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Key Risks Shaping the Banking Industry

by internationalbanker

By Lee Doyle, Global Head Banking Industry, Ashurst LLP


An accelerated period of change has long been on the horizon, and institutions are now facing an inflection point in the banking industry’s evolution. The digital revolution in retail banking has largely happened, and the interest is now in how consumers engage with this technology. This is not the case in corporate banking—digitisation is continuing at pace and will continue to do so over the next few years. Several megatrends are driving these developments, which will converge across retail and corporate banking in the coming years.

Retail-banking developments are clear for everyone to see on a day-to-day basis. The scale of big banking changes, however, is likely to only become evident within the next 12 to 18 months. As advisors to the world’s largest financial institutions, we at Ashurst are fortunate to work alongside them in dealing with these issues. We’re lucky to be behind the curtain. Goldman Sachs’ ground-breaking Digital Asset Platform (GS DAP) exemplifies what’s coming. In time, these fundamental changes will mean that corporates can access capital markets without layers of processes and bureaucracy—just as consumers now connect with retail markets.

Investor considerations are being matched by other factors, including the increasing focus on ESG (environmental, social and governance) compliance, the “fight” for talent and reshaping of the workforce, and the emergence of generative AI (artificial intelligence) and the fundamental changes it brings to our preconceptions and certainties of processes, controls and work-allocation norms.

These step changes in developments and potential uses of AI alongside human thought can’t be understated. One topic we certainly didn’t think would be driving so much change 18 months ago was the sector’s AI adoption. The genie is well and truly out of the bottle, though, and regulators and legislators will be playing catch-up for some time. The European Union (EU) is trying to legislate but is struggling to define the scope and breadth of AI rules, while the United Kingdom is attempting a sector-by-sector approach. The United States is currently seeking to define its approach to regulation. AI will perhaps move us towards more rather than less legislation.

Despite the multiple challenges, those banks that can successfully implement AI technology will benefit from large competitive advantages in terms of time and cost savings. My Risk Advisory colleagues always remind me that navigating the risk profiles that come with this is a daunting challenge. The black box of AI must be opened, and the recent Senior Managers and Certification Regime (SM&CR) in the UK has further complicated this.

With liability now landing on the shoulders of those at the top, senior executives must be able to not only understand how AI is being used in their businesses but also clearly explain its implications—a major challenge in a fast-moving area in which bank leaders are often far removed from the cutting edge of technology development.

Although AI is where the most far-reaching changes will come, ESG remains the number one boardroom megatrend for banks—now with the added complexity for global financial institutions of mixed messages from some political leaders and, in the US, a full-blown backlash against many ESG policies. The differences in approach in different countries and regions are the biggest challenges today and in the future. From London to Texas to Hong Kong, banks must not only comply with local legislations but also build effective strategies to cater to the firms’ global ESG objectives.

Sometimes, in the rhetoric, the views of investors are overlooked, and they are the banks’ ultimate stakeholders when you consider that their main purpose is to generate returns. Investors are not a homogenous group. However, understanding investors at both corporate and retail levels is a puzzle to solve. Some will take a longer-term view when ESG concerns are a priority, while others will target short-term financial gains. Balancing these perspectives must be a key focus for leaders.

The risk of failing to accommodate investors’ appetites for sound ESG credentials is substantial. The financial-services sector has been hit by a stream of greenwashing allegations over the past two years, with banks accounting for 70 percent of greenwashing, according to RepRisk, a firm specialising in ESG data. Avoiding these accusations and ensuring that products advertised as environmentally friendly meet this standard imposes a major new burden on banks, as complex supply chains must be carefully scrutinised—for example, ensuring that the investments advertised are genuinely sustainable.

Closely connected to ESG is another of the megatrends to which the banking industry has had to adapt rapidly: the net-zero transition. From finding sufficient investments to fund renewable energy worldwide and preparing for the impacts of climate change, such as rising sea levels and more frequent extreme weather events, the banking industry will need to adapt radically to the “E” (environment) in ESG. Industry leaders must make complex decisions, balancing numerous commercial and regulatory concerns, if they are to play the part that governments, and increasingly shareholders, demand in financing the net-zero transition.

Among the risks are complex supply chains, making vetting a product’s environmental credentials challenging and producing potential competition issues if firms coordinate their approaches to green products. The former will burden banks’ compliance professionals, especially as national and transnational jurisdictions become increasingly strict about how environment-friendly investments are defined. For example, would using steel produced with petroleum- or coal-based needle coke to make an electric vehicle count against its green credentials? Would a bank offering this as part of a carbon-neutral investment be required to include a carbon-negative investment to balance this out? These questions still have no clear answers.

Competition, too, presents a formidable challenge for banks. Competition regulations and enforcements have arguably not kept up with the need for companies to collaborate to ease the transition to net zero. Other industries have fallen foul of competition authorities over climate-related collaboration, as seen in a 2021 European Commission (EC) decision, which fined several auto manufacturers $875 million over their alleged collusion in developing emissions-cleaning technology for diesel cars. This willingness to probe competition issues, combined with the array of subsidies that Western national governments offer environment-focused companies, makes green financing an area in which banks must rapidly adjust to changing government regulations and competition enforcement.

Never have bank senior executives needed such an array of skills and abilities to deal with these fundamental issues, and never have they had to operate in a market so influenced by governments and regulators. The Global Financial Crisis (GFC) brought in necessary regulatory oversight, and subsequent conduct and liquidity issues in some areas have led to further regulatory scrutiny. Already one of the most regulated sectors globally, banking is unlikely to see another wave of regulation. Rather, one should observe to where the regulatory focus shifts. Shadow banking and private credit have grown enormously in recent years, and there are signs in both Europe and the US that, along with new technology, this is where the eyes of regulators and legislators are beginning to turn. It is unlikely this will occur without a fight.


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