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European banks' profitability gap shows big cost cuts needed

[LONDON] Europe's banks need to cut costs by a fifth and simultaneously grow revenues by 15 per cent just to get their profitability to match their cost of capital, a study said on Monday.

European banks' return on equity (RoE), a key measure of profitability, is likely to average less than half their cost of capital again this year, lagging well behind US rivals as lenders struggle with high costs and weak economic growth, according to a study by consultancy EY.

That means job cuts are inevitable and restructuring is likely to gather pace this year.

EY's European Banking Barometer showed RoE is expected to improve by 1.6 percentage points this year on average, but that would only lift it to 4.4 per cent, compared with an average cost of capital of 9.4 per cent and average returns of 12.2 per cent for US banks.

EY surveyed 226 senior bankers in 11 markets.

The findings indicate banks in the euro zone in particular continue to struggle to generate returns anywhere near what it costs them to raise capital, meaning investors would be better off putting their cash elsewhere.

The euro zone's banking supervisor has said returning to sustainable profitability is the industry's biggest challenge, and firms may need to sell off businesses.

British banks have restructured more and their returns are predicted to climb to 9.5 per cent this year, their highest since 2007, EY said.

EY said 69 per cent of respondents to its European survey said they were considering restructuring options, including selling or buying assets or forming partnerships or joint ventures, up from 55 per cent a year ago. "Both weaker growth and structural reform are forcing banks to seriously reconsider the viability of some business units. In particular, we may start to see concrete evidence of the effects of the structural reform agenda on the universal banking model,"said Steven Lewis, EY's global banking & capital markets analyst.

Costs at Europe's banks are expected to fall by an average of 1.6 per cent this year, and respondents predicted revenues would grow by 3.5 per cent, both improvements on last year, EY said.

Staff costs represent about 54 per cent of operating costs, and 43 per cent of respondents said they expect headcount to fall this year. The biggest cuts are expected in Nordic countries, Italy and Austria, EY said.