A Bank in Reverse. To what extent is the Belgian banking sector involved in the real economy? A study by FairFin. Author: Greg Van Elsen

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1 A Bank in Reverse To what extent is the Belgian banking sector involved in the real economy? A study by FairFin Author: Greg Van Elsen

2 Preface Now that the dust of the banking crisis has started to settle, consensus is growing that the banking sector in recent years has mainly taken care of itself, and less and less consorted with the real economy. With real economy we mean the set of economic activities that focus on the effective production of goods and services to meet specific needs, as opposed to the paper economy which merely plays out on the financial markets. In the golden years before 2007, this self-servicing led to spectacular growth and ditto earnings results. When it appeared that the financial boom was based on a weak foundation, rather than real economic performance, the various authorities had to intercede in an unprecedented scale to avoid a systemic crisis, with severe unpredictable consequences for the real economy. The involvement of a bank in the real economy expresses itself mainly in its traditional role, namely the attracting of private savings and the provision of loans to individuals and businesses. In the past decade the focus of many banks has, however, shifted from 'proper' credit activities to more lucrative businesses like proprietary investments, derivatives markets, asset management and the packaging of all types of loans for resale. A favourable monetary wind, excess savings from emerging countries, financial cutting-edge technology and a profit-driven bonus culture were making financing the real economy a boring endeavour. One figure perfectly reflects how the banking sector overwhelmed us all in a spectacular way: the total of all banking assets in the EU is currently 3.5 times greater than the monetary value of all goods and services produced in the EU in one year alone. The often quoted too big to fail will now probably become clearer. Also in our country, the financial crisis was never far away, with major banks like KBC, Fortis and Dexia being supported with billions in tax dollars. The total cost of this, however, is still not fully understood, partly because of the debt guarantees that the Belgian government carries. In this study we want to examine the extent to which banks are actively involved on the Belgian market in the real economy. How many of their possessions consist of outstanding loans, or rather high-risk investments? To what extent do they fund themselves with savings, or rather with current liabilities? So we are now looking for the most respectable bank in Belgium.

3 1. Intent For this study, we will put the following banks under the microscope: - The six largest banks, based on the total Belgian savings balances: BNP Paribas, Belfius, KBC, ING, Deutsche Bank and Argenta. These banks represent the bulk of the total amount of savings in Belgium. - Triodos: specifically included because it presents itself as a sustainable bank. Interesting to compare these results to those of traditional banks. Each bank was examined for a number of quantitative parameters that appear from their incorporated consolidated financial statements according to IFRS 1. More specific is the consolidated balance sheet, which on the one hand reflects a bank's possessions (the socalled assets), and on the other how it finances these assets (the liabilities), a crucial source of information. The relevant items of this balance are always indicated in advance. Subsequently a number of ratios are calculated that help to define the direct involvement of a bank in the real economy. This methodology has been previously used by previous international research Results 2.1 Assets The most relevant items on the asset side are the following: ratios: - Loans: this concerns loans to customers, i.e. individuals and businesses. Loans to other financial institutions are not included because they do not directly contribute to the real economy. - Furthermore, we look at the securities portfolios of the various banks. IFRS uses a number of classifications which could include financial instruments. Securities held to maturity for example, concern assets that a bank intends to hold to maturity, and thus are not speculative in nature. We focus our attention more specifically on securities held for trading: these are assets that banks hold in the markets for shortterm trading, where they attempt to attain proprietary profits through rapid buying and selling transactions. - Total assets: total value of all assets. This allows us to calculate the following 1 International Financial Reporting Standards, an accounting standard for annual reports of companies. Listed companies in the EU are obliged to apply these. 2 Report of the Global Alliance for Banking on Values: Strong, straightforward and sustainable banking. Financial capital and impact metrics of values based banking.

