European Banking Authority, Executive Director
De Nederlandsche Bank, Director Financial Stability
European Central Bank, Director General, Micro-Prudential Supervision IV
Luigi Federico Signorini
Banca d'Italia, Deputy Governor and Member of the Governing Board
HSBC Holdings plc, Global Head of Regulatory Policy
José Manuel González-Páramo
Banco Bilbao Vizcaya Argentaria, Executive Board Member
Moody's Investors Service Limited, Associate Managing Director
Deutscher Sparkassen- und Giroverband, Executive Member of the Board
1. Future of the EU banking sector: stake and drivers for the current evolutions
1.1. The banking sector has currently to address a multitude of issues at the same time
The Chair said that business models in banking have been in the spotlight for the last few years, both in the industry as well as in regulatory and supervisory work, with a slightly different objective. What is common in this analysis is that both supervisors and policymakers, as well as leaders in the business, are trying to come to conclusions as to how Europe can rebuild a sustainable, successful and well-functioning banking system and how business models need to change in order to achieve this objective.
An industry representative said that the challenges that the industry is facing are defined by a multitude of issues at the same time. Europe has emerged from the financial crisis that began in 2007, with the first impacts being seen in 2008 and further impacts being seen in 2009 with the decline in GDP; in Europe this situation triggered reactions on the areas of monetary policy and regulation. The industry representative stated that the monetary policy unfolded by the ECB contributed to help some economies and also financial institutions in Europe, and because of that the European economy survived at the outset.
The ability to cope with all those problems at the same time is restricted by political developments. Europe is entering the process of Brexit; some European countries are facing elections where the outcome is not yet clear, and Europe also has to deal with diverse or disparate signs from the United States in regulation and for the finance industry. Nobody knows exactly what is going to happen. All of this together creates uncertainty, and somehow the industry will have to deal with this.
A central banker noted that they strongly agree regarding ever more complex regulation, because the SSM also have to deal with this on a daily basis. A major reason for the complex regulation and the thick CRR is that there is so much lobbying and so many details that, for every detail, another subparagraph is required. This leads to complex regulation; whenever something is not exactly right, there is arbitrage, and the process begins again. Everyone would like to return to much simpler regulation, but it is not only the regulator that has to do this; this needs to be an initiative driven by both parties.
A banker said that it is very encouraging to see that the official sector has a very clear view of the problems and that everyone is on the same page. It is quite interesting to look around with a global perspective: the problems are slightly different in different parts of the world, but problems with revenues, low interest rates, pricing power, appetite for credit, costs and distribution, branches, fintech, balance sheets, liquidity and capital are faced by franchises around the world. There will be a bit more in Europe on the revenue side, and a bit more on the costs side.
The problems that banks face in some respects can be largely grouped into three categories. The first is uncertainty about things that are going on, and the destination: that is a pervasive concern, and it is small issues that continually damage confidence. The second is the need to maintain and return the cost of equity, and the fact that the cost of equity has not gone down as a result of the measures taken in the crisis. This is one area that the official sector has not reached agreement on, and it remains a real pressure on banks. The markets will say that the cost of equity has not gone down, and the reasons why that is not the case are understandable, but there have been discussions with central bankers and regulators in which they have said that they cannot understand why the cost of equity has not gone down. This is an area in which an understanding needs to be reached.
The biggest problem for banks is simultaneous linear equations. Banks are trying to solve all of these problems at the same time; if the only problem was interest rates or capital, they could address these, but a much higher level of leadership capacity, financial capacity and intelligence are required to tackle all of these issues at the same time. As in many areas, actually dealing with each individual problem is not too hard, but trying to do each of those things at the same time with the same amount of money is the problem. If this can somehow be spread over a longer period of time, or somebody can be brought in to help with specific problems, this may make the burden easier for banks to carry.
1.2. There is no single EU banking system and not every single business model or bank is challenged in the same way
An industry representative noted that earlier, the point was made that it is very difficult to come up with a single view; they strongly agree with this. Their personal portfolio of banks includes Italian and Dutch banks, and when Moody’s provides ratings and research to the markets on Italy or the Netherlands, they are not saying exactly the same things. There is no single EU banking system; there are many EU banking systems, including good ones and less good ones. Europe could look into this issue by saying that many banks are still dealing with legacy issues, and many banks are preparing for the future. This is not to say that dealing with the legacy is not preparing for the future, but it is a matter of balance.
