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The Future Of Banking


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I served as developmental and line editor on this white paper from Booz & Company's financial services team.

I served as developmental and line editor on this white paper from Booz & Company's financial services team.

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  • 1. Perspective Vanessa Wallace Andrew Herrick The Future of Banking Reappraising Core Capabilities after the Crisis
  • 2. Contact Information Amsterdam Milan Sydney David Wyatt Vincenzo Bafunno Vanessa Wallace Principal Senior Executive Advisor Partner +31-20-504-1940 +39-02-72509-278 +61-2-9321-1906 Bangkok Mumbai Andrew Herrick Arthur Calipo Jai Sinha Senior Associate Principal Partner +61-2-9321-1947 +61-2-9321-2804 +91-22-2287-2001 Tokyo Beirut Munich Takeshi Fukushima Peter Vayanos Johannes Bussmann Principal Partner Partner +81-3-3436-8642 +961-1-336433 +49-89-54525-535 Zurich Cleveland New York Carlos Ammann Steffen Lauster Paul Hyde Partner Partner Partner +41-43-268-2144 +1-216-902-4222 +1-212-551-6069 Copenhagen São Paulo Torsten Moe Ivan De Souza Partner Senior Partner +45-3318-70-02 +55-11-5501-6368 London Shanghai Alan Gemes Andrew Cainey Partner Partner +44-20-7393-3290 +86-21-2327-9800 Booz & Company
  • 3. EXECUTIVE For all the chaos in the global banking sector since mid-2007, some things have not changed. The purpose of banking, the SUMMARY needs of customers, and the core capabilities that drive the strategies of the most successful banks have endured. What has changed is the environment in which banks operate and compete. The level of government regulation and owner- ship in the sector has risen dramatically. The banking value chain has been fractured, particularly the links between banks and their customers, in pursuit of returns that proved unsus- tainable and must now be reforged. Finally, the outlook has shifted to what will almost certainly be a prolonged period of low growth in the broader economy and the banking sector itself, with important implications for how banks compete and capture value. If banks hope to survive and prosper, their leaders can neither conduct business as usual nor adopt temporary fixes and half-measures. They must respond at a more fundamental level, bolstering—and, to the extent that they are not already in place, creating—the essential organizational capabilities for the post-crisis era. This Perspective is designed to guide bank leaders as they ready their institutions for the challenges and opportunities ahead. Booz & Company 1
  • 4. The global financial crisis has triggered by increased regulation and even THE FUTURE dramatic alterations to the global econ- outright ownership of the sector. OF BANKING omy and the financial services land- scape. The banking industry has been • There is now an urgent need for accused of bringing the world to its banks to reintegrate the value chain knees by taking breathtaking risks, and regain their traditional close- spurred by astronomical compensation, ness to the customer in order to with little regard for the consequences. better manage risk and create value. Much energy has been expended in de- bating the responsibility for this uphea- • The outlook has shifted to what val; however, banking leaders cannot will almost certainly be a pro- afford to engage in the blame game. longed period of low growth, with They must realize that despite the chaos important implications for how and restructuring experienced by the banks compete and capture value. banking sector, the fundamentals of banking are unchanged. They must Although the fundamentals of continue to fulfill the societal purpose banking are unchanged, banking of their institutions while steering leaders cannot respond to these them to safe harbor and future success. challenges with the kinds of short- term solutions and temporary fixes To achieve this, senior leaders must re- that are used to weather minor cognize three developments that have cyclical dips. Instead, they must been set in motion by the financial crisis: analyze and adjust their companies’ core capabilities in their continuing • The role of government is grow- quest to outperform the market and ing around the world, as witnessed their competitors. 2 Booz & Company
  • 5. MAPPING THE Morgan’s takeover of Washington Mutual in the U.S., the merger of the entire sector—rating agencies, credit bureaus, and regulators—have NEW BANKING Lloyds TSB and HBOS PLC in the been compromised. Sovereign risk LANDSCAPE U.K., and Westpac’s purchase of St. George Bank in Australia. The has become a component of bank risk registers, since many counterparties ranks of the truly global retail banks are now functioning only with the are thinning, as yesterday’s titans support of their home governments. retreat to the security of their home And perhaps most critical, the public markets and capital bases, while trust on which banks and bankers The changes to the global banking domestic banks are merging, disap- depend has eroded—a trend that has sector are well documented. The pearing, and narrowing the focus of been exacerbated recently as some of world’s largest retail bank is now the their businesses. the banks that received U.S. and U.K. China Construction Bank, a Chinese public bailout money have gone on to state-owned enterprise. Six of the It is not just the footprint of the indus- reap record profits, and in some cases largest 20 banks are new to the top try that has changed; its business have even returned to the practice order, and four of them are from the models and supporting structure are of paying massive bonuses to staff. much smaller nations of Canada and being altered too. The value proposi- Besides the visible populist reaction in Australia (see Exhibit 1). The stand- tions of seemingly timeless models in many countries, there is also a quieter, alone investment bank, which formerly securitization, mortgage brokerage and but perhaps more serious erosion in dominated much of the sector, has