Rebooting financial institutions
The challenges facing the financial services industry are legion, ranging from a global economic slowdown and increasing regulation, to low interest rates and the possible defaults of Greece, Italy and Portugal. For financial institutions to prosper in this ‘new normal,’ they will need to refocus most of their efforts to the right side of their balance sheet. This is the part of the business that contains customer liabilities (i.e. deposits), debt and capital – what is used to fund assets and loans found on the left side of the balance sheet.
Before the 2008 financial crisis, most banks de-prioritized the right side in favour of aggressive left side strategies that drove ever-higher revenues and earnings (and expectations). This impetus combined with a loss of valuation transparency in many of the complex assets left the banks dangerously exposed from a risk perspective and unbalanced from a liabilities and capital standpoint. The 2008 crisis showed how vulnerable even the largest and most august firms were. While many banks have reduced their reliance on unstable sources of funding and increased the stability and duration of their borrowing, many have not made any appreciable progress.
Given market precariousness, a repeat of 2008 is still possible. Leaders will need to improve their right side performance, with the right mix of strategies and client liabilities, to reignite their growth engines and ensure financial stability. Three ways managers can achieve this is to get much closer to their target customers, optimize their product portfolios, and improve risk management practices.
- Get closer to the target customer
With flat consumer and corporate demand, financial institutions must deploy strategies that improve customer satisfaction. Achieving this will enable them to: maximize retention (strong loyalty correlates with high profitability) of their most valuable customers and increase cross-selling of higher margin products. Customer-centric strategies benefit both the left side (higher revenues, lower costs) and the right side (better quality deposits) of the balance sheet. American Express has successfully followed this strategy through the launch of a small-business focused brand, the Open card. By delivering a broad offering – from credit services to business networking – to a dynamic segment, American Express has been able to access new liquidity pools and refashion its funding profile, potentially reducing their reliance on capital markets.
- Optimize the product portfolio
Banks should emphasize strategies that rebalance the portfolio, towards clients and products that are rich in liabilities (such as vanilla checking accounts) and require minimal capital reserves, and away from low margin businesses that need high levels of capital. A pioneer of this strategy, according to strategy+business magazine, is the credit card provider, Capital One. In the late 1990s, Capital One realized that they can no longer properly fund their business model through wholesale markets or brokered deposits. The company avoided failure in the mid 2000s by aggressively revamping their funding pools and buying two stable and profitable retail banks. Later, Capital One continued on with this strategy by purchasing the online bank ING Direct. These strategic moves have helped the firm outperform its rivals since 2008.
- Improve risk and capital management
The credit crisis brought to light misalignments in many banks between their risk policies, practices and credit structures. Powerful software tools and risk management approaches (economic capital for one) have been available to better translate multiple risk positions into equity capital requirements. However, many firms have neglected to use them. This must change. At the same time, leadership teams need to also consider the people part of the equation. For example, most companies would benefit from a culture change around risk (i.e. risk is not something that is bypassed through regulatory loopholes) and by underscoring the importance of risk management training and compliance practices.
Given competitive yet risky financial markets, there is some urgency for banks to use right side strategies to rebalance their balance sheets. What they need is strong leadership, strategic finesse and executional excellence.
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