As the financial services industry digests one of the most profound periods of change, bankers need to consider new business models to deliver sustainable returns.

Firms must balance the need to centralize risk and capital allocation with the need to provide business units enough specialization and autonomy to take advantage of market opportunities as they arise.

The IBM Institute for Business Value's latest research — a global survey of over 2,600 financial services executives — indicates that regardless of whether a firm was badly hurt by the credit crisis or has come through relatively unscathed, 80% of executives say significant business model restructuring is required.

Radical change is difficult in such a complex and dynamic environment, but there is little choice. Firms that work through this challenge will be positioned to take advantage of the inevitable strengthening and expansion that will follow what may be one of the most fundamental competitive restructurings in the industry's history.

In the near term, the industry will continue to consolidate. In the United States, the top three banking companies controlled 20% of the banking assets five months ago. That figure has since shot up to more than 35%. Globally, the top 20 firms control 38% of the assets, and there is likely to be further consolidation to stabilize and flush out excess capacity.

As a result of growing concerns among regulators and executives that banks may become "too big to save," or perhaps "too big to profit," the longer-term restructuring will involve specialization. Executives have identified three basic models for companies.

  • Those that operate with higher risk to get higher returns: hedge funds, private-equity firms and spinoffs from investment banks.
  • Providers that assume lower risk for lower returns. These businesses will make up the majority of the financial services industry and will tend to be transaction-based businesses that "grease the skids" of the economy.
  • Advisers that assume little risk but can generate higher returns, such as wealth managers and providers of advice for underwriting and mergers and acquisitions.

As firms select a business model, they may wind up decoupling pieces of their business that don't fit. We will start to see a "barbell" effect as very large companies, along with boutique firms, fall into place in each of the three categories.What does all this restructuring mean for returns? Ninety percent of the executives who spoke with us say the returns of the past are over. From 1994 to 2006 the average return on equity for investment and commercial banking, asset servicing, and asset management (17%) nearly doubled that of all other industries (9%).
The current crisis will likely influence the speed at which the financial services industry reaches its inevitable economic maturity.

In addition, the crisis is providing firms an opportunity to avoid historical herding tendencies and ask themselves two questions: How do we deliver sustainable returns that outpace a maturing industry, and how can we really differentiate ourselves from the competition? They are also looking at ways to infuse intelligence into their systems.

For these reasons, executives said business model innovation was their top strategic initiative, followed by knowledge of client needs, risk management, and achieving efficiencies of scale.

Firms cannot afford to let the crisis serve as a distraction from focusing on clients. We found that firms and clients are disconnected 75% of the time when it comes to 12 top priorities. The industry will also come under significant pressure to improve its expertise in risk management.

Financial institutions spread risk, but they have not been able to track risk. The current environment provides an opportunity for the industry to go back to its roots of striking the right balance between return and risk — something it should be capable of doing, since risk management is the industry's business.

To achieve these goals, firms must overcome the tendency to squander scale by simplifying complexity within their models. Possible areas of investment include creating flexible architectures that can adapt to forces affecting their business, such as M&A, divestitures, and the anticipated myriad of new regulatory requirements.

Ultimately, we believe the financial services industry will navigate this historic period of change. After regrouping, it will begin to strengthen and continue its vital role in intermediating the flow of capital from savers and investors to productive users around the world.

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