Big banks to spend $200 million on preparing for FRTB regulation

09 August 2018

A number of the world’s largest banking entities are set to be hit by some $200 million in new trading rule costs. The so-called Basel regulations are due to take effect in 2019 and will create need for an additional 2,000 staff, along with creating a number of other costs to remain compliant.

The Basel Committee on Banking Supervision is a committee of banking supervisory authorities which was established by the central bank governors of the Group of Ten countries (a precursor of what is now the G7) in 1974. Since its foundation, the group has provided a forum for regular co-operation on banking supervisory matters, something which in the post-recession years has been extremely important in laying out plans to avoid a repeat crisis in the financial sector since 2008.

The latest example of how the Basel Committee is working to this end comes in the form of the Fundamental Review of the Trading Book, or FRTB. The set of new rules looks to overhaul the way banks treat the risk of the bonds, stocks, commodities and other assets they hold in the short term so they can facilitate clients’ trading. The rules have recently undergone a series of amendments, following fears of large costs to big banks, with the earliest iteration expected to increase capital demands for some banks by as much as 800%. Since then, the Basel Committee has revised the rules to ease the burden on financial institutions, but banks will still have to increase capital significantly for some activities.

Big banks to spend $200 million on preparing for FRTB regulation

According to consulting firm Oliver Wyman, which produced the new cost estimates of implementing the fundamental review of the trading book rules after studying the plans of 20 European, US and Asian banks with large trading businesses, implementation costs will likely range from $100 million to above $200 million. While this is a small percentage of big banks’ total annual cost bases, estimated at about $60 billion, the new costs still dwarf the $43 million to $129 million estimates which the same consultants produced just 12 months ago, suggesting that the true extent of the regulations might be hard to predict, and could be even higher.

According to Oliver Wyman’s Aude Schonbachler, Partner - Head of EMEA Capital markets risks, the mismatch between the expected costs of FRTB of last year and of 2018 represent banks having been caught in the early stages of costing, at which point a number of them underestimated the sizable effort required. The latest Oliver Wyman research on the matter puts the industry-wide costs of implementation for FRTB at an eye-watering $5 billion, including more than $500 million which has already been spent. So far, most of the fees have been sourced for “impact studies and planning”, but the consultancy expects that banks will have to add at least 2,000 new staff to their FRTB programmes, through a combination of hiring new staff, reassigning existing staff and using consultants, in order to meet the new requirements without sanction by the end of 2019.

While implementation could still be delayed, as the EU issued a directive suggesting a three year implementation period and the regulatory policies of the American and European authorities recently missed a critical deadline for agreeing on how banks should treat the riskiness of their loans – however, many banks are understandably still keen to work to the original deadline. Indeed, Schonbachler agreed that adopting a wait and see attitude amid the current labour market could be incredibly risky, as IT market risk analysts are already “extremely difficult to hire” in London. Because the UK particularly faces an ageing population and a constriction of talent moving from the EU following Brexit, even banks that have started early might have to make their implementation plans less ambitious.

Remarking on the state of play, Schonbachler said, that some banks said they would prioritise investing in areas such as US stress testing, the only regulatory programme with higher costs than the FRTB, before elaborating, “The banks are quite cost conscious and resource constrained.”

She added that time is a particularly precious commodity for banks looking to implement FRTB for a different reason, too, noting that banks will receive the best capital treatment if they use internal models to calculate their risk, but these models take a long time to design. “As they progress in the implementation it is likely that they will end up having to do some shortcuts if the timeline of end 2019 is not pushed back,” she concluded.

Related: Excelian Luxoft supports bank with FRTB compliance programme.

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The business and operating models of digital-only banks

04 April 2019

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.