At the start of 2020, most risk managers considered climate change to be one of their biggest issues over the next ten years, with Brexit remaining an economic concern in Europe. Banking institutions faced significant pressures and challenges to transform their businesses, deliver to raised customer-experience expectations, and further drive down costs – all through a prolonged period of very low and even negative interest rates - while continuing to deliver regulatory compliance and embed innovation in their operating models.
The emergence of COVID-19 and associated measures will amplify any weaknesses in business models or balance sheets. Below are 10 priority areas that we think the banking industry will be focusing on for the rest of the year:
Lockdown has put strain on the financial sector, but the banking industry is well prepared to manage the situation and weather the economic shock. Post-2008 regulatory reforms established robust capital and liquidity buffers to reduce the impact of shock events, and regulators have taken steps to help protect those buffers as coronavirus-related disruption continues into the long term.
Most banking institutions will suffer some operational losses, and low interest rates will also reduce net interest margins (NIM). Banks will need to review their risk profiles, operating models and strategic approach to manage the financial impact.
One of the biggest challenges for the banking sector is balancing losses, while continuing to provide loans, debt-moratoria, and intervention schemes to support financial stability. Under IFRS 9, loans that look set to default will trigger loss provisioning, potentially reducing the ability to offer credit.
In all likelihood, loan loss provisioning is only just getting started and there’s a risk of creating a cyclical effect, where the potential for default leads to reduced lending, which feeds into and contributes to recession. Banking institutions who will restructure early, will benefit from increased financial strength to seize future opportunities.
Banking institutions need agility and business resilience to meet evolving customer needs. Actioning lessons learned from the last few months, particularly around burst capacity processing and operational resilience, will improve customer service and responsiveness. They will also inform recovery, resolution and wind-down plans, operational continuity in resolution and stress-testing scenarios, strengthening financial stability in the long term.
Resilience plans will most likely move away from traditional disaster recovery sites, with the focus shifting to remote-working models. This will put more pressure on cyber security teams to prevent cyber-crime, phishing, and increase data protection.
Working from home will be a bigger part of many business models going forward, leading to a more-distributed workforce and greater workspace rotation. While this will reduce overheads, banking institutions need to review customer access points and establish the right balance between digital and face-to-face service delivery options. Banks will also need to remap their workforce to locations and functions, adopt to collaborative technologies and support greater flexibility.
Agility goes beyond working from home and fungibility is one of the recurring themes we have seen from banking institutions. A greater flexibility in the roles that individuals perform has promoted operational resilience and will most likely be part of the new normal.
As the situation has evolved, banking institutions have made cost reductions and initiated restructuring projects as needed in the short term. Many of these changes will not be appropriate for the long term, and banks will need to review and update their approach regularly, in line with the macro-economic landscape and business needs.
It will be challenging to balance risk exposures, while allocating capital and resources to core and periphery business lines. Banking institutions need to take an innovative approach to manage their expenses, for example, by commercialising technology assets to supply third-party services to other firms or leveraging balance sheets of large technology providers.
Reduced physical mobility under lockdown has forced an increase in the use of digital services by both employees and customers. This acceleration in adoption increases digital transformation efforts and will affect distribution strategies and a reprioritisation of enabling investments. This will continue the need to manage operations and reporting by maximising data assets and insights.
Coping with the change aligns to cultural support in using new organisational tools to better support banking service delivery. There will be pressure to maintain the speed of adopting technology solutions that we saw in protecting franchises throughout the rest of 2020, notwithstanding other budgetary issues described here.
As more customer services are digitised there will be an increased focus, not least from the regulators and politically, on ensuring that certain cohorts and elements of society are not left behind.
Central banks and regulators have focused on maintaining financial stability and operational resilience. To support this, they have offered greater flexibility for regulatory reforms, such as Basel III, and introduced new fiscal policy measures. As such, banking institutions have been able to focus their resources on governance, cyber security, and conduct, as well as essential programmes, such as the LIBOR transition, which remains on course for the end of 2021.
We anticipate further changes to regulatory priorities and tools as events unfold; not least if additional capital needs or the conversion of existing instruments are threatened. As with other initiatives, we anticipate this will always need more, and more frequent, review to keep organisational effort focused on the right areas and respond to official sector initiatives and priorities.
As with the financial crisis, short- to medium-term pressure will lead to market consolidation or a shift in product offerings. Pre-existing issues in the business model will be amplified under stressed conditions, and smaller and medium-sized banks may join forces to restore balance sheets and regain a positive return on equity.
Larger banking institutions may look to acquire discounted firms, or indeed their technology assets, and view this as an opportunity to expand or streamline their product lines.
Remote working has put digital transformation in the spotlight and acted as a catalyst for widespread fintech and regtech adoption. The main barrier to digital transformation is legacy technology architecture, which has gradually become layers of complexity from regulatory reform, change programmes or mergers.
Over time, these become costly, unreliable and unresponsive to change. The banking sector should review technology architecture and assess how digital transformation can reduce costs, support operational resilience, and improve agility and scalability. This will need to be done in a way that addresses the different cyber security risks that remote working brings to the model.
Many operating models rely on third parties to perform near- and off-shore services, and it has been challenging for many banking institutions to maintain their supply chains. Existing third-party arrangements may need a rethink.
For example, some of these services could be achieved through fintech and ecosystem platforms. Alternative solutions could improve business continuity, stability, and agility, while supporting innovation across the business. The use of off-shore centres is a key area of interest, and many firms post-crisis found that elements of these supported their operational resilience.
During the financial crisis, banking institutions were perceived to be part of the problem, but in the current situation, they are an integral part of the solution. Authorities across the globe have called on banks to offer financing and credit as part of a co-ordinated macro-economic response.
In the UK, ring-fenced banks have played a central role in the Treasury’s response, and it has been challenging to balance the pressures of long-term financial stability and short-term shareholder interests. Moving forward, there may be a degree of re-alignment between the financial sector and the government, with new governance arrangements and regulations to support it.
To continue the conversation about the challenges facing the banking sector, contact Paul Garbutt