LONGREAD: Is 2017 the end of banking?

Since the financial crisis, a combination of forces has put pressure on banks and made it increasingly hard to service clients while also earning a viable return for shareholders. Over the next few years, these forces will intensify and the pressure will accelerate.

"Culture eats strategy for breakfast."
Peter Drucker, Business management guru

Whether 2017 is the ‘end of banking’, really depends on the industry’s ability to respond.

In simple terms, there are four key pressures on banking today: low rates and growth, disintermediation, regulation and (last but not least) shareholders.

Let’s go through the list.

Low rates & low growth

The first major pressure on banks is simply a lack of deals and unsustainable terms on the ones which are happening. 

Low rates and liquidity pumping since the financial crisis have led to an unprecedented volume of cheap money sloshing around the world. As a result, competition among banks has intensified to the point deals are now being won on terms unsustainable for both banks and their clients. 

In addition, this cheap money is being pumped into an uncertain environment still scarred from the financial crisis. As a result, despite over a quarter of the global economy now running on negative interest rates, companies and investors remain wary of spending and are sitting on record cash balances.

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• Disintermediation

Another key challenge is the continued disintermediation and commoditisation of banking. Banks are essential value-creating middle men but new competitors are encroaching who promise even greater value creation at less cost.

Fintech has become the ‘word du decade’ as nimble companies with a high-risk appetite chip away at banking services. Some do it better, some do it cheaper and some solve problems that didn’t previously exist.

Fintech itself will not kill banking – many actually rely on banks and their client base. The real fintech wins are where banks and fintech can work together for the mutual benefit of the client. Without question though, culturally, fintech have set the bar for how banks should act.

Platformisation and commoditisation is a related challenge. Technology and big data have taken traditionally opaque businesses where banks had an informational advantage – a perfect example being FX (foreign exchange)– and commoditised them into bank-agnostic solutions where rates can be compared instantly.

This has further narrowed margins and in some cases led to banks simply providing white-labelled balance sheet – loan funding where the customer doesn’t recognise or value the particular bank making the loan. There will always be a role for advice from banks but it will be around an increasingly commoditised product set.

In addition to the wider fintech and commoditisation shift is the emergence of challenger and substitute banks. These range from the British Atom bank re-imagining the business model from first principles, through to crowdfunding and B2B platforms.

Some of the world’s most valuable and effective companies are already eyeing up banking, such as Alibaba’s Ant Financial which has grown to a $US70 billion company in three years. Take these channels and blockchain to a natural conclusion and it is likely the traditional concept of money itself will disappear in the medium term - presenting a different challenge entirely.  

A final source of disintermediation is clients themselves. Comcast and AbbVie are examples of over 20 deals in 2016 where the company chose publically to do their own advisory work. This removes a huge investment banking wallet from big banks, already under fire from smaller boutique advisory firms.

• Regulation

Less money coming in the door and more competition for it would be bad enough but the cost of doing business is also going up.

The regulatory requirements on banks are increasing at a seemingly exponential rate. This is not homogenous but creates a multi-dimensional challenge where every bank faces regulation unique to themselves.

Between Mifid III, Basel IV and other acronyms no-one is quite sure how to pronounce or which number we are up to, banks are facing increased costs by the day.

Much of this burden is passed directly on to the clients, who suffer through the pricing impact and the increasingly bizarre duplicate requests they field from banks.

Internally, regulations such as the senior-managers regime mean it is becoming riskier to be a banker by profession, and you could be personally liable for not just your own actions but those around you.

All eyes are on banking in 2017 to deliver not just results, but do it in the right way.  

• Shareholders

The final pressure is from shareholders themselves.  When was the last time you heard someone at a party confidently announce they are a banker?

As the industry continues to be hit by unexpected scandals shareholders are becoming increasingly wary. As a regulator friend put it recently when told at a conference these inevitable ‘grey swans’ come with exposure to the industry: “banks are beginning to look like grey swan petting zoos.”

However, you can’t cut shareholder returns in an industry which is less profitable and more risky than before – they will simply invest elsewhere for a better return for given risk. It is therefore incumbent on the banks to keep the sector as attractive as it has been historically. 

