Walking a fine line between growth and risk
On one side is the question of how much capital will be needed during what’s likely to be a hard-to-predict economic environment. Banks are setting aside more money for potentially bad loans, tightening lending standards, closely monitoring deposit flows and streamlining operations.
On the other side is the question of how much capital to allocate to growth initiatives. Uncertainty creates opportunity, and leaders who build their institution’s differentiating capabilities can help improve competitive positioning.
Where are today’s threats to tomorrow’s growth prospects?
Established technology and retail brands, hoping to capture more client time and money, are pushing financial services toward captive financing and strategic partnerships. With access to millions of customers, they can quickly scale a digital offering, threatening a bank’s market share similar to what we have seen across credit products and payments. In a worst-case scenario, digitally-savvy established brands may become the face of financial services, pushing traditional banks - and possibly some fintechs - into the background.
Still, the most likely near-term competitive threat comes from banks that are more digitally agile, delivering simpler, seamless and individualized experiences across their portfolio of products and services. Superior digital capabilities, especially those that offer advice to help customers navigate a difficult economy, can be a differentiator, inspiring customers to switch banks for a better experience.
It’s a challenging time for banking executives, balancing the opposing needs of spending to increase competitiveness, while managing an expanding set of financial and non-financial risks. Here’s our view of what’s next in banking and capital markets, and how these forces can help shape banking’s future.
To stand out in a crowded market, bank executives are refining their growth story around their institution’s unique clients. Whether that’s small business merchant services, a better mortgage experience or hyper-focus on a single industry’s needs, banks are responding to competition by playing to their strengths and exploiting market niches.
Despite the uncertainty, now is the time to refine a growth strategy so it’s ready to capture market share when the economy’s fortunes brighten. Today’s macroeconomic conditions also present an opportunity to examine spending on operations and internal systems with the aim of making changes that accelerate go-to-market plans. Constraining budgets can lead to creative thinking that optimizes processes (especially with the aid of technology), lowers expenses and refocuses capital on higher-value businesses.
What’s clear is that the refinement of your growth story this year will require continued investment in digital capabilities in concert with strategic cost reductions to weather an expected economic slowdown.
To date, a slowing economy is having little effect on the sector’s appetite for digital transformation. Banks know they need to deliver more sophisticated digital engagements, which are becoming table stakes to compete for new customers.
A rapidly maturing industry cloud for banking is helping accelerate the rollout of mobile and online banking solutions. Today’s leading digital solutions use a common cloud services platform to coordinate activity between a bank’s preferred digital software vendors and its existing computer core.
With a common cloud services platform, time-to-market for a digital product can be reduced to weeks from months, fewer computer programming resources are needed and ongoing computing costs are reduced as the solutions leverage the cloud’s flexible pricing models.
These combined benefits make it possible for banks to pursue their growth initiatives and reduce expenses amid an uncertain economy.
ESG continues to be a driver of bank strategy, whether in operations, lending, investing, risk management or compliance.
While harvesting the tangible and intangible benefits of trusted ESG reporting requires banks to engage with all three aspects of ESG, environmental sustainability appears to attract the most stakeholder attention because of its importance and complexity for financial services firms.
For many banks, trusted ESG reporting rests primarily on a reliable method for calculating scope 3, category 15 financed emissions, which is the bulk of their greenhouse gas footprint. An end-to-end ESG data strategy governing collection, staging, validation and reporting helps banks convey to stakeholders their process of gathering third-party data, improving data quality through upgraded processes and controls, and calculating the full scope of emissions of banking products.
As ESG becomes a larger part of a bank’s operations, managers will likely face questions from the board who want to make sure executives:
Evaluate and manage climate risk impacts
Factor ESG risks and opportunities when serving clients
Understand ESG-related product strategies and have appropriate processes and controls to help guard against greenwashing risks
Have a robust plan for ESG business decision-making and for external reporting
Together, the board and management should confirm that trust is the primary goal at every stage of an ESG strategy.
Deal activity has slowed, but the rationale for a merger — building scale, entering new markets or acquiring tech and talent — remains salient for banks feeling squeezed by peers, upstarts and incumbents alike. A reset in fintech valuations may yet spark a flurry of transactions that bolster a bank’s digital capabilities.
Despite economic and regulatory obstacles, deal-making remains one of the fastest ways to transform a company. Given how much digitization work remains to be done in the sector, reconfiguration through a transaction can help firms offset top-line pressures by tapping into new opportunities such as embedded finance, banking-as-a-service or buy now, pay later.
What’s not changing is the analytical work of making sure every avenue is explored to increase a transaction’s value amid more stringent regulatory reviews, which can lengthen the time between announcement and closing.
Financial services firms will need to monitor both broad-based and specific tax issues in 2023.
Of the former, the Organisation for Economic Co-operation and Development’s (OECD) Pillar Two global tax regime continues to move closer to implementation. Certain tax incentives in the US and abroad, however, could run afoul of the rules, resulting in incremental tax.
Included among the specific tax issues are the US book minimum tax, digital asset transactions tax and ESG tax credits.
US legislation has been drafted around tax information reporting on cryptocurrency and non-fungible tokens (NFTs). Taxation of digital assets — and the income they produce — is a key target, both at home and abroad. And regulation around those is expected to receive increasing attention due to recent, high-profile bankruptcies. Banks should expect regulators to provide guidance on reporting requirements, resulting in a need to prioritize holistic data strategies.
The rules around ESG tax credits continue to evolve after passage of the Inflation Reduction Act. New allowances and new tax structures housing ESG tax credits can impact a bank’s ESG profile as well as the economic value of various lending and intermediation transactions.