Banking: The Next Ten Years

A short while ago I was asked, in a private discussion group, what I thought that the main influences on consumer banking might be over the next ten years. This is a question that fits my skill set, but rather than answer the question in a private discussion group, I thought that a more broadcast answer might be appropriate.

As with many futures, it is worth spending a few moments just considering past events. Banking prior to 2007 was described to me, by a chief accountant for a global bank, as a licence to print money. In many ways it was. The sector enjoyed monetary easing, a light touch regulatory regime, and an economy that was more than benign. That all changed with the credit crunch. Banks were unable to ascertain the quality of assets pledged by counter-parties and credit simply dried up. It was then that the party started to go sour.

We now find ourselves in a situation where, although monetary conditions remain eased - possibly more so now than in 2007, the regulatory regime is much different and the economic conditions are far from benign. It is these that will shape consumer banking over the next ten years.

Whilst we can point to a very large number of longer trends that will impact consumer banking, it is helpful to reduce the analysis to a smaller range of very important trends. We have decided to limit ourselves to three key trends that we feel will be pivotal.

1. Trust.

It is wrong to consider money as the stock in trade of banking. The key stock in trade is trust. If I give you my money to look after, I am trusting you to let me have it back when I want it. Events over the last ten years have led to the serious erosion of this trust in the banking system. Bankers are easily characterised as greedy and self seeking people who act only for themselves. This might be an unfair caricature, but there is a grain of truth in it.

It would seem to us that an important objective for banks over the next ten years would be to regain public trust in banks as institutions. Unfortunately, this costs money. Banks are currently moving in the opposite direction. In a scramble to cut costs, they are putting more and more distance between themselves and their customers. They are relying more and more on technology to do the work of bank staff. This is fine when things work well, but when things go wrong, as they do too often in automated systems, customer trust in the bank as an institution is seriously undermined.

Fintech is often proposed as a solution to future banking systems, but an ever greater reliance upon more and more complicated technology places ever greater distance between the bank and it's customers. This does not help to create greater trust in the banking system. It erodes it. As the trend is for a greater reliance upon technology in banking, we could reasonably expect trust to diminish even further over the next ten years. This manifests itself in the public reputation of banking and the willingness of the public to see banks more closely regulated.

2. Regulation.

There are two aspects of regulation that are having an impact on banks - capital adequacy and the licence to operate.

In response to the recent financial crisis, banks are required to hold an increased back stop of capital. This naturally restricts lending. It is often presented as prudential lending - and there is a case for the belief that prior to the financial crisis banks lent to people who were not quite creditworthy - but, nonetheless, it is a form of credit rationing. Anyone currently involved in the property market will attest at the difficulties now experienced in raising a mortgage. There is also likely to be a greater emphasis on the separation of ordinary branch banking and what some have described as the 'casino banking' aspects of investment banking.

The licence to operate acts as a more subtle form of regulation. It limits what banks can and can't do. In recent years, the banking and financial services sector have become the front line in combatting money laundering, anti-terrorist financing, tax evasion, and the movement of the proceeds of crime. This has added a deadweight cost to financial institutions. This is unlikely to change in the next ten years as the emphasis on financial crime continues to grow, and banks become the unpaid agencies of the state.

3. Business Model.

It unfortunately the case that, in an era of ultra-low interest rates, banks are finding it hard to maintain profitability. The spreads between the rates paid to depositors and those charged to lenders are now at the lowest for a very long time, and there is no real prospect of this changing dramatically in the next ten years or so. The spreads on lending are mainly determined by the underlying strength of the economy. Growth is likely to remain elusive over the next ten years, in response to which ultra-low interest rates will continue, thus continuing to exert pressure on bank profitability.

Banks and financial institutions have reacted to this in three ways. First, they have embarked on cost cutting exercises by reducing face-to-face interaction and relying upon technology as an alternative. This is eroding the trust between banks and their customers. Second, they are reducing their coverage through a process of branch closures and by withdrawing from selected areas of operation. Their scope is reducing. Third, banks have been engaged in a process of consolidation. One could argue with certain justification that this is just the rationalisation of a market in which there is over-capacity. This process of rationalisation is likely to continue for some years to come.

If we draw these strands together, what do the next ten years look like? In some respects, the world isn't likely to be too much different from today. We may have a few new technological whizz-bangs rolled out, such as iris recognition or finger-print accessing, but the main customer experience of banking is unlikely to be radically different from today.

