Learning from earlier adopters how to simplify operations can help businesses streamline risk, compliance, and the finance function as a whole. FEI Daily spoke with Nigel Smith, National Financial Services Leader at Grant Thornton, about how banks are driving simplification by eliminating unnecessary products and features, and moving to a rationalized set of operations and IT platforms.
FEI Daily: What are the leading trends affecting the banking industry?
Nigel Smith: The major thing we identified is the long-term structural issue with profitability in the banking sector as we see it. Sure, you get changes from quarter to quarter, investment banks may have a good quarter and that might factor the results. But if you look under the covers, it’s really been a long-term structural issue with the industry, and not one that lends itself to a silver bullet, whether that’s an increase in interest rates or a rolling back in regulation. Whilst you certainly find bankers who would regard both of those things as being very positive, we think the nature of what needs to be done to truly return the industry to profitability is more structural than that, and is going to require more investment for the banks to get there.
FEI Daily: How are the trends translating into challenges?
Smith: The challenge is really delivering returns to the shareholders. If you look at the return on equity numbers for most of the banks, that's certainly true. Challenges in delivering a customer experience that can compete with the best customer experience in other industries, and the best experience that can be offered by new Fintech startups. I think that's very difficult for the industry.
Then, continuing to stay on top of the regulatory demands at an acceptable cost is another major challenge. The phrase we tend to use is the cost of compliance, but we're using compliance in a very broad sense, across all three lines of defense. The cost in the front line and operations in compliance and internal audit, and the number of people these banks have employed across all of those functions, is a very significant part of noninterest expense.
FEI Daily: Has that changed in the last five to 10 years?
Smith: It's post-Lehman's, post-financial crash and everything that's come with that, all of the Dodd-Frank and other regulations that have rolled out in reaction to the crisis, have ratcheted up the cost whilst at the same time volumes and revenues have been down, so as a percentage, it's really hurt the banks.
Some of that was masked because, for a long period of time, you had a lot of one-off structural changes to the banks' balance sheets if we shared under-performing assets as they went through litigation. Now we're starting to see more of a steady state with those one-off factors working their way through the system. That steady state is desperately attractive to most banking executives or to their investors.
FEI Daily: Technology can be a factor in cutting costs. How else are the banks addressing these challenges now?
Smith: Most of the banks are well down the path of some degree of cost-saving initiative. It may be called something different at each bank, they may be on their third wave or their second wave, but you'd struggle to find a bank in the U.S. that isn't well into what I would refer to as “traditional cost savings.” Going after cost of procurement, reducing head count, relocating staff to lower-cost locations, all of the normal levers. Success has varied across the banks, but they've certainly all driven a lot of the cost out though those initiatives.
What a lot of them are finding, though, is that there are only so many times you can reduce the cost of a laptop or whatever the item might be. The fundamental complexity in the business model is, in our view, what makes it hard for them to continue to drive down those costs. That complexity comes from many dimensions, it comes from the channel dimension, the explosion on customer contact methods that we've seen over the past 10, 15 years. That has added a lot of complexity. It certainly comes from the regulatory landscape, that's added complexity.
In some cases, it's a legacy of acquisition or maybe not completing to the full post-merger integration. That obviously differs across different organizations, but certainly the large banks are hugely complex, which then makes it very hard to continue to drive down some of those unit costs.
One of our themes is simplification. Do you need to be in all of those markets? Do you need to be offering all of those products or all of those channels? Do you need to be serving every customer segment? What can you do to actually simplify the business model, which in turn will flow through to lower costs. Rather than just driving down the unit cost, if you like, from a procurement point of view. That's one of those things that's easy for a consultant to say and pretty hard to execute.
You'll find most of the large banks have systematically worked through which markets they want to be in. They’ve downsized certain businesses; they’ve downsized certain portfolios and balance sheets. There's still more that can be done, and probably should be done, to really drive that simplification all the way through, not just the front office, but into the middle and back office as well.
FEI Daily: You mentioned Fintech startups. Can you tell me a little bit more about that particular challenge?
Smith: We're seeing two main things. We're seeing Fintech from a point of view of new entrants who can come in and and offer a proposition that's designed just for a niche market, and do it without the complexities of some of the established players. They can, to some extent, perhaps, fly a little under the regulatory regime at least until they have scale. That's one part of Fintech.
The other part of Fintech that's potentially very helpful to the banks is the new technologies that they can leverage both in providing the customer’s experience and also starting to address some of these challenges around cost.
From the bank's point of view, the latter is an opportunity to take some of those new technologies and figure out better ways of doing things.
The former is more of a challenge because somebody can come in and target a particular market segment with what might be a very attractive proposition, or keep the sign up process for the customer very simple. That's hard for a large established, highly-regulated financial services organization to compete with.
These Fintech opportunities are not necessarily restricted to banks. In terms of new technology capabilities, I think the banks will be early adopters of some of those technologies. Think about analytics and machine learning, for example. The finance and compliance functions within their clients can also benefit from those trends. Learning from the earlier adopters, whether it's Blockchain or machine learning or data analytics, can be used to streamline, not just risk and compliance, but also potentially the finance function as well.
FEI Daily: Looking ahead, how do you see the trends evolving?
Smith: I think there's clearly some major uncertainties around that, not least, recent events. I think, putting that to one side, one of the uncertainties is the extent to which the banks are prepared to go back to their investors and say, "Look. I know you've been very patient with us over the last few years, but actually if we're really going to tackle this, we've actually got to invest.” They’ve actually got to spend money on common IT systems, on common operations, and finally, perhaps, on integrating businesses, which today are very distinct around product. Doing omnichannel properly, having a single point of interaction with a customer.
These are all things that are going to take time, effort and money. That money has been very scarce over the last few years. Given everything we've just discussed, if the banks aren't prepared to grapple with some of those challenges, there is a danger of bumping along the bottom. It remains to be seen, the extent to which either the bank leadership and management, or the investors in those banks, are going to be prepared to grasp that nettle. The ones that do, I think, could be in a much stronger position in five to 10 years’ time than those that don't. It's certainly not straight forward.
They should really be thinking about those investments now and try to get to a structurally simpler, lower cost model that will serve them well for the future.
FEI Daily: What are the takeaways for those outside of the banking industry?
Smith: There are a couple of things. One, there is still going to be a lot of competition for their business, which should be good from their point of view. I think there is an opportunity to make the end-to-end processes more efficient, and so far as those CFOs are customers of these banks, they can collaborate in that process. Certainly for the larger enterprises, there's a real opportunity to drive costs out of both sides of that interface if those organizations and the banks are prepared to collaborate around how they do that. That’s certainly something they should have in mind.
I think awareness that there will be some continued structural changes in the industry, which also may have benefits and opportunities for some of those current clients of the banks. One of the things we talk about is the rise of industry utilities, the opportunity for certain functions that are performed today by the banks, to be performed elsewhere. There are two versions of that. One is a sort of a new startup that comes in and says, "We can do this better than the banks." I think we're already seeing some of that in the lending space. There are more sources of capital, perhaps, available to SME organizations today than there were 10 years ago.
The other version of that is the banks getting together themselves to say, "Hey, there's a better way of doing this. We've got some capabilities, some functions here, which are ultimately not a source of competitive advantage for any one bank. If we collaborate together, we can do that, both more effectively and more efficiently, which ultimately should flow through to their customers.”