A second delineation is common issues versus specific issues. All banks are dealing with regulation, IT and the low interest rate environment. At the same time, when it comes to business models, not every single business model is challenged in the same way. For some banks, this is a matter of survival, but for others it is only a matter of fine tuning, because their business model as it stands today is very strong.
In relation to IT, Moody’s talks to banks every day and asks questions, and invests a great deal of time in understanding IT development, digital banking, and related topics. It is critical to benchmark banks: strong, less strong, and weak banks. When asking banks how they position themselves in terms of IT, this is unclear, because they are at the beginning of their journey and it is very difficult for banks to have the solution. There are many solutions, but when the issue is the quality of the business model of banks, ‘the proof is in the pudding’. The business model will be strong if banks can generate profit and capital, and absorb what is expected and what is unexpected.
1.3. The banking system is not isolated from the financial system
A banker said that the banking system is not isolated from the financial system. Society needs to be clear about the nature of the banking system that it wants, and how much competition or protection is wanted. This will give a very clear steer to the leaders of banks as to what they need to deliver, which is somewhat lacking at the present time. The nature of the banking system has changed within the financial system and within society: if society is clear what it wants, this can be delivered.
2. Risks (and opportunities) the banking industry is confronted to: rapidly evolving technology, new competitors, regulatory and taxation uncertainty, NPL, challenging macroeconomic environment…
A central banker noted that political uncertainties, including Brexit and the new administration in the US, combine with a certain risk of reversal of risk premia.
2.1. Banks are embedded in the real economy and face the consequences of economic challenges in the form of technologic challenges, non-performing loans, the consequences of low or volatile interest rates but also lasting regulatory uncertainties
2.1.1. Banks are deeply embedded in the real economic system
A central banker said that a distinction has to be made between current challenges and strategic ones for the future, which are more important. The main challenge at the moment is still the weak economic environment, especially for banks like those in Italy that are deeply embedded in the real economic system. Banks cannot prosper if the economy does not prosper. They might not be ‘entirely at the end of the tunnel’, but there is light. The economic environment has improved a lot, and the recovery is hopefully consolidating. Signs are not entirely discouraging in retrospect, as well. The environment is one of the main challenges.
An industry representative acknowledged that another result of the crisis was that the share of NPLs in all portfolios in many of the EU member states increased substantially: in certain larger member states, this stands at 17% to 20%. In a small country like Malta, these are even higher, and the drag on the respective banks’ performance and the entire financial market which that high rate of NPLs constitutes should not be ignored. In the EU there are more than €900 billions of non-performing loans, which, although concentrated in some countries, is widespread.
Another industry representative said that when talking about the ‘bad bank’ or the NPL issue, it is striking that in many countries, the NPL ratio is very high, whereas in other countries, the ratio is very low. The cost of risk for many banks is at a very low level in many countries, such as the Netherlands, Belgium and France, where there is not a large problem. The NPL ratio might be a significant problem because of the impact of a country not doing well and spilling over negatively onto the neighbouring countries, and this issue needs to be solved.
A solution for that has to be identified. Some sympathy was expressed by certain panellists, for the proposal of Andrea Enria to create a ‘bad bank’ that could solve the NPL problem all over Europe. Europe has to start from scratch, and this would be a good way to achieve that.
The second big risk identified by panellists, from a market perspective, is interest rate changes. This is a real risk. It does not matter greatly if the interest rates stay low, interest rate models run out by a time and revenues go down, but if interest rates increase, banks will need to be prepared.
2.1.2. Positives and negatives of low interest rates
An industry representative said that there is an issue with low interest rates. That is more of a problem for other sectors, especially insurance in some countries, than for banks. The banks make money by exploiting the inclination of the yield curve, and when this flattens, there is a problem for banks as well. There are three points that need to be considered: firstly, it has had some effect, but the evidence so far is that the effect on bank margins has not been as bad as was anticipated. Second, there is an indirect effect of the low interest rates, especially these low interest rates determined by monetary policy. They have improved the economic prospects, which is important. The effect on the economic environment is the main issue for the profitability of commercial banks.
