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.
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.
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.