Regulation Is Relationship Banking's Biggest Disruptor

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After the financial crisis and ensuing credit crunch poisoned relationships between banks and many U.S. companies, client satisfaction levels among small and middle-market businesses have finally recovered.

In fact, according to data tracked by my firm, Greenwich Associates, satisfaction rates have climbed to a 10-year high. However, there are troubling signals from both banks and companies that suggest we could be on the verge of another breakdown in banking relationship quality. The culprit this time around: the increased difficulty in doing business with banks saddled with less favorable economics and new regulatory requirements.

Today's satisfaction levels are almost certainly unsustainable. While a decline would reflect a natural reaction to shifting market conditions, I am increasingly concerned that the banking industry is at risk of a much more serious and fundamental disruption to client relationships.

There is no doubt that the U.S. and global banking systems were in dire need of reform and that many of the new regulations passed will increase systemic stability. However, there was far too little time spent considering the effects new rules would have on business banking clients. Regulators focused on reducing systemic risk, while the banking industry primarily focused on avoiding failure. The real-world impact of these new rules is only now beginning to be felt as many requirements affect companies' interaction with banks directly.

The most obvious example is new loan-documentation requirements that increase the work required by applicants and prolong the process for review and approval. Less obvious, however, are the myriad ways companies' bank relationships will be affected.

New mandates are imposing huge compliance costs on banks and severely affecting formerly profitable lines of business. Together, these effects require banks to cut costs in order to preserve scant remaining margins. For small business and middle-market banking customers, these cuts will mean fewer relationship managers, streamlined service models and increased costs of credit and of other banking services.

"Ease of doing business" is now one of the primary drivers of client satisfaction in business banking. Some of my recent conversations with bank executives and business clients have underscored that both "ease of doing business" and broader client satisfaction scores are at significant risk as the combined impact of the new rules makes it not just more difficult for companies to do business with their banks, but much more difficult.

Smaller banks are most at risk in the short term. If the ability to protect customers from the headaches of new regulations becomes a primary point of differentiation among banks—and it will—large banks able to allocate significant resources to the task will be at a big advantage.

In addition, if the new regulation and compliance demands make doing business with traditional banks too onerous, companies will look for alternative providers to meet their needs.

The banking industry has for years kept a wary eye on technology firms and other new entrants into business and retail lending. By making the process of doing business with banks so frustrating for companies, lawmakers and regulators could be providing these new players with the ideal window. It is not hard to imagine how entrants such as Google, Amazon, Verizon or Facebook could alter the U.S. banking equation.

Of course, it's open for debate whether such a development would be good or bad for U.S. companies and the overall economy. What is not in question is that the disruption of the traditional relationships between U.S. businesses and their banks, the hamstringing of small banks and the possible movement of business lending from the heavily regulated and well-capitalized bank sector to new, alternative venues are not results that regulators had in mind.

Chris McDonnell is principal of banking and capital markets for Greenwich Associates. 

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