As vaccine programs gather pace across the world, thoughts are turning to what the world will look like after the COVID-19 pandemic. How will the economy recover? Will sectors be reshaped permanently? Will new businesses emerge? Will changes in consumer attitudes become embedded?
One sector that will certainly be reshaped is banking. A challenging economic climate, continued competitive threats from new entrants and clients demanding ever-more digital services all threaten banks’ bottom lines. There is, therefore, a real urgency for banks to reimagine their cost bases and customer propositions to improve returns. There has never been such an opportunity to transform.
A resilient banking sector
The last year has been a story of resilience in banking. Financial institutions have been a mainstay of support to individuals, businesses and the broader economy. In the earliest stages of the pandemic, many moved at speed to offer customers help and forbearance. As government-support schemes were formalized, banks were instrumental in facilitating them.
Overall, the financial system has proven remarkably stable. Capital and liquidity have generally been strong across the industry. Within exceptionally short timeframes, large banks moved most of their employees to home-working. Firms have worked hard to overcome concerns around employee monitoring and bolstered cybersecurity. Institutions have managed a surge in demand from customers seeking support and acted as pipelines for vast economic support packages.
Banks should accept the plaudits for doing the right things, successfully and at speed. But in the current climate, this success doesn’t necessarily translate into financial results.
The FY20 (fiscal year 2020: July 1, 2019-June 30, 2020) reporting season has not yet finished, but analyst projections for return on equity (ROE) for the largest 50 global banks will be nearly 3 percent lower than their FY19 results.1 Volatility has helped investment-banking divisions post some stellar returns, but more broadly, banks have had to bolster provisions to manage emerging asset-quality risks.
Most investors will be sympathetic to the plight of banks. Expectations of returns will have been low, and some regulators discouraged banks from paying dividends in 2020. But many will also be hoping for better returns in 2021.
Measured hope for a recovery
News of accelerating vaccine rollouts across the globe gives hope that economic growth will pick up in 2021. Yet, new lockdowns, such as those across Europe, bring a dose of realism about how fast the pandemic may recede.
At present, many forecasts predict a strong recovery in FY21 and beyond. The latest forecasts from the International Monetary Fund (IMF) projects that the global economy will grow at 5.5 percent in 2021 and 4.2 percent in 2022.2
A bounce-back after such a sharp decline is to be expected. The ability to sustain the pace of that growth is more open question. In the past decade, we have seen global growth at 3.8 percent or above only in 2010, 2011 and 2017, and projections of such robust growth to sustain may be optimistic.
If growth doesn’t accelerate, this spells bad news for banks in more ways than one. Firstly, demand for credit is likely to remain weak among consumer and corporate clients. Secondly, low growth is likely to delay central banks’ interest-rate increases, which will keep net interest margins (NIMs) under pressure.
Indications are that the US Federal Reserve (the Fed) will keep interest rates close to zero until at least 2023. But following the global financial crisis (GFC) of 2008—when the Fed’s balance sheet didn’t expand as far and as fast as it has this year—it was more than seven years until rates rose. In Europe, rates haven’t risen since the GFC—and an analysis by the European Commission (EC) last May highlighted structural weakness in Corporate Europe that could be exacerbated by rate rises.3
Continued pressure on net interest margins will create difficulties for lending businesses. And investment banks won’t be left unscathed, either. Trading businesses benefited from volatility in the last year. As volatility subsides, the revenue pool for the largest investment banks could shrink.
These pressures mean that banks’ leadership teams need to roll up their sleeves and drive real change and innovation across the organization to improve profitability.
A unique opportunity to transform costs
Analysts project that the largest global banks will cut costs, on average, by around 6 percent from FY20 to FY22. Alongside anticipated revenue growth of 3 percent, this would see average cost-to-income ratios fall by around 10 percent, but that still leaves many large banks (especially in the United States and EMEIA [Europe Middle East India and Africa]) operating at cost-to-income ratios of more than 55 percent, which suggests that more radical thinking on cost reduction is needed.4
The impact of and response to the pandemic has highlighted several areas in which banks can take such bold and radical action.
The success of remote working, accompanied by client demand for digital channels, will enable banks to reduce real estate. Many banks may adopt a flexible, hybrid approach to reducing their office footprints and retaining their competitive edges in the talent market. We have already seen many examples of banks looking to capitalize on the shift to digital channels by reducing their branches. Long leases mean it isn’t always quick or easy to reduce the physical network or downsize headquarter locations, but this trend is unlikely to be reversed. The challenge will be balancing a shift to home or hybrid working with ensuring that management can effectively mentor, train and build teams.