insurance, private banking, and even the credibility of the banking profes- all but disappeared. Consolidation is financial advice are being questioned. sion, particularly among long-term creating high levels of concentration The independence and relevance of the investors, pension fund and endow- in the banking industry; witness J.P. institutions that support confidence in ment managers, and large depositors. Exhibit 1 A Reordering of the World’s Leading Banks, 2007–2009 Top 20 (February 2007) Top 20 (July 2009) Market Cap Market Cap Rank Company Rank Company (US$B) (US$B) 1 Citigroup U.S. 247 1 China Construction Bank China 181 2 Bank of America U.S. 227 2 HSBC U.K. 172 3 HSBC U.K. 203 3 JPMorgan Chase U.S. 145 4 JPMorgan Chase U.S. 172 4 Bank of America U.S. 128 5 Mitsubishi UFJ Japan 134 5 Banco Santander Spain 117 6 China Construction Bank China 127 6 Wells Fargo U.S. 114 7 UBS Switzerland 125 7 Goldman Sachs U.S. 83 8 Royal Bank of Scotland U.K. 124 8 BNP Paribas France 78 9 Wells Fargo U.S. 117 9 Mitsubishi UFJ Japan 69 10 Banco Santander Spain 116 10 Royal Bank of Canada Canada 67 11 BNP Paribas France 97 11 BBV Argentaria Spain 61 12 Unicredit Italy 96 12 Industrial & Commercial Bank of China China 60 13 Barclays U.K. 95 13 Credit Suisse Switzerland 56 14 BBV Argentaria Spain 86 14 Barclays U.K. 55 15 Intesa Sanpaolo Italy 86 15 CBA Australia 54 16 Credit Suisse Switzerland 84 16 Westpac Australia 53 17 Mizuho Japan 83 17 Toronto Dominion Bank Canada 50 18 Goldman Sachs U.S. 83 18 Unicredit Italy 49 19 Morgan Stanley U.S. 80 19 UBS Switzerland 47 20 Société Générale France 78 20 Standard Chartered U.K. 46 Fallen from Top 20 since 2007 New to Top 20 since 2007 Source: Datastream Booz & Company 3
  • 6. THE Despite all of this chaos and restruc- money. And they assess their custom- ers’ financial needs and advise them as turing, the primary purpose of FUNDAMENTALS banking remains unchanged. Banks to the products and services that best OF BANKING ARE have always performed a critical set match their financial objectives. of functions in support of society and UNCHANGED human endeavor. They provide a safe Finally, the core organizational capa- haven for the savings of individuals bilities that banks need to pursue and businesses; they allocate capital their purpose and meet customers’ across the economy efficiently and needs have not changed. These are effectively; and they bridge the diver- customer management, product and gent maturity needs of short-term offer development, risk management depositors and long-term borrowers. and pricing, distribution management, If the global financial crisis has dem- operations and IT, asset and liability onstrated anything, it is the continu- management, capital management ing and essential nature of these and portfolio strategy, talent manage- banking functions to society. ment, investor relations and stake- holder management, and performance The functions of a bank reflect the management. needs of its customers, and these, too, remain unchanged. Banks provide So, if the fundamental nature of accounts and services that enable banking—its purpose, the needs of its individuals and organizations to safely customers, and the core capabilities hold cash and make transactions. They it requires—remains unchanged, how provide loans that enable customers to will the future of banking be affected bring forward expenditures or invest- by the current financial crisis? ments that would otherwise require years or decades of saving. They help As noted above, some overarching protect customers by absorbing risks developments have been set in motion that otherwise could not be borne at by recent events. They represent three either an individual or organizational broad areas where financial services level. They provide savings vehicles institutions will need to change their that enable customers to invest their practices and ways of thinking. 4 Booz & Company
  • 7. THE UTILITY- The magnitude of the government response to the financial crisis will In many countries, the regulatory pen- dulum in banking had swung toward LIKE have fundamental and long-lasting free markets during the previous 30 REGULATION OF effects on banks everywhere. In the short term, governments have been years. Many banks were partially or completely privatized in the quest for BANKING (and continue to be) forced to bail greater efficiency, enhanced ability to out insolvent institutions, supplying attract and retain management talent, liquidity and guaranteeing obligations and greater access to global capital so these banks can survive—and, in to fund innovation and growth. But some cases, taking ownership stakes now, five driving forces are causing in exchange. In the medium to long the pendulum to swing back: term, Western governments will seek to exit these investments in an • The growing perception that bank- orderly manner. However, a much ing is a public good: Recent events broader debate with more enduring have reinforced the fundamental consequences is occurring around the truth that a steady flow of credit long-term regulatory framework for and a stable banking sector are as the banking sector. important to a productive economy as abundant resources, physical It is highly likely that in the aftermath infrastructure, and human capital. of the financial crisis, the regulatory landscape in banking will more • The understanding that markets closely resemble that of utilities, such are not always efficient: For as electric, gas, telephone, and water decades the prevailing logic has companies, that provide society with been that market forces can best a “public good”: a product or service connect the sources and users of that is considered so essential that capital—with the resulting price its delivery cannot be left to market accurately reflecting all available forces alone. Utilities tend to face a information and therefore being, high regulatory burden, which dic- by definition, “right.” While the tates many elements of their pricing, free market philosophy is clearly customer bases, and competitive envi- here to stay, there is a growing ronment, and which therefore often realization that people, and inhibits their levels of innovation and markets, can and do behave irra- experimentation. tionally, and that these “animal Booz & Company 5
