Retail financial institutions see a future mixed with both opportunity and challenges. In the coming months, how will the industry respond to the fintech threat, rising interest rates, and regulatory changes?
For the last ten years, the banking industry wrestled with a languid economy, historically low interest rates, and a stiff regulatory environment. But the tide of forces squeezing margins could finally take a turn in 2017. In the U.S., a Trump presidency means the financial industry might find a real friend in the White House, and a Republican-controlled Congress will look at rolling back Dodd-Frank.
However, consulting firm Deloitte cautions banks not to overestimate their newfound potential political upside in 2017. While some regulations could be overturned, other new ones could be enacted. Don’t forget: Trump’s victory was based largely on a populist strategy, and the Wells Fargo cross-selling scandal reminded millions of Americans that banks can be both greedy and untrustworthy.
“Regulators used to make sure the system was functional. What we are experiencing now is a shift to consumerism. It is broader than just conduct; it is all about protecting the little guy.”
— Bank Director on Regulation
“Culture and conduct risk will be major agenda items for boards and executive management,” notes Deloitte in a white paper examining the banking industry’s future. “Regulatory backlash could force reviews of frontline staff goals and incentives, particularly those related to sales practices and cross-selling, as well as executive accountability.”
PwC predicts that the regulatory burden for banking providers will generally easeTrump’s broadest impact on financial regulation will come from his appointments to the federal agencies. They also forecast that stress-testing and resolution expectations will continue easing for smaller banks and stop rising for the largest ones.
The good news is that interest rates should continue to rise slightly — enough so that higher net interest margins can give banking providers the wiggle room they need to better offset whatever regulatory and capital requirements they face from government supervisors.
According to Deloitte, the residential mortgage business will likely grow despite this rise in interest rates, as housing starts are expected to jump to meet continuing demand. Deloitte also sees higher wage growth, rising household incomes and consumer confidence bringing new retail and small business lending opportunities. However, Deloitte cautions that retail deposit costs could rise faster than expected, as liquidity coverage ratio requirements place a premium on high-quality, stable funding.
The Fintech Threat: Making the Digital Shift
On October 5-6, 2016, more than 75 of the banking industry’s biggest players met in London for the EY Financial Services Leadership Summit. One thing that became clear from their dialogue is that financial institutions will need to adapt to a changing landscape… or risk obsolescence.
Participants in the EY leadership summit agreed the banking industry is facing an fundamental existential challenge that will require them to ask even basic questions about their relevance. Indeed, one summit participant predicted “a scale of transformation few of us have ever seen.”
“Financial institutions say they can do all of it, but the truth is that the days of being ‘all things to all people’ are numbered.”
In response, many large financial institutions are in the early stages of transforming themselves into more agile, digital-age companies. Under increased competitive pressure from fintech and other technology companies, EY says they are identifying ways to leverage technology to improve customer service, increase efficiency, simplify structures and operations, and make better use of their data.
Transformation will require some difficult trade-offs and new ways of thinking about talent and culture if banking providers are to successfully address legacy structures, processes, and systems to build a platform for the future.
“The process of transformation will be challenging, and some institutions may not survive it,” EY says. “Those that emerge as dominant will be leaner and will offer a different array of services and products. They will face new competitors and have more partners. Some suggest their role in society may also shift, particularly if they continue to retreat from long-term savings and investment products.”
“As banks have evolved, they have added complexity without taking anything away. Historically, the industry made do with cobbled-together legacy systems. That is too expensive today. If there is a regulatory change or a new product, you have to update your systems ten different times. That level of operational effectiveness is impossible. Everyone needs to radically simplify their operations.”
— Participant at EY’s Financial Services Leadership Summit
“Technology is lowering barriers to entry that have protected large financial institutions from new competition,” said one participant in EY’s leadership summit. “It is raising serious questions about the value of their legacy assets and transforming how they do business.”