A central banker asked what will happen if, and when, the interest rates increase. Here, the crucial point is whether there is a gradual, orderly increase; in the case of a gradual return in the medium term to more historically-normal interest rates, this will be manageable for banks. There may be capital losses on some assets, but this is manageable. It will contribute to their margins and it will not pose a significant problem. However, the scenario might be completely different if there is a sudden increase, and in that case, it is important that supervisors do as had been said, and test the ability and the robustness of the banks to ensure against such an event.
Another central banker said on the banking business models and challenges for the future, there are three key elements. The first is the cyclical elements in the environment in which banking has to take place in the years to come. In particular, that is the low current level of interest rates. If that is to continue, it will have implications for the profitability of the banking sector. There is the discussion of how low deposit rates can go, and what the impact is of low interest rates on credit rates. There is clearly a relationship between these low interest rates and banking profitability. There is also an element of upside, and what would happen if interest rates were to go up rapidly. There is also the issue of the NPLs.
An industry representative note that, however, maintaining the unnaturally low interest rate policy is contributing to many problems in the financial sector. At the same time, regulatory responses to the Global Financial Crisis, which started in 2009 and which are not yet finished, contributed to a growing fixed cost block. This particularly hampers those financial institutions which during the financial crisis proved to be the anchor of stability in the European economy: small- and medium-sized financial institutions, which financed the backbone of the European economies’, namely SMEs.
The European economy predominantly relies on bank financing, not on the capital markets, for good reasons. All factors affecting lenders will also have a serious impact on the SME backbone of the European economy. Financing SMEs was at the heart of the business of those traditional banks, which take in deposits from retail customers and turn out loans to the companies, particularly to small- and medium-sized enterprises. Currently net interest income of such banks fell considerably in 2016. On the other hand, commission income increased, but it did not compensate for the decline in the net interest income. For the time being, their business model has proven to be stable as exhibited by RoE levels and cost income ratios. But, they are increasingly feeling pressure from the monetary policy of the ECB, which threatens that traditional banking model which dominates the European banking industry. On the other hand, the fixed cost block created by regulation hampers the ability to cope on the costs side with the threat posed on the profits side of the P&L. That is why the situation is becoming more and more difficult.
2.2. Tax and regulation uncertainties
A central banker said that Europe has seen a very long asset price increase, which has helped banks’ balance sheets tremendously. This might reverse, and if it does, there will be losses. Everyone is subject to regulation and the current regulation still contains a large number of uncertainties. The CRR/CRD review that is now ongoing does not even try to incorporate the Basel discussions currently ongoing. The industry, which is hoping for stable regulation to be able to build its strategies upon, faces a situation whereby, if Basel comes to a conclusion, it will mean another two or three years of uncertainty, which will not help to build long-term strategies.
A central banker noted that there is the issue of regulation: which direction regulation, and Basel, are proceeding in. There is uncertainty about that, and banks have said that this is an element that hampers their strategy making and also, to some extent, their development of business models. Hopefully, they will be able to conclude this and bring an end to that regulatory uncertainty. There is also the issue of tax, which has not been mentioned much so far but, at least in the Netherlands, is very important. Tax is an element that can strongly affect banking market developments. In the Netherlands, for instance, until recently, unlimited deductibility of interest payments on mortgages had an enormous impact on the mortgage market. This is just one example of tax rates having a tremendous impact on markets, and therefore also on the banking sector.
A central banker noted that another issue is regulation costs. There have to be regulation costs; safety comes at a price. However, the main point here is that Basel III, which was necessary, has been highly beneficial in terms of the safety of the banking system. It is unfortunately not concluded, but is potentially very close to conclusion, and it is true that regulatory uncertainty is bad. If the last round of Basel III can be concluded, the statement has been made very publicly that it is no longer time for increasing further capital requirements; it is more an issue of the application of fine-tuning than big changes.
