Many aspects of the banking industry are almost unrecognizable now from the way they were in the period leading up to the financial crisis five years ago. At a global level, the scale of change in the industry since 2008 has been unprecedented.
Change will continue in the banking sector in 2014 and will be driven by multiple forces. Regulation remains one of the strongest forces to contend with, and capital and liquidity as well as structural reform will continue to dominate the agenda, according to the EY study Transforming banks, redefining banking – Global banking outlook 2014-15
. But is also expected that new pressures come to the fore in 2014, not least pressure from investors on return on equity (ROE).
“Many of the reforms banks need to make will be expensive to implement and often expensive to maintain. As a result, the impact on the cost of doing business will be even more severe in 2014. Investors may accept a lower risk adjusted return from safer banks, but that return still needs to exceed the cost of equity which sits at an average of around 10-12%.” commented Steven Lewis, Lead Global Banking Analyst at EY
“Normally the return expected by any bank shareholders for doing business in emerging economies is higher than the average above given the fact that the business risk is higher. Unfortunately in Romania we’ve seen this in real life as, over the last 10-12 years, the volatility of banks’ profits was higher compared to the same banking groups’ operations in more stable economies. I use this comparison as the risk appetite, related lending practices, expertize, etc tend to be aligned within a banking group.” told Gelu Gherghescu, Partner at EY Romania.
For many banks, resolving the cost of capital vs ROE issue will take revolutionary reform in how they structure their products and services. Regulators will need to be convinced that the banks can generate sustainable growth and support the next phase of economic recovery. But investors will need to believe that the bank's proposed reforms will fundamentally impact the business.
In order to transform their business model to the extent that gives their double-digit ROE target credibility, many banks will need to form alliances – perhaps with other banks or in some cases with non-financial companies. We have already seen a few banks partner with innovators such as peer to peer lenders.
Other aspects to be considered in 2014 and beyond, according to study:
Global economy – mostly on track
It looks like recovery has finally taken hold in Europe, with both the UK and Eurozone economies emerging from recession. Fears of a hard landing in China have receded, and growth appears to be more balanced, incorporating both investment and consumption. The new regime has also initiated some reforms of the banking industry, with tentative steps to liberalize lending rates. Further reforms are expected in 2014.
Compared to peers elsewhere, European banks have fared less well, as the Eurozone sovereign debt crisis effectively halted recovery in the region. Most banks in developed markets have undertaken some level of restructuring, and risk-weighted assets (RWAs) have fallen. They have exited non-core business lines and sold assets. Some have also acknowledged their lack of market leadership and wound down sub-scale business lines.
Costs versus revenue
Although compensation costs have declined as a proportion of revenue for the top 50 global banks (from 33% in 2009 to just under 30% in 1H13), non-staff costs have continued to rise faster than revenues, particularly for European banks. At a total cost level, only the Asian banks in the analised group have been able to grow revenues faster than costs.
Banks in emerging markets are suffering the effects of a low interest rate environment and will be exploring new revenue opportunities to secure new funding capital and maintain returns. Notwithstanding recent policy rate rises to combat inflation, competition is intensifying and banks remain under political pressure to reduce spreads on credit products to retail customers and small businesses. At home, they will focus on product innovation and broadening channel reach to attract new customers, though they must resist the temptation to win volume at the expense of appropriate risk-based pricing.
Customer: demands and expectations
Adding to regulatory pressures there is the increasing expectations from retail and business customers. Customer requirements are evolving rapidly. Banks are under pressure from customers, across both developed and emerging markets, to offer the levels of service and flexibility experienced in other sectors.
There has already been some consolidation in the European market. Markets such as Spain have witnessed significant restructuring, with over 50 institutions reduced to 12 in three years. We expect to see more in the medium term in those markets that remain overbanked, such as Germany and Italy.
About EY Romania
EY is one of the world's leading professional services firms with approximately 175,000 employees in 728 offices across 150 countries, and revenues of approximately $25.8 billion in 2013. Our network is the most integrated at global level and its vast resources allow us to help our clients benefit from every opportunity. In Romania, EY has been a leader on the professional services market since its set up in 1992. Our over 450 employees in Romania and Moldova provide seamless assurance, tax, transactions, and advisory services to clients ranging from multinationals to local companies. Our offices are based in Bucharest, Cluj-Napoca, Timisoara, Iasi and Chisinau. From 1 July 2013, Ernst & Young becomes EY, the logo has been modified in response to this change and the company's new tagline becomes "Building a better working world". The new visual identity reflects the new strategy of EY, Vision 2020. For more information, please visit www.ey.com.