There is a general consensus in the City that the banking industry has reached a turning point.
George Osborne signalled the end to ‘banker bashing’ in his annual Mansion House address in which he talked about “a new settlement with the City”. This is also reflected by statements from Martin Wheatley, chief executive of the FCA, who told the FT that policy making was at a turning point.
However, even if the regulators take a less heavy-handed approach and the days of banks saying sorry are over, this does not mean that they can return to the ‘glorious’ recklessness which characterised the industry prior to the financial crisis of 2007/08.
The Big Five – Standard Chartered, RBS, Barclays, HSBC and Lloyds Group – face incredible challenges to their profitability from a range of factors, as outlined below.
Regulatory framework and bank levy
Banks’ reckless pursuit of profitability that brought the industry to its knees and left the economy in tatters clearly illustrated the need for a more robust regulatory framework. The Independent Commission on Banking, culminating in the Vickers report, made wide-ranging recommendations; these were later put into law by the Banking Reform Act 2013.
One of the key proposals is that retail banking must be ring-fenced from the perceived riskier investment arm of a bank – these changes must be implemented by 2019 and some banks like Santander have already outlined plans to ensure compliance.
According to Treasury estimates, ring-fencing will cost banks £4.4bn a year to maintain thereby reducing their profits. In addition to ring-fencing, capital adequacy requirements have also been increased considerably since the crisis, thereby restricting a bank’s ability to lend as they have to maintain more capital on their balance sheet in order to absorb losses in the event of a crisis.
Aside from the above regulatory changes, banks are also obliged to pay a bank levy on the amount they hold on their balance sheet – this was recently increased by one third to 0.21 per cent.
Initially, the rationale for its introduction was to reflect the risk banks pose. However, there now seems to be a consensus that the levy should become a permanent feature of the British tax system as banks still have an obligation to pay higher taxes for years to come. Needless to say, the banks are not happy as this hits their bottom line. HSBC and Standard Chartered have threatened to move their HQs out of London.
The crisis severely tarnished the reputation of the established banks and the public discontent that ensued provided the impetus for disruptive forces to enter the industry in the form of challenger banks. Metro Bank entered the fray in 2010, becoming the first new bank to launch in the UK for over 100 years. Many others have followed suit including Aldermore, OneSavings, Paragon and in June of this year, the mobile first start-up Atom obtained a UK banking licence.
However, it must be noted that, although these challenger banks provide greater consumer choice, they have arguably not yet provided effective competition to the established banks because they are in many ways too similar to traditional banks – the combined loans of five of the largest challengers only amount to 5 per cent of largest five established banks’ loan books.
Nevertheless, there is a possibility that better differentiated challengers will disrupt the status quo even more if they target under-served markets. For example, OakNorth, which is set to launch this summer, will focus on lending to smaller businesses and will lend against a wide range of collateral. In contrast, established banks typically only accept property as collateral.
Inexorable rise of Fintech
Fintech is a line of business based on using software to provide financial services.
This includes crowdfunding platforms such as GoFundMe, Kickstarter and IndieGoGo. According to research by Massolution, crowdfunding raised over £16bn in 2014 globally, which is a 167 per cent increase over the £4bn raised in 2013. The growth in funding volumes continued to be mainly driven by lending-based crowdfunding, but significant annual growth in equity based crowdfunding.
There are also other tech firms that are focusing on improving customer experience and providing cheaper financial services, thereby taking away market share from the banks. International money transfers is one particular area where they have been particularly successful; for example, Transferwise is now valued at £640m and has achieved £500m worth of transfers through its platform each month.
Although it is unlikely that Fintech will be a terminal threat to traditional financial institutions, they will undoubtedly increase in significance and reduce banks’ market share. A report conducted by the World Economic Forum alongside Deloitte highlights that Fintech is here to stay and that established institutions and innovators should collaborate with each other. They argue that incumbents should view new entrants as an ‘external R&D function’ rather than a threat. Some banks have already started doing this, including Santander and Barclays.
In conclusion, even if there is a turning point in the policy approach towards banks, the environment that they now operate in and the challenges they face as compared to 2007/08 are significantly different, and there can be no return to business as usual – they must ensure that they continue to provide better service to customers on even more competitive terms.
Bernard Mustafa is president of BPP’s Commercial Awareness Society
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