It is not secret that banks are up against steep challenges operating in today’s environment – an environment that is defined by geopolitical and economic uncertainty, hyper-competition, and rapid change.
The questions of sustainable and sound profitability hang overhead, along with the cost of capital and how to make use of developed and integrated capital markets, such as those found in Europe.
In this first article based on our recently published report Banking for Tomorrow, we are going to deep dive into some of those challenges faced by traditional banks and what it might mean for their further existence.
Banks have been underperforming
Coming to the end of the post-2008 crisis, a lot of lessons have been learned. Yet after a decade of reforms, banks’ economic performance is lagging. European banks have achieved on average a return on equity (RoE) of around 3.0-5.0 percent, as opposed to 10.0 percent pre-crisis, not making up for the required cost of capital generally viewed to be around 8.0-10.0 percent to remain viable – one must note that this fall in RoE can be largely attributed to higher capital requirements and consequently lower leverage ratios, as return on assets (RoA) has remained broadly flat at around 0.4 percent.
The cumulative performance of European bank shares have similarly underperformed, with leading European banks now trading around 0.4-0.6x price-to-book, also indicating poor investor prospects. And as of today, still many banks such as RBS in the UK, DZ Bank in Germany, ABN AMRO and De Volksbank in the Netherlands remain in state hands after nationalization (state ownership being 48%, 100%, 56%, 100%, respectively), with poor prospects for privatization and (full) repayment of the state’s capital injections.
Pressured by evolving customer needs and fierce competition
Amidst financial uncertainty and underperforming economic returns, banks are facing pressure to transform their operations and reduce costs, in addition to innovating customer experience. Fintechs present perhaps detrimental competition in that they offer a breadth of innovative solutions for digital banking, consumer finance, international money transfers, back-office operations, and technology. Benefitting from a greenfield approach, combined with rigorous focus on one specific customer need (as opposed to banks that serve a wide variety of customers across large product portfolios), fintechs can provide better customer experience, with higher quality service and lower costs. Thereby they are driving innovation and raising customer expectations across the board.
Incumbents need to follow suit, yet many struggle to keep up with innovation and rising customer experience due to legacy organisations, traditional ways of working and outdated, siloed technology landscapes. In addition to complex governance structures, a patchwork of products, differing requirements, and local cultures have resulted in a ‘spaghetti’ of technology, individual monolithic and in-house solutions, each varying in age and capabilities. This limits the ability to operate in real-time, makes maintenance and change rather complex and time-consuming, and jeopardizes business continuity as expertise on outdated technology (such as COBOL systems) fades away. Although there are solutions available, historical and cultural barriers make it challenging to adopt standardized, cloud-based and composable solutions.
Brighter times lie ahead for those who act now
Across the board, many banks are grappling with survival, neither being able to generate the required economic returns, meet customer expectations, or transform themselves. This places them in a difficult position to start, and due to increased technological innovation and numerous macro-economic shocks the coming years won’t be any easier.
Nevertheless, as money shifts to new markets and innovations, the industry is moving forward and changing for the better. In a scenario of ‘creative destruction’, the dismantling of incumbents will drive the progression of the ecosystem forward, making way for new types of players with new technology, services and means of distribution. While weeding out weaker players, stronger ones will emerge building upon fertile grounds. As such, in the long term, consumers and society as a whole will be better off, benefiting from better customer experience and a more cost-efficient, resilient, inclusive and sustainable system. Thus, brighter times lie ahead.
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To find out how your organization can tackle current and upcoming economic trends keep an eye out for our next blog post or contact us directly at info@fincog.nl so we can provide you with dedicated support.
