Banks undergoing structural shift: review and outlook
Like other areas of the economy, banking is taking a big hit from COVID-19. Banks have proven highly stable around the world in terms of providing the funding needed for the real economy, and Swiss banks in particular have ensured an efficient supply of liquidity with the aid of government support. However, there is still a risk that a wave of bankruptcies triggered by the recession or other forms of market turmoil could weigh heavily on them.
This considerable uncertainty over how the economy will fare going forward comes at a time when banks are already thinking hard about the business models they need for the future. It is therefore time to take stock of the situation. To this end, it is useful to look back on the past ten years and forward to how the banking sector might look in the year 2030.
The three megatrends of the past decade
Since the financial crisis, the conditions under which banks operate have changed dramatically, triggering a transformation process. Three megatrends have played an especially important part in this respect:
- Low interest rates have held sway from a macroeconomic standpoint, putting a lot of pressure on earnings.
- More stringent regulation in the wake of the financial crisis has ushered in greater stability but also had a negative impact on profitability. On top of this, the Swiss financial centre has completed a paradigm shift to automatic exchange of information (AEOI) and tax transparency.
- The rapidly accelerating digital transformation, meanwhile, has brought significant efficiency gains for banks and allowed them to develop new offerings. At the same time, it has lowered the market entry barrier for non-banks.
These trends have altered how the market is structured and how it functions over the past decade, which in turn has changed the way products and services are priced.
Competitive pressure currently dominating...
These changes have conspired to make competition much more intensive. Digital technology is allowing local banks to offer services far beyond their catchment area for the first time. Even small firms outside the sector can now diversify into banking.
The Big Tech players, for their part, are influencing areas of the market in which they are not even actively involved. This is partly a consequence to the regulatory asymmetry between the financial and tech sectors in terms of supervision and also between countries. However, fair competition requires a level playing field.
Another consequence of the digital transformation is the “democratisation” of banking in that even smaller customers now have the power to shape the market by communicating their expectations. Banks benefit from customers’ trust through long-standing relationships, but the strength of their rivals means that they still need to review their business models if they want to preserve that loyalty.
...along with pressure on margins
In addition to the intensity of competition, the massively increased workload to ensure compliance with regulatory requirements is also depressing profitability. In my last blog, I explained how margins have been squeezed so much in some cases that even the Swiss National Bank is concerned, despite the fact that Swiss banks are considered a bastion of stability because they far exceed capital adequacy and liquidity requirements.
Persistently low interest rates in recent years have been directly affecting profitability. Banks that derive most of their earnings from maturity transformation and those with business models focused on net interest income are suffering most. Since interest rates look likely to remain low for years to come, many institutions urgently need to adapt their business model, especially with increasing numbers of non-banks entering the loan and mortgage businesses.
Digital transformation opening up new opportunities
Measures to fight the coronavirus have also changed the rules to some extent, creating added uncertainty and making it all the more difficult for banks to realign their business. National governments are pumping money into their economies, effectively manipulating securities prices, and they are also intervening in competition by taking a protectionist stance.
It is clear, however, that the digital transformation is giving banks a variety of tools that can help them to pursue new business models – for example by focusing more strongly on data-driven income streams or open banking. As set out in the Swiss Bankers Association’s recent overview of open banking, the aim here is to offer customers added value by enhancing the bank’s own offering with innovative products and services.
Added value for customers in the year 2030
Clarity about customers’ future needs is a prerequisite for financial institutions to add value in a profitable way. In its discussion paper, Swiss Fintech Innovations (SFTI) identifies four ways banks can create value in the year 2030:
- Protecting value: People want protection that goes beyond traditional financial assets, from data security and privacy to all forms of digitally represented rights to digital and non-digital assets.
- Facilitating the exchange of value: Ten years from now, the decision to enter into an exchange of value will be automatically triggered by an event in the real world. Bank customers expect this to involve automated payment execution. In addition, users want direct access to trading platforms for negotiable assets, some of which might be entirely new.
- Advisory and intelligence: The scope of financial advice will extend way beyond risk management and return optimisation. Assessing sustainability and social factors is playing an increasingly important part in the asset allocation process. Customers are generally looking for a sort of life coach rather than just an advisor. Financial institutions will thus offer advice on education or choosing an employer and will perhaps even book theatre tickets for their customers.
- Accessing exclusive value: Customers want access to assets that are currently beyond their reach. Financial institutions will thus make it possible for them to invest in asset classes such as intellectual property, which are only available to high-net-worth customers at present, and join communities that currently function as exclusive clubs.
Success hinges on the right framework
Given the fast pace of change, it is extremely ambitious to make any predictions over a ten-year horizon. There are therefore grounds to assume that not all of the scenarios in the SFTI paper will be borne out to the extent that banks can differentiate themselves in all the areas addressed. That said, it seems clear that traditional banking services will become increasingly commoditised, putting even more pressure on earnings. With this in mind, no bank that wants to survive over the medium to long term can escape the need to build up extensive and sophisticated digital capabilities.
At the same time, banks in Switzerland also need an optimum framework to continue their projects aimed at strengthening the country’s international competitiveness. The Swiss Bankers Association is working hard to pave the way towards attractive, sustainable added value for customers and the financial centre as a whole, for instance by clarifying issues concerning cloud use by banks, seeking dialogue on open banking and lobbying for changes in the legislation governing blockchain technology.