It is not hard to see the continued erosion of trust in banks as institutions. They are likely to become more remote from their customer base, who are also likely to be a little bit less brand loyal than they are today. Capital adequacy concerns are likely to restrict the arena of lending, just as further enforcement requirements push up the cost base of banking. The macro-economic environment is unlikely to improve dramatically from where we are today, which means that we can expect the period of ultra-low interest rates to continue. This will squeeze profits further. We could even see another global banking crisis if a moderately large, probably European, bank were to get into difficulties. This future is not exactly rosy.

It is possible, however, to buck the trend. A more interesting question would be one of how, despite all of this, a bank could thrive in this environment? To us, the key to bucking the trend is to reconnect with the customer base. News of a trustworthy bank, that delivers human scale customer service, with a range of affordable products, is likely to do quite well in this environment. We can see some of this in action already today. The mutualised Building Societies, offering a Captain Mainwaring style customer service, are performing quite well. They offer a straightforward range of services, which they deliver at a human scale, and they are rewarded accordingly. In the UK, new and insurgent banks, such as Metro Bank, are following the same path with similar results.

Whilst the overall outlook for consumer banking is not favourable for the next ten years, it is certainly possible that some banks will thrive. The key is to reconnect with their customers, as this is where the trends will resolve themselves.

Stephen Aguilar-Millan

© The European Futures Observatory 2016

Trump's Chinese Puzzle

What is Donald Trump's policy towards East Asia? We can view this thorny question through the twin lenses of trade and security. On the campaign trail, Mr Trump espoused his views on East Asia mainly in terms of trade. He expressed the view that China had gained an unfair advantage over the US through currency manipulation, and that China had stolen jobs from the manufacturing heart of America.

There are grounds to suggest that both of these statements have a grain of truth in them. The Chinese Yuan has been pegged to the US Dollar for many years. It currently enjoys a managed float against the US Dollar, and has helped to maintain a large trade imbalance between the US and China. The Chinese trade surpluses with the US have been largely used to amass holdings in US Federal debt. Mr Trump says that he wishes to take action against this.

In his statements, Mr Trump appears to be a mercantilist at heart. He speaks against trade arrangements with China that he sees as 'unfair', and he feels that American trade partners - mainly located in East Asia - enjoy a situation that is too much to the detriment of the US. This has led him to state that, on his first day of office, he will cancel the participation of the US in the Trans-Pacific Partnership (TPP).

The TPP was an attempt by the US to create a free trade area in the Pacific Rim in it's own image. It would allow America to dominate the conversation on trade well into the twenty-first century. By being such a large part of the TPP, and by making, perhaps, the most concessions on trade, Washington would have created a Pacific economic zone in it's own image, much to it's long term benefit. President Elect Trump is unwilling to pay that price. He, along with the American people, have opted for the short term gain from protectionism.

Cancelling US involvement in TPP, however, also has a number of spin-off effects because TPP is not only about trade. Whilst much can be said against President Obama, his administration does have a firm grasp that trade provides the mortar that binds the building blocks of security. Not only would TPP have established a free trade zone in the Pacific Rim, it would form the modern basis of a security counter-weight against more aggressive Chinese expansionism in the area. Those East Asian countries who are parties or interested parties to TPP must now be wondering exactly how much their security guarantee from the US is worth.

There are two ways of looking at this. From the perspective of China, ought this withdrawal of the US from it's 'Asian Pivot' embolden China in expanding it's influence in the region? From the perspective of the East Asian nations, ought they become more accommodating to an expansionist China and less accommodating to a withdrawing America? There is a good case for both to occur, for China to be encouraged and for the other East Asian nations to be less accommodating to a protectionist US.

This creates Trump's Chinese Puzzle. How can President Trump, when inaugurated, maintain both a protectionist trade stance whilst maintaining the East Asian security guarantee?

Stephen Aguilar-Millan

© The European Futures Observatory 2016

Has Europe Been Trumped?

To say that the election of Donald Trump as President of the USA was unexpected would be something of an understatement. Throughout the long election process - a good 18 months - he was dismissed as a joke candidate with no real hope of winning. And yet, he won. As the President Elect, he is now being taken seriously - perhaps for the first time - as the world tries to work out what President Trump might mean for them. We intend a series of pieces looking at this issue. We start with Europe because Europe has the potential for being the more immediate problem President Trump will face on inauguration in January.

One of the slogans from the Trump campaign in the election was to 'Make America Great Again'. We have to take this as a serious intention of policy, to the degree that a US President can influence the matter, in order to tease out what that might mean in policy terms. If we could assume, for the moment, that making America great again consists of restoring American power and authority in the world, then we are on a firmer footing.

