Having spent my entire career in banking and experienced many different economic cycles and banking crises, I decided in 2014 to take on a new challenge in the FinTech sector.
The experience garnered from 25 years in banking placed me in a unique position to deeply understand the business and strategic challenges facing banks. It is probably fair to say that, despite having a rich source of data and a wide platform of customers, traditional banks are less comfortable with technology and data science.
Progressive banks have accepted that their core competencies are banking and financial services, not data and technology. These banks have started to partner or indeed outsource these non-core competencies to ensure optimal delivery of their core competencies.
In some ways it is this industry trend that prompted me to join Nomis Solutions, a FinTech company focused on retail-bank pricing and portfolio management through data analytics. The company has a unique offering that supports banks’ ability to proactively and scientifically manage mortgages, loans and deposits pricing to achieve optimal shareholder and customer value.
The financial crisis of the last seven years has changed banking fundamentally, and as banks enter the next phase of the economic cycle, they are facing a set of new challenges in meeting regulatory requirements, internal operational needs and technology demands. However, weaknesses still persist in the system, and it will be many years before these have been fully resolved.
As we can see from the current situation in Greece, the overall stability of the economies in Europe remains delicate. Whilst the risk of Greece leaving the Euro area is a little different than the risk that persisted a number of years ago and the contagion effect that may have had, the risk of general Eurozone instability is still a real threat. The combination of central monetary policy and decentralised fiscal policies has been a driver of both recovery and stagnation. It is a difficult conundrum to have a single monetary policy that fits with several fiscal policies and underlying economic progress.
The reduction of interest rates over the past number of years to historically low levels was done primarily to drive increased spending, lending and investment. However, this has largely failed in terms of the expected pace of such spending and investment. Instead, many economies remain concerned about deflation, which would have a devastating effect on economic re-growth and result in persistent stagnation.
Despite these risks, we are beginning to see signs of a potential future interest-rate increase. Construction indications are now positive in most economies, mortgage lending is increasing, and consumer spending is beginning to rebound. The rise in interest rates will have a profound impact on retail-bank businesses, on both their assets and liabilities.
Retail bank mortgages
If we take mortgage lending, for instance, as property prices increase across the European Union and customer loan values decrease, customers are released from trapped mortgages. This will result in customers becoming more sensitive to price changes and more volatile in their selections of mortgage providers. Similarly, as rates and property values increase, consumers will be encouraged to get on the property ladder in anticipation of both higher property prices and interest rates.
To capitalise on rate increases, banks need to have a deeper analytical understanding of changes, their portfolios and future customer bases. Progressive banks are now adopting specific analytical strategies ensuring that they optimise both retention and acquisition strategies to ensure they meet the dual objectives of the customer and shareholder.
Nomis Solutions recently announced a partnership with Berkeley Research Group (BRG) to provide a holistic solution to banks driven from deep analytics, operational software to execute acquisition and retention strategies, and regulatory support to ensure strategies meet regulatory and customer objectives.
Retail bank deposits
On the liability side, banks are now facing a new set of opportunities and challenges as economies begin to recover. Whilst dealing with the outlook of increasing interest rates, banks must protect their margins, answer regulatory requirements (particularly Basel III) and grow stable forms of deposits to support asset growth.
One of the key focus areas of Nomis is its work with banks on deposits management. Having spent four years as Head of Deposits and Current Accounts in Bank of Ireland and experienced a unique challenge at the height of the financial crisis, I recognize that the capability to bring business, technology and analytical solutions to banks in deposits management is indeed strong.
Most banks have completed the downward repricing of deposits and repaired, somewhat, the negative jaw that existed as rates were falling. However, many banks are also “deferring” deeper analytics to support strategies for the upward rate cycle. The reason for this deferral is the lack of precision on rate changes. This short-term thinking generally leads to longer-term issues. Progressive banks are now deploying such analytical strategies to ensure that they maximise the benefits to them ahead of rate changes.
Having such strategies will improve the banks’ capabilities to answer multiple challenges. Banks will have a deep data-driven understanding of depositor behaviour and can execute strategies to understand and learn from the changing impact of prices in the market and use this to better forecast future behaviour and market strategies in relation to rate changes. They will also understand the new, changing and dynamic micro segments that help inform product, pricing and channel strategies as well as being able to act definitively and swiftly when changes occur, thus saving time and cost.
The differences between banks that have invested in price-optimisation solutions and those that have not are clear. Those that have invested already have clear, planned actions for changing rates. They will benefit from “knowing” what to do and when to do it, rather than traditional approaches of questioning strategy after it’s been implemented. To me, it’s not a question of whether banks should adopt a price-optimisation strategy; it’s a question of what are the consequences of not adopting one.
The other major challenge for banks in deposits management is the new regulatory regime under Basel III. Again, this requires a rethinking of channel, product and pricing strategies for deposits. Recently, Nomis published a White Paper on the impact of Basel III on deposits management, with recommendations on product and pricing strategies. In this White Paper, we highlighted some fundamental requirements for banks in managing their deposits portfolios. The financial crisis was the catalyst for new Basel III regulations, recognising the relative vulnerability of deposits and liabilities to banks’ viability.
Effectively, Basel III introduces two new measures. The first, Liquidity Coverage Ratio, focuses on the short-term vulnerability of liabilities and effectively compels the bank to hold high quality liquid assets (HQLA) against a portion or all of a deposit that has accessibility within 30 days. The second measure, Net Stable Funding Ratio, looks at the longer-term stability of such deposits and compels banks to reclassify the stability of every deposit, determining whether a specific deposit is wholly stable for lending or unstable. This effectively changes how banks will acquire deposits and to what extent these deposits are viable to lend against.
So, how are these new challenges under Basel III affecting deposits management? Most banks have made reasonable progress in establishing and embedding Basel III into treasury and liquidity management functions. However, some banks have not reflected the core of Basel III into the business or funds transfer pricing (FTP). Progressive banks have started to use analytical insights to understand customer behaviours, understand pricing differentials and execute pricing and product strategies at the front end. Clearly, not all deposits are of equal value to the bank, so the options open are:
- Reflect the “value” of the deposit through pricing differentials. Banks need to consider the cost of holding HQLA against the stable value of the deposit or the opportunity lost for lending all or a portion of that deposit and the likely lifetime value of that deposit. This task needs to quantify the outflow cost and the stability cost of each segment of the portfolio to feed into the customer rate.
- Execute strategies to improve products and channels to make them more “Basel III friendly”. For example, we are seeing more and more banks introducing 30-plus-day deposits that reduce or eliminate outflow costs (HQLA costs). In addition, more banks are looking to extend the maturity of deposits to grow stable funding measures and make the bank more fit for lending to a growing economy.
- Execute strategies to focus on growth, acquisition and retention of core segments, such as retail and SME (small and medium-sized enterprise) segments.
The world of banking has been fascinating to me over the last 25 years. But the challenges faced by banks over the next number of years require thinking of a different kind. In my view, more banks need to embrace and leverage the use of data to make fact-based, grounded and accurate decisions for both customers and shareholders.
Photo Attribution: © Depositphotos/pz.axe