Fast Forward To Germany's Banking Industry in 2030. Regulations disrupting the transformation process

Introduction

The financial crisis of 2008 stopped the deregulation and expansion phase that dominated from the 1990s onwards in Europe's banking industry. Over the last years significantly changes in the regulatory framework of banking have been made worldwide with the new rules of Basel III, CRD IV, Dodd-Frank and Solvency I to minimize the effect of future crises and protect consumers. Banks worldwide were affected by the increase in regulations, leading to a transformation of the banking industry. Instead of focusing on innovation banks spend large amounts on compliance, reporting and supervisory issues. In 2014 Deutsche Bank, Germans leading bank, spend an additional €1.3 billion on new regulatory requirements (Institute of International Finance, 2015). Therefore, the degree of regulations in the future will decide whether banks can transform their business successfully, being able to add value to customers and compete with new competitors.

This essay deals with the transformation process of the German banking industry to 2030.

The essay is divided into four main sections. First it will give an overview of the German banking industry. Then it will outline the major trends and driving forces of the transformation process, followed by the critical uncertainties. The fourth part describes four different scenarios of the German banking industry in 2030 according to the two major critical uncertainties that are the degree of regulations and the type of operating model. In my opinion, a high degree of regulations in combination with a universal operating model is most likely to happen. Therefore, this scenario will be described in more depth. In the end, some conclusions will be derived from the previous scenario analysis on how to survive the transformation process.

Banking Industry Overview - Germany (371 words)

To understand the transformation process of the German banking industry from now to 2030 a short overview of the industry will be given in this section.

The German banking industry is characterized by a three pillow system that consists of private, cooperative and public savings banks (Figure 1).

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Figure 1 Amount of credit institution by category in Germany, 31.12.2014, 1990 banks in total (Source: Deutsche Bundesbank 2015)

According to ECB statistics, more than a quarter of Europe's banking institutions belongs to Germany (European Central Bank 2015). Even though the majority of German banks are cooperative banks, the industry is dominated by the big banks, like Deutsche Bank and Commerzbank (Appendix B, Table 1), with a market share of 24% (Statista 2015). In contrast to countries like the US or Great Britain that have specialized banks to ensure banks are not too big to fail, the majority in Germany are universal banks, providing both investment and commercial banking services. Specialists like Wells Fargo or Goldman Sachs have the competitive advantage of higher return on equity and valuation over universal banks (The Financial Times 2015). Moreover, there is a positive correlation between the degree of specialization and the banks' profitability (Böve, Pfingsten 2015). Thus, it will be important for German banks whether they will transform their operating model to 2030.

Having a look at the past development of the German market, the total number of banks has steadily decreased from 1990 to 2014 (Appendix B, Figure 6), mainly caused by the merger of cooperative banks between 1990 and 2005 (Deutsche Bundesbank, 2015). Whereas this trend is expected to continue, the consolidation of private sector banks seems to be exhausted after the misleading merger between Deutsche Bank and Postbank AG that have not been profitable for Deutsche Bank due to difficulties with the integration of IT infrastructure. Furthermore, there has been a decline in the number of branches over the last years, in particular in rural areas. In 2014, 14 percent of regional branches closed (Bernhardt, Schwartz 2014). That tendency will carry on (Figure 2). Thus, there is the danger of financial exclusion in rural areas by 2030. Moreover, the aging population and the increase of people with migration background in Germany will enforce that issue. However, the extent of financial exclusion in Germany by 2030 is dependent on other factors such as the kind of new competitors entering the market and the degree of regulation for banks.

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Figure 2 Development of the total number of bank branches in Germany 2003-2020: 3 different scenarios; numbers in thousands (Source: KFW 2014)

Trends and driving forces influencing the transformation process Global megatrends in the macro environment will have a significant impact on the industry transformation process by either accelerating it or creating new markets for banks as customer needs evolve. The four main megatrends identified are shifts in global economic power, demographic and social change, rapid urbanisation as well as technological breakthroughs (PwC 2015).

