2012: a banking outlook

Yesterday, we talked about the economic outlook for 2012.  What about the banking outlook?

Well it’s also challenging, with five clear things happening:

• Regulatory change will still be high on the agenda
• Investment banking will get a radical overhaul
• Clearing and settlement will become a much bigger focus
• Reconstructing distribution will be a big challenge
• Contactless mobile will reach a tipping point in retail payments

Regulatory change will still be high on the agenda

It’s pretty obvious that the world’s regulators are continuing to struggle with how to manage the financial system, as most cannot even agree on a definition of what is a commercial versus speculative trade.

They’re getting there … but it’s taking time (three years so far).

Maybe that’s good, as we don’t want to rush into senseless change, but it’s also bad as every regulator has a different idea of how to tackle this crisis.

For example, in the USA Paul Volcker, the wonderfully outspoken former Chair of the Federal Reserve and creator of the Volcker Rule which bans proprietary trading in investment banks, says that working out what is speculative or not is easy: “Bankers know when they're doing a proprietary trade, I assure you. If they don't know, they shouldn't be in the business.  If there are big unhedged positions constantly, then it's proprietary trading.”

That’s the rule: if it's not hedged, it's pure speculation.

But this rule will cost, and cost a lot according to Oliver Wyman , who found that the decrease in market liquidity will deliver a $315 billion paper loss for investors in US corporate bonds.

Certainly, it will reduce trading volumes with the Financial Times quoting Brad Hintz of Sanford C. Bernstein, who reckons the Volcker Rule will see Wall Street’s fixed-income desks experience a 25% decline in revenue and a 33% cut in pre-tax margin. That ain’t good for jobs, and will only pile more misery on top of the 200,000 jobs lost on Wall Street in 2011 (compared to 174,000 in 2009).

London’s going through the same, but the challenges are different as the approach is different.

Here in the UK, we are ring-fencing investment and commercial banks under the Vickers report recommendations, which now have the government’s backing.

The idea is that banks are separated into two – an investment bank and the commercial retail bank.  The idea is that if the investment bank dies, it can be killed without murdering its sibling.

That’s great in principle, but in practice is far more difficult.

For example, the separation will cost anything up to £8 billion a year and it doesn’t even achieve the derisking it seeks.

The Vickers Report is designed to get rid of the results of casino capitalism, if it causes death to the investment bank; whilst the Volcker Rule is designed to get rid of casino capitalism.

The Vickers Report tackles the issue without recognition that it is often poor practices in commercial and retail banking that messed up our biggest banks.  Nothing to do with casino capitalism at all.

HBOS’s commercial lending portfolio, secured through easy access to wholesale funding markets, is the reason why it collapsed.  Same with Northern Rock and Bradford & Bingley with high risk mortgages.

So the idea of keeping the commercial and retail banking system ‘safe’, by ring-fencing it from the investment markets, is not something most people accept or believe.

Paul Volcker doesn’t believe it: “I don’t believe in a firewall or Chinese wall between them, as you need a very high ring fence to stop the deer jumping over.”

Then there’s the human cost of these proposals, with many thousands more losing their jobs in the City, and some estimating it could be up to forty percent of the total workforce in the City.  RBS, for example, has already shed a quarter of their workforce, with another quarter expected to go after Vickers.

Unintentionally, there is a belief that the Vickers reforms will also be a gift for foreign banks. 

Add to this the lurking storm of Europe and the UK’s veto over reforms due to City concerns, and it is no wonder that regulatory matters are still high on the agenda in 2012 … and 2013, 2014, 2015 …

Investment banking will get a radical overhaul

I’ve only put this heading in there as a follow-on to the regulatory piece that preceded this paragraph. 

Personally, I have a vision that investment banking will end up being a facilitative role, with platforms and technologies to enable trading, but no trading in the bank itself.  Instead, all the speculators and traders will be out there in private equity and hedgeland, not in the banking system.

Just a thought.

Clearing and settlement will be the big focus

Due to the changes taking place across the spectrum of investment banking and capital markets, clearing and settlement infrastructures will become a big focus.

This is partly down to the new regulations for OTC Derivatives and more, but also due to increased focus upon liquidity risk and collateral management.

Markets have an extreme between the high risk and high leverage we saw leading up the crisis – when Lehmans collapsed, every $1 of debt was leveraged twenty times across the markets so their $400 billion of losses escalated to near $10 trillion of risk – and minimal risk and leverage you see in markets like Russia.

When I visited Russia’s exchanges in 2009, here’s what I wrote about SPIMEX and RTS:

“Both exchanges proudly talk about their focus upon real-time analysis of traders’ positions.  In the case of SPIMEX, they offer real-time settlement and straight through processing, so there is no risk for trading. In the case of RTS, they offer real-time positioning of every trader and every trader’s client portfolio, not just in real-time for their own trades but also for the knock-on effect of their dealings in derivatives down the line.

“I asked RTS about their risk management, and they made clear that for each transaction, the risk is calculated for the trader’s portfolio, including all orders to be filled, in real-time. There are then two clearing sessions during the day. One at 14:00, which takes three minutes to process, and the second is at end of day, and takes fifteen minutes.  If a margin call is made, the broker must cover their position within two hours or, if at end of day, before the start of the next day’s trading.

