Several factors are conspiring to put banks’ margins under extraordinary pressure. First, structural changes in the market are reducing profitability (for example by preventing margin netting). Second, Basel III and the regulatory actions of national authorities are increasing capital requirements. Third, big one-off charges associated with various ‘issues’ are translating into higher on-going costs of compliance and control.
These pressures will reduce banks’ available return on equity to as much as 10 per cent – as opposed to the 20 per cent or so that was common in the boom years. And banks will have to be ruthless about costs even to get to that 10 per cent return on equity.
Many have cut deeply already, so the more obvious savings are no longer there. In addition, savings from some of the big moves we have seen (for example exiting whole product areas, as UBS is doing in fixed income) will be hard to capture given shared service structures and the need to maintain coverage. As a result, banks need to explore bolder and more radical approaches to cost reduction.
By questioning traditional assumptions about what they need to do themselves, by sharing services and infrastructure with other market players, banks can reduce cost, complexity and headcount.
Identify services you could share
A full-service investment typically provides a range of operational and supporting services that do not differentiate banks from their competitors – in fact differentiation here is likely to be unhelpful to customers who prefer standard workflows. The same capabilities are replicated at each major institution, with each carrying out essentially identical processes, often with the same software and tools. It makes sense to join forces with other companies in the same business and share those services and capabilities, as a number of firms already do in respect of retail banking operations. The iPSL joint venture involving Barclays, LBG and HSBC is an example of this.
Don’t dismiss the idea of working with competitors
If done correctly, even business-critical processes can be shared with competitors. Critical infrastructure is frequently delivered this way in other industries where competition is no less fierce: mobile telephone companies share masts, and airlines share logistical services.
Within the finance sector itself, there are already successful examples of competing organisations sharing infrastructure, for example in settlement services: CLS has operated successfully since 2002. The same model can deliver standardised operational processes to the market across a number of process areas, removing excess capacity and benefiting the industry as a whole.
Recognise that many conditions for success are already fulfilled
We aren’t claiming infrastructure sharing will be easy. Banks will need to collaborate intensively, and confront stakeholder resistance. That will depend on a purposeful approach and strong top-level sponsorship.
However, many of the conditions are favourable. Current market conditions clearly provide the necessary ‘burning platform’. Investment banks have a strong record of collaborating on initiatives that are important to the whole industry: a case in point is the development and expansion of clearing services for over-the-counter derivatives markets over recent years.
The financial services industry stands to gain substantial benefits from pooling operational services. Banks can increase return on equity while focusing on competing with each other in areas where differentiation is possible and desirable.