Major Industry Trends
While regulation continues to be the biggest challenge facing the banking and financial services sector during 2013, banks are facing challenges on a number of other fronts. In its 2012 report on the banking sector, consultancy Accenture points out that some of the key strategies that the largest banks favored to boost earnings before the financial crash have now been discarded. The requirement to hold more capital for what are deemed to be riskier loans will reinforce the tendency to be risk-averse.
Proprietary dealing desks are already under threat, although banks have had some success in arguing with the regulator to the effect that it is impossible to distinguish between some kinds of proprietary trading and the bank simply providing traditional hedging services for its commercial clients.
One instance of the more restricted world that banks will be operating in lies in securitization deals, or rather their absence in the current climate. Banks will have plenty of disincentives predisposing them against going in for securitization plays. These had been seen as highly profitable in the run-up to the crash, but mortgage-backed securitization packages turned out to be one of the most toxic items on bank books during the crash of 2008, and the appetite for large-scale securitizations has yet to return.
As mainstream banks increasingly withdraw from lending to corporates with C-grade investment ratings, other players from outside the banking world are emerging to “cherry-pick” clients that the banks no longer want. “New risk-takers—outside the classic banking system—will emerge to raise and deploy capital,” says the Accenture report. Already there are a number of new lenders interested in providing three to five-year loans to mid-range corporates at rates that are only slightly more expensive than traditional bank rates.
Another major trend that banks are grappling with is the emergence of innovative, mobile payments systems. This trend is bringing banks into direct competition with a range of new service providers. In a report on banking trends, Deutsche Bank (2012) points out that leading IT and software firms like Google and Apple, along with traditional payment services providers such as PayPal, are all active in bringing mobile payment systems to market. Card firms, too, are repositioning themselves to take advantage of payment via mobile phones, and telecoms providers are also potential suppliers, as they have systems designed to bill at periodic intervals for small amounts (individual phone calls).
This same theme emerged in a recent roundtable seminar hosted by IBM and FST Media. Brett King, a technology expert and futurologist, argued at the seminar that banks are going to find that customers are increasingly finding banks and traditional banking services irrelevant. The digitization of money and its disbursement electronically through the ubiquitous mobile phone represents a major threat to the bank’s traditional relationship with its retail customers, and can leave bank branch networks looking woefully underutilized. Banks are going to have to respond rapidly, both by building relationships with new players like Google, and by “going mobile” themselves.
By the start of 2013, the debate between those who want to see big banks broken up to get rid of the “too big to fail” trap once and for all, and those who simply want better regulation of the banking sector still had to be resolved. Many senior bankers argue that as companies operate in an increasingly global world, they need the spread of services and geographies that only the biggest banks can provide, and that unitary banks, which combine investment and deposit-taking activities, are best placed to provide that full range of services. Bank services directly affect the economy for good or ill, so the power of the banking lobby to restrict political efforts to regulate the sector should not be underestimated.
The other factor is fear of regulatory arbitrage. If most countries regulate banks heavily but a few do not, those few could see a number of banks relocating to their territory, with beneficial consequences for them and negative consequences for the rest. So far, while there is some movement towards an international consensus, actually achieving it remains elusive.
There is an obvious relationship between bank regulation and its potential impact on the economy, particularly when the regulatory authorities are concerned—as they rightly should be—with ensuring that banks hold sufficient capital to be able to weather reasonable levels of stress in the market. The debate here is all about how much capital banks should be made to hold in reserve, and how quickly they should be asked to improve their capital adequacy. There are real fears that making banks hold more capital in reserve, and calculating the amount of capital required with reference to the risks inherent in the bank’s lending book, will naturally lead to banks curtailing their lending to weaker companies. Clearly, cutting off riskier lending is one option, and in many instances it is seen as a more attractive option than raising more capital.
Basel III sets out minimum standards for enhancing bank capital requirements, and reducing the amount of leverage that banks should be allowed to consider prudent. It has been fiercely attacked by bankers as being far too pro-cyclical, i.e. likely to amplify positive and negative trends. The banking lobby also argues that Basel III is likely to pull money out of the economy (by making banks hold more capital) just when the economy most needs additional lending.
In addition to Basel III, there is a continuing effort by national regulators in general, and in the United Kingdom by the Financial Services Authority (FSA) and, as of April 1, 2013, its two replacement bodies, the Prudential Regulatory Board (PRB) and the Financial Conduct Authority (FCA), to work out what will be required to bring about an orderly resolution of any large, failed bank. Still another arm to this regulatory debate is the European Central Bank’s proposal, put forward in June 2012 and apparently strongly underwritten at the EU summit on October 17, 2012, for a unitary banking regulator and a single resolution fund that would be capable of bailing out any failed European bank without need for recourse to that bank’s sovereign government.
At a stroke, this is seen as the solution to breaking the pernicious negative feedback loop between failing banks and failing states, taking considerable pressure off the likes of Spain. It is important to note that the three regulatory initiatives aimed at banks, namely Basel III, the so-called “living wills” debate over how to manage the orderly failure of large banks, and a single European banking regulator, are all interrelated but somewhat independent regulatory projects. The single banking supervisory authority proposal was first mooted seriously by the European Union in June 2012, but in a fairly watery sort of way, with a lot of “wriggle room.” The October 2012 meeting of heads of state sharpened this up remarkably, calling for legislators to draft legislation to bring a unitary banking regulator into existence by January 2013.
However, the path to banking union in the European Union is not going to be a smooth one. Speaking at a conference in Frankfurt on November 19, 2012, Jens Weidman, the head of the Bundesbank, warned that a banking union would not of itself cure the current crisis. There were only two paths that would lead to a solution, he told his audience. Either member states would have to take greater ownership and responsibility individually for their own problems, or they would have to move to a full fiscal union, ceding national sovereignty to a European central state.
The Rise of Asian Banks
The last five years have seen Chinese banks moving to the top of the banking league tables. China now has three of the top 10 global banks in ICBC, China Construction Bank, and Bank of China, and it has seven of the top 10 fastest-growing banks, according to The Banker. Japan’s banks are also doing well, and have been involved in some major acquisitions. In December 2011, Mitsubishi UFJ Financial Group paid US$457.5 million for a 15% stake in AMP Capital Holdings, for example, and that deal was dwarfed by Sumimoto Mitsui Financial Group’s US$7.3 billion acquisition of the UK-based Royal Bank of Scotland’s aircraft leasing business. The rise of strong regional banks focused on regional trade, rather than on trying to develop a global footprint, is a potentially serious competitive threat to the big global banks, already under threat from regulators.
The US Banking Sector—Not Out of the Woods Yet
In its report in September 2012, “Banking system outlook,” the ratings agency Moody’s said that the outlook for the US banking sector remained negative. Moody’s had the giant US banks, including Bank of America, Citigroup, Goldman Sachs Group, JPMorgan Chase & Co, and others, squarely in the frame, arguing that the macroeconomic environment could well undo much that the big US banks had achieved by way of steadying the ship in the years since the 2008 global financial crash. “US banks remain in recovery mode, which is prone to reversal if the economy takes a turn for the worse. Nonperforming asset levels are still high, and legacy issues from the financial crisis will take years to resolve,” Moody’s said. In sum, the next few years are going to be difficult for banks in the United States and Europe, while Asian banks are likely to see their growth spurt continue.