From resilience to improved performance: making the second line pay its way
01 February 2017
Pressure on bank returns means there can no longer be a blank cheque for capital and compliance costs. The ‘second line’ needs to pay its way as part of an approach that shifts the business focus beyond regulatory compliance to sharpening competitive advantage.
Regulatory reforms have helped to make banks more resilient. The price has been a 60% rise in capital and big jump in compliance costs, which have driven down return on equity (RoE) in markets already grappling with low interest rates, weak economic conditions and the overhang of bad loans.
Our analysis shows that RoE in most of the global systemically important banks (G-SIBs) in Europe and the US fails to cover the cost of equity (CoE). Restoring economic viability demands much more than piecemeal cost cutting. Even just covering the cost of capital would require 15 G-SIBS to reduce costs and charges by at least 15%, and 11 by more than 20%. Even bigger reductions could be needed to compete with the cost benchmarks being set by FinTech entrants.
Mastering the new regulatory landscape isn’t just a matter of compliance. Rather than simply moving away from capital-intensive business lines, the need to make more efficient use of capital demands a fundamental rethink of costs, strategies and underlying business models. Risk and compliance teams should also contribute to improving business performance in areas ranging from enhanced analysis and insight to better customer outcomes.
How can your bank make the second line pay?
1. Ensure you have a skilled team to monitor regulatory developments, assess their impact on the strategy and operations of the business, and deal with short notice supervisory requests.
2. Clear insights into risk-adjusted performance to judge what business is genuinely economically viable and where to target capital allocation, both now and as demands change in the wake of ‘Basel IV’.
3. ‘Lean’ design of risk and compliance that aligns with overall business drive to control costs, improve efficiency, embrace new technology and deliver value.
4. Funds transfer pricing (FTP) to ensure business teams are given the right signals and understand their specific liquidity and funding drivers, the related impact on performance and pricing, and how to drive optimisation.
5. Recognition that capital management demands clear understanding and active management of multiple moving parts and understanding of new risks (e.g. flexible optimisation of conflicting regulatory requirements and the pricing behaviour of new untested capital instruments).
The banks that get this right will be in the strongest position to improve competitiveness, market perception and overall return on capital.
To find out more, see A Practitioner’s Guide to Banking Regulation: Mastering the New Regulatory Landscape.