At the Epicenter of the European Financial Industry | Nikoloz Donadze

At the Epicenter of the European Financial Industry | Nikoloz Donadze

The global financial industry is entering a new phase of development. Despite the difficulties and ambiguities caused by the pandemic, large banks are taking bold steps and making solid investment decisions, which analysts say will help develop banks, asset management companies and other financial services. Among them is the largest German financial institution Deutsche Bank, whose total assets at the end of 2020 amounted to €1.33 trillion. Forbes Georgia interviewed Nikoloz Donadze, one of the vice-presidents of Deutsche Bank, who monitors banking trends from the European financial center in Frankfurt.

Mr. Donadze, you have been Vice President of Leveraged Finance at Deutsche Bank (DB) for more than two years. How would you describe what you do?

Our leveraged finance department provides structured credit solutions in the EMEA region for primarily Private Equity backed transactions such as LBOs, carve-outs, refinancing, growth capital, pre-IPO, or post-IPO financing. We also provide our clients with financing for strategic takeovers of corporates on their way to acquisitive growth. Our clients are well established European based large and medium sized enterprises and DB is one of the leading finance institutions in this segment in Europe and worldwide.

You used to work in the same position in the UK, how would you compare these two countries in terms of development and the specifics of Leveraged Finance?

Firstly, I would like to touch on the similarities of those two markets, especially considering the low interest rate environment in Europe since the financial crisis in 2008, investors’ focus in investing in alternative asset classes such as Private Equity funds rose significantly. Private Equity backed transactions are characterized by a relatively high portion of debt financing and the lending market traditionally mirrors the PE-backed LBO-market. This was the reason for unprecedented growth in the market in both the UK and Germany. However, there are differences observable in the dynamics of how the markets in these countries develop. Whilst the market environment in the UK and all stakeholders are more open to Private Equity funds and their activities, German society and politicians traditionally showed more skepticism to this industry. Thereby assuming a largely profit-oriented approach of such funds rather than focusing on social well-being.

Overall, it can be stated that the UK market is the first country in Europe to adapt to new trends coming from the more advanced US LBO market, which historically spread with some delay across the rest of Europe (including Germany). In this context, it is not surprising that the relatively newly established asset class – so called Private Debt Funds – has experienced significant growth in the UK before they increasingly began to enter other markets, Germany among them. The UK has historically been and remains the largest LBO market in Europe, although the country has faced some headwinds related to the uncertainties regarding Brexit and the weakened sterling. However, this asset class has proven its robustness over cycles in Germany and enjoys increasing popularity across market participants. This increasing acceptance coupled with the German economy’s resilience with a large base of medium-sized, family-owned companies has led to accelerated growth in this area, giving it the potential to catch-up with the UK market in the long-run.

The German financial industry is one of the leading contributors to the country’s economy. What challenges do you see in this sector? How fast is it developing and what are the obstacles?

The financial industry, and banks in particular, face several considerable challenges. It is known that the low interest rate environment of the last decade led to shrinking revenues across all financial institutions in Europe. The reversal of this is not on the horizon and will remain a major challenge for financial institutions. On the other side, increasing regulation in the areas such as compliance, the prevention of financial crime, and increased capital requirements have all led to significantly higher cost base for banks adversely affecting their profitability. Furthermore, with more than 1,500 financial institutions in Germany the banking environment is highly competitive additionally pressurizing profits. Even though a consolidation of the banking sector is already visible; we might see accelerated pace in the mid-term. Digitalization is another challenge for upcoming years that will require substantial resources to be adopted in line with changing customer behavior.

You work in the German financial sector, where the head offices of many financial institutions are located. What has the pandemic done to this industry in Germany and across Europe in general?

It is not surprising that financial institutions like everyone else have unexpectedly faced difficulties related to the pandemic. In general, tighter regulation posts the financial crisis, regular stress tests undertaken by national banks and “lessons learned” from the financial and later the sovereign crisis in Southern Europe have well-prepared institutions for economic shocks. Having said this, the magnitude of the COVID-19 outbreak is something that no one could foresee. There was barely any industry that remained unaffected by the country-wide lockdowns. In particular, businesses, who suffered financial distress pre-Coronavirus, have been heavily impacted. Banks in Germany have quickly adjusted their approach by focusing on their portfolio and supplying existing clients with the required liquidity. The timely reaction of German and European governments – through large scale financing packages – paired with banks, who also provided funding to the economy, has helped businesses to overcome liquidity shortages relatively successfully during the pandemic so far. Even if today no one can predict the future of the pandemic, it is obvious that the swift joint approach of both governments and the banking sector in Europe avoided the worst-case scenario and many insolvencies.

