By Ron McMillan
As the global financial sector is undergoing dramatic changes, the banks of tomorrow will have to adopt a new mantra: precision over ubiquity.
Before the onset of the financial crisis, most banks believed the best strategy was to be a ubiquitous player in the market. Banking giants such as Citi and HSBC were frontrunners in introducing the universal banking model, whereby retail and investment banking activities were simultaneously developed in scores of countries far away from the lenders’ home markets.
However, combined with increasing deregulation of the financial sector, the universal banking model was in part responsible for creating an asset bubble and triggering a debt boom that ultimately culminated in the current financial crisis.
PricewaterhouseCoopers research, based on extensive experience of working with banks around the world, shows that as the banking landscape radically changes, financial institutions face a new reality in that they will have to revisit their strategy and focus on fewer activities. A flat or declining market means that growth will only come from a renewed focus on key client franchises and niche opportunities.
Previously, high or increasing financialization — i.e. banks’ deposits relative to gross domestic product — created the illusion that all uses of capital were earning superior returns. But in today’s environment, with capital more constrained, banks must focus on driving improvements in an economically sound manner.
Monetary authorities encouraged the development of the ubiquitous banking model by maintaining lax monetary policies without giving due concerns to the element of systemic risk. In addition, banks were run as aggressive commercial businesses where return on equity (ROE) mattered more than social responsibility. Following the financial crisis, banks will be required to demonstrate a renewed focus on delivering long term sustainable returns and providing socially useful products and services.
Until recently, western banks and financial centers dominated the global financial stage, relying on a large pool of experienced professionals and apparently stable regulation, and against an attractive business backdrop. However, banks from emerging markets in South America, Africa, Asia and the Middle East (SAAAME) and their financial centers are expected to grow in scale and credibility, increasingly challenging and ultimately outgrowing their established western counterparts.
In the run-up to the financial crisis, investors and customers trusted banks to sell products in line with the clients’ best interests. It is no surprise that clients now view their banks more skeptically and demand more transparency of the benefits and risks associated with the products they purchase.
Another key element of the pre-crisis banking sector is that banks were measured, and consequently rewarded performance, on the basis of short-term gains rather than longer-term value creation. Banks today will need to take on a more long-term view on value creation, and work on incentives designed to reward sustainable behaviors.
One of the downsides of the universal banking model was an increasing operational complexity that made it more difficult for management to fully understand and manage risk.
In order to help policymakers and bankers prepare their organizations for tomorrow’s banking world, PwC has identified four major short-term drivers that will have an impact on the banking industry in the next one to two years.
First is the decreasing size of the banking industry relative to the gross domestic product (GDP) of the country it operates from. For decades, banks grew at disproportionate levels compared to their home markets’ GDP. For instance, asset growth of the top 16 banks in the western world was 17 percent per year between 1995 and 2008, while during the same period the European Union’s GDP grew at around 4.5 percent per year. A similar trend took place in the UK, where mortgage lending increased at 17 percent per year between 1997 and 2009, whereas GDP grew only 5 percent per year over the same period.
The global financial crisis potentially marked a turning point for the European banks, as the top 16 lenders saw their assets contract by around 5 percent in 2009.
Growth for the Western banking sector will be more limited in the short- to medium-term. Weaker GDP growth in the US and Europe will constrain the growth of the local financial sectors and possibly lead to capital migrating to faster-growing economies in Asia.
It should also be noted that the European market is highly concentrated, especially in the Netherlands, France and UK, and growth through acquisitions — or organic growth — has become difficult to achieve. Public leverage is exceptionally high, suggesting the potential for additional borrowing is limited. Commercial lending grew at such pace that it is unlikely the domestic banks can attain much more additional growth.
There remain a number of opportunities for revenue growth which could arise from a number of specific areas such as emerging Eastern Europe, taking market share of other banks or chancing pricing models.
A second major short-term driver is the increasing fiscal pressure banks face. With soaring government deficits, austerity measures are expected to have a big impact in the next few years, affecting the speed and size of the recovery and the ability of governments to intervene. In a best case scenario, banking will grow at modest rates, although it is more likely the sector will contract. And there is still a risk of a sovereign debt default in Europe, which could result, and be exacerbated by, further major social unrest.
To assess the immediate challenges for the banking sector, one cannot ignore the potential impact of regulatory reform, the third main short-term catalyst. Banks could well have to alter their business model and shareholders may have to accept lower returns.
There is still much uncertainty regarding the precise impact of the proposed regulatory changes. There is no uniform approach, and key differences in regulatory approach could create uncertainty and be disruptive for banks operating across different jurisdictions. In addition, there is growing concern that the current proposals from regulators across the world could drive a larger share of activity into the so-called shadow banking sector. There is little doubt that following the global financial crisis, regulation is more than ever before on the top of bankers’ agendas.
Last but not least, banks will have to address the issue of stakeholders’ confidence in the banks. The financial crisis has profoundly shaken the customers’ trust in their banks and those bankers who aren’t sufficiently prepared won’t be able to seize opportunities in tomorrow’s new environment and regain their clients’ confidence.
Ron McMillan is the Deputy Chairman and Head of Assurance for PricewaterhouseCoopers, Middle East Region. This article was written exclusively for Daily News Egypt.
