Has the global bank had its day?
Bank relationship management in a retrenching landscape
While many banks are still assessing the precise impact of Basel III on their capital requirements, there is a general consensus that they are set to rise. Higher capital requirements will negatively impact the risk adjusted return on capital (RAROC) while, due to the higher business risk associated with the banking industry, shareholders are requiring a higher return on equity (ROE).
In search of shareholder value (i.e. RAROC > ROE) and fueled by previous regulatory requirements, many banks shifted their business model from supplying credit and earning a lending spread towards offering transactional banking products such as payments and cash management which have a limited, if any, impact on the capital requirements of a bank’s balance sheet. Combined with the globalization of the banking landscape, the ‘global network bank’ was born, vast financial institutions offering practically every banking service to everyone everywhere. Basel III is now challenging and possibly putting an end to this model.
The end of the global networking model?
Despite having dominated the banking landscape for the past few decades, the global networking model is currently falling short for three main reasons: First, despite being globally active, very few financial institutions are able to establish and leverage on a common infrastructure and company culture. While still being faced with the high operational costs of having so many branches and systems, global banks often do not score higher on the efficiency ladder than their smaller counterparts.
Second, although competition between global banks is fierce, global banks have had difficulties competing against super-regional banks as they can cover large geographic regions while still maintaining a relatively small overhead. In recent years, some less traditional non-bank organizations were added to the list of competitors such as shadow banks or crypto-currencies.
While the likes of Bitcoin today are not yet a viable alternative for a corporate, the idea and technology behind it might in the long term be a serious threat for the market share of current payment services providers.
Third, being globally active implies compliance to both supra-national as well as many local regulatory requirements, which puts a stress on compliance costs.
Basel III is enforcing an additional capital surcharge for big international banks. As recent legal cases have illustrated, banks are required to have visibility of their complete customer chain – i.e. ‘know your customer’s customer’ – to ensure they are, not even indirectly, involved in money laundering or tax evasion activities.
Basel III may force banks to use gross amounts when calculating liquidity ratios
Basel III and its impact on the capital adequacy regime may cause a shift away from the global networking model towards a focus on a bank’s strongest products and services in a limited number of markets.
Certain services, such as notional pooling, become more expensive as Basel III may force banks to use gross amounts when calculating liquidity ratios. This might lead to banks rethinking their willingness to offer such notional pooling arrangements or bank services in certain regions.
This winding down of global activities and focusing on its strongest products and regions is already taking place. At the beginning of March 2015, RBS announced that it would exit its GTS (Global Transaction Services) operations outside of the UK and Ireland, implying that cash management and trade finance activities will be wound down globally.
These actions are part of a large scale reorganization in which RBS Corporate & Institutional Banking (RBS CIB) will exit Central and Eastern Europe, the Middle East and Africa, and substantially reduce its presence in Asia Pacific and the US. In the end RBS CIB will have wound down its operations to 13 countries from over 50 at its peak in 2008, which will have a significant impact on nearly any corporate with RBS as one of its banking partners.
The more fundamental question is whether RBS is an anomaly or the start of a trend towards a new banking landscape in which most banks focus on a specific region or service and only a few are truly ‘global’. In April 2015, Deutsche Bank announced that by 2020 it will reduce its branch network by 200 branches and invest more than EUR 1 billion in its global transaction banking platform, clearly indicating its commitment to being a global corporate banking partner in the future as well.
The new corporate-to-bank relationship
As banks are putting an increased focus on their strongest products and services and de-emphasize lower-return business, the impact on the business of a corporate will be severe. However, corporates will probably not wait until the effective end of services before, in the case of RBS, moving their cash management and trade finance activities elsewhere.
The most straight forward approach would be a ‘lift and shift’ strategy, in which current banking activities are moved from the retrenching banking partner to a new banking partner. This approach is most suitable for corporates that have a limited amount of services with the retrenching banking partner. While less time consuming than other approaches to this situation, the banking structure will not be optimized and potential inefficiencies will continue to exist in the future.
A second approach sees the retrenchment of a banking partner as an opportunity to consider improvements in the banking structure of the corporate and unlock the full potential of the Single Euro Payments Area (SEPA). Centralizing all payments and collections in one country by moving towards SEPA 2.0 solutions leads to a more centralized, standardized, cost-cuttingand value-adding treasury department.
The most advanced approach considers the decision of a banking partner to stop offering certain services as a trigger for a full revision of the banking partners and banking structure of a corporate. This can enable a full transformation, which will create opportunities to improve working capital and liquidity management and look at the benefits of structures such as in-house banks and payment or collection factories.
Corporates should make sure their banking partners understand where they fit into the general treasury management strategy.
Ideally, a corporate has mutually beneficial relationships with its core banking partners who are committed to the long-term and rewarded accordingly. However, in light of recent bank retrenchment cases, one could question the added value of building long-term relationships if a banking partner announces overnight it will stop providing certain services.
Today’s methodology for analyzing and selecting banking partners often fails to incorporate such an event and assumes that banking partners will retain their status quo in certain services. A methodology that incorporates possible what-if scenarios and assesses the flexibility and ease of switching banking partner, if needed, would certainly prove its value in today’s changing banking environment.
Bank relationship on the priority ladder
A corporate should already start reviewing opportunities for improvement on its current systems and organization to ensure, in case of a switch in banking partner, a smooth transition from one banking partner to another. The impact of Basel III and the current trend of bank retrenchment has put the corporate-to-bank relationship high on the priority ladder again. Corporates actively responding and embracing this as an opportunity to optimize and future proof their banking structure will come out on top.