Change – will it bring success or suffering for UK lenders?

11 June 2010

By Mikael Krohn,
VP at EDB Business Partner

Liquidity and risk management will stand out as key challenges for the financial sector over the next year, not least due to the huge potential cost of compliance. In fact, the French Banking Federation predicted that Basel III proposals would lead to a €360 billion core capital deficit for eurozone banks and a shortage of stable funding estimated at between €2 trillion and €3.5 trillion (1). The coming months will undoubtedly be tough, as banks aim to meet these challenges while improving customer service and rebuilding trust in the industry’s ability to effectively manage risk. With the global banking industry in disagreement on how to achieve this, the road does not look any less rocky for the foreseeable future.

Regulation will be an ongoing theme, as banking supervision proposals first put forward by the Basel Committee last December are still being developed. These ‘Basel III’ proposals are designed as a way of modernising the existing Basel II Framework and strengthening the global banking sector in the wake of the economic crisis through new rules around capital bases, leverage ratios and liquidity standards.

If 2009 was the year when risk and liquidity management, as well as the desire for a renewed sense of simplicity in the banking sector, became of crucial importance for global banks and lenders, then 2010 is the year when banks are planning to implement these considerations for future economic recovery. When the formal list of Basel III rules are published at the end of the year, banks will need to have a clear implementation strategy in place, along with the technology to support it, in order to achieve operational excellence, manage liquidity and comply with regulatory requirements.

Achieving operational excellence

Lending levels in the UK still present a mixed picture. Bank of England figures released in April showed that bank lending to business fell for the third consecutive month. However the central bank's quarterly Credit Conditions Survey also showed that banks expected household demand for both secured and credit card lending to pick up over the next three months (2). In these uncertain conditions, it is vital that banks have systems in place that can streamline administration in order to achieve operational excellence. This involves a provision to capture the whole process structure through the full loan lifecycle, thereby reducing the risk of human fallibility and increasing transparency and auditability.

Keep it liquid

Liquidity will continue to be a high priority over the next year. The latest Basel committee proposals included the introduction of a minimum 30-day liquidity coverage ratio for all internationally active banks. This means that a bank will have to have enough financial resources set aside to meet short-term funding obligations for a 30-day period in the event of finding itself with a liquidity problem. Banks and building societies are also likely to be subject to far tougher stress-tests and risk analysis, putting pressure on them to ‘get their houses in order’. These suggestions are designed to prevent a situation where banks can fail to anticipate the illiquidity that can hit the markets, as many did during the worst of the crisis.

However, some industry experts are pointing to the unintended consequences of new Basel rules. Dr Hugo Bänziger, chief risk officer at Deutsche Bank, noted in an article for the Financial Times that these large high-quality liquidity reserves “cannot be sold immediately when needed, but only after a time-consuming and backward-looking stress test. As a result, banks cannot use the buffer proactively but will have to sell other assets” (3). This could actually increase market volatility during a crisis.

Ready to grow

In light of low activity in the lending sector, many banks are undergoing a period of cost cutting and slimming down their organisations. Previous research from Gartner showed that business expectations are now shifting from a focus on cost-based efficiencies, to achieving better results based on enterprise and IT productivity. These productivity gains will come from collaborative and innovative offerings that take advantage of the new "lighter-weight" services-based technologies (4).

Financial institutions now have an opportunity to use this low activity period to invest in building scalability into their lending processes in advance of the anticipated economic recovery. Bankers and lenders need to ensure that their processes are both efficient and high quality, in order to be prepared for the future economic recovery. Those who do not may find that the effect on the bottom line will be short-lived, whereas banks and building societies that are fully prepared for a new period of growth will be best placed to gain a significant competitive advantage.

Simple is beautiful

In line with the efforts of banks to achieve greater efficiency in their processes, the trend towards greater simplicity in banking, also known as a ‘back to basics’ approach, is likely to continue to gain popularity in the banking sector. Online banks that have been set up around Europe using very simple products and processes have already achieved a great deal of success, and more banks will also look to beat the competition through their own direct banking channels.

This concept also extends to a more simple and transparent banking model, but making this change would involve a major cultural shift away from so-called “casino banking” activities. However, this will not be an easy transition for banks as the culture of high risk taking dates back to the deregulation that began in the 1980s. In a scenario of “old fashioned banking”, banks would base their lending on the ‘real’ economy rather than the predicted economy of the future. Those banks that encourage a culture of ‘simplicity’ may be able to improve efficiency and also strengthen relationships with customers, positioning them for success in 2010 and getting their lending businesses back on track.

While regulations will undoubtedly have an impact on banks’ ability to control their risk, preparing for economic recovery and achieving greater efficiency in their processes will continue to be dominant themes in the coming months. Looking forward, achieving a balance between risk management, scalability and profitability will be a greater challenge than ever for financial institutions, but it will also be a crucial factor in their future success.

1. French Banking Federation response to Basel Committee proposals
2. Bank of England Credit Conditions Survey (Q1 2010)
3. Financial Times article (April 27th 2010)
4. Gartner EXP CIO Leading in Times of Transition: The 2010 CIO Agenda report

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