A banker noted that regulation is also an issue. For good reasons, Europe has embarked in the direction of reinforcing capital liquidity leverage, governance, and related topics, but there is also a lot of uncertainty remaining. With Basel III or Basel IV, parties do not know when this will be resolved, and in what terms. They have to prepare and invest long term. The priority is to finish Basel III and that this will be done shortly. This will be good news, as globalisation is critical in terms of setting the rules. Indeed it is difficult to have a capital ratio computed in one way in the US and in a different way in the EU, because the meaning of rating is, by definition, global. This is critical. The evolution of the BRRD is also raising uncertainty. Rating agencies have incorporated the implications of BRRD by removing the government support from ratings, because the public sector has said that no more taxpayers’ money will go to banks. This has been done, however this might need to be reconsidered in the light of recent developments, or maybe because BRRD could be reshaped in a different way.
An additional point is IFRS 9, and there are some concerns about its implications. Rating agencies considers that standard setters are reintroducing the models via the ‘back door’, after having criticised risk-weighted assets badly, and this has fuelled investor scepticism.
2.3. Fintech raises number of issues
A central banker said that the biggest risks are technology risks, such as cyber risk and accidents that have not happened yet, but will. Competition is starting in the area of fintech, but banks will also use fintech technologies to gain more efficiency, which will present some operational risks as they are new and untested.
Another central banker said that one important element is the whole area of fintech and technology in the financial sector. Looking at this from a long term perspective for the banking industry, being aware of and being prepared for technological innovation is key to banks’ futures. Two years ago, the question had been asked of who actually believes in fintech; it is very interesting to ask a group of bankers such an open question. First, nobody wanted to answer the question, but then one banker said, ‘Yes, we are a believer.’ That bank had already done some thinking on this issue. After this, all of the other bankers in the room declared themselves to also be believers. Now, two years later, that question does not need asking again; everyone believes that this aspect of technological innovation in banking will have an impact.
The things, said the central banker, which complicate matters even further, is that fintech represents a number of issues, one of which is technological developments in payment systems. Secondly, there is the impact on credit, such as crowd-funding or peer-to-peer lending. New forms of credit are developing rapidly due to technological innovation. The third one is the area of big data – the use of data both by the banks in terms of their marketing and their strategies, but also in terms of risk management – and banks can ask what can be done with these large data sets to improving their risk management. There are many challenging developments. The banking landscape is changing very rapidly and banks need to adjust; they are adjusting, and supervisors and regulators should also be prepared for that process.
A central banker acknowledged that challenge. What technology usually does is to create great opportunities for society, and on the other hand also challenge incumbents. That is exactly what is happening with financial technology for banks. The threat for banks, especially from outside the banking sector, is more acute in those areas where there is high standardisation: i.e. highly-intensive data processing such as payment systems, standardised consumer credit brokerage or securities, and passively managed funds, but also peer-to-peer, as had been mentioned. The issue is that the threats from outside the banking sector are based on unbundling banking services; trying to do small parts of the usual bundle of which a bank is composed more efficiently. There are potential efficiency gains to be made, but there are also complementarities across these services. The question is whether these complementarities are greater than the efficiency gains, and the way and the extent to which the banks will be able to exploit them by not being complacent, but accepting and taking on the challenge directly. This is the big question, and there is a challenge and a big opportunity.
A banker said that the issue of reputation is important. Since banking is not ‘cool’ anymore, therefore getting close to clients is an important thing. Conversely fintechs deliver ‘coolness’; it is ‘fresh and nice’, thought it remains to be seen at what point fintechs face problems like those that other market players have seen.
Finally, a central banker noted that he does not believe that banking needs to be ‘cool’; it may have been ‘a bit too cool’ in the past. However, the banking system also should not be very unattractive for new talent to enter.
3. Observed consequences of the challenges faced by the banking sector: reduced ROE, high cost-income ratios, still increasing costs…
A central banker alluded to a recent study done on RoEs in the Netherlands; its conclusion was that RoEs can be expected to decrease, but it can be debated whether this is a problem. A point had been made about the cost of equity, but to some extent it is unavoidable that if systems are made safer, with more capital, RoEs will decrease, and this is not necessarily a major issue.