The pandemic has also highlighted areas that banks should address: how to balance internal resources with external providers; use artificial intelligence (AI) to automate or accelerate manual processes; adjust the level of straight-through processing; and deploy automation to reduce dependence on manual processes or individual third parties.
Banks will also need to make greater use of managed services, especially in areas that don’t provide a material competitive advantage, such as anti-money laundering (AML) checks or know your customer (KYC) services. This can both reduce costs and achieve greater scalability. Many banks already recognize this need. The recent EY Tax and Finance Operate (TFO) Survey5 showed that more than 60 percent of banks are looking to co-source tax-related activities with third-party vendors.
As banks emerge from the crisis, freeing up capital through strategic growth and divestment opportunities will be critical. They will need to refocus on, and grow, core businesses and prioritize their heavy investments in technology. Some banks may sell stressed loan portfolios, and we should brace for a new wave of consolidation and portfolio changes across almost all markets.
Reimagining customer relationships
Banks have supported their customers through the pandemic and demonstrated the important role they have in communities around the world. In the recovery, there is an opportunity to rebuild the brand of a sector that has suffered reputationally in the last decade. By supporting customers through tough times, banks can build trust.
The pandemic has also dramatically changed how customers access financial services. Branch traffic is down, while digital solutions have surged. One major US bank reported that its digital sales had grown from 27 to 50 percent. Another saw an even bigger shift in digital sales, from 25 to 75 percent. In Europe, where digital adoption is typically higher, the EY Future Consumer Index6 showed that nearly a quarter of consumers said that they expected to bank more online in the coming years.
New ways of interacting will also bring new opportunities. By understanding their customers’ needs, banks can strengthen relationships and find new revenue pools. EY analysis suggests that major non-financial firms around the world generate more than US$200 billion in revenues from financial services. Meeting customers’ needs in a world changed by the COVID-19 pandemic will require banks to first understand new banking habits and then develop the right business models to accommodate them. But opportunities abound.
In an economic downturn, banks will need to consider how to adapt products and channels to meet the changing needs and specific pain-points of corporate, commercial and SME (small and medium-sized enterprises) banking services (CCSB) customers. These customers may also seek support to evolve their business models, including through advice on industry partnerships, fraud prevention or risk hedging.
Trade is likely to recover quickly as the pandemic eases, but as it does, we’ll most likely see a rise in credit and counterparty risks. This may lead firms to seek more financial instruments to enhance end-to-end supply-chain visibility and mitigate transaction risks. Banks will need to accelerate the digital transformation of trade products to meet growing demand.
The EY Future Consumer Index7 has shown how many customers are worried about their financial health and overall wellbeing. Banks must reassess how new concerns and needs will impact demand for banking products. For example, the industry expects to see more customers seeking subscription services, income insurance and risk-management products. Banks that proactively adapt their products and services, including digital channels, can help build customers’ financial security, boost their confidence and strengthen their own competitiveness.Customers will expect hyper-personalized products and services in the future.
Beyond supporting customers to navigate immediate challenges, banks should consider how to build a more customer-centric model over the long term. This means redefining business and operating models to help them best interact within ecosystems to bundle banking services with other day-to-day activities. This is a way for banks to capture new revenue streams and grow their customer bases. It is also a way for them to “lock-in” their customers, as consumer companies have been doing for years. Platforms that leverage data from multiple sources, combined with advanced analytics, can connect customers to hyper-personalized value propositions, such as loan-forgiveness solutions or innovative pricing options for products.
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The speed with which banks have been able to implement radical changes in operations in response to the pandemic demonstrates the strength and depth of banks’ talent pools and their ability to drive far-reaching change when under pressure. In the coming year, banks’ leadership teams will need to carry that momentum forward and build on this capability. Banks that accelerate cost and customer-transformation programs will be best able to deliver long-term value.
The road ahead may be challenging, but the banking sector’s response to the pandemic is cause for optimism. Banking in the next decade will offer more than just a better, more compelling experience for retail and business customers. Banks will forge a road to recovery that leads to an economy that’s not just revived but reimagined.
1 Refinitiv Eikon, accessed January 29, 2021
2 International Monetary Fund: “World Economic Outlook, October 2020: A Long and Difficult Ascent” WORLD ECONOMIC OUTLOOK REPORTS, October 2020
3 European Commission: “Identifying Europe’s recovery needs”, April 2020
4 Refinitiv Eikon, accessed January 29, 2021
5 EY Americas: “How a reimagined tax and finance function can improve your bottom line”, April 14, 2020, Carmine Di Sibio, Kate Barton and Dave Helmer
6 EY: EY Future Consumer Index
7 EY: EY Future Consumer Index