Weakest Banks May Never Recover, According to IBM Survey

A new survey by the IBM Institute for Business Value (IBV) reveals that over 75% of banking executives and government officials believe the returns of the past are over. At a time when trust in banks is at an all time low, too many banks are over-reliant on revenue streams that no longer exist, have cost structures that are unsustainable in an era of lower returns and are burdened by excessive levels of operational complexity and inflexibility. There is however no shortage of new champions ready to exploit these banks’ weaknesses.

“The banks that emerge from the current economic crisis as winners will be the ones that are focused on clients’ success, while the weaker, less focused banks may never recover,” said Shanker Ramamurthy, IBM’s global industry leader, banking and financial markets. “But restoring client relationships is only part of the solution – banks must also become far less complex and develop an enterprise-wide view of risk.”

According to the IBV report, banks can close the ‘trust gap’ by becoming for more focused and disciplined and by investing in analytics to gain a better understanding not only of their clients’ perception of value, but also of what they are actually willing to pay a premium for. Banks are currently far too reliant on less useful demographic metrics, such as age, health, or stage of life. Improved behavioural segmentation will lead to greater insight and thereby a potentially far healthier, more sustainable relationship with clients that could well be more profitable as well.

The survey found that relative share of wallet varies considerably between different countries, with as many as 46% of consumers in both the US and Australia opting to consolidate their financial services with a single provider, whereas in most countries customers tended to rely on two or three providers – typically including an insurer and a retail bank. Some countries, however, demonstrated considerably more fragmentation with over a fifth of consumers in Singapore (22%) and China (23%) relying on four or five providers and a tenth of consumers in Japan (10%) relying on six or more. However, when asked why they had more than one provider, various reasons were given, but only 22% said it was because they trusted their current providers.

On the financial front, while banks need to raise capital, the report finds that their access to equity markets is constrained not only by the decline in public wealth, but also by low investor confidence in the banks’ loan portfolios. In addition, the report finds that banks in many parts of the world have an unsustainably high cost of operation, rendering their traditional operating models obsolete. Banks must therefore lower operating costs through business model innovation, supported by long-term savings initiatives in areas such as IT, shared services and front/back office integration.

In addition, the IBV research indicates that business model specialisation is the winning theme within the financial ecosystem. Banks must also decrease complexity and increase efficiency. Along the way, some banks, such as smaller banks that lack economies of scale, will become candidates for mergers and acquisitions, while some larger banks, whose size has created extreme complexity, will divest divisions. Although some of these divestitures will be required by regulators, large banks should consider actively divesting low performing divisions in order to maintain their focus and fitness.

IBV’s analysis found that Chinese and emerging market banks, which have smaller product portfolios and simpler operational structures, have taken the lead (among the top 139 financial institutions) in establishing the best cost/income ratio, outpacing North American and Europe banks. Between 2003 and 2006, cost/income ratios for leading banks in China averaged 49.8%, already a good deal lower than their peers in the US (58.8%) or Europe (57.8%), while their average return on assets (RoA) was similar to their European peers, but lower than their US ones. However, in 2007 and 2008, the leading Chinese banks have moved ahead by reducing their cost income ratio to an impressive 35.8%, while raising their RoA to 1.29%. Meanwhile in the US the average cost income ratio has risen to 71.9% while RoA has fallen to 1.08%, and in Europe cost income ratios have risen to 73.2% with RoA as low as 0.01%.

While much of the regulatory focus has been on the western banks being ‘too-big-to-fail’, it is their complexity and inflexibility rather than their size that is really hampering them, as many are simply ‘too-complex-to-thrive’. Chinese banks are just as large, but are in an early phase of growth in which they are focusing on extending relatively simple banking services to the unbanked. Once the Chinese market is fully serviced, they will need to expand into new geographic or product markets in order to fuel further growth. In this next phase they will need to avoid repeating the mistakes of the western banks in becoming so overly complex that they find it hard to manage their businesses effectively.


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