We recently spoke to Björn Wahlroos, the chairman of the Board at Nordea, Sampo and UPM. In a wide ranging interview he outlined his views on Brexit, regulation, the future of banking and his plans for Nordea.
PA: Thank you for meeting with us. The topics we would like to cover with you, are: Brexit, regulatory changes and challenges, the evolution of bank industry operating models and the future operating model of Nordea, robotisation, automation, simplification, and the strategic direction of Nordea.
On Brexit, you have been quoted as saying that if the UK manage to get an agreement with the EU similar to what Norway has, then the long term impact is not likely to be substantial
Björn: I fully expect Britain to go down a negotiating route where they achieve, in practical terms, full access to the internal market and address a number of other issues. I am sure immigration will play a role in that, and I will say a word about that in a moment.
I think we have vastly exaggerated the consequences of Brexit in financial or economic terms. On immigration, I don’t think there is a strong concern about intra-European immigration in Britain - people are not worried about the Polish plumber. It is the external borders of EU that people are worried about.
PA: How do you think Brexit will impact the future of the European Union?
Björn: I think the problem is much bigger for the European Union than it is for Britain. The presumption of ever expanding and deepening European integration is now gone. When you accept that the momentum of that presumption is gone, you realize there are at least three different agendas in the EU.
There is the southern rim and part of the eastern rim. They are in it for the money, because they are the net recipients of the transfers. Central Europe, the original six, more or less, are strongly oriented towards deepening European integration. It has been a key aspect of their foreign policy for 50 years. Then you have the northern rim consisting of Scandinavia, Holland, and Britain, who are there basically for the internal market and for openness and free trade.
These are three quite different agendas. In a way, EU has been able to cover the differences in this great presumption that we would walk together towards a common European destiny. Now the common European destiny is not so obvious. EU has a problem of reformulating: a new agenda shared by all, since we know that the anti-EU sentiment is in no way contained to Britain.
PA: So in general, not too much will change.
Björn: I don’t think so. I believe that also has been the case in the past. It is politically expedient to say that joining something will dramatically change the whole world. It never does.
PA: Moving on to regulatory issues, we have double the capital requirements compared to southern Europe, and three times the pre-crisis level. What do you see as the core impact of this, for the industry and for society?
Björn: For the society, it is easy. From the point of view of a country or a currency, the choice of a capital adequacy standard is essentially the same choice as the choice of risk level in a portfolio selection problem. So choosing a capital standard is essentially choosing a risk level. The higher the capital requirement of the banking system, the lower the risk of the financial system as a whole. There is no explicit answer to that question in economic theory. It is like risk aversion or risk preference. In financial theory it is up to you. Are you a risk taker or a risk averse?
Considering what happened and what could be expected to happen at the time, we had too much risk in the financial system in 2006. The system was not resilient enough. It can be argued that we are now very close to the other extreme, where ultimately we will get a negative impact. We have become too conservative and this has impacted credit policy and the cost of credit.
PA: In the last decade, a significant change has happened to operations in banking - with robotics and automation driving that change. How do you see this evolving? What is your view of the end state - will there hardly be any employees left, and will everything be automated?
Björn: Yes, it has changed. Now virtually everybody does 90% of their banking transactions themselves, using one of the machines that we have on the table here. Banking has changed a lot over the last 30 years, but we have not and will not do away with all the jobs. Transactional banking will become very highly automated, but to some extent regulation will limit automation. The need for controls slows down the process, at least until you have taught the machine to do the controls.
We are told that big banks will struggle, as many new players will enter and take market share. But if you look at the financial services industry over the last 30 years, the development has been the opposite of this. Small banks with individualized business models or operating models have actually disappeared. This is true in virtually every country.
There is something weird about a prediction for the future that says that not only will current trends not continue, but actually reverse.
PA: You don't believe this will be the case?
Björn: No. I’ll give you a couple of reasons for it. Firstly, banking is a regulated industry with an enormously high minimum quality standard. A typical way entrants come in with new technology is to offer the consumer something that is cheaper and more fashionable, but also less secure. The regulators will not allow this. And if the big banks design their future IT in such a way that when an entrepreneur has a good interface, for instance a good app that customers like, they will leave room for that application to link to the bank’s infrastructure. Secondly, the bank’s infrastructure is completely protected. And to maintain that infrastructure, you will have to have a lot of capital and operating procedures, and meet a number of rules and regulations.
The amount of definitions or regulations on how we operate is astounding. This is why the first barrier is regulation, and then that we are required to provide a highly stable, highly trustworthy low risk product or structure for our customers. It's extremely difficult for new entrants to come into this, particularly if we are not totally stupid and try to stamp out all innovation.
PA: And the regulatory requirements are not likely to lessen?
Björn: No. Almost everything that banks deal with has to do with credit or counter party risk. But credit quality is exceptionally difficult to assess. Customers have a strong incentive to misrepresent themselves. So profiling in a context of credit quality is an almost impossible task. There is just no information, and there is a strong incentive to misrepresent yourself. As long as that is true, there is no way to deal with counterparty risk except through experience. The ones that have experience are the ones that have maintained records and relationships with customers. They can physically look them in the eye and demand collateral, and all the other traditional ways to handle credit risk.
