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Maintain Vs. Invest: What the Digital Era Ushers in for Banks

Maintain Vs. Invest

Taking place this week in Brussels, the European Credit Research Institute (ECRI) will host a high-level debate on how policymakers can build on the process of digitalisation of banks to raise competitiveness in light of increased competition from fintech start-ups and tech giants.

Associated primary and secondary research from ECRI brings fresh insight into how the banking sector manages costs while balancing the need to add value to services provided to both retail and corporate customers. Its findings analyse the arguments behind the ‘maintenance verse investment’ debate and the drivers of digitalisation, and provide constructive advice to businesses and regulators to further strengthen the banking sector in Europe.

The research comes at an opportune time as the debate around Europe intensifies. In the latest edition of its twice-yearly Financial Stability Review (Nov 2017), the ECB noted that banks’ solvency and profitability had improved, but still showed a “wide gap” with global peers; and that banks need to follow the examples of Scandinavian rivals by cutting costs and embracing digitalisation. “The big difference between Scandinavian banks and those in the rest of Europe is low costs,” Vítor Constâncio, ECB Vice President said in an interview with the Financial Times.


A Need for Structural Change

Calls for structural change in the European banking sector come at a time when US counterparts may see an easing of fiscal rules and capital requirements. With the added pressures of regulatory burden brought about by PSD2, Capital requirements, GDPR etc., innovation in the EU could slow, as the easy gains have already been made and global competitiveness has been hampered. Competitiveness of EU banks needs to be strengthened with the right incentives provided for developing the most up-to-date services to customers.

EU regulators are working on a revised Capital Requirements Directive (V) and Capital Requirements Regulation (II), which could be an opportunity to reconsider the role of expenses on digital elements in the calculation of capital ratios. The exclusion of software expenses for certain priority areas could be a powerful means for national supervisors to prioritise digital expenses where these are most needed.


Impact of Digitalisation on Costs

Identifying, measuring and allocating costs have become much more complex for banks. The emergence of hybrid models combining online and offline channels indicates that new cost drivers need to be developed and that these costs are adequately allocated to cost pools and cost objects. Legacy issues also add to the complexity of developing efficient cost systems. Most banks still use different methodologies, multiple and conflicting taxonomies, product hierarchies and accounting processes, varying definitions for many of the same terms and disparate cost allocation systems.

Although it is still too early to assess the full impact of the recent digital investment made by large banks on the costs and values of retail finance and corporate finance, specific trends can already be detected.

Adoption of real-time payments in consumer finance and the eCommerce space is strong as both require a high level of fidelity and customer loyalty to remain competitive. However, getting to a real-time footing for banks from an analogue world raises many technical questions especially on the extent of TPP integration that should be catered for. For example, ERP, CRM and accounting systems are beginning to be integrated into B2B services offered by some US banks. By broadening services and building trust in this way, financial institutions can consolidate the bond between customer and suppliers with the banking sector retaining the middle ground as the integrator and guarantor of identity, settlement and finality. Essentially, everything a bank does should start and end with the customer.

The gradual digital transformation of corporate finance and retail finance brings both opportunities and risks. Regulators should enhance these opportunities, while addressing the risks by promoting specific practices for both banks and regulatory/supervisory bodies. The generalization of such practices should ensure a balanced digital transformation and improve the overall quality of the banking system.


Read more about the digitalization of banks in the research report, “Cost and Value in Banks,” from the European Credit Research Institute