Banks told to go for radical rethink

Reuters: Banks need a radical overhaul to boost profitability against the backdrop of tougher new rules and a grim economy – and they expect their customers to share some of the pain.

That is the view of bankers, investors and regulators meeting in Copenhagen this week to assess how banks need to adapt to meet new regulations that require them to hold more capital and to cope with the deepening euro zone debt crisis.

“Let’s not waste a good crisis. Banks really need to focus on being quite radical in what they do,” Allied Irish Banks Chairman and a former senior banker at HSBC David Hodgkinson said on Friday.

“It is easier to do things when times are tough than when you are in good times.”

Bank bosses have been rethinking their business models since the global financial crisis erupted almost five years ago. However, many are now stepping up efforts as their return on equity (RoE), a key financial yardstick, is below their cost of capital.

Bankers at this week’s meeting of the Institute of International Finance (IIF) were in little doubt that business models need to change further. But they also expected customers to share the pain in the form of higher prices.

“The economy and customers will take the real hit. It’s our institutions, the economies and our families that will pay the price over the next few years,” said consultancy Promontory Financial Group CEO Eugene Ludwig.

Canada’s Scotiabank CEO Rick Waugh said: “There is no doubt that with all the regulation, risk-based adjusted return on capital for a lot of products and services are underpriced and so the costs will go up.”

He said the rise could be 0.25 to 1 percentage point.

It is already being seen. “There is a scarcity of balance sheet out there and we are seeing it reflected in the prices that corporates have to pay,” said Jes Staley, head of investment banking at J.P. Morgan.

There appears little prospect of a return to bumper RoE levels seen in the decade before the crisis. Average RoE for top investment banks is likely to fall to about 7 per cent from 20 per cent due to regulatory reforms, although mitigating action should lift it back up to about 11 or 12 per cent, according to analysis by McKinsey. J.P. Morgan’s Staley estimated the average cost of capital for investment banks is near 12 per cent. Cutting costs, improving risk management, taking advantage of technological change and selling more products to existing borrowers should lift returns for successful firms, bankers said, although they admitted there were few quick fixes. “What do we do to get a banking model that returns profit higher than the cost of capital? That equation is still pretty unknown...and banks are struggling to do that,” said Swedish bank Nordea CEO Christian Clausen.