The shift of the global economic power from developed countries to developing countries such as the BRIC countries will create new investment opportunities for German banks. Adapting to demographic and social changes will be a challenge for banks in the transformation process. With the ongoing digitalization in banking, consumer expectations continue to rise. For digital consumers, easy, accessible, available and secure banking products and services are most important (ebf, 2015). They compare traditional banks to new financial services start-ups that offer more flexible and innovative products. As banks have complex operating structures, it is difficult for them to respond rapidly to new technological breakthroughs. Even though the aging population will become more digital, too, banks need to develop special products for that generation that allows them for instance to diversify their risks (Moreno 2015). Therefore, banks will have to serve both customer segments, the digital and the older generation, to be successful in the future.

Other forces driving the transformation process of the Germans banking industry are Big Data Analytics and Cloud computing, new forms of competition and the migration wave in Europe.

Due to digitalization, regulations and the complexity of data processing Big Data Analytics and other Artificial Intelligent practices in alignment with Cloud computing will become more important. Examples of technologies available in other industries are 'Amazon's Redshift hosted BI data warehouse and Google's BigQuery data analytics service' (Mitchell 2014). Big Data will enable banks to identify trends in a way that they can add customer value by developing new products for customers and enhancing their bank experience. Thus, the implementation of own Big Data Analytics in Clouds or partnerships with already existing companies offering that service will be necessary for German banks to survive the transformation process.

Moreover, digitalization opens the door for new competitors, especially start-ups in the fields of FinTech and P2P lending. With 'Facebook applying for an Electronic Money Institution License and Google having launched its mobile wallet' (PwC, 2015), big technology companies are entering the financial service market (Appendix E, Figure 8). Both companies have a good reputation and large customer base that will disrupt the traditional banking market. To sum up, large digital ecosystems will shape the future banking landscape.

With the current migration wave of asylum seekers in Europe, the number of Muslims living in Germany will significantly increase until 2030. 1.5 million new asylum seekers are expected in 2015, adding to the 5.8 Muslims that are already living in Germany. According to a demographic forecast of the Bavarian lawmakers (2015) the Muslim population in Germany will have reached 20 million by 2020.

Muslims often do not have a bank account due to religious reasons as for instance interest on transactions is prohibited in the Shari (Worldbank, 2015). At the moment, Islamic banking is still in the early stages in Germany, with the first Islamic bank that was opened in 2015, after getting a full corporate and private banking license. Therefore, Islamic banks offering banking products and services that satisfy Shari's requirements (Appendix C) will become more important in the future and drive the industry transformation process. Furthermore, it is an opportunity for microfinance start-ups to enter the market.

Critical uncertainties in the industry determining the direction of the transformation process The trends and driving forces mentioned in the previous section present both, opportunities and challenges for the German banking industry. However, the direction of the transformation process depends on the critical uncertainties of the industry such as the degree of regulation and new entrants, the stability of the European money market, type of operating model and IT security. The two key critical uncertainties for the future German Banking Industry are the degree of national and international regulation and the type of operating model that German banks will have. The European banking reform has already caused a transformation process in the industry by increasing the 'liquidity, leverage and capital requirements' (Bain & Company, 2015) after the financial crisis. This trend seems to proceed (Appendix D). However, if negotiations between Europe and the US about a Transatlantic Trade and

Investment Partnership, TTIP, come to an agreement, this could lead to lower regulations in the industry. Furthermore, the European Union is trying to set uniform regulation with the European Banking Union. So it might be that the peak of the degree of regulation is already reached. Still, a successful execution of the European Banking Union and TTIP is uncertain.

The second key critical uncertainty is the operating model of German banks. It is unclear whether German banks, primarily private and public saving banks, will decide to become specialized banks if pressure from new competitors and operating costs increase. The key critical uncertainties are defining the two dimensions of the four different scenarios of Germans Banking Industry in 2030 (Figure 5).

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Figure 3 Scenario Analysis of Germans Banking Industry by 2030

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