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23 April 2013Robert Mancini
Bank revenue is the hot topic today. How are banks performing in spite of the regulatory costs imposed on their business model? More importantly, what does the future look like? Let’s start with current events and performance. The press headlines these days reflect a poor performance from US banks in terms of revenue and performance. Examples include a decline in profit from Bancorp South, Bank of America, Bank of Hawaii, BNY Mellon, Capital One, Fifth Third, Huntington, JP Morgan, Sun Trust, and Wells Fargo. However, a few banks have demonstrated a better performance such as City National, and Zions. Many of these banks are attributing their poor performance due to the housing loans. There is another important element. Banks have been spending more on regulation and these costs are impacting the bottom line. According to the Federal Register, Dodd-Frank alone has imposed $14.2 billion in direct compliance costs since its passage and will require 25,679 full-time employees to file 51.2 million hours of paperwork annually (as of Q3 2012). In the global arena, some of the largest commercial banks are pulling out of high growth markets in the Middle East and certain regions in Asia. This appears to be in response to the tightening regulatory rules on anti-money laundering and will contribute to further declines in revenue. So what does the future hold for bank financial performance? Let’s be clear on one point – cost of compliance to regulations is not going away anytime soon. With Basel III, this has impact to all large banks (over $50 billion in assets) beyond the US marketplace. The regulatory implications will likely require banks to invest heavily in technology to meet the dynamic reporting demands. In sum, cost will go up for banks. It’s really a simple formula – Profit is equal to Revenue minus Expense. So banks will need to find a way to boost revenue. This is easier said than done. The regulatory implications expect to cause lower revenue. According to a Standard & Poor’s report last year, “The Dodd-Frank Act could reduce pre-tax earnings for the eight large, complex banks by a total of $22 billion to $34 billion annually – higher than our previous estimate of $19.5 billion to $26 billion”. So what should banks do to get better performance? At the end of the day, businesses need banks and their services. Banks have been successful at selling deeper into the client value proposition – although there is competition from non-banks. Banks need to continue on this trajectory if they want to be successful. Instead of cutting costs across the board, they need to invest in new products and services. This does not limit bank options to product development. There are other ways to get there. For instance, banks can leverage partnerships (domestic and foreign) for market and vertical expansion. We have seen lots of activity in the press around bank M&A. My question is “why aren’t banks buying non-banks?” Banks should be buying technology firms, firms to augment distribution of their products (e.g. small business solutions), etc.. You don’t even need to buy the firm; you can conduct a joint venture. It’s okay for banks to try something new and different. Banks will need to change their traditional ways of doing business and act slightly more entrepreneurial. It’s not like they need to bet the bank away. We did see some of this many years ago when a few leading US banks bought firms in the payments and healthcare space to penetrate that market. The results were not fantastic. It doesn’t mean they should give up. How will the economy be impacted by these events in the financial sector? There are two sides of the answer. The taxpayers will be less at risk for another systematic risk to bail out banks. This is the good news. However, there will be a price to pay (rightfully or wrongfully). According to a report published by Oliver Wyman last year, “The Volker Rule cost American businesses up to $315 billion, increase borrowing costs by up to $43 billion per year, require 6,600,000 hours of implementation, dramatically which reduces liquidity”. I think that Small Business will be hardest hit. The smaller banks, those that are over $50 billion but still regional, will need to abide by the same liquidity regulatory requirements as the biggest global banks. This will translate to less lending to small businesses and have downstream effects on the economy.