While few doubt that the fintech sector will have a significant impact on traditional financial services, skepticism remains regarding how truly disruptive the fintech boom will be. However, some believe that incumbent firms have both the time to adapt and the scale and reputation to outcompete the new entrants, while others deny the impact of fintech.
When one participant asked, “How long do we have to respond?” another answered immediately, “It’s urgent.”
In December 2016, the Office of the Comptroller of the Currency said they will start offering national charters to fintech firms, allow upstarts to become special-purpose national banks.
Thomas Curry, head of the OCC, said his agency would begin granting banking licenses to fintechs, giving them greater freedom to operate across the U.S. without seeking state-by-state permission or joining with brick-and-mortar banks.
Under such a policy, firms offering online loans, smartphone payments and other financial-technology products would gain new flexibility to expand and further shake up the banking industry.
“It’s important to note that investments in innovation work differently for established organizations. If you are a startup, you can pitch an idea to 20 different venture capital firms and only one has to say ‘yes.’ At a bank, a new idea may have to go to 20 different people, but it only takes one to say ‘no’ to kill it.”
— Roger Park, EY Partner of FS Strategy & Innovation
Deloitte sees both threats and opportunities facing banks on the technology side of the business.
“Refining the customer experience will be the main driver for technology that drives core transformation, digitization, and automation,” Deloitte says. “As technology upgrade cycles continue to shorten, banks may finally demonstrate a willingness to retire legacy systems for cloud-based platforms.”
According to Deloitte, assets managed by robo-advisors are likely to continue increasing at a fast clip, as banks, insurance companies, and traditional wealth managers embrace the technology.
Deloitte also predicts that marketplace lenders (MPLs) — online platforms that match borrowers with lenders — will see consolidation in 2017, and will continue to converge with banks through partnerships, white label contracting, and even some mergers. Meanwhile, the more established MPLs are expected to gain scale while the smaller ones without strategic bank relationships could begin to disappear.
Payments: Towards a Faster and More Customer-Friendly System
Deloitte says digitization to improve customer experience will dominate growth initiatives in the payments space.
The global drive towards faster payments has pushed U.S. banks to join the Federal Reserve’s Faster Payments Task Force to collaborate on a linked, networked nationwide payment system. In line with this effort, many banks have joined the eWallet bandwagon.
IoT-enabled payments, bots and encryption solutions will be primary technology drivers, according to Deloitte.
“Now that in-app and mobile wallets have become ubiquitous payment tools, their operability will likely see frequent and transformative software and maybe even hardware upgrades throughout the year.”
Similarly, biometrics are expected to increasingly become integrated into digital payment systems, particularly mobile, to increase security.
“Faster payments will see a significant surge in 2017, as banks roll out a collaborative system while agreements and partnerships increase among banks and fintechs with the blessing of the Federal Reserve,” says Deloitte.
Deloitte also predicts that 2017 will likely see the introduction of a next generation PoS system that leapfrogs the need for the many merchants who haven’t done so yet to install EMV terminals.
Faster payments, cyber risk and intellectual property take center stage in the payments regulatory radar. Deloitte says the diffusion of real-time payments will draw the attention of the Consumer Financial Protection Bureau (CFPB), which has been on “fintech high alert” lately.
“When you can’t see what the future holds, you have to be ready for anything.”
As EY notes, the financial services industry faces daunting challenges, but there are still reasons for optimism. Established financial institutions continue to maintain certain advantages over new competitors, and a few of these traditional players will emerge from this transitory period as leaders and innovators.
However, EY says that this will require some difficult decisions grounded in a long-term vision, despite any short-term pressures. Boards will need to ensure that their institutions can navigate this turbulent environment and position themselves for future success. It is the role of the chairman to create an agenda where everyone understands these dramatic changes that will be needed to survive.
“When we emerge from all of this — and I don’t know when that will be — things will look very different,” observed one board director at EY’s leadership summit. “Products and services, the shape of organizations, who your major competitors are… all of this will be different.”