EMEA Banking Spotlight, Edition 9

In this edition of EMEA Banking Spotlight we focus on emerging risks and challenges that banks are facing – as well as outlining ways to overcome them.

First up we look at LIBOR transition, finding that two years on from the FCA’s announcement about the future of the rate there is still a lot of work for banks to do. With 2021 fast approaching, the clock is ticking.

Next, we look at operational resilience – a fundamentally different process to traditional business continuity (BC) and disaster recovery (DR). We argue that in today’s disruptive business landscape operational resilience needs to move up the agenda.      

For wealth managers, meanwhile, our annual analysis found that global high-net worth (HNW) wealth growth slowed to 4 percent in 2018. To overcome this, wealth managers need to rethink their footprint in Emerging Markets, as well as simplify their operating models.

Finally, we take a look at bad behavior in banking, arguing that in most instances a firm’s culture is the source of the problem – not just its people. To sidestep these issues, financial institutions need to create a culture by design rather than default.

Why It’s Time To Accelerate LIBOR Transition

It is almost two years since Andrew Bailey, CEO of the Financial Conduct Authority (FCA), announced that the FCA would not compel panel banks to submit to LIBOR beyond 2021. While progress has been made for the transition since then, there is still much to do for banks.

Our new report on the LIBOR transition argues that while banks with large LIBOR-based exposures have used the time since the FCA’s announcement to assess their exposure, develop transition plans, and begin moving certain new transactions to Risk Free Rates (RFRs), additional risks and complexities have also emerged.

Progress has been held back by uncertainties around where and whether term RFRs or alternative credit sensitive benchmarks will be available. Smaller banks with less exposure appear to be planning to rely predominantly on the existing fallback clauses in contracts to bring about the transition away from LIBOR – an approach which regulators have advised against.

Activity now needs to shift from fallbacks to new product development and transition. As a result, banks should develop loan products based on RFRs. In the near-term, backward looking RFRs are the only available option and adjustments to interest observation periods may be required to give advance visibility on cashflows and mitigate systems.

Preparations for transition of legacy transactions should also accelerate. Different impacts across different products within a single customer relationship will require integrated data and analytics and a consistent playbook for re-negotiation, which will take time to develop due to the complexity of bank systems and organisations

The Need For Operational Resilience

Increasing complexity in processes and IT, dependence on third parties, data sharing, and sophistication of malicious actors have made disruptions at banks more likely than ever before – and their impact more severe.

It’s no surprise, then, that operational resilience has become a key agenda item for boards and senior management. As our paper Striving For Operational Resilience outlines, resilience is fundamentally different from traditional business continuity (BC) and disaster recovery (DR). These have historically been heavily focused on physical events, were designed and tested in organizational silos and are, by most institutions, primarily viewed as a compliance exercise.

Operational resilience, instead, focuses on the adaptability to emerging threats, the dependencies and requirements for providing critical business services end-to-end (crossing organizational silos), and the broader economic as well as firm-specific impact of adverse operational events. 

Exhibit 1: Key Characteristics Of Operational Resilience

It requires a mindset shift in the organization away from resilience as a compliance exercise to resilience as a key organizational capability that is everyone’s responsibility to maintain and improve.

Financial regulators have started to stipulate expectations around management of resilience, resilience reporting, and effective oversight. In response, many institutions are embarking or will need to embark on transformational programs to strengthen their resilience to disruption, incidents, and attacks.

Achieving operational resilience is inherently challenging given the increasing complexity of processes, technology infrastructure, and organizational silos. But the business benefits are beyond risk and compliance, often forming part of a firm’s value proposition.

Searching For Growth In Wealth Management

The latest edition of our annual analysis of the wealth management industry has found that as wealth managers faced growing headwinds in 2018 global high-net worth (HNW) wealth growth slowed to 4 percent.

Exhibit 2: Global private HNW wealth by major region 

Note: HNW wealth is measured across households with financial assets greater or equal to US$ 1 million. Financial assets include investable assets (deposits, equities, bonds, mutual funds and alternatives), excluding assets held in insurance policies, pensions and direct real estate or any other real assets. Numbers exclude the effect of currency fluctuations.

Source: Oliver Wyman Wealth Management model

As a result of lower AuM growth – as well as more challenging markets and continued fee compression – wealth management business valuations also declined, with the revenue pressure felt by the industry late last year highlighting the continued vulnerability of operating models to market stress. And although the rebound earlier this year brought short-term relief for some, further pressure is inevitable as the end of the cycle approaches.

With this in mind, wealth managers need to take action now. Our report outlines two key priorities for them to consider. Firstly, they need to rethink their footprint in Emerging Markets, which will constitute over half of global wealth growth, with APAC and LatAm particularly important. Secondly, they should simplify the operating model and demonstrate their ability to prepare for an approaching downturn. This can be achieved by simplifying their front-office operations and getting into the driver’s seat for allocated costs.

Achieving success in both areas will be the single most important factor in determining future winners and losers for the industry.

Bad Banking Behavior: A Cultural Problem

The financial services industry has suffered a string of conduct and culture failures over the past decade. And the damage caused has been tremendous with fines and lawsuits, management time diverted away from business growth, and a loss of customer trust.

Our article Broken Systems Beget Bad Behavior argues that corporate scandals within and outside the industry share several common elements — structural failings that created cultural breakdowns and, ultimately, led to misbehavior. In short, the problem isn’t the people, it’s the culture.

Fear can also be a strong driver of behavior. Left unchecked, toxic subcultures fueled by fear can lead to undesirable behavior across an enterprise. This can include fear of losing one’s job, fear of not fitting in, fear of retribution, fear of disappointing one’s manager, fear of failure and so on.

Meanwhile, some organizations underestimate the importance of strong middle managers. In many large organizations, the only way to reward outperformance — and get people pay raises — is to promote them to the managerial ranks, regardless of their ability or desire to lead, inspire or develop others.

Firms that are beset by these problems are creating the perfect conditions for misbehavior. But financial institutions and others can sidestep them by creating a culture by design rather than by default.

The companies that prioritize these elements are likely to stay out of the headlines for conduct failures, and will continue nurturing client relationships during a period of intense competition and technological change.