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Expanding your Margin in the Midst of Regulatory Chaos

To multiply the challenges facing financial institutions, interest rates in the developed world are close to zero.  These rates and quantitative easing have effectively wiped out most cash related income that banks have relied upon in the past.

Basel III
Across the globe, central banks have imposed new capital requirements on financial institutions.  As we know, this was a result of “bail outs” and government takeovers of privately-operated enterprises.  These interventions led to regulation that aimed to build up capital buffers, enhance risk calculations and coverages. The Basel Committee issued the text of Basel III rules on bank capital adequacy and liquidity in December 2010. Endorsed by the G20, “Basel III” aims to raise capital levels and quality standards.

Governments worldwide are reviewing anti-competitive practices of payment networks and issuing banks, which has resulted in the US and EU drafting and implementing legislation to effectively cap the interchange rates that are paid by the merchant banks to issuing banks.  In the US, the Durbin Amendment has been much discussed and recent developments (August 2013) moved the interchange fee for debit transactions from 44 cents to somewhere in the range of 12 cents.  

The EU proposal would cap charges at 0.2 percent of the transaction total for debit transactions and 0.3 percent for credit card transactions. If implemented, this would result in up to six million euros being regulated away from the marketplace. Hungary and Poland currently have interchange fees at 1 percent of the transaction.

Impact on the Banks
These three issues have wiped away revenues and placed limits on aggressive lending.  Margins have been impacted in the following ways:

• Traditionally a bank could profit by charging borrowers for money they lend. With interest rates close to zero, this has been difficult to make profitable.

• A raising of reserve requirements has slowed down loans, so even with smaller margins per loan, banks cannot get the scale they need to meet return on investment hurdles.  Capital must be kept within the bank.

• A solid and growing source of revenue (interchange fees) has been regulated away in Australia, New Zealand, the US and areas of the EU (with more to come).

Strategic Imperative
Banks have to fill the revenue holes that have been regulated away from interchange fees and cannot be filled by interest rate revenues.  It is critically important for the health of the global economy to have a healthy and functioning banking system.  

What Can They Do?
Banks can take an approach to regulation where they can turn compliance into a competitive advantage. The standard view is that regulatory compliance is costly for financial organizations. It requires significant levels of effort, time, staffing and investment. Becoming fully compliant with the latest regulations just preserves the ability to perform business as usual.  Forward-thinking organizations revolutionize the compliance process. They can build repeatable processes and procedures and are able to meet the requirements of the regulation as well as the challenges of the future regulations. 

Look out for more on how banks can take new services to consumers…and generate revenue. 

Expanding your Margin in the Midst of Regulatory Chaos by Paul McMeekin

Payments Expert

ACI Worldwide powers electronic payments for financial institutions, retailers and processors around the world with its broad and integrated suite of electronic payment software.