Another representative of the public sector said that looking at the current situation of European banking, it can be seen that the RoE has been stable and positive, but at a very low level. In 2014, average RoE was 2.8% for European banks; in 2015, it was 4.9%, and in 2016, it was 3.5%. It is stable, and that is a good thing, but it is much too low.
However, 30 banks had a RoE of more than 8%, which is a good sign: it means these banks are not concentrated in a country, of a certain size, or a certain business model. There are banks that manage to earn money in this environment, but from looking at these RoEs, there are cost-income ratios of more than 65% average in the European banking area.
Two things are clear: income needs to go up, and income is decreasing. Interest income is going down, as well as net fees. Costs increased last year for 60% of the banks in the SSM, but they did not decrease, despite all the cost measures that have been taken. As such, the problem is not getting better, but is getting worse.
4. The role of supervisors regarding the evolution of bank business models
4.1. The discussion regarding bank business models between supervisors and bank management boards is one of the three essential forward-looking elements introduced after the financial crisis
A central banker said that business models have been discussed with the banks now for a number of years. In the beginning, this was considered somewhat easy. There was a discussion about whether supervisors should really discuss business models with banks, because banks are there to be involved in banking; supervisors should supervise, and should not get involved with banking business models. That discussion has now been had and there is a joint common understanding that it is relevant and important for supervisors to engage in discussions on business models with banks, because this is a key element into assessing developments in the banking sector and also to assessing risks.
Supervisors have been making this part of banks’ supervisory agendas, with three more forward-looking elements in supervision introduced after the crisis, one of which is focused on banking business models and strategies. The second is focused more on behaviour and culture in banking, because that is an important element, and thirdly more focus on macro-prudential relationships. These three things are done to get a feel for where the banking sector is heading. It is a forward-looking element of supervision, and that is why the Netherlands Bank is very happy to discuss this issue.
4.2. SSM specific focus regarding bank business model challenges: adaptation of stress tests to new interest rates evolutions, NPL guidelines, demanding discussions regarding the sustainability of bank strategies
A central banker said that the SSM has identified risks, and is challenging banks. Banks might not always perceive this as help, but hopefully will do so in time.
The focus is on NPLs, and there NPL guidelines exist. The SSM makes sure that banks consider NPLs and find strategic ways to deal with them. For the interest rate changes, they do a stress test this year, with nearly all banks simulating shocks and identifying vulnerabilities; not only seeing them as they stand but also asking for the effect of the models. The interest rate models have all been calibrated in a decreasing interest rate environment, but the environment in future will not be one of decreasing interest rates. Nobody knows whether these models will hold, so there is a big model risk within banks; they should not rely too much on their own statistics. The SSM also contributes to analysing profitability, going into decomposing every component, whether it is cost, interest income, or fee income, and helping Joint Supervisory Teams in their discussions with the bank to challenge and to force development of stable strategies.
4.3. Many initiatives are underway to address the many challenges faced by the banking sector
A central banker noted that a cyber risk database has been established in the SSM and is now being rolled out to achieve much more transparency.
For NPL, there is NPL guidance, and work is taking place with the European authorities regarding further ideas. In relation to the interest rate changes, stress testing will bring this onto the COO agenda, and this has already succeeded. COOs have discussed interest rate changes before, but now they incorporate it into the scenarios, which is a very good development.
A central banker said that stress tests are also an important instrument to test what impact will be seen from these developments in the sector. Netherlands Bank has been developing its stress testing skills over the past years, and it will need to continue to do so. There also needs to be not just a single stress test with one variable influencing the balance sheet, but scenario analysis regarding what the banking system may look like, and the impact of that on certain variables.
A central banker said that in relation to the political uncertainties, there is a Brexit taskforce in the SSM, which is very successfully working on this issue, and providing security and certainty to the market as to how supervisors will deduce those issues. On profitability, the SSM asks banks for their multi year forecasts and then back tests. They can do so on a sample of 125 significant institutions in order to give real feedback to the supervised banks, and that is helpful.