SO HOW DO (AND SHOULD) BANKS RESPOND?

It doesn't take a genius to see from the above banking is facing a long-term, structural problem. Moreover, it is the banks’ problem to address – not the clients, competitors, regulators or shareholders.

There are however a few key simple responses that can turn these challenges into opportunity.

• Cutting costs and simplifying

Banks have already cut considerable infrastructure and staff costs in recent years, as well as rationalising their client base to only those whom they can best service with their given product and geography set.

As part of this, staff compensation will also likely reduce. Even ignoring the media focus on the top 1 per cent of bankers, in a true global economic context, bankers are paid too much for what they do.

The historic reason is understandable – bankers work hard to make large revenues, a portion of which is fed back in part to the employees.

Put simply, less money coming in and higher costs, means rebalancing the historic pay levels.

Banking therefore becomes a slightly less sure, slightly more risky, slightly less well-paid, but still great profession to be a part of.

A knock on effect is talent may leave banking for other sectors. This move is already well under way, and in reality talent not coming is a much bigger challenge for banks hoping to innovate their way to greatness. The leading way to attract and retain talent in 2017 is having a simple and attractive organisational culture.

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• Outsourcing & automating

Anything not core to being a bank and a source for competitive advantage should arguably be automated or outsourced. 

Arguably almost half of the effort in banking is not ‘banking’ at all. Many roles run the huge (and critically important) infrastructure that supports it. Furthermore this effort is duplicated across banks, which have created mirror infrastructures.

One simple example is KYC (Know Your Customer). It makes no sense at all for 50 banks to be doing similar due diligence on a given multinational’s 30 subsidiaries. These thousand conversations would be much better be centralised with a blockchain-driven intelligent third party, reducing everyone’s wasted time, cost, and frustration.

Some of these are repetitive tasks machine learning will robotise and automate. Some are arguably more important to the bank for the future than the client-facing roles. The future of competitive advantage is therefore hitting the right balance of outsourcing, while also investing in the bank and its people.

• Innovating

Some of the best banks are now using speedboats in the form of innovation and digital units to drag their ocean liner of an organisation around.

The hottest topics for big banks at board level include digital, big data and future developments such as blockchain and machine learning. Some of these innovations are in fact simply essential to compete going forward, while others may prove a source of competitive advantage. One example is harnessing and monetising the vast amounts of data that banks sit on.

In short, banks are becoming technology companies.

Regulation has long been both an excuse to lean on and a barrier to entry to hide behind, justifying the lack of innovation in banking. Despite increasing regulation, this is no longer an acceptable defence, and the focus is now on the culture.

• Culture, culture, culture

There is one thing that binds together everything above – culture. Historically, banks allowed ego and internal politics to drive their productivity, rather than their clients. In some areas, the gap between traditional banking culture and the innovation sector remains startling.

I recently watched a conversation between a top city banker and Google employee about an altercation in work. After a five minute background to the story, the Google employee asked about the very first thing he had said “Why on earth would you email someone who sits next to you?”

Banks have a way to go to catch up to culturally ‘newer’ industries.

PROGRESS

The tide is changing across all banks, and fresh ideas and collaborative behaviours are appearing across the industry. More importantly, clients from retail clients to institutional are seeing innovation and more client-centric behaviour from banks.

For our part at ANZ, the tone has been set by bringing in expertise from the tech sector and innovation labs along with a clear organisational purpose:  to shape a world where people and communities thrive. This is not a fluffy strapline and should shape every action taken by employees in their day job.

As famed management consultant Peter Drucker said, culture eats strategy for breakfast. If the culture at the centre of a bank is not one of embracing and actively driving change, 2017 could well be the end of banking.

Get it right though and the costs will control themselves, fintech and regulatory partnerships will work and the improved customer experience and revenue will follow.

For those that can achieve these changes, 2017 actually represents not the end of banking but a phenomenal opportunity to define the future of finance.

Alex Kewley is a Director, Client Insights & Solutions at ANZ