The health crisis also showed that certain industries – such as the technology sector – have even benefitted from the pandemic, whereas for some businesses – such as aviation or tourism – it will take longer to recover and return to pre-COVID-19 levels. In the second half of the pandemic, after existing clients had been adequately supplied with the required liquidity, lenders have continued to increasingly support their new clients and we can see there is growing activity in the current financial year. In retrospect, a positive balance can be drawn so far on the outcome of probably the most severe crisis in decades.

I would also like to ask about regulations in Germany and the EU’s financial sectors. Analysts often say that regulations are quite strict, and this hinders flexibility. What is your view?

This is no doubt true. Before the international financial crisis, extensive deregulation of the financial sector took place in major developed countries. With the outbreak of the crisis in 2008, this trend reversed and the G20 countries initiated reforms to regulate the financial markets with the aim to strengthen the robustness of individual institutions and increase overall financial stability. Regulations were manyfold and included reforms for minimum capital requirements, regulation of liquidity to avoid liquidity shortages, creation of the single resolution mechanism to protect taxpayers in the event of bank failures and maintaining financial stability. Leveraged Finance as a lending class was no exception either. In 2017, the ECB published guidance for banks on leveraged transactions with the aim of establishing sound origination and risk management practices to facilitate adequate financing of the real economy. The implementation of the new rules tied up banks’ resources and further increased their capital requirements, massively impacting their cost base. Tighter regulation is expected to continue over the upcoming years and it remains one of the major challenges for financial institutions to overcome.

An increasing number of fintech companies are giving the banking sector competition. What is the response of the German traditional banking sector to this?

This is an accurate observation. Fintech companies have started to compete with traditional banks across almost the entire value chain. They are fast, innovative, agile and have a high degree of client orientation, building their business model around factors such as convenience and innovation. Beyond that, they are the forerunners of digitization in the financial services market working on the platform principle. Established financial institutions are also improving their know-how in these fields and can rely on their long-standing relationships with their clients. These strengths – the innovativeness and agility of Fintech companies and the strong client base of the banks – offer attractive opportunities for both to supplement each other and cooperate in multiple fields, such as cash management for instance, is a classic win-win manner. Fintech companies are increasingly seen as potential partners to work with to develop new services for their clients. Banks and the Fintech space learn from each other and are getting closer, thereby making the economy more efficient.

Do you observe any development in the Georgian banking sector and what is happening in the Leveraged Finance space?

I have been observing the banking sector and its dynamics in Georgia, although I would not claim a high degree of familiarity with the local banking market. From my point of view, Georgian banks showed solid growth and delivered sound profitability over the last two decades. However, the banking sector as such appears still relatively small to me, judging by the scale of their consolidated assets. There are a couple of players dominating the market and increased competition would come to favour local corporates and private clients with an ultimately positive impact on the economic growth of the country. This is, however, a long-term process and presumably, it will take some years to align the scale of the banking sector to the country’s economy. Regarding the banking environment around Leveraged Finance, the entire CEE (Central and Eastern Europe) region accounts for a low single-digit percentage of the European LBO market, indicating that countries (including Georgia) lag well behind their Western European peers. There are several crucial aspects needed to build a functional, reliable environment for LBO lending. In order to attract foreign asset management companies, it is imperative the region demonstrates long-term political stability – within the countries themselves, but also in their foreign affairs. Also, a harmonization of the local legal framework with the Western European markets, alongside appropriate regulation of lending would be a solid base from which to build. Furthermore, the professionalization and development of Georgian asset management companies are necessary – deploying their funds in this asset class would be beneficial for the market as a whole. Finally, Georgian based businesses must achieve a certain scale and must demonstrate resilient growth over a longer period of time, as well as diversify their revenue streams across a larger number of geographies, preferably beyond post-Soviet countries, where the vast majority of the country’s exports is concentrated. The aforementioned aspects represent notable hurdles to developing an efficient Leveraged Finance market, and this will not happen overnight in Georgia.

The pandemic caused digitalization to a large part of the services in the Georgian banking sector. Was this the same in Germany?

For a couple of years now, the digitalization of services has been on the agenda of German banks. The process towards the improvement of digitized services started before the pandemic. However, the rapidly changing behaviour of clients during the last one and a half years and increased demand on digitized banking products, such as cashless payments, for instance, will accelerate the process. This applies to both the digitization of services to the end customer and to bank-internal processes to achieve a higher degree of efficiency and agility.

Today, no one doubts that successfully developed and implemented digital solutions coupled with up to date functional IT will be a critical factor for German banks to succeed in this highly competitive environment. The first successful results are already visible but there is much more to come in the following years.

And finally, do you have any plans related to Georgia?

Despite my desire, it appears rather challenging to connect my professional future with Georgia in the short term. In the long term, however, I remain optimistic and would be delighted if I had an opportunity to someday apply my professional experience in a Georgian company. This would be a great privilege for me.

 

The views expressed in the interview are the opinion of the respondent and not the views of Deutsche Bank.

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