After a decade of banks raising capital, restructuring, transforming systems, and refining strategies in the wake of the 2008 financial crisis, European banks are facing a new set of challenges. International structures are being reshaped, such that banks are rethinking how best to operate across Europe.
At the most recent gathering of the Bank Governance Leadership Network (BGLN), created by EY and Tapestry Networks, banking executives discussed the political volatility (particularly disruption from Brexit), new regulations, hardening attitudes around free trade and ongoing concerns about technological transformation that are influencing their decision-making. The main points of discussion are summarized below.
The post-Brexit landscape
The final shape of Brexit is still to be determined, but the UK’s imminent break from the EU means that Europe’s preeminent financial center will soon be located outside the EU. Financial services leaders are now taking decisions regarding operating and governance structures for UK and European operations (passporting rights being one key issue) without knowing the outcome of negotiations.
Uncertainty around the UK’s future relationship with Europe (and London as a financial center) is having a knock-on effect in banks’ planning and decision making. Many organizations continue to play a wait-and-see game about where best to locate people for future London-related business in Europe.
The key questions raised by Brexit include:
- What options for legal structures will be available to banks following Brexit?
- Will EU regulators and individual countries have the experience and capabilities to handle new international banking operations?
- How can regulators offer sound guidance in a time of such political uncertainty?
- Will current regulatory promises be kept when the future is in such flux?
The growth of bespoke European financial centers
Despite uncertainty generated by Brexit, London is likely to remain one of the most important financial centers in the world for some time to come.
London’s finance-friendly infrastructure – which extends beyond financial services-related systems and regulation to encompass attractive social and cultural surroundings, transport, housing, schools and so on – has evolved over 30+ years.
This environment will be difficult to replicate in other cities, at least in the short term. Nevertheless, some clients have already launched plans to move out of London. What the EU won’t want is a Brexit scenario where it is “locked out” from the main financial center in Europe.
London’s hegemony may seem secure in the short run, but other European cities certainly see an opportunity to become specialized centers for particular FS businesses and activities. Banks are beginning to consider a modular approach to locating different business activities – choosing future host cities not for legal or regulatory reasons but because talent and infrastructure will begin to converge in new places.
Calculating risk in a new era of regulation
Brexit has dominated headlines for the past two years but the increasingly unpredictable political landscape in the US, the push for Catalan independence in Spain, and growing nativist movements in Europe all suggest the FS sector will have to manage a variety political instabilities for the foreseeable future.
These instabilities could lead to major regulatory changes that will impact banks’ operating and business models. Bankers and some regulators at the meeting suggested that, while we are reaching the end of regulatory reforms that have now stretched on for a decade, the implementation of GDPR, MiFiD II, the Second Payment Services Directive (PSD2) and Basel III by no means guarantee an end to costly and disruptive change.
The implications of uncertainty around geopolitics include serious challenges to quantifying risk. Banks are dedicating increasing amounts of time and resource to integrating different kinds of risk planning – including more scenario analysis – into board level discussions. Brexit (and nationalism more generally) may perpetuate regulatory fragmentation, given that regimes across different countries are responding differently to the challenges, further hampering banks’ planning.
While a soft Brexit could see the UK adhere to existing EU regulatory standards, a hard Brexit could prompt a divergent approach where the UK government passes new regulations at odds with the EU. Competition among counties could lead to increasingly divergent approaches globally. As the Financial Times observed recently, “One can only hope that ... the wider competition between US and European banks, will not lead to another phase of financial deregulation.” i
The rise of subsidiary governance poses additional challenges in already uncertain times. Since the 2008 financial crisis, regulators in the US and Europe have sought to give subsidiaries sufficient levels of independence from their parent banks to ensure their own solvency in times of stress. For example, the US requires foreign banking organizations with non-branch assets of $50 billion or more to establish a US intermediate holding company with an independent board of directors. One concern voiced at the BGLN event was that subsidiarization actually weakens the ability of the parent and its subsidiaries to combine their strengths and survive in a crisis.
Global banking models at a crossroads
The operational consequences of these political and regulatory pressures are causing banks to consider whether it’s best to build a truly global operation. Alternatively, should they reconsider the value of international operations?
The regulatory reforms of the past decade have tried to make smaller and simpler operating models more appealing and to discourage larger, more global institutions. It was suggested that those that have accordingly streamlined operations and focused on fewer businesses in fewer geographies will find it easier to develop a vision of what they want to look like in the future, and a plan to get there.