  • 8. spirits,” as John Maynard Keynes • The realization that “too big to The extent and speed with which these famously called them, can dramati- fail” is simply too big: The con- drivers will affect banking regulation cally skew market behavior. sequences of failure among key depend on a range of factors, including banking players are causing policy- the strength of each nation’s banking • The rising levels of systemic risk: makers to reappraise the need for system, the broader economic outlook, The increasing interconnected- governmental control over the size and the market philosophy that holds ness of the global financial econ- and scope of the largest banks. sway with the government. But the omy has introduced multiple, overall rise in state ownership and and often hidden, points of failure. • The broader consequences of regulation has implications for banks’ Strategies that make sense at the misaligned compensation and risk portfolio choices, product offering level of a business unit or a single management structures: Existing and pricing, investment and capital institution (for example, regard- compensation models, in both the management, and reporting and talent ing portfolio choices, product size and the design of their incen- management (see Exhibit 2). Further, offerings, or capital allocation) tives, encouraged outsized risks by if banks do not or cannot fulfill their may not optimize outcomes at bank employees. They enjoyed the larger societal purpose, governments the level of a large bank, a na- upside reward, but left sharehold- will stay involved longer and enact tional economy, or a global ers, and ultimately governments, stricter regulations, which could financial system. responsible for the downside. result in a less global, less innovative, and less talented financial sector. Exhibit 2 Implications of Government Ownership and Utility-Like Regulation Short-Term Government Ownership Longer-Term Utility Regulation Portfolio Choices - Restricted global aspirations, as governments draw in capital - Likely return of Glass-Steagall–style separation of retail banking, and restrict activities to national boundaries investment banking, insurance, and wealth businesses - In countries where multiple players have been acquired, - Closer monitoring of mergers—potentially similar to Australia’s potential breakup with merger of similar lines of business to “Four Pillars” policy—to maintain competition and avoid “too create single-purpose utilities big to fail” scenario Product Offering & Pricing - Potential for government to provide basic services—simple, - Supply-side regulation around pricing and customer choice for low-cost banking, savings and pension accumulation, “critical” products—low-cost transaction banking, access to basic protection basic credit, retirement savings and pensions, life insurance, - Increased requirements on loan portfolio, including pricing of health savings accounts risks and flow of credit to specific sectors Investment & Capital - Free cash flows siphoned off in the form of dividends to the - Much greater intervention across the board to ensure Management government, constraining investment options and potentially “protection” of community—e.g., funding and liquidity stifling innovation regulations - More sophisticated calculation of minimum capital requirements—e.g., linked to economic cycle, bank risk processes and appetite, compensation models Reporting - Greater focus on forensic reporting into areas of interest to - More comprehensive and onerous reporting requirements governments—e.g., economic stability and political agenda - Need for reporting to satisfy broader set of stakeholders, provide greater transparency, and cover longer-term perspectives Talent Management - War for talent between private and public sectors, similar to - Shift to long-term compensation models to limit short-term risk the competition between healthcare and education sectors in taking most developed economies Source: Booz & Company 6 Booz & Company
  • 9. BANKS REASSERT Many of the excesses that contributed that allowed “shadow” assets to be to the financial crisis are related to hidden off balance sheet. OWNERSHIP OF the unbundling of the banking value THEIR ASSETS chain and the resulting decoupling of Starting in the early 1990s, the bank- assets from risks. Banks shifted from ing value chain was impacted by a long-term, balance sheet manage- discontinuous changes at both ends. ment approach focused on maximizing Banks relinquished the customer return on assets to a short-term, earn- interface (and resulting information ings-driven approach that maximized flow) to a host of intermediaries return on capital. The latter model was including brokers, aggregators, and further facilitated by accounting rules referrers (see Exhibit 3). At the same Exhibit 3 The Unbundling of the Banking Value Chain Banks packaged and TRADITIONAL sold loans to investors RECENT (until 1990s) (1990s–2007) (on balance (off balance Govern- Hedge Mutual Final Asset Banks Banks sheet) sheet) ments GSEs funds funds Holder Securitization – 2nd and higher orders Vertically integrated lenders Vertically integrated lenders Securitization – 1st order Banking value chain Originators Originators disintermediated at Investment Retail banks Credit unions both ends banks Brokers Aggregators Referrers Customer/Borrower Customer/Borrower Banks relinquished customer interface to intermediaries Source: Booz & Company Booz & Company 7
