Banking sector: Drive to raise standards
With banks still struggling to shed their post-financial crisis image, Robert Outram reports on moves the industry is making to reinvent itself.
Nearly seven years on from the height of the global financial crisis, banks are still hitting the headlines, in
many cases for all the wrong reasons. The CA brought together senior figures from the banking world, as well as representatives from the advisory and regulatory spheres, at KPMG's Canary Wharf offices, to talk about the challenges – and the opportunities – facing the sector.
Chairing the discussion was Jim Pettigrew CA, chairman of Clydesdale Bank – and incoming ICAS President. He started by asking: "How robust are the UK's banks? What sort of environment are they operating in now? And what has been the impact of the 'challenger' banks?"
Brendan Nelson CA is chairman of the Royal Bank of Scotland's audit committee, as well as chair of the BP audit committee, and he is a past president of ICAS. He said: "The UK banks are on a different scale of robustness compared to what they were pre-crisis. They have much stronger capital ratios, reduced levels of leveraging and higher levels of liquidity driven in part by much tougher regulatory requirements."
He cited the move towards much more solid capital ratios and reduced levels of leveraging, driven in part by regulatory requirements. Brendan said: "The safety and soundness issue has been addressed and continues to be addressed."
'Customer-first' business models
Banks are changing their business model becoming much more "customer-centric" and focusing much more on service and customer retention, noted Brendan Nelson.
Jim Coyle CA, who has been group financial controller at Lloyds Banking Group, and is about to retire into an NED portfolio, agreed and cited the increased frequency and scope of "stress tests" the banks are running now to gauge their resilience against future shocks.
David Sayer, global head of banking with KPMG, said: "Banks' balance sheets are almost fixed, but in strengthening the balance sheets, the P&L accounts and return on equity in banking have become unsustainable." He added that the established banks are going to have to rethink their business model and look at ways to cut costs by transforming their business processes.
The banking sector is using systems that are very old. The question is how long those systems can last without major outages; and how difficult it will be ... to replace them"
Andre Spicer is professor of organisational behaviour at Cass Business School and co-author of a report last year that called for sweeping changes in banking culture. He said that information technology presents a challenge: "The banking sector is using systems that are very old. The question is how long those systems can last without major outages; and how difficult it will be raising the huge amounts of investment that will be needed to replace them."
The rise of challenger banks
The big banks have come under pressure from governments and regulators to divest some of their operations and branches. In the UK, the major banks have also been told to divide their operations between "ring-fenced" entities and "non-ring-fenced" entities, in an attempt to insulate "high street" banking from "riskier" areas.
As Brendan Nelson noted, if UK banks scale back their investment banking profile the gap is likely to be filled by other multinationals rather than home-grown challengers.
David Sayer said: "A lot of the challenger banks are small versions of, and running on the same business model as, the big banks ... in every other industry, the challenge has not come from smaller versions of the larger players, using the same business model. In banking, the challenge is likely to come from businesses coming in and taking parts of the value chain, using data analytics, and real customer service."
He added that only the relatively low returns on capital to be had was probably keeping other organisations from entering the market. Sayer said: "The most effective 'challengers' will probably be 'First Direct'-type spin-outs from the major banks, producing a new offer for an existing customer base."
Brendan Nelson said: "The challenger banks are essential for a healthy competitive environment, but they are in a sense niche players. The assumption is that the Big Four [banks] are not doing anything to address ... the changing expectations of customers or the move to a digital society. Nothing could be further from the truth. The investment to compete and widen the service offering ... the challenger banks will themselves be challenged by the Big Four."
Jim Coyle added: "You need scale and you need the technology to be a real challenger. In addition, we [Lloyds] are investing £1bn over three years in digital processes."
Jim Pettigrew argued, however: "One advantage for the challengers is their agility."
Accountability for banking failures
The panel also considered the regulatory environment. As Jim Pettigrew noted, the Prudential Regulation Authority has set out proposals for the "senior managers" regime – which holds individual executives to account for banking failures – to apply also to certain non-executive directors such as board chairmen and chairs of audit committees.
Brendan Nelson commented: "The danger is that this imposes additional obligations on certain directors, which challenges the idea of the unitary board. Recruiting high- quality people to join the boards of banks is already becoming increasingly difficult."
Seema Jamil-O'Neill, project director for banking and insurance with the Financial Reporting Council, pointed out that a number of the requirements are consistent with the corporate governance code which already applies to non- executives at listed companies.
Jim Coyle said: "There has been a lot of good work [in regulation], for example FRC's guidance on Fair, Balanced and Understandable."
Changing banking culture
The panel turned to the question of culture and ethics. Andre Spicer said that, when things have gone wrong: "A lot of the time someone further down in the organisation knew about the problem but didn't pass that information upwards."
The banks have been addressing the issue, though, according to David Sayer. He said: "The incentive structures in branches are now much more based on customer service [rather than sales volumes]. The acid test on culture is that banks have enough data to prove to themselves that the products they are selling are appropriate, suitable, affordable and that – if it was a family member – you'd say that was a sensible product to buy."
Jim Pettigrew agreed that "product governance" was much improved, with much more vigorous reviews of new and existing products. He said: "There's been a major step forward."
Andre Spicer said: "Our study of 15 banks found that all of them had substantially changed their remuneration and promotion policy, and have also addressed product design. But while the 'tone from the top' is right, the message is getting lost in the middle." Also, he said, many junior staff, including people on or near the minimum wage, reported that they are working longer hours to meet these new obligations.
Jim Pettigrew said: "The banks are populated by many, many decent people, at all levels, really trying to do the right thing, often with pride in their institution. But you can never guarantee that someone won't do something they should not.
As Atholl Duncan, executive director with ICAS, pointed out, until the number of ongoing investigations and fines directed against banks reduces, it will be hard to convince the public that banking culture has changed for good.
'Reimagining banking for customers'
Sayer noted: "There is a real opportunity for the banks to reimagine banking in the interest of customers, using available technology to produce an entirely different experience. Much regulation seems to have made customers' lives harder. Technology could be used to absorb that regulation and make it easier for the customer; the first bank to do that will have an immense first mover advantage."
He added that developments in financial software, to carry much more information in every banking transaction, could reduce costs and boost growth across the economy.
Brendan Nelson said: "I think opportunities for the industry will come from simplification, which will provide greater transparency for customers in terms of what they're buying."
Seema Jamil-O'Neill agreed: "Opportunities for the banking sector will come from simplification and more engaged boards. I am heartened to see the enthusiasm in this room for increased engagement."
As Lloyds' Jim Coyle put it: "The UK economy needs strong banks and the banks need a strong UK economy. There is a win there for everyone."