Top 10 banking industry trends

Geopolitical tensions

Geopolitics is likely to continue to dominate the outlook over the coming months. Banking institutions have had to adjust quickly to changing sanctions systems. They have also had to develop their understanding of the second-order risks that may affect their assets and customers, as well as the long-term financial consequences of the conflict that may equally affect both portfolio growth and the recoverability of existing loans.

In addition, the conflict has had direct repercussions on the activity of the entities, derived from the restrictions imposed by the regulatory authorities on the movement of capital of some citizens and corporations. Entities have invested a great deal of resources in recent years derived from regulatory requirements on the knowledge of the "beneficial owner" of assets and other collateral, which they now again must put to the test in an environment with high regulatory pressures. Banks that fail to master this area may face economic as well as reputational sanctions and, above all, the moral dilemma of their possible role in this conflict.

Macroeconomic uncertainty

One of the immediate effects of uncertainty is the impact on energy prices and the growing prospect of material inflation, as well as the consequences it may have on customers' ability to pay. The main drivers of inflation before the conflict began - energy prices and supply chain issues - are now more likely to be amplified and more and more products in the shopping basket are joining this inflationary escalation.

One of the lessons learned from the COVID-19 situation is that one of the most effective ways to tackle the impact on customers' ability to pay is rapid coordinated action by both supervisors and banks themselves. This action during the pandemic allowed banks to suffer lower than expected impacts in terms of income and delinquency, although in this new situation of uncertainty the situation may be different. The outlook is less favourable due to the current great uncertainty, as well as the fear that this situation will remain for a long period of time, which generates a greater difficulty in the effective and coordinated response. In this regard, some regulators and entities have begun to anticipate an increase in delinquency in Spain, up to 5%-6%. These levels, although they seem reasonably moderate in relation to previous crisis scenarios or some estimates at the beginning of the conflict between Russia and Ukraine, highlight the importance of adequate monitoring and the reinforcement of early warning measures for the deterioration of credit quality by banking institutions.

In short, in a scenario of a contraction in the standard of living, there could be an increase in credit provisions, which would imply greater volatility in banks' profits.

Interest rates and central bank actions

Sustained inflation is beyond the memory of most companies and both companies and banks must carefully assess its commercial impact. Thus, in May inflation in Spain stood at 8.7% year-on-year, 0.8% higher than in April, driven by higher fuel and shopping basket prices. In response to inflationary pressures, central banks are raising interest rates, as expected: In the United States, the Federal Reserve raised interest rates by 0.5% in May, the largest increase in more than 20 years, and they point to further similar hikes at upcoming meetings. In Europe, the European Central Bank has stepped up its messages on its roadmap to fight inflation and has just announced a first interest rate hike of 0.50% for July.

Although banks' net interest margin (NIM) increases when rates are higher, this may be offset by adverse financial repercussions, mainly due to deteriorating credit quality, which could lead to a higher cost of credit risk. Rising rates and credit costs have also sparked discussion of a cut in living standards, which will affect both individuals and businesses. Both could find it difficult to manage the new costs and, as a result, we could see an increase in delinquencies and defaults.

Value of expenses

The capital requirements imposed by regulators, together with an environment of negative or very tight interest rates, have led institutions to seek greater efficiency in expense management. This quest to reduce inefficiency is a challenge for institutions and entails risks that can affect both their operations and their reputation. In this respect, these processes can involve very aggressive and rapid approaches, or on the contrary, more limited, and insufficiently developed approaches that could have a significant impact on operating models.

In recent years we have seen explicit cost reduction targets. As that agenda continues, we anticipate an increased focus on "value for money" and "getting it right the first time". However, the costs associated with recovery remain considerable and, in our view, for most large banks the monitoring and measurement of the effectiveness of cost efficiency program measures should be strengthened, avoiding the implementation of measures that create long-term inefficiencies or that could lead to the generation of new operational risks.