  • 10. time, they packaged the resulting • Originate-to-distribute model: The At the same time, many financial loans into securities and sold them to new business model compensated services products became more investors, who saw them as a new— banks and their third-party origina- complex and difficult to analyze. and apparently high-yield—asset class. tors for the volume of loans origi- As a result, the effective credit nated. It should come as no surprise analysis of institutions and, in This trend was driven by three inter- that banks came to focus on distri- particular, investment products locking and reinforcing factors: bution reach and became less con- became compromised, as evidenced cerned about underlying asset quality. by the elevated number of defaults • Product innovation: The “tranch- in highly rated securitized products. ing” of securities according to • Reliance on external rating agen- risk and return, and the variety of cies: The unbundled value chain The crisis forced bankers to recog- product innovations it stimulated, might have been sustainable if nize that by shifting ownership of allowed investors to choose among investors were able to accurately loans—and the customer relationships levels of risk and be compensated gauge the quality of assets they that they represent—to others they accordingly, at least in theory. were buying. Unfortunately, rating reduced transparency and increased Unfortunately, these new asset agencies were paid by the same risk. To reverse the situation, they classes also facilitated the expansion institutions that were issuing these must reassert that ownership, and of leverage to unrealistic levels and securitized assets and, in some leverage the resulting information separated assets from the capital cases, actually worked with them flow for more effective risk manage- supporting their associated risks. to reach desired rating outcomes. ment and value capture. 8 Booz & Company
  • 11. NEW LENS ON A rising tide lifts all boats—and there were few exceptions to this rule in slump has already cut deeper and lasted longer than any recession to VALUE IN A global banking between 2001 and hit the U.S. economy since the Great LOW-GROWTH 2007. During this time, many banks took advantage of favorable mar- Depression (see Exhibit 4), and its impact around the world on con- ENVIRONMENT gins and thin capital buffers to set sumer buying patterns continues. hurdle rates for return on equity of Beyond the standard boom and bust 20 to 30 percent. They relied on a cycle, this crisis is underpinned by simple formula for success: Increase fundamental structural imbalances cash earnings by 10 to 12 percent that will take years, even decades, to annually by growing revenues in the work through, such as the U.S.–China high single digits and keeping cost trade deficit, the mismatches in increases in the low single digits; use Euro-zone growth rates, the size and high dividend payouts to add another likely duration of the U.S. budget few percentage points to shareholder deficit, and the disparity between returns; and exploit their own high personal saving rates in Western and (and continually rising) price/earnings Asian economies. As a result, asset ratios to offset the low beta and cost growth will be significantly subdued of capital in the banking sector. and it is likely that the banking sec- tor’s margin expansion of mid-2009, Clearly, this equation will no longer which occurred in response to a work. First, a quick economic restricted supply of credit, will not be rebound is unlikely. The current sustainable. Exhibit 4 Quarterly GDP Change in Major U.S. Recessions % Change 1990 from Start of 2001 S&L Crisis Recession Tech Wreck 4 1981 U.S. Fed Starts Inflation 2 Targeting 0 -2 1973 OPEC Shock -4 2008 -6 Global Financial Crisis -8 -10 -12 1929 -14 Great Depression -16 Quarters from 0 1 2 3 4 5 6 7 8 Start of Recession Note: For the 1929 recession, only two data points are marked, as data is available only by year, not by quarter. Source: Federal Reserve Bank of Minneapolis; Bureau of Economic Analysis; Booz & Company analysis Booz & Company 9
  • 12. Second, keeping cost growth low will investors and bolster their P/E ratings. ating growth shifted back to cost not be sufficient, and reducing abso- In addition, their P/E ratings are like- reduction. lute cost levels will not be easy. Low ly to reflect an expectation of lower growth in assets and a weak pricing risk and return signatures over the The early signs from the current environment in the medium term will medium to long term. recession suggest that a similar pat- require banks to keep a tight lid on tern is developing. Already margins costs just to maintain their margins. To see how conditions like these have are widening as nonbank and foreign However, the need to comply with played out in the past, it is worth competitors exit markets and the increasing regulatory demands and revisiting the last major recession, remaining banks use this opportunity to invest in a significant refocusing in the early 1990s, and the asset to reprice lending, especially in their of capabilities—both prerequisites clearing period that followed. In that loans to businesses. However, this for operating in the post-crisis recession, margins initially widened is likely to provide only temporary environment—will create upward as banks were able to pick and relief. Competition will increase as cost pressures. choose customers and dictate loan stronger players use this opportu- terms. Profit growth was generated nity to reposition and enhance their Third, the price/equity ratings of mainly by working out bad debts. market share, and in the medium banks will languish. Banks can But margins soon shrank: Increased term, securitization and nonbank no longer afford to pay out large competition created rising costs at lenders will reemerge, driving amounts of their free cash flow in the same time that bad debts were renewed competition and with it, the form of high dividends to attract resolved and the burden for gener- continued margin compression. Low growth in assets and a weak pricing environment in the medium term will require banks to keep a tight lid on costs just to maintain their margins. 10 Booz & Company