4 Ratio 1: Loans/ Total assets Table KBC ING Argenta Belfius BNP Deutsche Triodos Paribas Bank Loans 138,28 602,53 18,03 91,93 665,83 412, Total assets 285,38 1,279,228 34,02 232,51 1,965,283 2,164, Loans/total assets* % 47.10% 52.98% 39.53% 33.87% 19.06% 66.13% Sums in million euro, at 31/12/ 2011, source: 2011 annual reports by the respective banks This ratio indicates the extent to which banks use their resources to finance individuals and businesses through loans. We indicate in Table 1 that the investigated banks take on their role as traditional lender quite differently. We distinguish a middle group with KBC, ING and Argenta, which use about half of their total resources for funding individuals and businesses through loans. Belfius runs somewhat behind with only 40% of traditional lending operations. Remarkably, BNP Paribas (33%) and Deutsche Bank (19%), the third largest and largest bank in the world, respectively, take their traditional bankers' roll substantially less seriously. At Deutsche Bank, with total assets of no less than trillion euros 3, traditional loans represent less than one fifth of its activities. At the other end of the spectrum we find Triodos, which invests two-thirds of its assets in loans that benefit the real economy. Ratio 2: Trading/ Total assets This ratio indicates the extent to which banks hold high-risk assets that explicitly envisage short-term profit 4. We restrict ourselves to those assets for which banks themselves state that they are aimed at rapid buying and selling on financial markets. Table KBC ING Argent Belfius BNP Deutsche Triodos a Paribas Bank Trading 26,94 123, ,49 763,39 1,100, assets Total assets 285,38 1,279,228 34,02 232,51 1,965,283 2,164, Trading/total assets* % 9.66% 0.62% 14.83% 38.84% 50.85% 0% Sums in million euro, at 31/12/ 2011, source: 2011 annual reports by the respective banks 3 Compare with GDP of Belgium of approx. 370 billion euros. 4 The emphasis here is on the search for short-term profits. Securities held to maturity can also be risky. 5 Triodos has no financial statements to IFRS and does not specify this item. We can clearly conclude from their detailed balance sheet that their securities portfolio consists of government bonds that according to IFRS would not fall into this category. 1

5 Table 2 gives an overview of the trading assets, possessions that a bank holds onto for (very) short-term profit-making purposes. The detailed figures show that the main type of product in this category is derivatives. Derivatives are basically useful to hedge various risks 6 but in practice became a speculative instrument for short-term profit-chasing. The growth of the derivatives market is widely regarded as one of the catalysts of the financial crisis 7. If we look at the banks that are active on the Belgian market, we note that Argenta barely enters into this market; KBC and ING for just under 10%. Belfius concentrates almost 15% of its total resources in this type of risky assets. Very striking is the score of the two largest banks in this ratio: 4 in 10 of BNP Paribas possessions include trading assets, and at Deutsche Bank this is even slightly more than half. These figures are congruent with the previous ratio (loans/ total assets). Banks that are less concerned with the financing of the real economy through the provision of traditional loans will obviously have more room to invest in high-risk proprietary investments Liabilities On the liability side, we look at the following items: - Deposits: concerns the savings of customers (companies and individuals). Deposits of other financial institutions are not included. - Total assets: total value of all assets. Ratio 3: Deposits/ Total capital This ratio indicates the extent to which a bank is financed with savings of its customers to be able to acquire its possessions. Table KBC ING Argenta Belfius BNP Deutsche Triodos Paribas Bank Deposits 139,79 467,55 21,9 70,27 546,28 601, Total 285,38 1,279,228 34,02 232,51 1,965,283 2,164, capital Deposits/ total capital* % 36.54% 64.36% 30.22% 27.79% 27.80% 86.94% Sums in million euro, at 31/12/ 2011, source: 2011 annual reports by the respective banks If we go back to the traditional banker's role, namely the attracting of savings, and then use this for lending operations, we again see various profiles in the Belgian banking landscape. From the traditional banks, Argenta (65%) finances itself most through savings deposits of its customers, followed by KBC (49%), ING (37%) and Belfius (30%). BNP Paribas and Deutsche Bank once again find themselves at the extreme end of the spectrum. Only slightly more than a quarter of their resources is obtained from depositors. Conversely, Triodos funds itself with no less than 86% of savings deposits. 6 The traditional example is that of the farmer, who wants to safeguard the selling price of his future harvest against a possible fall in prices of his products. 7 Source: High Level Expert Group on reforming the structure of the EU banking sector, Liikanen report.

