Having pulled through the Covid pandemic, the unravelling of international supply chains and a global energy crunch, commercial banks must now grapple with a spike in interest rates and the collapse of some high-profile peer institutions. Rarely have I seen the banking industry in such flux and uncertainty.
How should banks respond? My advice: Pause … take stock … focus on the fundamentals.
Shifts in the global macro market prompted many banks to start the year cautiously. They kept a watchful eye on likely investment opportunities while looking to gauge where the economy was heading.
Now, in the face of yet another acute threat to the industry, most banks will likely spend the coming months sharpening their focus on business fundamentals. Some will also address the big transformational programs they’ve already begun.
No, we’re not seeing a freeze on investment in banking. Rather, banks are investing with more focus and discipline. This increased attention and deliberation is providing them with an opportunity to concentrate on improving the fundamental activities that drive and support their businesses.
Systems, processes and personnel need to be aligned with the company’s operations and business strategies. Risk management, governance and compliance controls must be current and comprehensive. All these improvements should be undertaken with a renewed focus on customer deposits, both commercial and retail.
It’s clear more regulatory scrutiny is coming.
Why the need to focus on fundamentals? Two reasons:
1. Regulatory focus: It’s clear more regulatory scrutiny is coming. The collapse of a number of banks will trigger more stringent banking regulations. Tighter controls on deposits and payments seem inevitable. Stricter constraints on other parts of the banking industry may also be in the cards. Furthermore, as banks increase their focus on internal controls, they will likely identify further potential audit and operational shortcomings. They need to swiftly remedy such flaws. If they don’t, they risk relinquishing control of their change agendas.
2. Cost is key: A potential increase in capital requirements, coupled with slower economic growth, will put further pressure on banks’ cost management and operational efficiency. While deposits will probably climb, banks need to keep a tight rein on their loans and credit as the repricing of commercial real estate, higher vacancy rates, and rising goods and services costs constrain customers’ cashflow.
Many banks need to improve the efficiency and risk management of their treasuries.
Banks that double down on strengthening the core of their businesses will likely spot prime opportunities for improvement. Our Commercial Banking Top Trends in 2023 report identified key areas many commercial banks need to bolster. Four stand out:
1. Treasury management: The recent demise of a number of banks highlighted the critical importance of the sound supervision of bank deposits. Rising interest rates and the growth of real-time payments will require many banks to invest in new technology to improve the efficiency and risk management of their treasuries. Furthermore, banks that can give their customers access to real-time data, advisory insights and tools to analyze their payables, receivables and cash flow will gain a strong competitive advantage.
2. Back office: Many commercial banks have been slow to invest in their back office. Portfolio management, covenant monitoring and collateral valuation, for example, are frequently underfunded. What’s more, banks often run their back-office operations on old technology with aging workforces. Such firms should consider increasing the digital automation of their operations, reskilling and re-incenting their ops teams or possibly outsourcing this function to an established external service provider.
3. Trade finance: The last analog frontier of the banking industry, trade finance has long been ripe for digital automation. With growing competition from many new entrants to this sector, offering quicker and lower-cost services, now is the time for many commercial banks to breach the final frontier.
4. Talent: The war for talent has been exacerbated by the pandemic and the Great Resignation. However, recent lay-offs in the tech industry could provide banks with a rare opportunity to secure much-needed development and operations skills. To further attract and retain skilled staff, especially tech workers, banks need to provide compelling and rewarding career paths that span their organizations.
A flight to safety could lead to a systemic advantage for large banks.
Mid-size and regional banks must contend with what might be a permanent shift in commercial deposits. The dust from the banking shake-up is far from settled, but there is significant risk that a “flight to safety” could lead to a systemic advantage for large banks at the expense of their mid-size and regional counterparts. Already, we are seeing a widening divide between these two groups. Big banks are outpacing smaller institutions as they bolster their core digital capabilities and strengthen their client offerings. Mid-size and regional banks will need to aggressively ramp up their capabilities and client offerings in the battle for commercial deposits.
A final comment: The upheaval currently shaking the banking industry will likely settle later this year. Overall, we remain bullish on banks’ appetite to pivot back to spending on their business and technology transformations. Those banks that take the opportunity to strengthen their businesses, streamline their operations and improve their controls will be best positioned to excel when the time to pivot arrives.
To learn more about the big trends we expect to shape our industry this year, read our Commercial Banking Top Trends in 2023.
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