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If the two big Swiss banks want to grow again, they will have to buy European rivals. Their top management, however, are pursuing a strategy of preservation. They need new CEOs with greater risk appetite.

The 2019 result presented by UBS on Tuesday laid bare two issues: first, Switzerland's biggest bank has a major problem with growth. Second, the gulf between U.S. firms and UBS is getting ever larger. To revise down its own goal for return on capital looks like a frank admission by the management.

The first of the two problems is all-too-apparent given that UBS had fewer revenues and a lower profit than a year earlier. In 2018, profit amounted to $4.5 billion, last year the bank generated a profit of $4.3 billion. This comes as a surprise given that 2019 was a great year on the stock market – something that might have helped the bank. But this clearly wasn't the case. And its stock was the second-worst performer on the Swiss Market Index, adding a paltry 0.2 percent.

Numbers Don't Add Up

The business model initiated by CEO Sergio Ermotti some eight years ago, which put the focus on wealth management and reduced investment banking to being a mere product supplier, doesn’t work. This is a concern because UBS lays claim to the title of the world’s biggest wealth manager and boasts being the leader in banking with the richest – i.e. billionaires.

The strategy doesn’t add up because the rich may entrust their assets to the Swiss bank but conduct their investments through rival firms. This makes UBS a wealth preserver instead of a wealth manager and hence revenues are down. Rising costs, stiffer competition from digital banks, increasing hurdles set by regulators and persistently low interest rates make life hard on the cost side – and the two developments combine to depress profit. Investors have taken note of this a long time ago – and on Tuesday, shares fell by 4.5 percent following the news.

Great Discrepancies

The second major concern – the might of the U.S. financial services industry – has reached momentous proportions. J.P. Morgan generated a profit of $36.4 billion in 2019, eight times the amount UBS earned. The discrepancy between the two banks isn’t a singular example but symptomatic for the development in European banking, where companies over the past decade failed to position themselves in a way that would allow them to stand up to their U.S. rivals. The most drastic example of this development is Deutsche Bank, which still is in dire straits and is looking for the right shape to meet the future.

The strength of U.S. banking is down to a number of mainly structural factors. The U.S. market is more homogeneous than Europe’s, so is regulation. The Federal Reserve took a much more active approach following the financial crisis to get banks back in shape and – last but not least – U.S. companies used takeovers to generate earnings of scale, to grow and keep costs under control.

Ermotti concurred to a certain extent on Tuesday and referred to the financial crisis. The U.S. authorities had reacted with aplomb, forging or allowing the merger of large banks, while the banks in Europe were forced to reduce their business following a tightening of capital requirement rules. Now, the consolidation has to happen in Europe, Ermotti concluded.

Waiting for the Banking Union

This is the development that failed to materialize in Europe. The main reason for this is the so-called Banking Union, initiated in 2012. It entails common financial market regulation, rules for the winding down of non-viable banks as well as common deposit insurance. These measures would enable European companies to merge more easily and better confront competition from the U.S.

«Consolidations could be useful from an economic point of view,» said Majoros Gergely, an expert on banking at French asset manager Carmignac Gestion. «We have many financial-services companies in Europe that still are too national in character. Europe at the same time needs bigger banks to better compete with major U.S. and Chinese companies.»

The Banking Union, however, isn’t gaining traction, partly because the savings and cooperative banks in Germany worry that they will have to vouch for banks in the South. This may be about to change, with Germany assuming the presidency of the council of the EU in the second half of 2020, paving the way for the Banking Union by giving up on its resistance against the deposit insurance.

«We need a real European common market if we are to keep up with the global powers U.S. and China for the long term,» said Stefan Simon, board member-elect at Deutsche Bank at a New Year’s reception in Freiburg last week.

«Too Small to Survive»