Ten years after the financial crisis, banks are no longer overwhelmed by regulatory change programs or consumed by compliance requirements. EY’s survey of 221 institutions across 29 global markets reveals that banks are turning toward growing and optimizing their businesses: 12% of respondents expect double-digit revenue growth in the next year, rising to 31% over the next three years.
To do so, banks must become more digitally enabled and effectively collaborate with new, innovative partners. In other words, they need to become more digitally mature.
Despite growth prospects, banks must address three key challenges to deliver sustainable profitability:
1. Cost pressures: Our survey reveals that most bankers expect costs to increase by 2.1% on average over the next three years, as the moderate reductions in regulatory-related spending are reallocated to growth initiatives and cybersecurity.
Figure A – Costs and efficiency remain challenging
2. Subdued income expectations: It is widely perceived that an increase in central bank interest rates will boost interest income. However, higher interest rates would naturally lead to a rise in defaults and loan losses, increasing the cost of credit and offsetting improvements in net interest income.
3. New competition: Banks face increased competition from new market entrants, including digital banks and FinTechs. Leading banks are forced to respond, investing in technology to prevent customer leakage and preserve their value chain.
Risks are shifting from unambiguous regulatory and compliance demands to ever-evolving risks that demand creative, holistic strategies. Bank leaders are focused on three risks in particular:
1. Cyber risk: Our survey reveals that addressing cybersecurity is the top priority for banks in 2018. Artificial intelligence and advanced analytics can play a key role in the prevention of cyber attacks, reducing conduct risk and improving transaction monitoring to prevent financial crime. However, given the cybersecurity talent shortage and the ever-evolving nature of technology, costs are likely to be substantial and could reduce investment in other areas. Banks should plan to collaborate more with their peers and better leverage the ecosystem by sharing data on external cyberattacks, for example.
2. Reputational and conduct risk: Our survey finds that banks are increasingly concerned about managing reputational and conduct risks. Improving culture is critical for limiting the sizable risks associated with poor organizational behaviors. Banks are also looking for new ways to manage the risks associated with financial crime and anti-money laundering compliance and are increasingly using technologies to support these efforts.
3. Fragmented regulation: The post-crisis global regulatory alignment is fragmenting as certain jurisdictions begin considering regulatory relief. Still, banks should not expect compliance requirements to loosen. In fact, pressure on banks is likely to increase, as supervisors around the world each implement their own particular version of the Basel reforms and as regulators set the rules under which banks must deal with the challenges posed by new technologies.
Of the five stages of digital maturity (not pursuing, beginning, transitioning, maturing and digital leadership), most global banks consider themselves as transitioning. Reflecting this, two-thirds anticipate their technology investment budgets to rise by more than 10% in 2018 as they mature. We question, however, whether this spending can necessarily lead to digital leadership.
Digital maturity is not simply a function of the types of technologies banks invest in. Digitally mature banks require a deep understanding of how each technology can benefit business, operational and organizational strategies. Banks can then allocate meaningful budgets to the technologies that drive sustainable efficiencies, rather than trying to invest in every new technology.
As our survey suggests, in-house solutions continue to lose favor but are more favorable than acquiring an entity. Leading organizations are aggressively seeking internal simplification and are increasingly using external utilities, platforms and managed services. This type of banking ecosystem lays the foundation for digital maturity.
However, banks must hold third-party providers and partners in this ecosystem to strict standards, and new models for sharing risk must be developed.
Banks must answer six key questions to ensure they are ready for innovation-led change.
Today, banks are optimistic about the outlook for their financial performance and increasingly confident in their ability to deliver sustainable double-digit returns. This stance is supported by benign economic conditions and anticipation of a boost to interest incomes from rising interest rates.
Banks should enjoy this while it lasts. Because it won’t. Many banks remain exposed to a cyclical downturn.
Banks can defend against these vulnerabilities. Those that act now to embrace an era of innovation-led change and deliver leaner, more scalable and digital business models can deliver sustainable double-digit returns, even through the gathering storm.