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Time for a reset in bank thinking - Luc Vantomme

Time for a reset in bank thinking - Luc Vantomme

 

The banking industry is at a crossroads. For all the recovery since the 2008 crisis, there has not been a return to ‘business as usual’. Balance sheets may have been repaired but profitability has not. Many banks are failing to make a satisfactory return on equity. It is time for a new approach.

The problem is not difficult to identify. Top-line revenue has been shrinking while regulatory and other cost pressures have been intensifying. Consultants Oliver Wyman calculate that revenue pools contracted by 4% a year between 2010 and 2015. Over the same period, tougher regulations forced banks to increase the capital allocated to their capital markets activities by around 10%.

A variety of responses

Banks have responded by attacking costs, paring back staff numbers and exiting marginal businesses. They have downsized their balance sheets. There have been big strategic moves too. Some banks have moved to a narrow banking model that favours advisory and asset management over lending and deposit-taking or trading. Others have reoriented the business to perceived growth markets.

Moves to shift activities to lower-cost centres have been of marginal benefit at best, after a one-off impact. Attempts to rationalise IT platforms have proved difficult to execute effectively and slow to pay back. The imperative of meeting new regulatory requirements has consumed the bulk of IT budgets and resources.

Time for a reset

I believe the industry has to ‘reset’ the way it looks at this problem. On the one hand, banks have to find new ways of doing things, such as automating areas that have been left behind and finding new ways of working where automation is impossible. This means focusing on high-impact solutions with manageable risk. Solutions where new technology – such as data analytics, cloud services, robotics and others – can be positioned easily alongside old processes but still achieve major efficiency gains.

At the same time, the industry needs to work towards simplifying the data model by which it operates. This is where Distributed Ledger Technology (DLT), or blockchain, may come in.

Simplifying the data model

Improving the way data flows through the system is where the battle on costs can be won. All banking operations rely on changes to, and exchanges of, data. The cleaner that data is, the less work it requires.

DLT offers exciting possibilities. In the securities holding environment, for instance, the successful introduction of DLT could enable the many different players that provide services to investors to run their business using the same underlying records of holdings, transactions and obligations. This could simplify transaction processing and reduce the need for reconciliations. Importantly, it would also reduce the hidden costs of ‘trust’ faced by the industry today in the form of audit, due diligence, operational risk management and regulatory oversight, not to mention the cost of the capital required to mitigate the operational and credit risks within the current system.

The challenge of change

There are obstacles to overcome before this becomes reality. History shows that attempts to introduce shared service solutions or platforms are fraught with problems. Trading platforms have come and gone. New market utilities take time to bed in.

There are other issues to resolve as well. For a start, there is a big challenge in aligning interests. Each firm will have different legacy systems; some will find it hard to justify the new investment.

Legal and regulatory considerations, and potentially changes, will also be needed before the market can fully take advantage of the new technology. A research paper produced by Euroclear together with fintech lawyers from Slaughter & May in November 2016 detailed a list of open questions about the current regulatory and legal environment, at least in the European Union. It concluded that regulation is not currently optimised to facilitate the widespread use of DLT in the securities post-trade process and to take full advantage of it.

There are practical questions as well. How would the migration to DLT systems work? How would those systems link to traditional systems in non-DLT jurisdictions or markets?

Finally, whatever course existing players take, we need to look beyond the traditional banking industry to new entrants and how they will be accommodated in a regulatory system geared to minimising any threat to financial stability.

A role for Financial Market Infrastructures (FMIs)

I believe FMIs, such as Euroclear and other global settlement systems, have an important role to play, both in driving change and innovation, and ensuring the stability of the system. FMIs have vast operational experience and associated risk management structures.

We operate governance models that balance the needs of all market participants. And we have the regulatory framework to allow us to operate at the heart of the financial system, whatever the mechanics of the markets might be.

DLT is an area that Euroclear has been investigating for some years and where we have a number of pilot projects, both in-house and in partnership with fintech companies. That experience shows that DLT has enormous potential in many areas, including the post-trade arena.

There are a number of areas that could benefit from this new technology. One is the distribution of French funds, and we are exploring ways of innovating in this area together with a new working group.

Need for one or more central authorities

We would expect the adoption of DLT to have an impact on the role of FMIs. In some cases it could obviate the need for certain FMI services. In other cases, it could create a need for them to provide additional infrastructure services due to the adoption of new ways of working, such as private key and smart contract management.

In all cases, whatever efficiencies might arise from managing data on a distributed ledger platform, someone will need to be accountable for the overall integrity of the system, the data it maintains, and the business it supports. FMIs play that role using today’s technology. There is no reason to believe they will not be needed in the technology of the future.

Collaboration will mark the way forward

The timing is right for regulators, FMIs, banks and fintech providers to come together to realise new ways of working.

The real benefits offered by any radical innovation are normally seized at the point where technology advances coincide with a rethinking of business models. That is the sweet spot where tomorrow’s solutions can gain traction. And it is for all of us to make the most of this in the coming few years.

 

Time for a 'reset' in bank thinking - Luc Vantomme, Head of Product Innovation

Luc Vantomme

Luc Vantomme

Luc is Managing Director and Global Head of Innovation for the Euroclear group and a member of the Group Extended Management Committee.

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