The EU referendum in 2016, the geopolitical environment in certain countries, and trade agreement decisions such as the U.S. pulling out of the Trans-Pacific-Partnership (TPP) have impacted the global economic climate. These developments had ripple effects in the financial services industry. Macroeconomic factors have not been reassuring either, with global economic growth turning slightly positive only recently in 2017. The twin forces of digitization and competition have also had a bearing on the industry’s ROE, languishing at 8%-10% levels. Bank margins are under further threat from agile players such as financial technology (FinTech) providers and new entrants, especially in areas of limited regulatory oversight.
The retail banking and payments space has witnessed the maximum disruption from FinTechs and digital players. For instance by end of 2017, nearly 80% of mobile payments in China were processed by non-bank payment platforms like AliPay and WeChat Pay. A money market fund set up by Alibaba as a repository for leftover cash from online spending emerged as the world’s biggest, with over $175bn under management. However, amidst this disruption, the corporate banking business has been somewhat more protected. With global economy showing some signs of recovery, albeit slow, infrastructure spending and economic activity are expected to increase heading into 2018. Technology powered consortium-led corporate banking solutions such as enterprise payments, trade finance and syndicated lending can help banks gain ground. While these solutions are not new, banks can now offer these with near real-time transactions thanks to technologies such as blockchain and open APIs. An optimal mix of fixed and differential pricing for these offerings can help banks recoup some of the losses suffered in retail business.
Furthermore, regulations such as Basel III that require banks to meet higher capital requirements and increased liquidity limits are further impacting the ROE. New regulations like GDPR are also posing implementation challenges for banks in certain processes such as secure customer onboarding, and aligning data storage with the new guidelines. The open banking initiatives, such as PSD2, are likely to open multiple new fronts for competitive battle.
To keep pace with evolving expectations, banks are sharpening their ecosystem strategy and moving towards the platform business model. In its latest annual report global assessing banks, the consulting firm Mckinsey noted that the core businesses of financing and lending that pivot off the bank's balance sheet generated 53 per cent of industry revenues, but only 35 per cent of profits, with an ROE of 4.4 per cent. On the contrary, the distribution business produces 47% of revenues and 65% of profits with an ROE of 20%. Consequently, banks are becoming aggregators of third-party products and services, as well as enabling their services on third-party distribution channels. In 2018, we believe, there will be a greater push towards platform business models and ecosystems will come into sharper focus. This will increase the fee-based revenue as a percentage of total revenue for banks. Another development will be the shift in the nature of transactions. With the increasing number of channels that customers can perform transactions on, there will be a surge in the volume of transactions as average value of transactions plummets further.
In these changing times, banks that emerge as winners will be those that embrace change, innovate constantly, and have and relentless focus on the customer. Banks thus need to develop a culture of innovation and collaboration, empower their employees, and realign their organizations for the future.
Our coverage of business trends this year, focuses on the key aforementioned trends of platform business model, cultural readiness of banks, future workforce, reimagined customer journeys, and pervasive security.