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A new dawn? Restoring profitability while rebuilding capital

Read more about Accenture’s study on how financial institutions can restore profitability while also taking care of ring-fencing parts of their business.

Overview

Universal banks need to find ways to mitigate the costs of regulatory developments, particularly for non-ring-fenced operations, while identifying opportunities to restore profitability by increasing existing revenue streams or generating new ones.

The years since the global financial crisis have seen an emergence of a complex web of new bank solvency regulations. With implementation scheduled for 2019, the ICB’s proposals may seem way off, however, with the changes it envisages so profound and pervasive, banks should start considering the impacts as a matter of urgency. Those that hit the ground running now will have a head start in the future race for differentiation in an even more constrained capital environment.

Background
The proposal from the Independent Commission on Banking (ICB) on loss absorbency will intensify already strong regulatory pressures on banks’ capital, liquidity, funding and leverage. Also, the introduction of ring-fencing will make it even more difficult to manage these tasks by requiring universal banks to address them separately for the ring-fenced and non-ring-fenced operations. The overall impact will be to raise the cost of doing business even more, while simultaneously restricting banks’ opportunities to pursue revenue growth.

Analysis

As banks look to prepare for changes by building the right level of capital adequacy and optimise their ring-fences, they are likely to have four immediate priorities.

  1. Raising capital: In the past the Treasury used other group divisions to raise capital, it will now be more difficult to achieve. Asset sales may also be useful for raising capital.

  2. Retain earnings: The options include paying a lower or no dividend, reducing operational costs and generating higher revenues by boosting sales and/or prices. Cutting bonuses is another option and is looked at more by politicians, regulators and activist investors.

  3. Cut down risk: Banks may need to identify core assets and sell off others, reducing the size of the balance sheet.

  4. Change the business model: This is the most radical of the four priorities. Banks can change their business model by identifying the loss absorbency implications on both sides of the ring-fence.

Recommendations

In Accenture’s view, the key to reducing the cost implications of the ICB’s proposals lie in understanding the cost of capital for serving clients and pricing correctly, managing real weighted assets to maximise risk adjusted returns and ensuring that operations are underpinned by an efficient cost base. This can be achieved in four steps:

  1. Analyse the implications of the ring-fence to determine the new business model, products and services.

  2. Understand cost-of-capital to develop a profitable pricing strategy.

  3. Focus on efficiency; manage real weight assets to mitigate capital costs where possible and drive operational realignment to reduce operating costs.

  4. Identify growth opportunities.