2.2.2 The business model of a bank

In line with the definition of credit institution, a typical bank takes deposits from savers (primarily households and corporates) and grants loans to borrow ers (mainly corporates, governments and households).1 The ability to pool deposits from many sources that can be lent to many different borrowers creates the flow of funds inherent in the banking system. By managing this flow of funds, banks generate profits, acting as the intermediary of interest paid and interest received, and taking on the risks of offering credit.2

In addition to taking deposits or other repayable funds from the public and granting credits for its own account, a bank can conduct many more activities. Annex I to CRD IV contains a list of activities that are subject to mutual recognition between the Member States. This means that Member States have to ensure that these activities may be carried out within their territories by any bank authorised and supervised by the competent authority of another Member State, provided that these activities are covered by the authorisa tion.3 These activities include, besides takings deposits and other repayable funds and lending, financial leasing, payment services, providing guarantees and commitments, providing investment services, conducting investment activities, providing ancillary services (such as safekeeping and administration of securities) and issuing electronic money.4 The variety of activities that a bank can conduct make that the European banking sector is characterized by a continuum of possible business models, rendering any classification based on balance sheet indicators difficult.5

A distinction could, for example, be made between, on the one hand, banks that conduct the full array of banking services, ranging from the traditional banking services of deposit taking and lending to payment services and investment banking activities (so-called ‘universal banks’) and, on the other hand, banks that cover only a few of these services (so-called ‘specialized banks’). Examples of the latter category are banks that focus on retail banking, corporate banking, investment banking (that is, proprietary trading, market making and/or hedging activities) or private banking.6 Universal banks are not necessarily large (or systemically important) banks and specialist banks are not necessarily small banks. This depends on their franchise and the scope of business lines they cover.7 The largest banking groups in the EU are however typically universal banks.8

Banks operate in an environment that is characterised by constant change and constant competition.12 In 2015, the EBA flagged: “(…) there are significant potential implications of the new regulatory measures for certain components of banks’ business models. There is likely to be pressure on the future profitability and the returns of the banking sector as it changes to meet the new requirements. In addition, the complexity and costs of managing the change in the regulatory environment will be high and some banks will need to develop new business models, which will be successful once the regulatory framework is finally in place. (…) As a result of the changes in banks’ business models, it is also likely that some aspects of lending will move to the shadow banking sector. Non-traditional banking institutions will start to participate in markets that ‘traditional’ banks, either for reasons of profitability or complexity, decide to leave. This trend is already evident in the increasing role that private equity firms and hedge funds are playing in the commercial real estate segment in some countries. There is also cross-sector interplay as insurance firms have started to participate in certain areas of lending/financing, leading to some overlap with the banking industry.”13 In 2019, European bank profitability is still under pressure due to cyclical factors, cost inefficiencies and competitive challenges arising from outside the sector.14