EY: Banks need to transform and redefine industry practices to meet future ROE

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Kuala Lumpur, 13 January 2014 – Since 2008, banks have been trying to rehabilitate the industry in the face of significant headwinds. Challenges, including ongoing reputational damage and recession in major economies, have resulted in return on equity (ROE) at many banks failing to cover the cost of equity. There is a need now more than ever for banks to reconsider how to meet the expectations of their shareholders, customers and markets within increasing capital and regulatory constraints, according to EY’s latest report, Transforming banks, redefining banking: Global banking outlook 2014-15.

Steven Lewis, Lead Global Banking Analyst at EY says, “Change in the banking sector will continue to be driven by multiple unavoidable forces in 2014. Regulation remains the strongest force to contend with, and both capital and liquidity and structural reform will continue to dominate the agenda. But we also expect new pressures to come to the fore in 2014, not least pressure from investors on return on equity (ROE).”

Over the next few years, besides global and local regulatory reforms, the following are expected to drive banks to change:

  • Customer – Customers are demanding greater transparency, personalized products and seamless transition between channels. They also expect banks to replace outdated systems and processes, and to focus on solutions instead of “product push”.
  • Technology –   Banks are finding that current systems are ill-suited to cope with the scale of regulatory change and a more digital business environment. “Disruptive technologies” are also providing customers with a greater choice of products and service providers.
  • Competition – regulatory requirements are intensifying the battle for scale and market leadership, and banks operating in domestic markets can expect  intense competition from regional and global banks looking to broaden their reach. New entrants are envisaged to further bring improved service and experience innovation to  the current range of banking, payment and lending products. 
  • Society – Customers expect cultural and behavioral change in their banks and investors are looking for credible and sustainable business models. Activism, by both consumers and shareholders, is on the rise, with the pendulum of responsibility swinging to a more extreme form of consumer protection.

Banks’ responses to the above forces of change will be severely constrained by regulation, but a “wait and see” approach is no longer a viable strategy. Transformational change is required.

Chan Hooi Lam, Partner, Financial Services and Country Leader of Financial Accounting Advisory Services, EY, Malaysia comments, “ “For many banks, resolving the cost of capital vs ROE issue will take revolutionary reform in how they structure their products and services. Regulators will need to be convinced that the banks can generate sustainable growth and support the next phase of economic recovery. But investors will need to believe that the bank's proposed reforms will fundamentally impact the front or back office. In most cases, marginal reform is not going to cut it. Instead, there is a need for a strategic restructuring of business and operating models.”

  • Business model: redefined

    Strong regional institutions are expected to emerge, particularly across rapid-growth markets. There will be a need for increased focus on scale and efficiency, and organizations are expected to redefine the concept of universal banking as they explore alliances and partnership opportunities to strengthen product propositions and drive growth.

    Lewis explains, “In order to transform their business model to the extent that gives their double-digit ROE target credibility, many banks will need to form alliances – perhaps with other banks or in some cases with non-financial companies. Partnerships with innovators such as peer to peer lenders and further collaboration in both front office and back office activities are not only necessary, but in the long term, inevitable.”

    Customer relationships: refreshed / restored
    Banks must turn their attention to greater targeting of defined customer segments that align with their competitive advantage and offer revenue growth opportunities. There needs to be a focus on rebuilding trust, new performance goals and reward strategies that reflect a customer-centric culture. Harnessing new technology that enables customers to personalize solutions whilst ensuring data security, will also help strengthen relationships with customers.

  • Organisations: restructured 

    With significant changes to business models envisaged in the coming years, existing operating models will also need restructuring. Reactive tactical fixes must be replaced with integrated reforms that are transformational and that cut across the organization. New structures, strategies, models and entities need to be configured to comply with resolution requirements, to optimize efficiency of capital and liquidity allocation, and to reduce costs.

    Hooi Lam says, “In addressing the need to restructure, regional and global institutions must familiarize themselves to restrictions on the activities not only in their home countries, but even more so with their foreign branches. With the rise of regulatory nationalism, where local rules take precedence over global standards, processes and procedures to address existing portfolios and to minimize risk across multiple locations are necessary to improve capital efficiency and to simplify internal structures and hierarchies.” 

  • Infrastructure: redesigned, shared

    Redesigning processes and data systems will be necessary to deliver standardized systems and procedures as well as meet regulatory challenges and provide business lines with customer data analytics to improve operations.  Additional outsourcing and greater sharing of non-core infrastructure across the industry may be the way forward in reducing costs and improving efficiency.

    Hooi Lam concludes, “As the dust settles around the regulatory reform agenda during the course of 2014, institutions will be keen to restore their reputations and recover profitability. Cultural reform has long-been acknowledged as one of the industry's biggest challenges and banks need to develop mechanisms and tools to monitor progress, particularly on those less tangible aspects of reform. But delivering and maintaining an acceptable and consistent ROE is going to be just as challenging, if not more so.”

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