6 These figures imply something else important. When a bank is only partly funded through savings deposits, there have to be other funding sources. Part of this is the bank's own funds, money that the bank therefore only owes to its owners, the shareholders. The size of it and the associated capital requirements fall outside the scope of this study. Besides savings deposits and own funds, there is a third funder of banks: other financial institutions. However, such financing is subject to a short-term pursuit of gain, and a lot less stable than the deposits of a patient saver. Furthermore, these practices cause a dangerous interrelatedness of banks, such as the recent financial crisis has shown. It is clear that the more a bank finances through normal savings deposits, the less they depend on other, often more volatile funds flows. 2.3 Aggregated results The results of the various banks on the various ratios appear to show a clear correlation. In general, banks that deploy the bulk of their resources on funding the real economy through traditional loans to companies and individuals are less inclined to bet on high risk investments and mainly live by the savings deposits of their customers. Conversely, we find that banks that move away from their traditional role as lender, often see salvation in investments that give a demonstrable rise to speculation. This type of banks is also far more dependent on other financial institutions for their funding. Based on the three investigated ratios which are indicative of the extent in which a bank is involved in the real economy, we can state the following regarding the banks operating in Belgium: - Argenta scores best of the examined traditional banks on the various ratios: it deploys more than half of its resources for the effective financing of the real economy and depends mainly on its customers' savings deposits. Furthermore, the bank barely holds any products that explicitly pursue short-term profit. - KBC and ING, followed at some distance by Belfius form the middle bracket of this story. Of the former two, almost half of their total portfolio consists of outstanding loans to individuals and businesses. Belfius follows with 40% of disbursed loans. Furthermore, KBC can count on an ample amount of savings deposits that funds almost half of its possessions. With 36% and 30%, respectively, ING and Belfius score significantly lower. Finally, this middle group also is somewhat more active in trading. - At BNP Paribas and Deutsche Bank the picture looks completely different. A clear minority of their assets can be found in traditional loans that benefit the real economy. At Deutsche Bank, even less than one fifth. This obviously leaves much room for high risk investments, and here too the German giant takes the crown. It catalogues more than half of its activities as trading. BNP Paribas hold its own compared to Deutsche Bank, with 40% of this type of investments. Finally, both large banks fund themselves with only 27% of customer savings deposits. - In addition to traditional banks, we chose Triodos, which explicitly focuses on sustainable and ethical banking practices, to place under the microscope. Triodos scores best on the various ratios. Two thirds of its assets consist of traditional loans, and to this end it funds itself with 86% of its customer's savings deposits. This makes the bank by far the champion in funding the real economy.

7 3. Conclusion This research seeks to both make a modest contribution to the debate around the financial crisis by examining the extent to which banks that are active in Belgium dedicate themselves on behalf of the real economy. Simultaneously, it can point depositors to a bank that mainly dedicates itself to the real economy. We fully realize that the indicators used do not completely offset the complexity of today's financial sector. Further research could be done toward some assets that are not classified as loans, but possibly still support the real economy in a positive way. Nevertheless, we are convinced that a number of macro trends emerging from this study are significant in the debate on the causes of the banking crisis, as well as the ways in which their repetition can be avoided. These trends are also confirmed by international research 8. The following passage from the recently published Liikanen report strengthens our opinion: "The analysis conducted revealed excessive risk-taking - often in trading highly-complex instruments or real estate-related lending - and excessive reliance on short-term funding in the run-up to the financial crisis. The risk-taking was not matched with adequate capital protection, and strong linkages between financial institutions created high level of systemic risk. 9 Our research shows that banks that primarily committed to providing loans to companies and individuals are far less inclined to play around with complex proprietary products. Moreover, relatively speaking, these banks fund themselves more with savings, rather than relying on often short-term financing from other financial institutions. At the other end of the spectrum we find banks that find high-risk proprietary investing more interesting than investing in the real economy. These banks are invariably more dependent on other financial institutions for their, often short-term, funding. The dangers of this banking model have been adequately demonstrated during the recent financial crisis. We are therefore convinced that most banks should become somewhat better behaved, and be mostly at the service of the real economy. So in fact, a bank in reverse. 8 Report of the Global Alliance for Banking on Values: Strong, straightforward and sustainable banking. Financial capital and impact metrics of values based banking. 9 Source: High Level Expert Group on reforming the structure of the EU banking sector, Liikanen report.

8 To that end, FairFin would like to encourage depositors to place their deposits with banks that, in the first place, commit themselves to the real economy. The following tables reflect the research results in images and figures. Funds real economy Active in speculation Stable financial status KBC average average average Belfius poor average poor BNP Paribas poor poor very poor Argenta ING average average very good average good average Deutsche Bank very poor very poor very poor Triodos good very good very good Loans/ Total Trading/ Deposits/ Total assets Total assets capital KBC 49% 9% 49% Belfius 40% 15% 30% BNP Paribas 34% 39% 28% Argenta 53% 1% 64% ING 47% 10% 37% Deutsche Bank 19% 51% 28% Triodos 66% 0% 87% Sources Strong, straightforward and sustainable banking; The Global Alliance for Banking On Values (2012) Final report; High-level expert group on reforming the structure of the EU banking sector chaired by Erkii Liikanen (2012) Annual report 2011; ING Group Financial report 2011; Deutsche Bank Annual Report 2011; Triodos Bank Annual report 2011; Dexia Bank Belgium Registration document and annual financial report 2011; BNP Paribas Annual report 2011; KBC Group IFRS Financial Statements 2011; Argenta