In the past several months the attention of the public has shifted somewhat from managing away from the financial crisis to the Tea Party, re-election politics and the lingering recession. As we move through the last quarter of 2010 into 2011 though, financial institutions are have only moved to the next phase of the crisis- struggling to react to the Dodd-Frank regulatory reform law, and the myriad business issues it affects: risk, finance, revenue strategy and customer relationships.
The FinTech 100 and Enterprise 25 rankings are focused on technology companies and their relationships with their customers, financial institutions. The struggle for financial technology vendors will be to innovate and return value to their stakeholders serving a market under duress. Regulation aside, the other primary stressor for financial institutions is that global economies, for the most part, are struggling to recover from recession.
Consumers are still carrying record levels of debt on all types of financial products, and this debt load — coupled with a U.S. unemployment rate hovering around 10% — means greater payment stress. That in turn leads to additional defaults and credit losses. Commercial lending has also come under increased stress due to slowed economies and valuation resets on loan collateral, namely commercial real estate. With the specter of a "double-dip" recession or further economic weakening, there is a virtual guaranty of ongoing or increased levels of credit volatility that financial institutions will be dealing with through the rest of 2010 and through 2011.
The financial challenge for both financial institutions and FinTech vendors is how to drive stakeholder value in this type of environment. Financial institutions are facing market demand for greater diversity in products and providing higher levels of convenience for their customers while still making a profit. FinTech vendors have responded over the past few years with new software solutions that enable financial institutions to track and respond in near real time to changes in loan-portfolio composition and performance. A revitalized market for software that makes collecting on bad debts more efficient and sensitive to stressed consumer populations is gaining strength.
It is important to remember that risk solutions span the entire credit lifecycle, from the good to the bad to the indifferent. In a recent survey of financial institutions, conducted by IDC Financial Insights Global Risk Management team, showed that two thirds of senior risk officers surveyed are concerned about heightened levels of credit risk over the next 12 months. Based on the date of the survey, this means into the first half of 2011.
Compliance has become a very large issue for financial institutions and has put a new key operational risk into focus. Because government agencies on a global basis became material stakeholders in financial institutions, there was a rush of new legislation to look at lending practices. Another angle to compliance has involved regulators stepping up and into organizations to look at their practices around economic capital, how much capital they have to offset volatility and risk in their portfolios.
The only problem with this is that most risk officers feel the knowledge and intellectual property on safety and soundness does not reside with regulatory bodies. They feel that regulators are stretched from a capacity standpoint and are playing catch-up from a technical perspective. The concerns about being examined and reviewed by entities with less technical finance and analytic knowledge than resides inside the institution come primarily from tier 1 banks. Tier 1 institutions have generally over time built up analytic and finance teams that are quite astute on economic capital analytics. So post-crisis, the relationships between banks and their regulators are a work in progress, to say the least.
The credit market has shrunken substantially over the past 18 to 24 months as banks have tightened up their lending criteria. With a smaller market comes more competition for the goods and services that banks offer. In my recent survey work with risk professionals, one issue that came up often was the key operational risk of customer service. In a tighter credit environment banks cannot readily replace clients lost through failings of customer service by running marketing campaigns as often as they used to. Therefore customer retention comes into sharp focus and becomes a primary concern. Not only do banks want to keep their current clientele, but it also becomes critical to gain new product revenue through cross-selling and up-selling to existing customers. Banks are currently addressing a real operational risk of customer retention. FinTech vendors are working to enhance solutions that combine hardware, software and consulting services to help institutions wring out more revenue from existing populations — a very tall order.
As we move through 2010 and 2011, financial institutions will find their way in a newly normalized environment of dealing with volatility, evolving the financial analysis of their business model and its products, creating and maintaining productive relationships with regulators, and finding new ways to satisfy and gain incremental revenue from existing customers. Banks that can do this will ease their way to the future, while institutions that struggle with any aspects of these four points will find themselves in tough situations. We expect industry consolidation to continue and accelerate because if nothing else, the market for financial products has become constrained and the battle of institutional abilities to manage risk, finance, compliance and their customer relationships is on.
Dana Wiklund was formerly the research director at IDC Financial Insights.
