KPMG’s US Banking Industry Outlook Survey 2013 released in August marks the fifth consecutive year we’ve surveyed senior US banking executives for their perspectives on a variety of topics. Unsurprising navigating regulatory change is a dominant theme throughout our survey responses and continues to pose challenges as US banking executives indicate increasing concerns over the impact these requirements will have on growth and business models.
For example, almost three quarters of executives surveyed cite legislative and regulatory pressures as the most significant barrier to growth over the next year, while nearly 80 percent believe political and regulatory uncertainty poses the greatest threat to their bank’s traditional business model.
It is worth noting these early impacts represent a relatively early indicator of a larger wave of change to come considering we are still in the initial stages of a new regulatory timetable in the US. For example, there are hundreds of rules coming out of the Dodd Frank Act - including the Volcker Rule, living wills, and consumer protection – that are still being written. In fact, less than 40 percent overall have been finalised to date.
Meanwhile, exams and interactions with regulators continue to increase for banks and there is little indication that this will end any time soon.
With gradually improving economic and business conditions, US banks are also looking at numerous ways to grow the top line, including new products and services and expansion into new geographies and customer segments.
Cross-selling of services is viewed as a key growth driver in the year ahead, moving into the top spot over traditional banking products, which dropped significantly from its position as top growth driver last year.
Finally, IT remains a key priority for most US banks as executives increasingly recognize the value of leveraging data to optimise customer development as well as improving operational efficiencies in managing regulatory compliance and platform simplification. In addition to increasing IT spending, banking executives in the survey said they plan to spend more on their regulation and control environment and geographic expansion over the next 3 years.
An increasing area of spend is in cyber-security as the motivation for cyber assaults is shifting, from financial crime to political and ideological attacks, with the number of state-sponsored hacking and 'hacktivist' revenge incidents growing. Six major US banking institutions suffered website outages in 2012.
Also released in August was KPMG's UK Bank Performance Benchmarking Report which explored the key trends in the first half results of the big five UK banks and warns that, despite improved financial performance, real threats and uncertainties remain.
All five major UK banks recorded a profit in the first half of the year, for the first time since 2010, with combined profits of some £16.5 billion. However, the industry emerging is very different to how it was before the crisis started and is adjusting to a future in which bank business models in the UK are "unlikely ever to be the same again".
Whilst overall lending was up by less than one per cent and customer deposits increasing by 6 percent during the period, return on equity has roughly halved compared to 2005 levels, from near 20 percent to under 10 percent now – and this looks unlikely to reverse in the near-term. This is accentuated by the fact that average capital ratios have increased from to 12 percent.
In addition, almost 20 percent of first half statutory profits were wiped out by the continuing need to set money aside against mis-selling claims. Over the last two and a half years, the total costs of remediation and litigation amongst the top five banks equates to 45 percent of total profit before tax.
KPMG’s UK report also warns of other more systemic threats than the familiar mis-selling issues. Firstly, waves of regulatory change, both local and global, appear to be pushing some countries – and the global financial system – beyond the 'tipping point' at which the negative impact of regulation on economic growth begins to exceed its benefits and this is being exacerbated by the speed at which changes are being implemented. Secondly, these changes are coming at a time when a new group of leaders is at the helm of UK banks.
At the same time, between 2006 and 2012 more than 75 percent of non-executive directors and 72 percent of executive management have been replaced at the five major UK banks. There is a risk that boards and senior management are forced to become short-termist and risk averse, focused on their institution’s (and indeed their own) immediate safety and survival, rather than looking for a sustainable route back to growth.
There has been a move towards a more local and domestic emphasis amongst UK banks. There has been an increasing localisation of banking markets as different jurisdictions impose their own capital, liquidity, governance and structural requirements in the scramble for greater control over what happens on home turf. This fragmentation, will severely constrain international banks' ability to provide financial services effectively to their international corporate customers.
Finally, KPMG’s report also warns that the next systemic shock, if there is one, could come from an as yet unforeseen event such as a massive systems outage or a new breed of cyber attack. After years of improvement, UK banks suffered a 12 percent increase in online account fraud last year. While UK banks have escaped mass disruption assaults so far, they remain under pressure to ensure systems are robust enough to cope with a failure.
While the US and UK banking industries are at different stages of their recovery, there are a few useful parallels which can be drawn to the Australian marketplace. Locally, APRA has indicated that "we are over the hump" of major changes to the prudential regulatory framework, however, industry participants are still awaiting final rules in a few areas, such as in relation to conglomerates policy and securitisation.
Looking at the implications of international regulatory changes, local banks are still uncertain with respect to certain aspects of US regulatory reform, e.g. the Dodd Frank Act and FATCA compliance (as an intergovernmental agreement is yet to be signed). Similar to the challenges facing UK banks abroad, Australian banks will need to consider their regional operating models in light of regulatory, legal and tax developments in the region and each market they operate in, e.g. regional booking models, subsidiarisation.
In a low growth, low interest rate environment, similar to US banks, many Australian banks’ growth strategies is centred on increasing cross-sell rates to existing customers. A core feature of this activity is investing in IT and leveraging data analytics capabilities to better understand and anticipate client needs.
Australian banks are all investing heavily in technology and while a lot of the focus is how much they are spending and in what areas the spending on, e.g. core systems upgrades, front-line systems, mobile banking, etc., not enough attention is being placed on how well this expenditure is being executed (and as a consequence, the realisation of benefits).
Another common area of focus with both UK and US banks, is the increasing concern around cyber threats for the Australian banking industry. As more transaction move from branches to electronic forms (e.g. online and mobile), the importance of cyber security increases. Against this context, the Australian banks continue to invest heavily in this area and at an industry level, collaborate and share information to ensure that threats are identified as early as possible and appropriate actions are taken.
At a practical level, many industry participants are investing in running crisis simulation exercises, often involving their boards and senior management teams, to ensure their business continuity plans are robust and have been tested under pressure.