Why Banks Need To Simplify: A Business Case

By David Maya and Til Schuermann.
This article first appeared on American Banker on September 11, 2018.

Although it seems like a distant memory now, the forced bankruptcy filing of the giant investment bank Lehman Brothers over one perilous weekend in September 2008 set off the worst financial crisis since the Great Depression.

The good news is that banks are far better capitalized today. The bad news is that their awkward response to the dizzying array of new regulations imposed on them since the crisis has left many looking like lumbering public utilities rather than savvy, nimble stewards of capital. While banks, like utilities, can still make a healthy profit in a heavily regulated environment — and many are — neither is generating significant returns on their capital.

To get back to full health, banks need to simplify — radically. They must completely overhaul the way they make decisions, organize themselves, serve customers and pay employees. The ones that pull off the biggest transformations will be poised to generate strong shareholder returns for the first time in years. Those that make the least effort will likely keep limping along

The cost of shoring up banks over the last decade has been enormous. The Federal Reserve noted recently that the 35 largest banks in the United States, representing about 90% of the U.S. banking system by assets, have added about $800 billion in capital since the crisis a decade ago.

Is that enough to keep them safe? Consider this: Our analysis of the most recent stress test shows that these banks had more capital on their books after the stress scenario than nearly the entire U.S. banking system had before the 2008 financial crisis.

The problem is that their bulging coffers of idle cash are weighing on shareholder returns, which have tumbled from an average of roughly 18% for the five largest U.S. banks from 1999 through 2007 to about 7% since the crisis. Banks’ price-to-book ratio, well over two before the crisis, now hovers around one.

This is forcing banks to choose a path. One unappealing option is to reconcile themselves to slow growth, investor apathy and talent drain for years to come. Another is to break themselves up into smaller, more specialized institutions — extreme makeovers that would be difficult to execute and could cause unintended disruptions to the global financial system.

A more realistic approach is to learn to act like smaller, simpler institutions while maintaining the advantages of size. To meet today’s challenges, leading global banks are learning they must change how they run their businesses in fundamental ways.

First, they need to change their approach to making strategic decisions. Static planning must give way to decisions based on dynamic, scenario-based analytics that integrate the impact of one business’s actions on all of the regulatory and economic constraints the entire enterprise faces.

Banks that have started to take this approach can now forecast financials or run strategic analyses that used to take months to pull together in less than 24 hours. They can identify potential areas of weakness in their strategic plans and adjust accordingly. And they can make decisions based on key metrics across multiple businesses rather than the “gut feel” of individual executives.

Banks also need to rethink and rationalize their legal-entity structures. Their unwieldy global organizations — the result of operating in dozens or hundreds of countries and jurisdictions — diminish the scale advantages large institutions are supposed to have by making it far costlier to manage scarce resources across these entities.

Likewise, today’s banks need to change the way employees collaborate and make decisions. The key is to be multidisciplinary, with deep integration and shared goals and governance across their various business and functional lines. This means collaboration to a degree that wasn’t necessary in simpler times.

Products need a reboot as well. Most financial services products, whether checking accounts or complex capital markets derivatives, were designed decades ago and haven’t changed much until recently — and even then, only slightly. Yet there has been a sea change in digital technologies, providing enormous opportunity to simplify the design and delivery of these products in ways few could have imagined even five years ago.

While many institutions have been aggressively using automation and digitization for their back-office operations to provide such services and save costs, most still aren’t applying these new technologies to product design and client service functions to the extent they could.

In the same way that Google is no longer a simple search engine, banks no longer can simply be providers of deposits, transfers and loans. Instead, they should build on their data assets and positions of trust to provide highly customized products and services that improve their individual clients’ daily financial lives and meet a much broader swath of companies’ financial needs.

Finally, banks need new incentive structures for workers — without which few of their other changes will stick. Many global banks have conflicting objectives for their executive ranks and fuzzy linkages between the metrics for rank-and-file staff and a company’s aspirations. They need to align employee incentives with their institution’s broad strategic objectives as well as between the C-suite and the rest of the organization. They can do that by structuring their compensation around simpler, clearer and fewer metrics that better balance the performance of each individual with his or her business unit and the institution as a whole.

If banks hope to improve their returns, capture growth and ensure they are part of a stronger and more resilient global financial system, they must become dramatically nimbler. The time to do it is now, when the U.S. economy is expanding and interest rates are rising — especially since the hard work of complying with the raft of new regulations is largely in the rear-view mirror.