Challenges for banks in a bleak new world

The global financial downturn has profoundly shaken their customers' trust and bankers who are not prepared for a new environment will pay a heavy price.

PwC has identified four major short-term drivers that will have an impact on the banking industry over the next couple of years. Andrew Winning / Reuters

As the global financial sector is undergoing dramatic change, the banks will need to adopt a new mantra: precision over presence.

Before the onset of the financial crisis, many banks believed the best strategy was to be ubiquitous. Giants such as Citigroup and HSBC were front-runners in introducing the universal banking model, whereby retail and investment banking activities were simultaneously developed in scores of countries far away from the lenders' home markets.

However, combined with increasing deregulation of the financial sector, the universal banking model was in part responsible for creating an asset bubble and triggering a debt boom that culminated in the current financial woes afflicting the world's economies.

Research by PricewaterhouseCoopers (PwC), based on extensive experience of working with banks around the world, shows that as the banking landscape radically changes, financial institutions face a new reality where they will have to revisit their strategy and focus on fewer activities.

A flat or declining market means growth will only come from a renewed focus on key client franchises and niche opportunities.

Until recently, western banks and financial centres dominated the global financial stage, relying on a large pool of experienced professionals and apparently stable regulation, and against an attractive business backdrop.

But banks from emerging markets in South America, Africa, Asia and the Middle East and their financial centres are expected to grow in scale and credibility, increasingly challenging and ultimately outgrowing their established western counterparts.

To help policymakers and bankers prepare their organisations for tomorrow's banking world, PwC has identified four major short-term drivers that will have an impact on the banking industry over the next couple of years.

First is the decreasing size of the banking industry relative to the GDP of the country from which it operates. For decades, banks grew at disproportionate levels compared with their home markets' GDP.

For instance, asset growth of the top 16 banks in the western world was 17 per cent a year between 1995 and 2008, while during the same period the EU's GDP grew at about 4.5 per cent a year. A similar trend took place in the UK, where mortgage lending increased at 17 per cent a year between 1997 and 2009, whereas GDP grew only 5 per cent a year over the same period.

The global financial crisis marked a potential turning point for the European banks, as the top 16 lenders saw their assets contract by about 5 per cent in 2009.

Growth for the western banking sector will be more limited in the short to medium term. Weaker GDP growth in the US and Europe will constrain the growth of the local financial sectors and possibly lead to capital migrating to faster-growing economies in Asia.

It should also be noted that the European market is highly concentrated, especially in the Netherlands, France and UK, and growth through acquisitions - or organic growth - has become difficult to achieve. Public leverage is exceptionally high, suggesting the potential for additional borrowing is limited. Commercial lending grew at such pace that it is unlikely the domestic banks can attain much more additional growth.

There remain a number of opportunities for revenue growth that could arise from a number of specific areas such as emerging eastern Europe, taking market share of other banks or chancing pricing models.

A second short-term driver is the increasing fiscal pressure banks face. With soaring government deficits, austerity measures are expected to have a big impact in the next few years, affecting the speed and size of recovery and the ability of governments to intervene.

In a best-case scenario, banking will grow at modest rates, although it is more likely the sector will contract. And there is still a risk of a sovereign debt default in Europe, which could result from, and be exacerbated by, further major social unrest.

To assess the immediate challenges for the banking sector, one cannot ignore the possible impact of regulatory reform, the third main short-term catalyst. Banks could well have to alter their business models and shareholders may have to accept lower returns.

There is still much uncertainty regarding the precise impact of the proposed regulatory changes. There is no uniform approach, and key differences in regulatory approach could create uncertainty and be disruptive for banks operating across different jurisdictions.

There is also growing concern that current proposals from regulators across the world could drive a larger share of activity into the so-called shadow banking sector.

There is little doubt that following the global financial downturn, regulation is more than ever before on the top of bankers' agendas.

Last but not least, banks will have to address the issue of stakeholders' confidence in them. The financial crisis has profoundly shaken customers' trust in their banks and those bankers who are not sufficiently prepared will not be able to seize opportunities in tomorrow's new environment and regain their clients' confidence.

Ron McMillan is deputy chairman and head of assurance for PwC Middle East Region