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Chief Digital Officer –Vorstand at Sparkasse Bremen
Why Does the World Still Need Banks?
We see an interesting phenomenon unfolding in the banking world in Germany (and more widely, Europe): The long-term underlying trend of accelerating change, now made more complex by sudden increase in volatility, at a time bank balance sheets are especially vulnerable.
Accelerating Change Leads to Little Change
The last decade has seen a massive change in the competitive environment for banks: new technologies that enable new competitors and products on an almost weekly basis; easy funding leading to a mushrooming of fintechs, insurtechs, and proptechs; the big techs increasingly encroaching into the financial services world; the eroding of traditional business models as customers get more choices.
This challenging new world was complicated further by the reluctance of banks and banking regulators alike to really embrace the change. The lack of bold visions, an alarming disregard for changing customer needs, slow and cumbersome processes, and an inflated and sticky cost base made the change difficult.
Obviously, the pain was not intense enough to drive real change in the business models. There was a lot of window dressing about customer centricity, digitisation, automation, and a lot of announced investments, fintech partnerships, and corporate ventures, but ultimately most of them remained at the edges of the core business.
Interesting Interest Rates
For years, banks in Germany have been complaining about the low interest rates. For commercial banks, which generate a significant portion of their revenues through interest─ in many cases, up to 90 percent ─ this was, of course, a difficult period.
At the same time, the credit defaults were at all-time record lows, and the central banks compensated the missing interest revenues by dropping their interest rates (which reduced and wildly simplified the interest costs for banks).
The portfolio effect made the pain much more bearable: If every mortgage has a period of say, 10 years (the commonest in Germany), then in a portfolio, 10 percent of the newer, lower interest rates substitute the older, higher ones every year─ giving the banks ample opportunity to adjust or to remain complacent.
Change Vs Volatility
The real killer for most bank balance sheets, however, are not low interest rates, or─ in the short term ─ even business model disruption, but high volatility, unless you are a trading house in the business of volatility.
Volatility causes asset values to drop (reflecting higher risk) or at least to fluctuate wildly and in a system with an expensive legacy pension system, the liabilities (or latent liabilities) tend to increase.
Change, even accelerating change, following a long-term trend is much easier to cope with than wild swings. The last years were characterised by a unidirectional change towards more individualisation, digitisation, and automation, with given unknowables like which exact players would disrupt which products, services, and business models.
That suddenly changed for the worse the day Russia marched into the Ukraine.
Mortgage Interest rates jumped within 3 months from 0.7 percent to 3.5 percent, inflation went from below 2 percent to above 8 percent, energy prices, depending on your mix, by up to 100 percent or even more.
Volatility causes asset values to drop (reflecting higher risk) or at least to fluctuate wildly and in a system with an expensive legacy pension system, the liabilities (or latent liabilities) tend to increase
A False Breather?
As a side effect of the happenings of the past few months, fintech fundings dried up almost overnight and a long due consolidation and clean-up wave began.
At the same time, rising interest rate have begun to show first positive impacts on bank P&Ls, especially since interest costs for banks lag behind. The negative impacts on credits usually take many quarters to unfold: so the risk cost scenario still looks good in the short term.
All this gives the incumbents some much needed breathing space, but carries with it the risk of complacency and a lessening sense of urgency, which might be more dangerous in the long run.
Add that to a potential explosion in credit defaults and inflation in banks‘ own P&L, and the situation is ripe for a crisis which might exceed Lehman and the DotCom blowup.
Call to Action
An analysis like this, by definition, describes a scenario which might come to pass, or not. It certainly is one possible outcome. The existential risk it poses to banks should be enough to make us banks squirm in our seats and lay awake at night.
What can we do?
The answer would be different for every bank, based on the deeper questions:
Why do we exist as the bank we are? What is our DNA? How do we really create value for our customers? Is this enough to stay relevant for our customers in the future?
The answers would probably lead to a very intensive scrutiny of almost all banking business models. The alternative is the rather simple question: Why does the world still need banks?
