The global banking industry could regain a significant proportion of the profitability lost during the financial crisis by adopting modern banking platforms, according to new research by Temenos and Deloitte, the business advisory firm.
Bridging the Profitability Gap analysed levels of bank profitability globally since the 2008 financial crisis, which were found to be less than those experienced pre-2008. Between 1980 and 2007, the average return on equity (RoE) across the global banking industry was approximately 16 per cent per year. This figure plummeted as a result of the financial crisis, to 4 percent in 2008, and then recovered to10 percent in 2010 – leaving a gap of 6 percent, the equivalent of USD $310 billion. Contributing factors included increased regulatory pressures, changes to bank funding, more intense competition and shifting customer behaviour.
The research finds that the implementation of modern banking platforms could close this gap by as much as 60% or USD $180 billion. Over the past three years, banks using modern banking platforms have experienced, on average, 25 percent higher return on assets, and a 37 percent higher return on capital than banks running on legacy applications.
Ben Robinson, director of strategy at Temenos, said: “The banking profitability gap is structural, the effect of structural changes in regulation, competition and customer behaviour. To bridge it, banks will need a structural answer. However, most banks’ responses so far, like staff reductions, hiring freezes and tighter procurement processes, do not address the root cause and are not sustainable. Banks need to improve revenue generation per asset and lower cost to income in a systematic way that will yield sustainable improvements in RoE across the business cycles. And they need to act quickly: slow income growth in developed markets will expose structural cost inefficiencies, while heightened competition in emerging markets will force banks to innovate at the same time as reducing cost to serve.”
Tim Walker, financial services partner at Deloitte, added: “The case for core system renewal is highly compelling. In our experience, banks have tended not to modernise their systems for two reasons: a reluctance to undertake what they view as a risky IT project and the fact that there has been limited market pressure to do so. However, the situation is changing. The core banking industry has seen systems providers and suppliers mature significantly. And, secondly, the new economics of the industry won’t allow banks to continue to defer action.”
Bridging the Profitability Gap has identified four levers to raise banks’ RoE:
- Move into more profitable markets and segments – modern banking systems give banks the flexibility to act quickly in response to changing market opportunities, such as the ability to launch products quickly reusing existing components.
- Raise asset yield within existing business – modern systems give banks the single, complete and real-time view of the customer and risk that is essential if banks are to lower the level of asset provisioning and increase the level of cross-selling.
- Identify sustainable cost cutting measures – cutting costs in a manner that is efficient and sustainable, long-term, is challenging, and requires the streamlining, automation and optimisation of processes, rather than simply paring them back.
- Extracting economies of scale – banks have a poor track record of extracting IT economies of scale, with many running on complex, siloed systems which necessitate manual workarounds. Effective technology infrastructure is integrated and scalable, and allows banks to add increased levels of customer and processing volume, without experiencing a commensurate increase in software or labour costs – thus reducing IT costs relative to income.