“This discussion got interesting, as RTS and SPIMEX appear to be developing systems that ensure no trader can leverage risk to the levels where the market implodes, and they do this in real-time.”

So we’re now seeing US and European markets grappling with how to implement clearing and settlement systems that enable liquidity, minimise risk, and strikes a balance between unbridled speculation and zero risk.

This is an area that has grown in interest with our clients and sponsors, so much so that on February 29^th the Financial Services Club is launching a Clearing & Settlement Working Group (CAS-WG).

The CAS-WG will hold its first meeting at BT’s offices in Newgate Street, and is organised in association with the Realization Group.

The aim of the CAS-WG is to debate and discuss all aspects of clearing and settlement infrastructures, and the first agenda will have four panels discussing:

• Volker/Vickers/MiFID II and impacts on post-trade operations and IT, particularly with regard to OTC Derivatives and Clearing
• T2S – problems of change and implementation for settlement
• Giovannini Group Recommendations, Innovation & Technology – what progress has been made?
• Standards in Post-trade operations

Panellists from organisations including Euroclear, LCH.Clearnet, EuroCCP and EMCF will be attending.  If you would like to attend, then let us know.

Reconstructing distribution will be a big challenge

Moving away from investment markets, retail and commercial banking is still undergoing big changes.  As discussed all the time here, branches specifically are a problem.

Banks will have to deal with this problem in 2012, as they cannot sustain loss-making operations anymore.

In some regions, six out of ten branches have closed (Iceland); in others three out of ten (Denmark); in the USA, four out of ten branches are loss-making; whilst in the UK, some analysts (me) estimate that as many as four out of five bank branches could close by the end of the decade.

The fact at the core of this change is that banks are electronic businesses distributing through electronic media, and the branch just does not fit that model of business.

As banks need to be the most cost effective they can, why have a branch?

It would be like bookshops fighting to keep their stores open, when it’s obvious they’re dead as they’re all losing money; or travel agents, record shops, video rental stores, etc, etc.

When your business model is dead, admit it and move on.

Contactless mobile will reach a tipping point in retail payments

Speaking of new business models, the one that most retailing banks will move towards is contactless mobile and contactless tablets.

The experience is highlighted well by various firms, but my favourite contactless illustration is from Discover Card and Square:

The reason why I use this one is that everyone assumes contactless = NFC chips.  It doesn’t have to be.  Contactless in my world, is any payment that is simple, automatic and wireless.

That’s what the Discover video shows.

However, NFC is a key part of most contactless plans, so it is also a key part of the process of evolution.

Contactless chips have been around for ages but, on their own, are relatively useless.  We then put chips in cards, but these again are not great.

But put a contactless chip into a mobile and then we’re rocking.

That’s again illustrated well be Google.

The tap-and-go experience is good one, and one that provides major convenience for the customer – whether the customer is a corporate who wants to drive higher sales through their checkout points, or the consumer who wants speed, ease, convenience and value.

It can focus upon not just turning phones into higher volume purchasing points, but into point of sale points too, and all geolocated as contextualised point of focus.

That’s why Movenbank is launching in 2012, as the first cardless and cashless bank.

So, if the major conversation of 2010-11 was mobile, the focus in 2012-13 will be contactless mobile.

Visa Europe endorses this view:

2012 set to be the tipping point for mainstream contactless adoption

77% of contactless owners across all three markets agreed or strongly agreed that contactless technology would ultimately become more commonplace than cash as a payment method (UK: 73%, Poland: 79%, Turkey: 79%)

 87% also agreed that contactless will be instrumental in bringing mobile contactless payments to market in the near future (UK: 84%, Poland: 89%, Turkey: 89%)

And, just in case you want any further detail, checkout this infographic from NFC rumors:

‘Nuff said.

So there you go, the five biggest things that will happen in 2012 in banking:

• Regulatory change will still be high on the agenda
• Investment banking will get a radical overhaul
• Clearing and settlement will become a much bigger focus
• Reconstructing distribution will be a big challenge
• Contactless mobile will reach a tipping point in retail payments

This is not exhaustive of course, as there’s plenty of other things happening, such as Fred Goodwin being brought to trial for breaching company rules (a sure vote winner for the coalition government).

Anyways, a final set of predictions tomorrow about how and which technologies to watch in banking in 2012.

 

This is one of three 2012 outlook pieces:

• 2012: an economic outlook
• 2012: a banking outlook
• 2012: a bank technology outlook

 

SPECIAL NOTE

Make your own mind up about my predictions.  Here's what I said would be the big ticket items for 2011 a year ago:

• Trying to gain clarity from the regulatory mess;
• Restructuring to maximise opportunities to arbitrage regulations;
• Reducing cost by moving to variable cost infrastructures;
• Maximising returns through creating high frequency intelligent trading (H-FIT) via algorithmic automation with real-time newsfeeds; and
• Creating differentiation through secure mobile financial services.