CE Banking Outlook Winning in the Digital Arms Race October 2016 www.deloitte.com\cebankingoutlook Contents Foreword Index of Banks Covered by Digital Maturity Executive Summary Analysis Banking Outlook Contacts in Central Europe Bulgaria Croatia The Czech Republic Hungary Poland Romania Slovakia Slovenia Foreword Although the performance of the banking sector in Central (1.3-1.5 percentage points above the eurozone). This relatively Foreword Europe (CE) is shifting up a gear as lending growth accelerates healthy economy has led a faster recovery of loan growth in CE to Executive and asset quality improves, profitability is still well below 3.4% y/y in 2015 (3 p.p. above Euro area) and should allow a further Summary pre-crisis levels. With low interest rates driving margin pick up to 5.0% y/y in 2018. Banking compression and a rising regulatory burden, banks need to Outlook improve operating efficiency. Asset quality has also been improving, with the non-performing loan Banks covered (NPL) ratio in CE down from a peak of 11.0% in 2013 to 8.8% in 2015 by Digital Maturity The digital maturity of banks in CE countries varies greatly but and is expected to fall to a level of 7.0% in 2018. As the region’s digitalization is a strategic priority for all. It can not only provide a key recovery progresses, the disparities between the leading countries in Contacts avenue for banks to reduce their cost to serve, it is also an imperative the north (Poland, the Czech Republic and Slovakia) and those in the that enables them to keep pace with the expectations of customers south (Hungary, Romania, Bulgaria, Croatia and Slovenia) are who are increasingly online and mobile. M&A activity has picked up expected narrow. visibly in CE in recent years, with growing activity in Southern markets (Hungary, Slovenia and Romania), supported by stabilizing asset The Return on Equity (ROE) of CE banks rose to 6.7% in 2015 from quality and often involving non-bank buyers (such as private equity 4.5% in 2014, maintaining a gap of nearly 2 percentage points over funds and insurers). Uneven profit distribution in the banking sector banks in the eurozone. Falling costs of risk, a pick-up in lending to and the advantages of scale will drive further consolidation. support revenue growth and cost containment are all expected to help drive a further improvement in ROE to 7.8% by 2018. However, While Europe’s economic recovery is expected to slow in 2016 and ROE will remain far below the pre-crisis double-digit level and even 2017, and the UK’s Brexit vote has increased uncertainty, conditions the 8-9% level of 2009-10. Limiting factors are margin pressure, with are expected to remain relatively favourable for CE banks. The interest rates in CE at record lows, and higher regulatory burdens Economist Intelligence Unit (EIU) is forecasting GDP growth for the (such as Poland’s bank levy and rising capital requirements). CE CE region to be 2.8% for the whole of 2016, and 2.7-3.0% in 2017-18 banks have a much higher net interest margin (2.4% in 2015) than Foreword those in the euro area (1.3%), but they also rely more on net interest Consolidation will also be driven by the advantages of scale. The income (which represents 67% of their net revenues). Already down distribution of net profits in the CE banking sector is skewed towards Foreword from 2.7% in 2012, the net interest margin of CE banks is expected to banks with larger market share: those in the top quartile achieved an Executive fall further to 2.2% in 2018 (even while Poland’s banks should buck average ROE of 10% in 2015, while those in the bottom quartile on Summary the trend as the costs of the bank levy are passed on to customers). average only broke even. Banking Outlook Improving cost efficiency will therefore be a key priority for CE banks, a factor that will help drive both consolidation and digitalization. More than 95% of the banks surveyed in Deloitte’s CE Top 500 have Banks covered by Digital put a digital strategy in place. However, the 76 banks included in our Maturity M&A in the region has picked up in recent years. The number of digital maturity analysis show a wide variation in their approach and Contacts transactions per annum involving a target with at least EUR 0.7 bn of level of development, leaving only a narrow set of core digital assets has steadily grown, from 1-2 in 2011-12 to 5-7 in 2014-15. This functionalities. Only 13% of features were present in more than 80% increase in activity has been driven largely by markets in the south of the banks we analyzed. With such diversity, there are clear leaders (Hungary, Slovenia and Romania), which between them accounted and laggards. Poland (48.1% of identified best practices) and Slovakia for 11 of 17 transactions in 2014-16. This was accompanied by (47.5%) lead CE in terms of digitalization, followed by the Czech increased buying by non-banks (organizations such as private equity Republic (40%), Romania (37%) and Bulgaria (37%). Hungary (32%), funds and insurers), which accounted for 8 of 17 transactions in Croatia (32%) and Slovenia (29%) lag behind. 