Banking facing pressure to adapt in changing marketplace

Corporate banking looks for the switch

Pressure on margins, tougher regulation and new digital competition mean corporate bankers need to adapt – and quickly – in a rapidly changing marketplace.

By Stephen Craft and Louise McCabe

Corporate banking divisions have long been an engine room of banking profit growth. According to McKinsey & Company, corporate banking now gen­er­ates well over half of all global banking revenue. However, in the wake of the global financial crisis, the bankers’ cash cow is proving harder to milk.

A recent Boston Consulting Group survey found that more than half of all corporate banks across the globe have reported weaker profits over the past three years, with an increasing gap between the innovators and the underperformers. Tighter regulation designed to minimise future banking crises has increased the costs of providing loans, while sluggish economic activity in key markets has limited growth. Now a new generation of digital disruptors is challenging the old ways of doing business, putting established market leaders under pressure.

Yet while there is no doubt that life has become harder for corporate bankers, a rapidly evolving marketplace is also creating opportunities for those who can move quickly to meet changing customer demands.

Margins under pressure

While the banks’ cost of funds has fallen since the global financial crisis, interest rates have fallen further, thanks to government policies that have flooded the world with easy money. As a result, the margin between the interest bankers receive from borrowers and their underlying cost of capital has shrunk, hitting their bottom line. And according to Brian Johnson, director and senior banking analyst at CLSA, the problem is at its most acute in Asia.

"It comes down to this: all the world's excess liquidity has to get deployed somewhere and that's largely been Asia." Brian Johnson, CLSA

Brian Johnson“As long as we’re in an environment of low interest rates and low credit growth then you continue to get structural compression in lending margins,” says Johnson. “It comes down to this: all the world’s excess liquidity has got to get deployed somewhere – and that’s largely been in Asia.”

However, there is also some movement, at least in Australia, says Johnson. The intense competition and package discounting that had driven down margins for business lending has recently reversed. He points out that in May, three out of the four major banks held back five basis points of the Reserve Bank of Australia’s 25-basis-point official rate cut – “so margins are coming back up again.” Although this is bad news for customers, Johnson notes it is good news for the banks.

The cost of regulation

In addition to dealing with lower margins, corporate banks are working to comply with the latest wave of global banking regulation. It began in 2013, when banks started to implement the Basel III reforms. A frame­work designed to help banks improve risk management and deal with future shocks, Basel III is widely con­sidered a key measure in minimising crises like that of 2008. For banks it means holding a higher proportion of high-quality, liquid assets, a move many banks claim will generate lower yields and drive down margins.

Some banking industry insiders also claim that these reforms could change the entrepreneurial culture which has made corporate banking divisions such successful money-spinners in the past.

Richard Gibbs is a finance industry veteran, with past roles including director and head of economics at Macquarie Group and global economist and strategist at Abu Dhabi Commercial Bank. Now working as a corporate finance analyst and director of Plantagenet Investments, he says the Basel III reforms have seen a significant shift in power inside the walls of some of the largest banks. 

He describes it as an environment where “the lawyers and compliance masters are pretty much driving and dictating the terms of the business”. He’s concerned that corporate banking could lose its entrepreneurial, inno­vative drive, becoming instead a regulated rate-of-return business. “This could change the face of corporate banking altogether,” he says. But other commentators believe the Basel regulations don’t go nearly far enough.

Dr Imad Moosa, finance professor at Melbourne’s RMIT University and a former investment banker, says that far from being disempowered, the banks retain substantial power in the new regime. In particular, they retain the power to calculate their regulatory capital – “something like allowing the inmates to run the asylum”. Moosa, and many other critics, would prefer a tougher regime aimed at preventing a future global financial crisis.

And the Australian Prudential Regulation Authority (APRA) and some industry observers have noted that if regulation does make banks safer, those banks are likely to enjoy lower funding costs and better access to fund­ing. As APRA pointed out in a 2012 paper, depending upon the assumptions used, this safety effect could offset the other increased costs of Basel regulation “partially, fully, or even more than fully”.

Increasingly savvy clients

As well as being faced with increasing costs of regulation, corporate bankers are under increasing pressure to provide a higher level of service to corporate customers accustomed to fast, convenient, digitally enabled personal banking.

Police patrol in front of People's Bank of China in BeijingNick Glenning is a senior partner and the head of corporate development, Australia and New Zealand, at the Boston Consulting Group. He says that many corporate bankers have been slow to leverage new technologies to deliver a higher quality customer experience – and customer satisfaction is suffering as a result.