However, a counterpoint to this view was also expressed at the BGLN: namely that large-scale operations are still important (even in a simplified system) because banking products are becoming more standardized and commoditized. The return on these products is only truly realized at scale, so some banks may choose to ramp up international operations to compete in a global volume market.
In wholesale markets, US-headquartered banks are pushing to expand while many European competitors have retrenched in recent years, with some shifting away from investment banking to focus more on wealth management or local retail banking. This may imply a competitive disadvantage for Europe, especially in light of supporting structural benefits enjoyed by US banks – a huge domestic market, stronger domestic capital markets, and so on.
Some banking leaders have called for the creation of a “European superbank” in investment banking, but the current political climate would make this difficult. As Barclay’s chairman John MacFarlane observed in 2015: “If you did want to create an investment banking champion for Europe, you would have to combine the investment banking arms of the main players, but you would have to swallow really hard and you would need political support,”.ii
While mergers offer a route back to global expansion, many European banks now find themselves struggling to articulate what they should stand for. Such is the pace of change within the sector that a major merger no longer guarantees a bank will be able to defend its geographic footprint or compete with US institutions. Faced with so many questions about how to create sustainable output in the future, it’s no wonder the global banking model feels like it is at a crossroads.
The FinTech differentiator
Faced with a resurgent and expansionist US FS sector, European banks do several advantages, such as their proximity to European clients, a strong asset management and wealth businesses and an industry strength in credit cards.
But it is Europe’s (especially the UK’s) market dominance in FinTech that could offer a real competitive advantage on the global stage. EY’s most recent FinTech Adoption Index found that the UK, Spain and Germany are all embracing FinTech faster than the US, though it should be noted that China and India are leading the charge.
The advent of open banking regulations – specifically PSD2, which requires banks in the EU and the United Kingdom to provide third-party access to current accounts via application programming interfaces (APIs) – poses both the greatest FinTech threat and opportunity for European FS in the coming years.
There is a risk that open APIs will simply allow FinTech competitors to take advantage of banks’ systems and data without the same limitations that regulated banks face – reducing the institution to the role of a mere utility. PSD2 will provide FinTech companies (and those that utilize low-overhead “banking as a service” technology) with opportunities to undercut the traditional players and so pick up market share.
However, legacy banks that have a clear idea of where their strengths lie and then collaborate effectively with FinTech providers to highlight those strengths will have a distinct advantage over competitors. Boards are spending more time discussing the competitive and business model implications of financial technology and other technologies that can transform their institutions.
Whether banks take a defensive or optimistic/collaborative stance towards FinTechs could go a long way towards determining their future success. On the retail side, traditional institutions can draw on their longstanding relationships with consumer clients to build goodwill and use Fintech to strengthen their offering, as a recent EY Financial Services Insights piece explains.iii
However, an alternative path to success could involve taking a step back from the consumer, drawing on the bank’s institutional knowledge and connections to create platforms that host other consumer-facing banks. FinTechs are viewed as less of a threat to wholesale banking because the barriers to entry are much greater than in retail banking.
The need for a strong vision
Amidst so much upheaval and sector disruption, how should banks prepare for the future? Certainly boards must be bold. They must consider the size of and shape of operations to suit their strategy and enable future growth. And they must adapt to a landscape where there could be multiple financial centers, with different areas of expertise spread across Europe. Then there is FinTech, which could change all aspects of banking. How incumbent banks partner with new entrants to the sector will go a long way to determining future success.
Ultimately, as the viewpoints of the BGLN community make clear, the sharper the vision, awareness and focus of banking executives, the better-placed they will be to navigate through this age of uncertainty.
This article is a summary of a recent Tapestry Bank Governance Leadership Network (BGLN) roundtable discussion. The BGLN is organized and led by Tapestry Networks, with the support of EY.
For additional information on Tapestry and this article, please visit the Tapestry’s Bank Governance leadership site.
Footnotes
i Catherine Lubochinsky, “France Balks at Reforms That Will Standardise Banking Rules,” Financial Times, October 23, 2017.
ii Martin Arnold, “Barclays Chief Says EU Banking Champion Needed to Compete with US,” Financial Times, October 11, 2015.
iii https://www.ey.com/gl/en/industries/financial-services/fso-insights-to-be-successful-open-banking-initiatives-must-win-hearts-and-minds