  • 13. A CAPABILITIES- While the developments described The three sections that follow, and above do not change the core capa- the key questions and recommen- DRIVEN bilities required for banking success, dations within them, are designed APPROACH they do require that those capabilities to assist executives as they evaluate be retooled to better respond to the the current capabilities of their TO BANKING demands of the post-crisis environ- banks and gauge their capacity SUCCESS ment. Each of the three developments to cope with and profit from the has specific implications for the core post-crisis banking landscape. capabilities of banks (see Exhibit 5). Exhibit 5 The Capability Impacts of the Three Major Developments THE FUNDAMENTALS ARE UNCHANGED … … BUT HOW BANKS DELIVER CRITICAL CAPABILITIES IS BEING IMPACTED BY MAJOR DEVELOPMENTS Societal Purpose of Customer Core Macro Capabilities Banking Needs Capabilities Developments Impacted Customer Investor relations & Savings & management stakeholder management investments – Utility-like regulation of banking Provide safe haven for the Performance Product & offer savings of individuals and management development businesses Risk management & Customer Transaction & cash pricing management flow management Distribution Risk management management – Banks reassert ownership & pricing of their assets Distribution Ops & IT management Allocate capital across the economy Borrowing efficiently and effectively Asset & liability Product & offer management development Capital management & portfolio strategy Ops & IT Protection Talent management Asset & liability – New lens on value in management a low-growth environment Bridge divergent maturity needs of short-term Investor relations & Capital management & depositors and long-term stakeholder management portfolio strategy borrowers Advice Performance Talent management management Source: Booz & Company Booz & Company 11
  • 14. MANAGING As banks face the need to be more proactive in dealing with govern- toward restoring confidence and stability, particularly around com- THE RISING ments, and are required to provide pensation and risk management. REGULATORY more transparent and relevant infor- mation to investors and other stake- The recent and very public efforts of some Australian banks to reduce BURDEN holders, they will need to address executive salaries and exception two sets of questions: fees are a good example of this approach. 1. Do you have the investor relations and stakeholder management capabil- 2. Does your performance manage- ity necessary to influence the policy ment capability include metrics that decisions and regulations being con- reflect your organization’s broader sidered within your bank’s geographic role in society? Are those metrics footprint? properly balanced, as well as trans- parent to stakeholders? Banks need to enhance their stake- holder management capability to Regardless of the degree of regulation earn a seat at the table and influence and government ownership that arises outcomes before, not after, the new from the crisis, banks must be pre- regulatory landscape is mapped out. pared to respond to demands for much This is especially critical given the greater transparency from all of their wave of negative publicity that is con- stakeholders—including shareholders, fronting both the banking sector and governments, and communities. the policymakers who are perceived to be propping it up. To counter this, • No longer can metrics be focused banks must be able to proactively solely on short-term financials, engage government officials in the such as profit growth, cost to following ways: income performance, and dividend payout ratio; they must expand to • Articulating the fundamental social include longer-term measures that roles of the banking sector and offer insight into funding dura- fully explaining the implications— tions, loan to deposit ratios, and positive and negative—of increased capital management through the regulation and intervention. economic cycle. • Showing that they understand • Banks must prepare to report the needs and objectives of public in greater detail on a variety of officials, particularly the need for factors—such as capital base, asset systemic stability, and helping quality, compensation, and risk and to achieve those objectives in a derivative exposures (by industry manner that supports rather than and country)—that concern the undermines the goals and priorities full spectrum of stakeholders, both of banking institutions. public and private. • Demonstrating on an ongoing basis • Banks must begin to augment the steps that banks are taking reporting with metrics that demon- and the progress they have made strate their contribution to systemic 12 Booz & Company
  • 15. REDESIGNING In the post-crisis era, as global finan- that still have product-defined orga- nizations will have to rapidly rethink cial markets deleverage, banks will VALUE CHAINS have to reevaluate and redesign their how they can create a targeted FOR RENEWED value chains. They will return to customer-centric orientation. more vertically integrated manage- CUSTOMER ment systems, bringing their underly- Customer insight is the key to success OWNERSHIP ing assets closer so they can better in this shift. Like most other busi- nesses, banks need to sharpen their assess risk, safely deploy their balance sheets in an environment of scarcity, capability for capturing customer and maximize value capture. This information in a timely manner—for raises three sets of questions about banks, this means analyzing their cus- a bank’s capabilities: tomers’ product holdings, cash flows, behaviors, and personal circumstances. 1. Does your customer management Depth of relationship will be more capability enable you to get close important than breadth. For example, enough to the customer? Are you it will be more valuable for a bank to collecting the right customer informa- have an 80 percent wallet share of 1 tion? Are you leveraging this informa- million customers than a 10 percent tion to greatest effect? share of 8 million customers. Greater wallet share permits greater insight Bankers now realize that their core into buying patterns, credit risk, and asset is their customer base, compris- churn potential, enabling a stronger, ing both individuals and businesses. more profitable lifelong customer A well-honed customer management relationship. Customer and decision capability—one that enables them to analytics, which are too often relega- engage, win, and retain customers— ted to credit card departments if they will enhance both revenue generation are present at all, will now become a and risk management. Those banks critical capability. Booz & Company 13
