Compiled by our banking team, these are the key themes shaping the banking industry right now – and how to stay on top of them for a more resilient future.
Geopolitics is likely to dominate for months to come. Banking institutions have had to adjust quickly to the changing sanctions regimes. They've also had to build out their understanding of second order exposures (certain automotive firms are vulnerable to their dependency on Ukrainian wiring plants, for example) and the longer-term financial consequences of the conflict (typically a fall in global trade and GDP).
On sanctions, banks are increasingly focusing on understanding the ‘ultimate beneficial owner’ for property and other collateral assets. Banks who do not get a grip of this area will face large regulatory fines, reputational fallout and not least the moral dilemma of their potential role in this conflict.
One of the immediate effects of the uncertainty is the impact on energy prices and the increasing prospect of material inflation. The key underlying drivers of inflation before the conflict started – energy prices and supply chain issues – are now more likely to be amplified.
And while the pandemic left banks relatively unscathed in revenue terms, the benign impact on earnings may not continue. Losses on lending did not crystallise in many cases, in large part due to the government furlough and other support schemes. But the outlook is less favourable. The cost-of-living squeeze, among other things, will affect banks and vary their earnings. We expect to see an increase in loan loss provisions and increased volatility in bank earnings.
Sustained inflation is outside of most corporate memories and both businesses and banks must assess its commercial impact carefully. In response to inflationary pressures, central banks are predictably hiking interest rates – the Bank of England raised the base rate to 0.5% on 3 February, and lifted it further to 0.75% on 17 March, with more increases anticipated. The longer that inflation is sustained, the more we will see interest rate rises. The current environment signals an end to the quantitative easing (QE) and asset price inflation (eg, Nationwide's annual house price index rose to 14.3% in March 2022) of recent years.
While net interest margin (NIM) for banks increases when rates are higher, this may be outweighed by the adverse financial impacts as customers and sectors struggle. Higher rates and credit costs have also sparked discussions of a cost-of-living squeeze, which will impact both individuals and companies. Both could struggle to manage the new costs and we may consequently see delinquency and defaults rise.
Banks will want to reduce inefficiency – which can be exceedingly difficult to get right. Some will cut too deep and too soon; others will fail to act sufficiently swiftly or broadly. Both could have significant impact on operating models.
In recent years we have seen explicit targets to reduce costs. While that agenda continues to play out, we anticipate a greater focus on ‘value for money’ and ‘getting it right first time’. The substantial costs of remediation continue, however, and our view is that for most larger banks it is still not possible to draw a line under ‘the mistakes of the past’.
Further conduct challenges lie ahead as the regulatory bar is raised again this year. The FCA’s new consumer regulations – a new Consumer Duty with final rules due in July – is moving the dial for the financial services sector. Banks will not only have to be fair, but they also must act in the best interest of customers. We have seen for example that insurers have had to stop price walking back-book customers into higher premiums – the ‘loyalty tax’ has been effectively banned.
Similarly, banks will have to provide evidence to show that they have acted in the best interests of their customers. This may require fewer changes at larger banks with a relatively more diversified product range and income channels, but smaller and medium-sized banks may struggle to justify that their business models are in the best interest of customers.
Payment fraud is on the rise – criminals are developing new ways to target and obtain money from their victims, with authorised push payment (APP) fraud now exceeding card payment fraud. Scams involving the purchase of goods and services which are never delivered or never materialise are also increasing.
The EU and UK-wide regulatory technical standards on strong customer authentication (SCA) and Pay.UK’s Confirmation of Payee (CoP) have sought to secure customer funds and reduce losses from fraud. However, these measures and changes come with unique implementation challenges.
In 2021 there were several high-profile fines relating to financial crime, which continues to be an active focus for the regulator. Past failings by banks continue to come to light and most financial institutions will have to continue to invest in this as part of remediation or to keep pace with regulatory expectations. With recent geopolitical events and the use of sanctions, the regulator is unlikely to take their foot off this particular pedal.
Regulators are placing increasing pressure to ensure the information that comes to them is reliable and accurate. Strengthening regulatory reporting is an ongoing theme, and firms need to both keep up with reporting requirements and ensure that their processes are genuinely fit for purpose.
Leveraging data and analytics to support reporting is a common theme and organisations should look to this as an opportunity to transform their regulatory reporting, risk and finance teams. The regulators have signalled their wish to be more data-led – the industry will need to support that.
Traditional net interest margin (NIM) may no longer be the biggest revenue source in banking.
Equity valuations for payment firms and those that ‘own’ the customer interface are massive, far exceeding valuations for traditional banks and their operating models. Increasingly, the value is seen as those elements of banking that touch the customer with other points becoming less important. In short, having control of the customers coming to you is where the value lies.
Banks are making more money by having good customer relationships. Therefore, disintermediation is a major risk that is starting to materialise and must be considered by banks. Other non-banking firms are also starting to offer services in this space, which could encroach on bank market share.
Banks will need to decarbonise their loan portfolios (Scope 3 carbon emissions), as well as taking the steps to be more sustainable internally (Scope 1 and 2 emissions). There is an ongoing focus on environmental, social, and governance (ESG) issues, but we are seeing nuances around other topics beyond climate change begin to surface. These include biodiversity, diversity and inclusion, and sustainability in the broader sense.
The societal (S) and governance (G) points are still second to climate and the environment (E), but they are growing. For example, there is a growing pressure on banks to change lending habits and try to gauge how ethical their investments and services are.
There is a growing emphasis on collecting and improving data across financial services. Having access to this information can support both internal and external decisions by banks. It allows firms to better justify their direction and can support information requirements from regulators.
The underlying data must be robust to support the broader business and investments in innovation. Banks must also consider who owns the data, as different teams might have separate ideas of what is and is not the right data source.
The banking and payments sector has many competing priorities around these key themes. Adapting quickly to new stakeholder requirements will help to ensure future resilience.
While staying on top of all these topics may seem daunting, banks have an opportunity to transform frameworks and processes so that they are more sustainable, scalable and future-proof. A review of internal frameworks will help decide whether they align to existing and future commercial strategy and goals.