Regarding whether problems can be spread over time, this sounds like a good idea, but it has two drawbacks. The first is that uncertainty is not removed from the market by spreading it over time, and the second is that it requires a clear commitment that everyone continues lending whatever happens, because only then will there never be a liquidity problem. Hackers also need to be asked not to hack for a certain time, because then there will be no cyber risk. This clearly will not happen. All these problems arise at the same time, and have to be dealt with at the same time.
4.4. NPL deserve a bespoke and balanced approach
A central banker said that there are two things that can be done on NPL, and are being done, and two things that should not be done. The first is that there is very strong attention being paid on the part of supervisors to the issue, action, and guidelines. That is welcome, and some further regulatory incentive to dispose of NPLs could be added to this. Secondly, there are initiatives, some of which have been mentioned, such as the EBA initiative; this is a discussion that is currently ongoing. The concept of an AMC, or several AMCs, is a welcome discussion; it remains to be seen what policymakers are going to do about this. Policymakers have reduced the room of manoeuvre but within existing rules many things can be done, and hopefully will be done.
The two things that should not be done are, firstly, to have an indiscriminate approach to the issue. The problem is not the European banking system, but it is not, for instance, the Italian banking system either; the problem is some banks. There are banks that are perfectly sound that have inherited a lot of NPLs from seven years of recession, and 10% less in GDP and a quarter less industrial production. In a way, this is normal; it is unavoidable. As these banks are perfectly sound, they can go to the market, tap the market, and solve their problems. Other banks, however, are facing much more difficult situations and need to receive special attention.
The second thing that should not be done is to indiscriminately force fire sales. The issue has repeatedly been framed to get rid of these NPLs within a week, a day, or an hour, but this is not possible, and believing that it can be done makes the problem more difficult to solve. This is extremely important; it is vital to have a determined, but sensible approach to NPLs.
4.5. A smooth exit from unconventional monetary policy has to be planned
A banker said that with so many changes, there are immediate challenges that have to be dealt with. First, there needs to be a smooth, well-planned and well-communicated exit from unconventional monetary policy, because many business models have been adapted to almost zero price for liquidity, and this situation is not sustainable forever. The normal situation in regard to liquidity pricing is having positive rates and a positive slope for the J curve. When this comes, some banks will face a harder reality, and so policymakers face some challenges in making this transition a smooth one.
5. Though there is room for manoeuvre in many banks in this respect, the cost income ratio issue leads to overcapacity and consolidation issues
A central banker insisted on two points. The first is bank costs and cost-income ratios. There is a problem that needs to be tackled, and averages are not the only thing that matters; it is also important to look at the fact that there are big differences across banks. Some of those depend on differences in business models, but the fact that there is such a high variation means that there is room for improvement in many banks. It is not an issue of ‘banking system versus banking system’; it is more an issue of individual banks that need to tackle these types of issues, in terms of being more efficient or changing their business models in order to reduce the cost-income ratio.
This gives rise to the issue of potential overcapacity and consolidation. That is something that may be overemphasised sometimes, but it has to be tackled, and doing so depends very much on the different structural and legal situation of various countries in Europe. For instance, in Italy, there is the issue of the legal structure of cooperative banks, which has been tackled via welcome legislative changes; these were not welcomed by everybody, but were mostly welcomed from a public interest perspective. This is a means of tackling some of the structural problems that exist.
A banker said they were in full agreement that Europe is facing a ‘perfect storm’ in terms of adaptation to the new environment; the issue is not just monetary policy, which, for good reasons, has been delivering low rates and plenty of liquidity, and inflation risk is now in the past. One factor is that the return on equity remains at levels that signal that the banking sector has to consolidate and reduce capacity, because a banking system that constantly delivers a return of equity below the cost of equity cannot be sustained. This has been the situation for some years.
An industry representative said that in relation to consolidation, there has been discussion on cross border consolidation; this is a possibility, but there are many obstacles to that. Domestic consolidation might be easier to achieve. In Italy, the top five banks account for 40% of banking assets in the country, whereas in France, they account for 85%, so there might be some room for internal consolidation.
