If banks do not catch up with technology and the possibilities and requirements of the modern world, shadow banking could well come out of the shadows, says Bill Michael, Financial Services Head at KPMG.
With the economy offering encouraging signs of growth and a general election on the horizon, businesses in the UK are facing an uncertain political and economic environment ahead. Business is engaging with a very different banking system than the one that was around as the UK came out of the last recession.
The great uncertainty for businesses is to what extent banks will provide them with they need and, crucially, what the future shape of banking in the UK will look like. Speaking to businesses, they understand that banks are in a much safer state. Quite rightly the focus of the banks and regulators for the last few years was to make the system safer. Capital levels and leverage ratios for the UK banks are now at a much more comforting level. The big unanswered question UK business has is what will my bank look like tomorrow? What will it be able to offer me and what will it not.
One of the main drivers of change is the wave of regulation approaching. Last week the Bank of England gave banks until January 2015 to submit their plans for ring-fencing. Those who have followed the debate will understand the rationale to split the banks into safer entities to avoid contagion risk from investment banking type activities to customer deposits.
What is less well understood is what impact this could have on UK businesses. For example will SMEs be able to access the products they may need to hedge their risks when exporting? Will large corporates with global operations have to find other banking services for their non-European operations?
Ring-fencing has forced banks to assess every part of their business and decide on the practicalities and benefits to offering relevant services or operating in certain countries. While that deadline may seem very soon, banks have already spent a lot of time and money thinking through what it means for them and ultimately the services they can offer customers. We have already seen some banks exiting businesses that were not ultimately able to achieve a meaningful return on equity.
As banks have withdrawn from offering such services we have seen other players come in to fill the gap. The insurance industry has long championed its role as an alternative source of funding for large corporates and infrastructure projects. The asset management industry has also started to make inroads into what are under-served areas of the market.
This creates new players but also new risks. As the IMF has warned, it moves the risk of defaulting from heavily regulated banks to this so called “shadow banking” system, which has had much less regulator and policy focus. Businesses will need to better understand the opportunities and risks this new form of lending can offer.
The G20 next month will be crucial in ensuring the financial services sector contributes to job creation and economic growth. There are other major factors that will see banking transform over the next few years. Business customers will see a continued move away from branches to digital. Technology has already become a competitive advantage issue for banks as they seek to attract customers, I think the greatest opportunity for embracing technology will come in back office operations. Like the car indsutry in the 1970s, when it embraced robotics, the banks must face up to a once-in-a-generation infrastructure project.
For example, there is opportunity to share services when a new customer opens an account. Currently a bank needs excessive systems and inefficient processes to check against tougher and changing anti money laundering rules. Why does each bank have to do this? Why don’t all the banks have a shared platform that means a customer only needs to do this once?
The reality is, a great deal of what banks do can, in fact, be done outside the sector. If banks do not catch up with technology and the possibilities and requirements of the modern world, shadow banking could well come right out of the shadows.
We are also seeing banks working hard to change their culture. The changes are significant, but they will inevitably take time to trickle down from the boardroom. The ultimate judge of whether banks have really changed will be society itself, when it decides banks and bankers have earned its trust again.
It’s going to be a long journey. Setting examples of better customer outcomes and a body such as the Banking Standards Review Council can only help on that journey, but real cultural change is always slow and often painful. Just look at the shock when seat belts were made compulsory and when smoking was banned in pubs and restaurants. Now most of us find it almost incomprehensible that it was ever any other way.
The only real current certainty is that banking must change. For the sake of UK business we need to get these changes right.