Back to basics

'Back to basics' is the cry, from all quarters of retail banking. What is it likely to mean? Peti de Wit and Fabiano Gobbo discuss the implications.

The call for retail banking to get back to basics has rapidly become a cliché. But like all clichés it captures a real truth. The financial crisis has exposed the dangers of combining investment in opaque and highly-complex structured products with retail deposit-taking. One way or another, retail banking should re-engage with its original core purpose: collecting deposits from savers and lending to enterprise, financing the real economy. No doubt a role will remain for esoteric and relatively high-risk financial speculation; structured products and derivatives will continue to play their part in spreading and transferring risk. But these forms of business should be increasingly segregated from reliance on retail banking balance sheets.

For its part, the retail banking sector will probably evolve a range of different business models in the course of its response to the crisis. A number of the largest banks may shrink by divestment under pressure from regulators. Others may focus on particular niches or geographical territories - concentration on the home market is likely to be an underlying theme for many banks. But some themes are likely to be common across the sector.

Retail banking is likely to return to a model more like a public utility, providing a clear and defined service for an adequate, if not especially exciting, margin. From the perspective of private sector shareholders, the focus is likely to be on steady returns and long-term sustainability. From the customer perspective, those banks which rebuild trust will be those which understand and respond to customer needs. The contrast between a now-discredited 'Anglo-Saxon' model and less well-developed, more cautious approaches has probably been overstated in recent months. Nevertheless, big financial conglomerates motivated mainly by quarterly Return on Equity could be a lot less sustainable in future.

Risk management
Alongside the return to a customer-centric approach (see articles: 'A customer-centric approach: the key to driving revenue growth', frontiers in finance, March 2008 and 'Moving clients to center stage', frontiers in finance, December 2008), risk management should move to center stage, becoming embedded in strategic decisions. Hitherto, risk management has tended to be seen by many as a matter of compliance rather than a source of added value. This is not to say that risk management has been ignored. On the contrary, many leading banks believed they had implemented advanced risk management systems and procedures. But these procedures under-estimated the actual risks in the complex investments banks were making.

Basel II has been criticized by some industry commentators for being pro-cyclical and for encouraging banks to reduce capital as far as possible. In reality, one of the problems was the way banks chose to implement it. Since risk management was seen as a compliance issue rather than part of core strategy, many banks chose the easiest route to implementation, increasingly adopting off-the-shelf models which satisfied regulators. Combined with investor and shareholder pressure to increase yield and return capital, attention focused much more on reward than risk.

These attitudes are changing. Regulators are pressing for risk management systems tailored to the individual nature of a bank's exposures. Banks are realizing the need to balance modeling with judgement and experience. It is more complex - and costly - to have to explain the specific details of a particular risk calculation. But banks who are able to do so are demonstrating a better understanding of the risk profile of their products. In the long term, this will lead to better pricing and added value (see article: 'Towards a single view of risk and return', frontiers in finance, February 2007).

Structural change

The last few years have seen a tremendous wave of aggregation and consolidation in the banking sector. This trend has been brought to a standstill by the crisis. In the near term, some further consolidation is likely, but this will be on a small scale, far from the industry-shaking takeovers of the past. Different sectors of the industry will come under contrasting pressures, reflecting the degree of their dependence on state aid. Those banks which have been wholly or partially nationalized are likely to come under increasing pressure to restructure and divest non-core operations.

Many regulators will be pushing this agenda, encouraged by those healthy institutions which have avoided or refused state aid. So a series of comparatively small-scale sales and purchases is likely. Who will be in the market? It is unlikely that many  Western institutions will want, or be allowed, to continue following the conglomerate model. In the latest edition of the Top 1000 World Banks published by The Banker magazine, the three largest banks by market capitalization are all Chinese, as are three of the top four banks by pre-tax profits. Could the West see Chinese banks stepping in to speed up restructuring of the sector?

Humility

The banking sector as a whole has been humbled by the crisis. New business models will be developed in response: smaller, simpler, more customer-focused, more transparent. Products and services will be developed which focus more on what they offer to the customer than how much yield they can achieve. Many banks are already looking to sectors outside the financial industry for lessons on how best to re-establish trust through service, efficiency and performance.

Article authors

Peti de Wit
Partner
KPMG in the Netherlands +31 20 656 7382 Peti de Wit View all articles by this author

Fabiano Gobbo
Partner
KPMG in Italy +39 02 6764 3620 Fabiano Gobbo View all articles by this author

1. 'A question of Trust', The Banker, 4 June 2009.
2. 'Why the world of banking must go back to basics' Daily Telegraph, March 14, 2009.
3. 'Update on strategy: Taking ING back to basics', http://www.ing.com/, April 9, 2009.
4. The Herald, June 1, 2009.