2014-16. This suggests that further growth in M&A activity lies ahead, as many new PE owners will seek to build the value of their holdings Development efforts have so far focused primarily on customer through consolidation and restructuring before eventually exiting in acquisition and day-to-day banking, but banks are already taking the years to come. first steps towards the full digitalization of their sales processes. Mobile banking functionality in CE still has a long way to go to converge with what is already available via the internet. However, in countries that have lagged behind in developing internet platforms, Foreword there is now a strong argument to focus first on mobile. This report examines the outlook for performance, consolidation Foreword and digitalization in the CE banking sector. It seeks to identify key Executive drivers of profitability and balance sheet growth over the next three Summary years, while examining competition in each CE market. The report Banking Outlook analyzes the advantages of scale and trends in M&A activity and, explores in detail the digital development of CE banks. We hope the Banks covered by Digital study will help readers better understand the challenges and Maturity opportunities facing the region. Contacts Dr Grzegorz Cimochowski Vincent Bastid Lead Partner in Strategy Consulting CEO, Efma in Central Europe, Deloitte Executive summary Executive Summary Foreword Executive Summary Despite a backdrop of slower expansion Asset quality is improving. While there Net interest margin is declining in an Banking in the eurozone, economic conditions for are significant variations in asset quality, environment of low interest rates. After Outlook Central Europe’s banks are relatively non-performing loan (NPL) ratios have falling from 2.7% in 2012 to 2.4% in 2015, a Banks covered favourable. GDP growth expectations for CE been falling in every CE country. further decline to 2.2% is expected in by Digital Maturity are above those of the eurozone by around The costs of risk across the region fell from 2018. All CE countries face a declining 1.3-1.5 percentage points, standing at 2.8% in 1.7% of average gross loans in 2012 to 1.2% in margin except for Poland, which is expected Contacts 2016 and 2.7-3.0% in 2017-18. 2015, and appear set to decline to 0.9% in to buck the trend following the introduction 2018. of a bank levy. Interest rates are at record lows in both Loan growth is picking up. After rising The profitability of CE banks is on a trend Europe as a whole and the CE region, and from 2.3% in 2014 to 3.4% in 2015, a of improvement. The Return on Equity no significant increase is expected in further acceleration in lending is expected (ROE) of CE banks improved to 6.7% in 2016-18. Easy monetary policy will help spur to reach 5% in 2018. The weakest markets 2015 (up from 4.5% in 2014) and it is on the economy and stimulate lending (Slovenia, Croatia, Bulgaria, Romania and expected to rise again to 7.8% in 2018. growth, it is putting bank margins under Hungary) will benefit from recovery while the While facing pressure on their margins and pressure. current leaders (Poland and Slovakia) face high regulatory costs, CE banks will benefit more moderate growth. from the falling costs of risk. Executive summary Foreword Executive Summary Profitability is below pre-crisis levels and CE banks are investing in digital now to Digital banking maturity is highly differ- Banking Outlook distribution is uneven, skewed towards enable future transformation. While entiated among CE countries with clearly those players with higher market share. necessary to satisfy customer expectations, visible pioneers and laggards. Bench- Banks covered by Digital Smaller banks in the bottom quartile are at digitalization will also drive down branch marked against the best practices of the 5 Maturity breakeven, while those in the top quartile numbers, reduce cost to serve and lead to leading banks in CE, most digitally mature Contacts have an average ROE of 10%. better efficiency in the medium term. markets are Poland (48,1%) and Slovakia (47,5%) followed by the Czech Republic (40%), Romania, (37%), Bulgaria (36,9%), while Hungary (32,3%), Croatia (31,9%) and Slovenia (28,8%) lag behind.