However, a central banker noted concentration also trigger risks. Europe is aiming to have banking systems that have a balanced composition. If there are one or two suppliers fully monopolising the new financial technology environment, this also creates risks for the system. Changes in the system should not be overly disruptive; although some believe that disruption is good and regular developments are bad.
6. Accelerating technology changes is essential for the banking industry. It has also to do with regulation and supervision.
A banker said that traditional models are based on technologies that were incrementally innovating, but the market is now at a point where technology evolutions are exponential. They combine with each other, creating huge changes: not just in banking, but with society and the economy at large. He was of the opinion that if changes are not faster in the banking industry, this has to do with regulation. The banking business is essentially a knowledge business based on data and information that can be managed in an intelligent manner in order to compile information, process the data, turn data into knowledge and then produce value in it. Many newcomers in this area do not want to be supervised: not just the big players, but also small ones. This gives rise to an issue of a level playing field.
Fintechs are a small part of this process: they unbundle and focus on elements of the value chain banking. Hyper connectivity and the power that the clients have, changed completely the demand for financial services. Now, clients are becoming more and more ‘millennial’ and ‘centennial’ people, connected 24 hours, seven days a week, and capable of comparing offers in real time. The power now is on the side of the client, and new clients are used to online connectivity, instant response and one-click demands. This has to be delivered.
Services can be supplied by fintechs, newcomers, and also potentially the big institutions and traditional banks. However, it can be asked whether traditional banks can keep up with the pressures of technological change. There are some supervisory institutions that understand these challenges and understand the need to balance promotion or acceptance of new value propositions with protection against the associated risk, consumer protection, investment protection, and cyber security. Progress in technology cannot be stopped; the issue is whether to permit and promote the adaptation of banks for those that can adapt to new patterns of technology, and doing so is not very easy. From the point of view of the banks, reflection will be required about what the definition of a bank is, going forward. It is no longer an institution that takes deposits and grants loans; many other entities can do so. Either they offer a bundle of financial services that permits people to realise the opportunities that are available to them, or they essentially do nothing. Going forward, this means banks moving closer and closer to what Amazon and Google do than what traditional banks are doing, and this represents a challenge, not just for the banks but also for regulators and supervisors. Understanding the potential of big data or artificial intelligence combined with Cloud computing is vital to have a healthy – although not necessarily ‘cool’ – banking industry in the future, on the basis of a level playing field. ‘Cool’ fintechs should not be created on the basis of regulatory arbitrage.
A majority of banks existing today will not exist in 10 years. It is not an issue of believing in a vision or not, but about opening one’s eyes and looking at what one’s children do; a vision is needed, along with the financial capacity to adapt. It needs to be understood that the skills in banks are changing, and IT engineers and data scientists are needed, within flexible and lean organisations. Change is required within the banks in order to keep up with the competition of fintechs. This cannot be done quickly; it is a long process. Yet there may not be enough time to adapt while, at the same time, reducing capacity, dealing with increasing rates, regulatory uncertainty and other problems. This is one of the key challenges that business models are facing today.
A banker said that on regulation regulators need to be somewhat ‘ahead of the curve’ in relation to technological change. They need to understand what the Cloud means for the operations of banks, for cost-cutting and for recovering return on equity, and the same applies to blockchain. There is much to gain from jointly trying to gain an understanding of these emerging technologies, which combine with each other and can potentially allow for a lot of cost savings and more efficiency.
A central banker stated that supervisors and regulators should understand the issues and study them, in particular the financial sector technology developments, and discuss and debate with the industry to at least understand what is happening. Another representative of the public sector said that it is important that in terms of the regulatory response, technological developments are not unnecessarily blocked or frustrated by regulation; this needs to at least be the intention. Some supervisors and regulators’ initial reaction is to regulate immediately, so that technological developments cannot develop further; however, they should be open to change, as the industry will be.
New risks such as cyber risk cannot be underestimated either. This is a risk, not just for individual banks, but for the system and for economies. There is a need to increase efforts, both in the industry and on the supervisory side, to control these very new risks which are rapidly developing. Developments can be pro cyclical; it can be that new parties enter the financial sector in good time and develop things, but when the situation worsens, they withdraw from the sector. This is not good, as it has the risk of amplifying cyclical developments.