  • 16. 2. Are your risk management processes prospects. To enhance effectiveness, customers. At a minimum, banks optimized for efficiency and effective- banks will need to assess the qual- must augment their statistical risk ness? Are you confident in your risk ity of information being used to feed assessment of consumer loans with pricing approaches? Does your asset their risk models, as well as review more sophisticated use of customer workout group have the right skill set? risk management approaches within behavior information. the different parts of their portfolios. As they forge closer connections with For risk-assessed loans, banks will Banks with large portfolios of bad customers, banks need to revitalize need to augment external ratings debt will also need to retool their their risk management and pricing with a more robust internal analysis asset workout capability. The “bad capabilities. They must ensure that of risk and pricing. This will have bank” model used in Australia and they are pricing accurately for risk an added benefit in terms of reduc- the U.S. during the early 1990s may and fully leveraging the improved ing systemic risk by broadening the provide a useful model for isolating information flow that will result from base of information available to bad loans in separate business units “natural ownership” of their assets. banks, minimizing their reliance on instead of offloading them at deep the narrow and potentially skewed discounts. This grants some measure Both the efficiency and effectiveness analysis that resides at centralized of protection to the larger organiza- of risk processes must be improved. credit bureaus. Because of the impact tion and enables the “bad bank” to To enhance efficiency, banks can of unemployment and poor stock focus on helping borrowers get off revisit their credit processes and market performance, banks will need life support, restructure their busi- ensure that they are properly aligned to account for altered risk profiles nesses, and repay loans. Like private with the organization’s risk objectives. in their statistically managed loans; equity investors, bankers will need A “triage” approach provides abbre- broad-brush approaches such as relevant operational expertise in viated or short-form processes for community-rated pricing will prove addition to the classic financial reen- existing customers or for refinancing, less competitive as more sophisticated gineering skills, especially in leaving full analysis for higher-risk competitors cherry-pick low-risk geographies where nonperforming 14 Booz & Company
  • 17. loans will force banks to operate design differentiated customer experi- remains sound: For lenders, it provides significant numbers of companies ences that align with their brands, and an alternative means of funding and for years to come. deliver supporting value propositions. managing the balance sheet; for in- In particular, banks will need to vestors, it represents an asset class 3. Does your distribution manage- be able to plan and deliver a tar- with tailored risk and return profiles. ment capability allow you to optimize geted customer experience across It is highly unlikely, however, that control of the customer interface? an integrated suite of touch points. second- and third-order securitiza- How will your investor distribu- For example, HSBC has created a tions will reemerge, given the lack tion capability respond to the likely high-touch customer experience for of transparency and unsustainable reemergence of securitization? its “premier” clients in Hong Kong. leverage they engendered. Instead, In addition to a branch upgrade investors will conduct their own Banks need to place less emphasis that allows tellers to spend more due diligence, demanding clear on third-party distribution channels. time on service and less on routine transparency into asset quality and Instead, they need to focus again on transactions, these high-net-worth first-order relationships with lenders. establishing and developing customer customers receive preferential Banks that deploy their brands and channels over which they have greater counter service and pricing, sup- provide superior reporting about control, either by direct ownership ported by a 24-hour call center and the quality of their assets will com- or through operational and platform a website providing an integrated mand strong relationships with linkages. These in-house channels view of both local and foreign cur- investors and maintain an edge will permit more targeted customer rency accounts. over resurgent nonbank lenders. acquisition, service, cross-selling, and They may even be able to develop retention. They will require a distribu- Banks will also need to re-evaluate and market “branded” securitiza- tion capability that enables banks to how they distribute loans off their tions, in which the integrity of the become increasingly sophisticated in balance sheet via securitization. The originating institution becomes a how they define customer segments, essential premise of securitization key selling point to investors. Booz & Company 15