“Business banking has always been a relationship manager model. But often businesses don’t need or want a high-cost traditional model of speaking face to face with someone, but would prefer a combination of other channels – self-service, telephone, video – to have those needs met,” he says.

“So if I’m a treasurer or CFO or head of a small business with a nice smartphone in my hand, I’m going to start to expect that I’ll get the same service from my corporate bank. I’ll want a desktop that can give me really rich information about how my business compares to others, data analytics to help me be more effective, and I’ll want to access services very simply, any hour of the day.”

Large corporate banks can be among the worst performers in digital innovation because of the difficulties they face in transforming outdated legacy systems. According to a recent McKinsey & Company report, only 20 per cent of corporate banks have started significantly updating their technology, even though four out of five believe digital disruption is a grow­ing competitive threat.

The rise of the digital disruptors

That threat is becoming real, with a new generation of niche financial services players now taking advantage of digital technologies to bring financial products directly to corporate customers. A key factor in their success is the ease of price discovery that digital plat­forms allow. In short, customers can and will go elsewhere if they can find better rates or faster, more responsive technology.

While Glenning says these new players are currently limited to areas such as foreign exchange and marketplace or peer-to-peer lending, he cautions that banks which fall behind are likely to lose both customers and revenue over the longer term. They also risk missing out on the ability to leverage client data at each step of the value chain.

“In the past, banks have not exploited all the information that they have on how to understand credit risk. As well as their own data, there’s also third-party data such as social media that they can incorporate to make a more accurate risk assessment, for instance.”

He believes institutions that invest in technology now will reap significant rewards in the future, creating stronger customer relationships, reducing churn and sustaining profitability. That’s because technology underpins a higher level of advice, informed by richer customer and market data.

“Shadow banking is one of those things that works wonderfully well when things are good. But what makes business models robust is how well they work during periods of stress..." Nick Glenning, The Boston Consulting Group

“When they get a new customer, they can get a very quick understanding of what that business looks like by collecting and assessing data, and know what offers might be relevant to them. Then, once they serve that customer and they buy a product, they can better understand what other products they might need, and make sure they get targeted offers. 

This helps the business because it feels more proactive; and it helps the bank because they increase the level of cross-sell and depth of the relationship.”

Brave new banking world

In the new global environment of enhanced regulation, tightening margins, tech-savvy clients and increased competition from new entrants, the corpor­ate bankers’ traditional business model is under pressure. They need to adapt – and quickly – if they hope to thrive in this new environment.

Glenning says there are already signs that the fittest banks are overtaking their weaker peers, with the gap between highest and lowest performers continuing to widen.

“Change is demanding,” he says, “but those that can take most advantage of it are gaining over slower-moving competitors. It’s already showing up on their return on capital.”

Shadow banking — threat or opportunity?

Shadow banks are financial organisations outside the formal banking sector that supply credit and wealth management products to corporate and personal customers. They include microfinance companies, wealth management businesses and trust managers, and in China they’re a major source of business finance.

Nick GlenningEstimates of the size of China’s shadow banking sector vary considerably, from RMB 5 trillion to RMB 46 trillion. While China’s central government has embarked on a regulatory push, introducing a suite of regulations designed to restrain the shadow banking sector, some analysts say risks remain.

Corporate finance analyst Richard Gibbs says that shadow banking potentially creates inefficiencies across the Chinese market, distorting price mechanisms as businesses go to the shadow banking sector for funding, while banks lend money to state-owned enterprises that are seen as a lower risk.

However, both Gibbs and CLSA’s Brian Johnson say that shadow banking also brings benefits for China – at least while the economy remains strong.

“Change is demanding, but those that can take most advantage of it are gaining over slower-moving competitors.” Nick Glenning, The Boston Consulting Group

“So we’ll have to wait and see how robust it is for these guys in China,” Johnson says.

Three paths to corporate banking success

Boston Consulting Group (BCG) analysis of recent corporate banking results suggests banks can boost performance by going where the money is …
  • The right industry: In the US, for example, what BCG calls the “corporate banking wallet” of the health care sector is four times larger than that of the media and film sector, and is growing twice as fast. 
  • The right segment: Exports by small and medium businesses as a share of total exports should rise by more than 10 percentage points in both India and China through 2020. 
  • The right product: Specialised lending products like asset-based lending and equipment finance have been growing faster than traditional corporate lending in many markets, and BCG expects this will continue over the next five years.

This article is from the September issue of INTHEBLACK

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