Risk of fraud and financial crime

Payment fraud is on the rise: criminals are developing new ways of capturing and obtaining money from their victims, and authorized push payment (APP) fraud now exceeds card payment fraud. Scams involving the purchase of goods and services that are never delivered or never materialize are also on the rise. In this regard, cybersecurity is a priority for institutions in the face of increasingly sophisticated attacks and threats, as well as the increase in intensive use of technology by customers, which has been accelerated as a result of the COVID-19 pandemic.

EU regulatory technical standards on strong customer authentication (SCA) and confirmation of payee (CoP) have sought to secure customer funds and reduce fraud losses. However, these measures and changes bring with them real implementation challenges.

Several high-profile fines were imposed in 2021 related to financial crime, which remains an active focus for the regulator. Past failures by banks continue to come to light and most financial institutions will need to continue to invest in this area to keep pace with regulatory expectations. With recent geopolitical events and the use of sanctions, it is unlikely that the national and European regulator will take its foot off the gas in this area.

Regulatory expectations

Regulators are under increasing pressure to ensure that the information they receive is reliable and accurate. The reinforcement of regulatory reporting is an ongoing issue, and companies must keep up with reporting requirements and ensure that their processes are truly adequate. In this regard, the importance of reliable information and reporting by entities to regulators is a key aspect when assessing possible solutions in uncertain environments such as the current one.

Leveraging data and analytics to support reporting is a common element, and organizations should view this as an opportunity to transform their regulatory reporting, risk, and finance teams, seeking efficiencies in information management through IT systems and applications. Regulators have signalled their desire to be more data-driven, and the industry will need to contribute to this.

Customer journey and value chain

The traditional net interest margin (NIM) may no longer be the largest source of revenue in banking. Increasingly, value is seen in the elements of banking that are in contact with the customer, while other points are becoming less important. In short, the value lies in having control of the customers who come to the bank.

Banks make more money by having good customer relationships. Therefore, the elimination of intermediation is an important risk that is beginning to materialize and that banks must consider. Other non-bank companies are also starting to offer services in this space, which could encroach on banks' market share, bearing in mind that these companies have lower regulatory costs in many cases, allowing them to generate greater price competitiveness. On the other hand, the importance of transparency rules and requirements to banks additionally poses a challenge in generating additional revenue, given the environment of increased customer litigation resulting from the recent economic crises. Undoubtedly, this is an aspect in which great progress has been made by the entities, but which must continue to be reinforced in the search for income to compensate for the possible impacts of the macroeconomic situation.

ESG and ethical banking

Banks will need to decarbonize their loan portfolios (Scope 3 carbon emissions), in addition to taking steps to become more sustainable internally (Scope 1 and 2 emissions). Attention is being paid to environmental, social, and corporate governance (ESG) issues, but we are seeing nuances starting to emerge around other issues beyond climate change. These include biodiversity, diversity and inclusion, and sustainability in a broad sense.

Social (S) and governance (G) issues are still appearing second only to climate and environment (E), but they are growing. For example, there are increasing requirements for banks to change their lending habits and to try to gauge the degree of ethics of their investments and services.

Data collection and improvement

There is increasing emphasis on data collection and enhancement in financial services. Having access to this information can support banks' internal and external decisions. It enables firms to better justify their direction and can support the reporting requirements of regulators.

The underlying data must be robust to support the overall business and investments in innovation. Banks also need to be mindful of who owns the data, as different teams may have different ideas about what is and is not the right data source. Proper data quality management, coupled with advances in data usage models, can enable institutions to generate multiple efficiencies in both customer management and institution risk management. Likewise, the adequate protection and security of this information, as mentioned above, must also be a fundamental principle in its management.

What can companies do now?

The banking and financial sector has many competing priorities around these key issues. Adapting quickly to new stakeholder demands will help ensure future resilience.

While staying on top of all these issues may seem daunting, banks have the opportunity to transform frameworks and processes to be more sustainable, scalable and future proof.  A review of internal parameters will help decide whether they align with current and future business strategy and objectives.