Banks are facing profound structural changes to cope with regulatory and market developments that are driving down traditional revenues and driving up capital requirements and costs. In this brave new world, ‘business as usual’ is not an option.
Dodd-Frank’s Durbin amendment on debit card interchange fees and proposed changes to Regulation E giving new protections for consumers who send remittance transfers to designated recipients in foreign countries are estimated to have removed US$25 billion alone in potential revenues from the country’s banks. On top of this, the Volcker Rule has significantly reduced proprietary trading and further eroded revenues significantly. In many markets, demand for commercial lending is low and consumers are deleveraging. In addition, net interest margins are at or near historic lows. On top of all this, Tier 1 capital requirements have increased aggressively – particularly for ‘systemically important financial institutions’ – as Basel II has become Basel 2.5 and then Basel III.
Meanwhile, the regulatory burden is also driving up costs. On one hand, banks have to pay significant fines to address past issues, from payment protection insurance and LIBOR rate fixing in the UK to money laundering and improperly foreclosing on homeowners in the US. On the other, banks have to invest heavily in people, systems and controls to ensure compliance with the deluge of new regulations.
To deal with these challenges, underlying cost bases have to be reduced, which means addressing the structure of the business model and, in particular, the ways in which the bank goes to market. One of the keys to increasing operating model efficiency and end-to-end risk management will be divestment of non-core businesses that are outside the scope of the banks’ expertise, do not have the critical mass for growth, or have risk profiles that are too capital intensive. Another will be economies of scale and automation. Inefficiencies in terms of siloed structures that duplicate technology solutions, and staffing can no longer be afforded. Huge infrastructures with multiple lines of business and branches will need to be streamlined. Geographic consolidation, outsourcing, offshoring, use of lower cost channels and delivery mechanisms will all have to be studied.
With banks’ return on equity forecasted to decrease to historically low levels, changes to the business model must occur, including integrating the regulatory compliance and cost reduction agendas with the development of new sources of profitable revenue, whether by developing new products, targeting new markets, or repackaging existing products and pricing. Everything is in the mix, from pricing of loans or deposit products to fees and other revenue producing strategies. New models of customer segmentation are required in order to understand better, for example, where transaction fees may be introduced, value-added services linked to monthly fees offered, or mobile solutions to reduce processing costs adopted. These new customer categories might include the use of social media and non-traditional channels, propensity toward self-service, purchase patterns or a preference for certain payment types.