While corporate and investment banks have already optimized business lines in recent years, withdrawn from certain segments and taken a range of other measures, their actions have not been enough. Financial institutions need to fundamentally transform their business if they are to cover their cost of capital in the future, according to the findings of a new study by Roland Berger Strategy Consultants, Nomura Global Research and Tricumen, titled "CIB Outlook 2015: Industrial Journey – Episode II".
High one-time costs keep returns low
Revenues in corporate and investment banking are not set to rise significantly in 2015 given that higher income from share trading or M&A transactions will be diminished by the effect of falling revenues from bond trading. Non-recurring costs serve to reduce the cost/income ratio even further. Jon Peace, Managing Director at Nomura: “Weak revenue growth, high structural costs and regulatory RWA (Risk-Weighted Assets) inflation will keep pressure on CIB ROEs in 2015”. The ten biggest players in the market saw 12.5% of their total costs go on restructuring, compliance and, especially, litigation costs in 2014. The majority of these costs are in the form of penalties, which have amounted to a total of 160 billion dollars since the financial crisis.
"Many banks are going to have to cut costs even further to offset these substantial cost effects," said Roland Berger Partner Dominik Löber. "If they manage to do that and if their one-time costs come down, ROE could realistically rise to 11-14% by 2016." The important factor here is what happens to the cost of risk, as it is currently extremely low owing to the fall in credit default rates.
Client-centric industrialization – the right mix of factory scale and boutique skills
In some areas of banking, expertise and agility are instrumental in successfully being able to offer products with big margins in small quantities. In other areas, economies of scale are the key to creating large quantities of standardized products with small margins. Financial institutions in the corporate and investment banking world now have to combine these two different approaches – depending on what their clients want.
Many banks have already responded and aligned their entire organization and back-office processes more strongly toward their clients' needs. However, this strategy calls for detailed customer segmentation and closer cooperation between client advisors, product experts and back-office departments. "Corporate clients expect a broad product portfolio – from traditional loans to complex acquisition financing," said Dominik Löber. "It's a balancing act. To manage it and meet the regulatory requirements at the same time, banks need to systematically analyze their client and product profitability so that they'll be able to react fast to any negative developments that may arise." It's also important for financial institutions to implement compliance structures that match their portfolio of products and services.
Driving business model digitization
Banks need to quickly push forward with digitization if they want to be in a position to meet their clients' needs better than before. The digital experience that customers have – on e-trading platforms for example – will be incredibly important here. And a higher level of digitization is becoming increasingly relevant in internal processes owing to cost and efficiency considerations. While this does demand considerable investment in new systems, it will be a basic requirement for an institution to remain competitive in the future. Big data analysis systems are also going to be instrumental in the digitization of the corporate and investment banking sector. It's these systems that enable banks to analyze relevant client and risk information in more precise detail and control their banking processes better. Pierre Reboul, Global Head of the CIB practice at Roland Berger, comments that "the pace of digital transition that we have evidenced across the industry and our clients has been so significant that it is no longer large scale digital initiatives that will differentiate CIBs from their peers, but rather the lack of them, which will produce the outliers in the industry".
However, the digital transformation affects a much wider range of institutions than just banks. FinTech companies are breaking into the traditional business segments as new market players. But they're not just competing with the banks, they can also partner with them in digital ecosystems. "It's very difficult for financial institutions to manage the digital transformation alone," explained Roland Berger Partner Klaus Juchem. "Partnerships and digital ecosystems offer banks and FinTech firms the chance to learn from one another and mutually benefit from this market."
New business model calls for cultural change
Implementing digital business models is not the only area where the global banking sector is in need of cultural change. The recent scandals surrounding interest rate fixing and exchange rate manipulation or the lack of proper advice in loan transactions have seen banks saddled with substantial penalties. As a consequence, the image of banking has suffered greatly in recent years, with banks no longer seen as such an attractive place to work. So what banking institutions need to do is combine traditional HR measures with innovative ideas. Reverse mentoring, for example, is an approach whereby each top manager is assigned a digital native as a mentor to help them become more aware of digital trends. It's equally important to hire people from outside the industry as a means to acquire in-depth expertise in the areas of industrialization and digitization.
Nevertheless, this kind of cultural change can only be successful if it is supported and lived out by all of the top executives in a financial institution. That is what creates confidence in new structures and responsibilities. "Even though cost pressure, industrialization and regulation remain the biggest challenges for the banking sector, corporate and investment banks should work consistently to turn themselves into client-centric, digital banks so that they remain competitive in the face of new market players moving in," said Juchem in summary.
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