  • 18. PROFITING IN A Growing shareholder value in the post- crisis banking environment will require In the post-crisis era, customers will increasingly concentrate their LOW-GROWTH a comprehensive and balanced business in banks they perceive as ENVIRONMENT approach to both financial and non- financial capabilities. Banking leaders stable, secure, and able to provide the products and services they must augment their past focus on re- require. Winning these customers venue and cost with a more sophisti- and the greater wallet share they cated approach to capital. At the same represent will require banks to pro- time, successfully responding to the vide the proof points of security scope and scale of change will demand and longevity needed to secure their that banks revisit their people pro- trust. As the industry consolidates cesses and underlying cultures. Five through mergers and acquisitions, sets of questions need to be consid- and global universal banks face ered, by the CEO and executive team the challenge of retaining and and in more detail by functional leaders: strengthening their connections to larger numbers of customers, the 1. Do your product and offer devel- ability to create and demonstrate opment capabilities enable you to brand value will be key to build- leverage your brand in developing ing this trust, as will the ability to long-term customer relationships? manage and align multiple brands. How will you use your brand to earn Meeting a full range of customer needs the chance to satisfy a broader set of will provide a level of return beyond customer needs? what can be derived solely from depo- 16 Booz & Company
  • 19. sits and loans. Banks will increasingly architecture around customer-centric the increased taxpayer funding of offer services such as cash flow man- imperatives? banks and associated public scrutiny. agement (especially as customers re- In fact, some CEOs have already pub- spond to changing personal situations Over the past decade, many banks licly ruled out offshoring in an effort and budgets) and new forms of finan- have focused their efforts on cost to improve battered corporate reputa- cial advice, with a likely greater focus reduction, but for the most part, tions and brands. on transactional support over the tradi- they have not been able to achieve tional holistic approach. Bancassurance reductions sufficient to compensate Many banks will thus need to develop represents another critical opportunity; for shrinking margins—so that overall better operational and IT management with the destruction of wealth in stock returns on assets have been flat or capabilities to attack the structural markets and other investment channels declining. Further cost savings are drivers of cost and achieve customer- over the last year, banks can expect to hampered by two obstacles. First, cost centricity. This is a major, near-term see a strong and growing demand for efficiencies have typically been driven opportunity for many banks to rein- simple wealth creation and protection by process improvements that have vent their systems architectures at the products such as mortgage protection, leveraged an end-to-end product view. same time that they replace core main- income protection, life insurance, and Now, however, banks find the result- frames that date back to the 1970s or health savings accounts. ing product-aligned architecture to earlier. In parallel, banks can overhaul be at odds with the need for greater the associated business models and 2. Do your operations and informa- customer-centricity. Second, a large structures that are inhibiting customer- tion technology capabilities enable portion of operational savings has centric innovation. cost reduction and productivity pro- come from outsourcing and offshor- grams that attack structural cost driv- ing, but these options will likely The cost drivers in most banks are ers? Are you aligning your business become more difficult to exploit, given deeply embedded in their legacy Many banks will need better operational and IT management capabilities to attack the structural drivers of cost and become more customer-centric. Booz & Company 17
  • 20. process, technology, and product of the role of deposits as a critical analytics to understand the drivers of architectures. They are best addressed source of funding. Too often, deposits customer value and retention and to by fundamentally realigning the were treated as a consumer banking analyze elasticity and demand in their structure of the business around product, and were managed in a frag- efforts to optimize pricing. customer needs, rather than overlay- mented manner across multiple lines ing new operating models and IT of business. Now, however, banks 4. Do you have an integrated capital systems on legacy product-based pro- must manage their cash holistically management and portfolio strategy cesses and organizational structures. and on a group-wide basis. In fact, capability? Are you managing capital Greater customer-centricity will the banks that already do this have a as a strategic asset? What alterna- permit a more sophisticated under- distinct advantage in the post-crisis tives do you have if current funding standing of the drivers of customer era and in some cases have emerged sources dry up? value and their cost. In turn, this as aggressors in M&A deals as mar- will permit banks to deliver “smart kets consolidate. Capital is now acknowledged as a customization”—streamlining and critical strategic asset and needs to be consolidating delivery of customer The recent dramatic rise in saving managed as such. A restricted flow of “nonnegotiables,” while charging rates in developed economies repre- capital destroyed institutions such as appropriately for extra features that sents another major opportunity for Bear Stearns and Lehman Brothers, customers actually value. banks to shore up a critical gap in while more savvy stewards of capi- their customer offerings while more tal such as JPMorgan Chase and 3. Do your asset and liability man- proactively managing a core element Goldman Sachs are emerging from agement capabilities enable you to of their funding mix. Capturing these the crisis as clear winners. manage your funding mix holistically? new deposits will require banks to How well positioned are you for the apply a level of sophistication to But it won’t be enough to manage coming scramble to attract deposits? product innovation and pricing that capital strategically. Banks must Easy access to low-cost wholesale was previously applied only to the also effectively communicate their funding during the pre-crisis era asset side. Banks will need to use strategy to investors, particularly as caused many banks to lose sight increasingly sophisticated customer they seek to expand. Big is no longer Capital is now acknowledged as a critical strategic asset and needs to be managed as such. Low growth in assets and a weak pricing environment in the medium term will require banks to keep a tight lid on costs just to maintain their margins. 18 Booz & Company
