Now that the president has signed the financial reform bill, banks inevitably must think about how to deal with new regulations.
Though a first phase of reform has been catapulted by the bill's enactment, this is only the start of a series of rulemakings that will occur during the next two years.
The upside of the new law is that it is a forcing mechanism for change. Instead of weakening precarious balance sheets, the expected government mandates could actually create an opportunity for the industry to strengthen its core to increase profitability.
IBM's analysis shows that, for the past 20 years, the financial industry has profited by capitalizing on "pockets of opacity," that is, creating, buying and selling complex products, often through lightly regulated entities. Though this approach was broadly successful up until the financial collapse, it did not create sustainable value. The use of sophisticated financial instruments and structures can generate and guarantee very high returns, but it also produces more extreme risk assumption and mitigation cycles and makes the markets much more volatile.
Though it is too early to predict what financial reform's next phase will look like, it is possible to speculate about some aspects. The shadow banking system is likely to become much smaller (for now) so that it cannot jeopardize the entire system. Capital and liquidity requirements will increase, and incentives will be scrutinized.
If the industry is to thrive within this environment, it must adopt a novel outlook and approach. Specifically, it must deliver on its brand promises and solve its business-model identity crisis.
Most financial markets companies have brands that implicitly promise agility and stability, plus a focus on clients' interests. In practice, however, the opposite is often true.
In an analysis of more than 2,700 financial services industry participants, three-quarters (76%) of executives said they believed they fail to deliver on these brand promises. This proportion grew from 67% in late 2009 when executives were similarly queried for IBM's previous survey.
This failure to deliver on brand promises has further accentuated clients' growing distrust of, and alienation from, their banks and financial markets companies. Most clients, nearly 70%, felt that financial companies are likely to offer products and services that serve the company's best interest versus the client's. More disturbingly, 66%, or two-thirds, of providers agreed.
But the beauty of it is that these trust gaps can be closed if companies start paying closer attention to their clients. Any company that can deliver what clients truly want will be able to charge a premium of 5% above their competitors' pricing — a significant opportunity for the industry if it can broaden its definition of innovation to focus not only on products but also on clients.
Skill at serving specific client clusters is a major — and largely ignored — profit opportunity for the industry. It has long excelled at creating innovative products. Imagine what it could achieve if it used the same discipline to understand its clients and fulfill their needs.
The shakeout from the impending reforms will simultaneously inspire a period of business-model innovation. Banks will not be able to be all things to all people and, therefore, will have to focus on their strengths and competencies.
Identity creation is a very healthy process, and companies must think through their responses to three questions: What should we do? What should we not do. How can we specialize in what our clients actually want?
Smart organizations that want to get ahead in the new economy and drive higher profitability are catching on to the theme of specialization. And for good reason: On average, specialized organizations deliver 5.7% better return on equity than more "universal" types of companies.
The new realities of regulation should be seen as an opportunity, not a threat. Wealth destruction has created self-reflection — and this is positive for the economy. Changes will make the industry stronger and more sustainable in the long run, and profits earned based on transparency will far outweigh those that were earned based on opacity.