Take peer to peer lending. People are convinced that this will be very troublesome. I’m absolutely sure this will never amount to much of anything. There’s one big difference between the financial services industry, and network based companies such as Amazon and Uber: Transaction frequency. You get a loan once every ten years, whereas you are likely to buy a book or take a cap several times a month. There is no way you can create a rating system of any quality that can validate peer to peer lending.
PA: There are two big things happening in Nordea now: one is your legal restructuring of the bank. The other is a new core banking system. If you take the first one, the legal restructuring, what is your expectation on what you will accomplish and what will your next steps be following this?
Björn: The legal structure programme was originally intended as a combined measure of reducing administrative costs on one hand and making more efficient use of capital on the other. Now the first objective is very much still there. The second isn’t really because capital requirements have changed so much that the amount of capital that you can free up is limited. Essentially, we still have four banks.
The key thing for the future is flexibility. Through the legal structure programme we want to create a bank which can morph flexibly and be adaptable in a changing world. As it becomes one bank, we can more easily improve our operational routines, so it works together with the other change you mentioned. It creates more flexibility, and we can more easily allocate our resources.
PA: What about regulatory simplification, is that a driver for a simpler legal structure?
Björn: I would love to say yes. But we will still be subject to a number of regulators because we bank in a number of jurisdictions. And we have simplified regulation already: for instance for the insurance company If, the Finnish regulator is the main responsible supervisor for If. Even though it’s a Swedish company, the Swedes have farmed out the job of supervising to the Finnish regulator, apparently for reasons of resource allocation which is really smart. So you can make these kinds of arrangements.
PA: You have compared the new core banking platform and the App store. How do they compare?
Björn: Essentially the point is that as you develop your business model what you’ll have to become, in a sense, is what the App store is. You will have to be the provider or the infrastructure of all those apps. And ultimately that is how I would like to see banking in the future. Where we would become more of the hub for all this traffic and leave enough room for the App developers to come up with innovative new customer solutions - the kind of stuff that big organisations are never that good at. The regulator will protect the infrastructure, and we don’t even have to establish a unique sort of App store, because it is there already.
The regulator has essentially created it and stated that it is our proprietary technology and we own the structure which underlies this. And if we can provide an interface which is more efficient from the point of view of the app developer than that provided by some of our competitors, we will be able to attract more of these people to come up with these innovations. We would like to link them into our universe or our infrastructure.
PA: The world of payments is changing. PSD2, the Payment Services Directive, opens up the market for new players. What is your view on these changes?
Björn: Well that’s an interesting question. It is not clear exactly what this means. Like so much EU legislation, it’s more of a declaration than a statement. We may want to open up, but that doesn’t change the fact that we are the owners of the infrastructure. The people who are most worried about this, essentially say this will make us a utility. We will no longer have complete control of our infrastructure. It’s a small step in that direction, yes, but if you do it right then you can actually create the kind of environment that I was talking about. It’s not that you charge the people who link their app into our infrastructure, the point is that you create a hugely successful service concept which will attract customers.
Once somebody comes up with a good payment interface that links into our account system, that’s fine with us. Because we’ll probably make more money out of accessing a new customer that likes that app and then will take out a mortgage with us or something else.I have to make just one more point, banks don’t make that much money from payments anyway. Again I go back to the teller example. When you ask what a bank is, people used to say it’s the teller and cash, today they say “well it’s how I pay my bills”. The fact is that we don’t make money on payment of bills. We make the money from the fact that people who use our transactional system will then use our other services, for instance they either invest with us or they borrow from us. We earn most of our income from credit or counter party risk. That’s what people don’t really understand. They think of us as a credit card company, we are not. Visa and MasterCard are charging you anything between 1½ to 3%. That’s their business. We don’t get that money, we get a small amount from them. That’s it. We make our money on assessing risk. I shouldn’t say that, it sounds bad but it’s true. And as a consequence it really doesn’t matter that much to us.
PA: How do you see the strategic direction of Nordea going forward?
Björn: Well in a sense, given the new environment we are in, your question is much simpler than it would have been 10 years ago. Our approach is essentially back to basics, let’s cut the nonsense and let’s not roll out new innovative health insurance products or whatever, get away from that and do the big things right. Today I think the key is the two changes we have discussed here, capital requirements and regulation. It’s pretty clear that the pace of change has slowed down. You might also argue that technological change relevant to us has slowed too.
PA: Do you think there will be any changes in your customer group focus?
Björn: No, I don’t think that will change much. In a bank like Nordea, the basis is the service offering to the mass market. We are required by regulators and legislators to provide services to broad mass markets, on terms that are seen as reasonable. Even if this is not explicitly regulated, there is an implicit contract that we have to provide those services. You might say that with various international regulatory changes, the interest in moving into the international customer market has gone down dramatically. With present AML restrictions, you are not going to be particularly keen to access new groups of high net worth individuals in the international market.
PA: You might become more Nordic, less international?
Björn: Well, we have stated very clearly that, without making a big issue out of it, we are cutting down our operations in Russia. We have sold our operations in Poland, and we will see what happens in the Baltics. There are strong incentives, not just to focus on your core competencies, but to do the big things right. There is also a strong incentive to focus on markets where you are less likely to get KYC problems.