Spring opened with the G-20 Summit in London, where world leaders agreed to extend financial regulation to all systemically important institutions, take a common approach to cleaning up toxic assets, and establish a forum to broaden international cooperation and create an early-warning system for future crises.
How these broad outlines will translate into specific policies remains an open question. With no comprehensive international regulatory framework on the near horizon, and new domestic regulations looming but unclear, financial institutions will need to find their way largely on their own. To avoid many of the risks that brought this crisis, they'll need to treat the pending regulation as a floor, not a ceiling, for effective risk management.
This will not be easy. The G-20 Summit also made clear that, within the banking world, a shift of influence from developed nations to emerging ones is well underway. So in addition to regulatory headwinds, U.S. banks will have to face a new vanguard of foreign competitors — both domestically and abroad.
If the staggering losses racked up during the credit crisis have taught financial firms anything, it is that risk management can no longer be relegated to secondary status. Treating risk as a mere compliance issue leaves banks vulnerable to further market convulsions and shareholder value-erosion. Repositioning risk management as a fundamental part of institutional culture is essential. Banks need to better integrate their finance and risk departments and break down internal walls between business units and risk management so the actions and decisions taken regarding risk will be more aligned with and reflective of market realities.
Many U.S. banks, expecting weaker profits near-term, will continue to emphasize cutting costs. But the key is striking the right balance between short-term tactical cost-cuts and longer-term efficiencies like streamlining core-banking operations.
U.S. banks can wring out even more costs by embracing more shared services and utilities for back-office functions. They also need to rationalize branches, promote customer self-service, reduce the volume of product variations and generally automate their businesses.
Clearly, the economic crisis has hit the U.S. financial sector hard. But institutions in emerging-market nations like China, India and Brazil and smaller Western leaders like Canada and Spain have managed to fare much better. For instance, the ratio of bank capital to assets in developed economies has been as low as eight percent, while in emerging economies it ranges from 10 percent to 15 percent.
Our recent analysis suggests that U.S. banks' return-on-equity will decline from highs of 26 percent down to four percent among top performers, because of higher capital ratios, deleveraging, higher costs of funding, reduced fee income and nonperforming loan provisions. Restoring this figure even to 15 percent will require banks to go back to basics. That means winning deposits one customer at a time, but doing so cost-effectively with the right products and strategically by restoring customer trust.
Instead of emphasizing commodity online services like bill-pay and account-transfers, banks should focus on funneling high volumes of customer traffic to their Web sites and converting that traffic into deposits. This is particularly crucial for mid-tier institutions.
With tighter restrictions on exotic securitized instruments, there will be fewer ways for U.S. banks to boost margins. That means they'll need to raise fees, and one of the most important things they can do to justify that in this environment is to restore customer loyalty.
By September when the G-20 leaders meet again, more regulation (both international and national) is a near certainty. U.S. banks will look at the information and practices needed to ensure their risk management controls are robust, and will not look at regulatory compliance as a mere box-ticking exercise.
In two to three years, a new wave of institutions will emerge in far better shape than many of the traditional leaders that are currently saddled with system-wide risks and have seen steep declines in return-on-equity. That leaves U.S. banks with a stark choice: get on their front foot strategically or risk being outperformed or acquired by new and emerging competitors that have better weathered the downturn.