Gerd-Jan van Wiggen: Banks embrace cost cutting in a shifting economic landscape
By Gerd-Jan van Wiggen, Partner at Probability & Partners
Over the past two years, banks across Europe have been facing economic uncertainty, initially driven by changes in inflation levels and the interest rate environment. New regulations have also added to their cost base. This has urged many banks to focus on efficiency, often by adopting a cost-cutting approach.
Large geopolitical shifts have recently led to increasing uncertainty, such as negative effects of potential trade wars. This could lead to higher costs for businesses, lower revenues and therefore impact profitability in the short to medium-term. An increase in default rates is not unlikely. The ECB’s Euro Area Bank Lending Survey already shows that banks expect a net tightening of credit standards for both businesses and households in the first quarter of 2025 due to higher perceived risks and lower risk tolerance.
On top of this, there are measures aimed at ‘regulation for growth’. This often leads to deregulation, for instance by cutting down the scope of sustainability disclosures and proposals in order to encourage retail savers to invest in capital markets. This also leads to concerns among supervisors. At the Morgan Stanley European Financials Conference, the ECB’s Frank Elderson stated that ‘the debate on competitiveness should not be used as a pretext for watering down regulation’, pointing to the massive government support that was needed during the 2008 financial crisis.
At the same time, advances in AI lead banks to review certain business processes. Many initiatives are still in pilot phase. However, many banks expect that AI will eventually improve efficiency and enhance customer experience. The investments needed are sizeable and lead to a reallocation of budgets at the expense of areas such as client satisfaction or risk management.
This can be illustrated by a number of examples from across the Euro zone.
In the Netherlands, ING has been focusing on a digital-first strategy for a number of years and is leading compared to many Eurozone competitors. The expectation of decreasing interest rate margins, the commitment to share buy-back programs and the path towards a lower CET1-ratio, has led the bank to focus on improving sources and volume of fee income and a strong emphasis on cost-control.
Santander has actively managed costs by consolidating back-office functions and branch closures. Their aim is to build a ‘digital bank with branches’ faster to create value. They are creating new internal platforms to cut costs by eliminating overlapping expenses.
Deutsche Bank recently announced the cutting of 2,000 jobs in parallel with a reduction of the number of branches, a decrease in management layers and the integration of teams. It also changed its cost/income ratio target, moving it up to ‘below 65%’ versus an earlier ‘below 62.5%’.
Société Générale is also taking a strict cost control approach. Its cost base is higher than that of competitors. Making the business less complex and more competitive, the bank indicated it would slash the spending on IT and external consultants.
These developments are not only taking place at large banks, smaller ones are following similar paths. Not being able to catch up on this could spark a wave of consolidation across the sector.
Challenges and criticisms
Despite the progress made in cost-cutting, there can be a longer-term impact on customer experience and innovation. Reduction in the number of branches is effective in the short term. However, it can alienate less digitally savvy customers. Chatbots put in place to deal with client questions often lead to frustration. They work for very simple tasks, but the customer journey to someone who can actually solve a problem is much more cumbersome.
Moreover, the aggressive focus on cost-reduction has come at the expense of innovation in certain areas. Banks that overly cut back on technology investments or research and development could find themselves lagging behind more agile competitors in fintech and digital banking.
Looking ahead
Looking ahead, it is clear that European banks face a delicate balancing act: they must continue to streamline their operations to ensure long-term profitability while also investing in technology and customer-centric innovations under increasing uncertainty. As the economic environment continues to evolve and competition from non-traditional players intensifies, banks cannot afford to rely on cost-cutting approaches for too long, or they risk being overtaken by alternatives.