Profitability of banks

Many banks blame the ineffectiveness of the ECB's monetary policies has caused a fall in their profits; however, the Chairman of the European Central Bank, Draghi, blames that the banks should not blame the ECB but forget about their poor profitability, which is the fundamental problem.

Although great monetary policies can help to improve the banks' profitabilities, the banks' own profitabilities are key to the sustainable development of the banking industry. What determines the profitability of an ordinary firm? There are several important factors: competition, market growth, cost of production. Then we use these factors to judge our banking sectors. The competition in the banking sector varies across different parts. However, there is one common rule that larger institutions are more powerful than the smaller ones, which means the larger institutions face less competition pressure. In terms of market growth, recently the financial markets are less prosperous than before; therefore, some degree of decrease in the banks' profitability is reasonable. However the cost of production in the banking sector is much lower than that before 2008. The base rate is at the historically lowest point, and the quantitative easing programs have provided the markets with enormous hot cash inflows. From this angle, the profitability of the banking sector could increase. But if we change our angle, we could find out the cost of production actually increases. The cost of production in the banking industry also involves the market risks and the future expectations. When the market risk increases, the banks start to worry about potential losses, so instead of seeking for more profits, they tend to limit their potential losses, when more banks start to do so, the less risky financial markets will have excess demand, and then returns will drop sharply. Moreover, when the future expectations lower, the banks will start to worry and play less risky strategies which are likely to reduce profits.

Therefore, we can see that the limited banking sector growth affects the profitability growth in the banking sector; moreover, as the profitability in the banking sector is also dependent on the willingness of taking risk that when banks are willing to take high risks, they will make more profits if they succeed, and the current environment disencourages the banks to take high risks, leading to a reduction in the banks' profitabilities.