Group Co.
The Power of the Crowd
Traders Magazine Online News, November 15, 2017
After a decade of reform and retrenchment, the banking industry is on a more secure footing. Balance sheets and capital levels increasingly reflect regulators’ desire to minimise systemic risk. But it is less clear whether banks have adjusted their business models and operating infrastructures to the realities of the post-crisis landscape. In many cases, the ghosts of the past continue to hamper efforts to cut costs and improve efficiency to the extent required to accommodate lower margins. Nevertheless, technology offers new opportunities for banks to pool resources and expertise, thereby mutualising and minimising operating costs and risks.
In June, the Federal Reserve confirmed that all 34 major US banks had passed its latest round of stress tests, enabling them to resume dividends and stock buybacks. In Europe, despite slow progress toward European banking union, the worries that prompted the initiative are receding. All major European banks achieved core equity tier 1 capital ratios well in excess of regulatory minimums in Q2 2017 (ranging between 11-16%), significantly higher than five years previously.
Now that banks have pushed through the hard yards of compliance with Basel III’s capital regime, other regulatory deadlines are fewer and further between. Alas, the end of an existential crisis does not herald the resumption of business as usual. Recent financial performance is still well below historical norms, and other sectors. Having inched up steadily in recent quarters, the US banking sector finally achieved return on equity (ROE) above 10% in Q2 2017, albeit with wide differences between laggards (5-6%) and outperformers (12-15%). In Europe, the picture is worse. The European Banking Federation puts European banks’ collective 2016 ROE at 3.5%, down from 2015’s 4.3%. With a 9% average cost of capital, the sector is barely breaking even.
Indeed, few banks were looking forward to the Q3 2017 reporting season with much confidence, some warning investors to expect 15-20% falls in trading revenues, with a lack of volatility having weighing on Q2 figures. Once the dust settles on the Q3 numbers, fundamental realities are likely to depress earnings outlooks and book values. The rising costs of meeting steeper compliance obligations and evolving customer expectations will continue to far outstrip revenues, regardless of changes in interest-rate policy or termination of quantitative easing.
We are entering a new era. The era of high leverage, low wholesale funding costs and high margins is over. Pledges on both sides of the Atlantic to review post-crisis reforms to support economic growth may ease transition to the new normal, but will not bring back the good old days. Pressure on banks to continue to cut costs through operational efficiencies will only intensify.
Cutting operational costs is, of course, no easy matter. Compromising on quality of service delivered by the back office is not an option in times of low yields. Indeed, errors, delays and breaks are tolerated less when there is less profit to go around. How then to reduce their stubbornly high cost and frequency, thereby reducing the back-office’s burden on balance sheets, without further damaging customer trust and confidence?
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