will not be a priority in many a workforce of the future: As banking changes, so does the workforce required by banks now and in the future. Banks will need to use innovative approaches to talent management as well as workforce planning to attract and deliver the talent they for our societies: The financial crisis triggered long-term political changes with significant implications for banks. The growth of nationalism and populism is putting further onus on banks to be part of the solutions to society s broader BANKING 2017S TAT U S OFRESTRUCTURING6 EUROPEAN BANKING 2017 Exhibit 1: Average return on Tier 1 capital for EU : Includes domestic and foreign-owned branches and subsidiaries; excludes Poland, Lithuania, Croatia, and Hungary due to data availabilitySource: ECB Consolidated banking statistics, Oliver Wyman analysisThe performance of European banks has recovered from the lows of 2008.

7 However, at percent, the average return on capital remains well below the hurdle rate for most banks (see Exhibit 1).Banks across Europe have been through a major process of restructuring in response to weak profitability and to meet the regulations that came in the wake of the financial crisis. Progress varies by country, but most European banks are now nearing completion of their efforts to shut down unprofitable lines of business, clean up the balance sheet of non-performing assets, and meet the higher capital requirements and liquidity ratios. They still have a fair way to go, however, on cutting costs and simplifying Wyman s project experience, conversations with management, and public data make us think that about a third of large European banks are still focused on the full restructuring AGENDA , a third are almost finished balance sheet restructuring and are cutting costs, and a third have made sufficient progress to move BEYOND restructuring and have started investing for renewed growth (see Exhibit 2).

8 7 EUROPEAN BANKING 2017 Exhibit 2: Position of large European banks in the restructuring cycleCost cutting at the end of the restructuring phaseShifting from growth to cost controlMixture of investment and cost-cuttingInvesting in growthFull restructuring modeLargeUSbanksLargeEuropeanbanks20%100 %0%60%80%40%POSITION OF MAJOR EUROPEAN BANKSIN THE RESTRUCTURING CYCLEINVESTMENT CYCLES ource: Oliver Wyman analysisBanks in the US are further through their restructuring efforts compared to those in the Europe; their restructuring and cost cutting is largely complete, and many have now begun investing in growth. This may lead to an increased competitive threat in the EU: US banks could start to gain market share from those European banks whose management teams are still focused on reducing cost. This effect may be increased as many US banks set up new entities in the EU as a result of Brexit and need to find new sources of revenue to meet the increased cost of their EU footprint.

9 An early example of this is the recent announcement by Goldman Sachs that it intends to launch a greenfield digital-based retail bank in the of growth may be hard to find in many of Europe s mature markets. Some hopes remain that as monetary easing ends, interest rates will rise and this will ultimately lead to an increase in margins, and increased profit. However, there are reasons why this conventional wisdom may not hold: First, easing is likely to coincide with an increase in competition as banks in EMEA begin to have capital to put to work as a result of restructuring. Second, price transparency has increased across all segments in the last ten years as a result of digital innovations (for example comparison websites) and regulatory requirements (for example the transparency measures in MiFID II) and may prevent banks from realizing margins seen in previous high rate environments. Finally, and perhaps most concerning in some markets, for example the UK, higher rates will likely drive increased credit defaults (particularly in consumer) which in turn will reduce overall profit.

10 Overall, the balance of the expansionary vs profit reduction forces is uncertain, and shouldn t be counted upon to drive higher returns in many BANKING 2017 Exhibit 3 outlines the status of banks in key focus areas. In the rest of this section, we chart the progress of European banks in meeting these major recent 3: Areas of management focus at major European banksStatus of costInitiativesTop costOptimizationLeversTop balance sheetand capitalprioritiesTop areas ofM&a interestSPECTRUM OF RESPONSEFUTURE AGENDARESTRUCTURINGM ajor open questionMajor focus with plans in placeIn-execution Traditional approachesBroad approach no clear top leverDigital re-engineeringNo clear priorityPlanning & managementof financial resourcesBooking modelRing-fencing/RRP/ BrexitNo interestMore divestments Bolt-on acquisitionsActivetargetingSource: Oliver Wyman analysis9 EUROPEAN BANKING BA L A N C E S H E E T CLEAN-UPFor a number of European banks, the main focus of the restructuring work has been in cleaning up their balance sheets by selling off or winding down large non-performing loan (NPL) portfolios (see Exhibit 4).