Regulation is on the rise in Europe and will have a massive impact on the banking industry in the next decade. Crispian Lord examines the conflict between bankers and regulators, and suggests three key steps for a bank’s strategic response.
A substantial amount of regulation and mandatory change is coming in the next five-to-10 years and this will be forced through by the EU Commission to meet the objectives and deadline of the Lisbon Agenda. The bank ‘death rate’ is likely to accelerate as a result of this change and the banks that survive will be those that consider the overall direction and potential outcomes at a strategic level and alter their business model appropriately.
The crest of a regulatory wave
The 1988 Basel Accord (Basel I) was the beginning of a shift in the financial services industry. Regulation has permanently taken a more invasive, professional, rulebook and legislation approach. Each year since Basel I, there has been an increase in regulatory focus on the industry with the move to single regulators (for example, the Financial Services Authority in the UK), active regulatory counsels (for example, the Bank for International Settlements’ committees) and the intervention of the EU Commission (for example, the credit transfers directive). Whatever the reason for this change – BCCI, Barings, globalisation, the establishment of the EU, Enron – the banking sector is at the crest of a wave of regulation that will have a fundamental impact on the industry in Europe in the next decade.
The amount of regulation and other industry change that is anticipated based on existing pronouncements and white papers is significant (see figure 1 download file). Despite this wave of regulation, most institutions continue to deal with each piece of regulation (whether it is Basel II, the Markets in Financial Instruments Directive or the Payment Services Directive) as a separate problem and project, rather than looking at the potential opportunities and threats to the overall business strategy. Furthermore, most institutions still falsely believe that they can continue to fight the regulators and prevent or significantly slow these changes.
Tense relationship
The EU Commission increasingly appears to believe that the banking industry is unable to look after itself and make the fundamental changes required of it. Increasingly vitriolic statements are being made by commissioners as they assess the lack of progress made by the industry towards the intended single European area for financial services as articulated by the Lisbon Agenda. The result has been a number of committees, white papers, discussion groups and advisory boards. This has mainly resulted in the regulators saying “get on with it”, and the bankers agreeing but not delivering.
Among the recent shots across the bows from the commission was its final warning to stock exchanges on costs. European clearing houses and exchanges could face EU legislation if they do not take action to open up their clearing and settlement systems to competition and lower the costs of cross-border share trading. Competition commissioner Neelie Kroes and internal market commissioner Charlie McCreevy were expected to announce that the EU would consider legislative action before the summer unless the industry takes steps on deregulation itself. “If necessary, the commission will make some agreed industry standards mandatory and include the roadmap for the single payments area in our draft legal text,” Mr McCreevy said in March.
Why the conflict?
There are two sides to this issue. Bankers operate in a competitive environment where co-operation is a challenge. Moving towards a single European area for financial services would result in a loss of revenue because charges on complex cross-border transactions would be lost and barriers to entry for competitors would fall. Furthermore, consolidation would be inevitable and senior management would be at risk.
Regulators do not inherently like to impose solutions on the market. Generally, they do not have the expertise to do this effectively and so risk distorting the market, which would result in an outcry among large stakeholders. Furthermore, they do not want to risk looking as though they are dictating to the market as if Europe was part of a new state-run bloc. This loses votes and undermines the credibility of a commission that continues to stand on shaky ground.
What will happen next?
The Lisbon Agenda 2010 deadline is rapidly approaching and it seems as though the commission’s patience has finally run out. The banks will continue to use their influence at the commission and with their own governments to prevent change and consolidation in the industry for as long as possible.
Increasingly, the commission will be issuing directives that force change at the infrastructure, manufacturing and distribution points of the banking value chain. The commission’s principles and rationale for this change will continue to be based on improving the life of the European consumer and reducing costs. The commissioners have found this to be an excellent foil with which to attack the industry because it wins votes, and arguing against these underlying principles is difficult for the banks.
The impact on the banks
The credit transfer directive, which forced banks to charge the same for an international payment within the EU as they do for a domestic payment, provides a taster of the type of impact that the commission can have on a bank’s business model. Banks will increasingly find that the destruction of national barriers will affect their existing revenue streams and supposed differentiation to customers. National banks will increasingly face competition from the larger institutions that can offer real pan-European and international coverage of products and can deliver local needs at much lower cost.
Some banks will survive by re-evaluating their offering and targeting clearly differentiated strategies, such as tailored, local service delivery and products. In addition, local banks are likely to create joint utilities for parts of their operations to reduce costs and focus on client service.
Despite these responses, many banks will not survive. In the past decade, the number of banking institutions in the EU has decreased by 5% per annum. This trend is likely to increase and accelerate as a result of regulatory changes. On this basis, the net result could be as many as 2500 institutions disappearing by 2015.
How should banks respond?
The banks that will be successful over the next 10 years are those that accept that the landscape will change and incorporate this into their strategic assessment and plans. The wave of regulatory change will crash into those that do nothing. The end game is likely to result in consolidation, as well as a need to revisit service offerings and to take decisions on which parts of the value chain the banks need to maintain in house.
Three key steps should be addressed as a part of a bank’s strategic response to this issue:
- Undertake a comprehensive assessment of the strategic direction of regulation and mandatory industry change, including current, proposed and possible requirements in the next five-to-10 years.
- Run potential scenario analyses based on the strategic impact assessment and determine how the current business model will be affected.
- Develop business model options that will deliver winning strategies based on these scenarios and outline the impact on the current strategy.
Crispian Lord is a managing principal at financial services consultancy Capco.
