Swiss banks must cut costs despite healthy 2016 performance

26 July 2017 Consultancy.uk

Swiss banks have managed to generate healthy gross operating profit margins, outperforming Western and Southern neighbours. However, the Swiss still trail their Nordic counterparts, and are advised to leverage innovative new techniques to cut costs and keep pace with their rivals. Institutions may face an increasingly tight environment as investors become weary of traditional business models and low interest rates and competition bit into net income from interest. Diversification and cost control are ways in which the region’s banks may be able to improve margins further.

The private banking landscape in Switzerland remains unmatched. The country has the most private banks in the world, while the sector itself remains diverse in terms of the size of providers – from banks with hundreds of millions under management, to banks managing trillions. However, recent analysis had suggested that while the Swiss private banking scene remained relatively stable, trends in the sector suggested profitability was becoming harder to book.

Despite such worrying projections, a 2017 study from Oliver Wyman has since found the Swiss financial services sector to be continuing to perform well. One of the larger parts of the wider Swiss economy, representing 10% of the economy in 2014, with the banking sector representing more than half of the amount. The report, titled 'Swiss Banking 2017: Room for Improvement’, shows that the country’s banking system remains relatively robust, with return on equity even in light of the continued low interest rate environment.

Profit and returns

The research focused on the largest domestic banks in the country, including the Swiss units of UBS and Credit Suisse, Kantonalbanken, Raiffeisenbanken, regional banks and other retail-focused banks, and the most recent results shows improvement in the industry’s gross operating profit margin. Margins remain down slightly on 2011 however, when they stood at 44.8%, along with return on equity, which fell from 7% to 5.7% in the same period. The risk adjusted return on equity, which takes into account overcapitalisation – where the valuation of an asset is superior to its 'real' value, putting a strain on attempts to obtain a reasonable return on investment – was actually slightly higher at 7.8% though.

The firm notes that, if the change in interest rate is taken into account, the difference between the two years is the same, which, given the change in conditions within the wider banking sector, from capital buffer requirements to regulatory requirements, highlights considerable operational improvements.

Regional comparison

In terms of a regional comparison, Swiss banks have outperformed almost all of their European peers. In terms of gross operating profit, only the Nordics have performed better, with an increase in margin of +11% to 53% while Southern Europe has fallen further behind to 31%. German banks meanwhile continue to face a tough environment, even if margins have softened a little, improving from 28% to 30%.

According to the consulting firm, the Nordics have managed to improve margins in part on the back of various transformations and a continued focus on cost cutting. However, the firm also notes, that regional factors, relating to macroeconomic conditions played their part as well.

Operating revenue and costs

While the Swiss banking system has managed to perform relatively well with respect to its regional counterparts, the research highlights a number of areas in which there is apparent weakness. Banks in the region have seen their price-to-book ratio (P/B) by around 25%, to a value of 1.3 on average. The decline highlights investors’ reluctance to pay a ‘premium’ for stock in the segment.

The institutions too have seen moderate increases in costs, at around 2.2% per annum between 2011 and 2016, with the larger share of costs going to general administration increases. Revenues meanwhile were up only slightly, at 1.3% per annum on average, largely due to improvement in fee and commission net income increasing and trading net income, which saw 3.8% growth. Net interest income, given the current environment, saw a slight increase of 0.2% per annum.

Future view, expected operating revenue 2022

The study suggests that operating revenue will shift slightly as low interest rates continue to affect the market, driving banks to explore other revenue streams, while highlighting that net interest income is set to grow below Swiss GDP growth (2% between 2016 and 2022) at around 1.2% between 2016 and 2022. Traditional fee and commission net income will meanwhile stay relatively stable.

Diversification may provide institutions with a way forward however, with ‘other income’ and trading net income each set to increase by around 5% per annum. In addition, banks may be able to supplement their income with a move into new fee and commission net income areas from various additional sources. Globally, banks are facing increasing competition from new market disruptors. Leveraging new technology as a means of diversification, along with cutting costs and maximising profits, is being seen throughout the global financial market as key to any bank’s survival. This process has even seen long-term market incumbents put under pressure.

In their conclusion, the authors of the report recommended, “a focus on capturing additional revenue pools which are independent of the interest rate business. While being challenging, we believe that most players should be able to increase revenues through wealth management, insurance business, SME business, asset management and trading income. Cost reduction initiatives need to be performed, but are unlikely to be a source of a long-term sustainable advantage. However, cost mutualisation initiatives, especially when responsible for new revenue, could be carried out more vigorously.”

Profile

×

The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.