  • 21. beautiful unless it leads to a firm that Banks will also need to reset the expertise; a single executive might is better aligned with its core value ex-pectations of equity markets. The need to be fluent in customer analyt- proposition and delivers an attrac- low-risk, high-return proposition ics, asset and liability management, tive, sustainable return on capital. that the banking sector implicitly distribution, products, and opera- Shareholders will no longer tolerate promised investors has proven illu- tions. This highlights the value of empire building for its own sake sory. Banks can no longer afford a more traditional rotation model, but will expect to see a compelling high dividend payout ratios or use in which well-rounded, high-potential business case for each M&A deal, leverage to generate oversized returns bankers are groomed for senior lead- as well as subsequent reporting on equity. Shareholders are now ership by serving in multiple func- around deal performance. Share- presented with a less attractive, tions during their careers. And holders will also expect to see how although arguably more sustainable, it further reinforces an already exist- specific deals fit into a broader opportunity that can best be sum- ing shift from talent recruitment to M&A and capital management marized as “low risk, low return, talent retention and development. agenda that includes divestments as but low volatility too.” Banks need well as acquisitions. to set and manage this expectation Important cultural changes will also proactively. be required in the aftermath of the To securely fund business growth in current crisis. The need for a holistic the coming era, banks will have to 5. Does your talent management view requires effective teaming at diversify their funding base. For debt, capability support the human capital senior levels and the elimination of this will mean diversifying duration; requirements of the post-crisis era? the “cult of the leader” phenomenon in fact, regulators in some countries that creates barriers to collaborative are already moving to mandate The last decade has seen an increased management. Banking cultures will longer-term requirements. For equity, trend in banks hiring from outside also become more outwardly focused: it will mean thinking ahead about the financial services sector, focusing They will center naturally on the cus- alternative sources of capital before on functional skills like marketing tomer, and will work with regulators, they are needed, including strategic that were thought to be transferable. investors, and communities in a more investors and sovereign wealth funds. Today, banks need more holistic inclusive way. Booz & Company 19
  • 22. IMPROVED Banks—whether government con- trolled or privately held, whether financial crisis—their core purpose, customer needs, and capabilities— CAPABILITIES: specialist, regional, or universal while recognizing that profound THE KEYS TO players—are still the heart of the global economy. They pump the funds market changes have occurred and will impact how these capa- SUCCESS IN on which productive human enter- bilities need to be delivered. Those BANKING’S prise depends. Banks must perform this role effectively with all the due leaders whose banks can respond to the times and enhance their NEW ERA diligence we would expect of any capabilities will be tomorrow’s custodian of such an essential role. winners. Banking must refocus on those fun- How ready are you to compete in damentals that are unchanged by the this new era of banking? 20 Booz & Company
  • 23. About the Authors Vanessa Wallace is a Booz & Company partner and leads the financial services practice in Asia, Australia, and New Zealand. She specializes in strategy, postmerger integra- tion, and restructuring in retail banking, wealth management, insurance, and the public sector. Andrew Herrick is a senior associate with Booz & Company’s financial services practice and is based in the Sydney office. His exper- tise is retail and business bank- ing, with a focus on strategy, organizational transformation, and operational excellence. Booz & Company 21
  • 24. The most recent list of Worldwide Australia, Dublin Middle East Mexico City our office addresses and Offices New Zealand & Düsseldorf Abu Dhabi New York City telephone numbers can Southeast Asia Frankfurt Beirut Parsippany be found on our website, Adelaide Helsinki Cairo San Francisco Auckland London Dubai Bangkok Madrid Riyadh South America Brisbane Milan Buenos Aires Canberra Moscow North America Rio de Janeiro Asia Jakarta Munich Atlanta Santiago Beijing Kuala Lumpur Oslo Chicago São Paulo Delhi Melbourne Paris Cleveland Hong Kong Sydney Rome Dallas Mumbai Stockholm Detroit Seoul Europe Stuttgart Florham Park Shanghai Amsterdam Vienna Houston Taipei Berlin Warsaw Los Angeles Tokyo Copenhagen Zurich McLean Booz & Company is a leading global management consulting firm, helping the world’s top businesses, governments, and organizations. Our founder, Edwin Booz, defined the profession when he established the first management consulting firm in 1914. Today, with more than 3,300 people in 59 offices around the world, we bring foresight and knowledge, deep functional expertise, and a practical approach to building capabilities and delivering real impact. We work closely with our clients to create and deliver essential advantage. For our management magazine strategy+business, visit Visit to learn more about Booz & Company. Printed in USA ©2009 Booz & Company Inc.