Leaving aside the contentious question as to whether or not there has been a diminution in American power in recent years, we can draw upon models of international power to guide us along the road ahead. Traditionally, a nation is seen to draw power from three pools - military power, economic power, and cultural power. These act together to provide a nation with enough authority to shape events to it's will.

We can set aside the question of cultural power because this takes decades to manifest itself and we are concerned solely with the impact of President Trump for at least one, or possibly two, terms. There is little that a President Trump can do today to have an impact on the cultural power of the USA over his term that is not already under way. President Trump, when inaugurated, will be able to influence American military power and American economic power almost immediately. It is with these two pools of power that we will be primarily concerned. It is over the use of this power that Europe is currently concerned.

As the Trump Presidency commences, Europe is not in a particularly good shape. A number of fissures are starting to emerge in the fabric of Europe. The most obvious one is the decision of the United Kingdom to leave the European Union. At present, nobody quite knows what this means or how it is likely to play out. Or even when it will occur. There are a number of Eurosceptic tests that the EU will face in coming months, starting with the Italian constitutional referendum in December 2016, but also including popular votes in Holland, France, Germany, and Italy in 2017. If the Eurosceptic parties do well in any one of these election, it has the potential to seriously de-rail the European project.

Whilst Euroscepticism may be one fissure, there are two others that need to be accounted for - the economic and the military. The two are linked, but it is more convenient to consider them separately at first. The economic fissure between northern Europe and southern Europe is well documented. Southern Europe is mired in policies of fiscal austerity at a time when fiscal expansion is needed. What draws our attention less is that northern Europe is mired in policies of monetary expansion when policies of monetary contraction are needed. The vulnerability of northern European banking systems - especially those of Germany - at a time of ultra low interest rates is an issue that has the potential to widen the economic fissure even further and has yet to fully run it's course.

In the arena of diplomacy, defence and security, a fissure has started to emerge between the United Kingdom and France on the one hand, and Germany and Brussels on the other. The latter seek to establish a common European framework in this area, whilst the former are adamant that this should be retained at the national level. In some respects, this feeds into the Eurosceptic agenda of resisting the efforts of Brussels to ever extend it's brief, but, more importantly, it extends into the American criticism of Europe over defence in general and NATO in particular.

The goal in NATO is for the member states to spend a minimum of 2% of GDP on defence. In recent years, only four European members of NATO have achieved this goal - the United Kingdom, Estonia, Poland and Greece. The rest of Europe has slacked on their commitments. During his election campaign, Mr Trump called attention to this fact and asked why US taxpayers should pay for the defence of European nations who were not prepared to defend themselves. He suggested a weakening of US resolve to defend Europe.

This potential weakening of the NATO commitment has set off alarms across the continent. Many Europeans consider the possibility of an expansionist Russia as a real prospect. The nations considered to be particularly vulnerable are the Baltic States. Latvia and Lithuania have responded by proposing to raise their defence spending to 2% and 1.5% of GDP respectively. Of the three largest shortfalls in defence spending, Spain (shortfall $US 15.98 billion) and Italy (shortfall $US 18.35 billion) are hemmed in by fiscal austerity. Germany (shortfall $US 30.28 billion) has the fiscal capacity to meet the 2% target, but lacks the political will to do so. If President Trump keeps to his word, then we can expect the US commitment to NATO in Europe to be compromised in the years ahead.

This is a policy bind - to improve the US security commitment to Europe will involve greater defence expenditure on the part of the European nations. Greater defence expenditure will either mean reduced social welfare programmes or a weakening of fiscal austerity. Either case has an unattractive consequence. One way of squaring the circle would be for Europe to find growth again. Since 2010, economic growth in Europe has been quite sluggish. Could this prove an opportunity for President Trump to exercise US economic power?

It is customary to exercise economic power through trade and investment policies. The European Commission and America are currently negotiating such a deal - the Transatlantic Trade and Investment Partnership (TTIP). Even before the election of Donald Trump, TTIP was in trouble on the European side. There are serious reservations about the agreement at the national and regional levels in Europe that question whether European ratification could be achieved. After his inauguration, it is likely that President Trump will not advance TTIP from the American side. The long and the short of it is that Europe can expect little help from American economic power in the immediate future.

So where does that leave us? We can reasonably expect a weakening of European influence on the world stage at a time when the US becomes less engaged in the world, partly as a result of the internal fissures within Europe and partly as the result of a desire in America to become less engaged . It may be that President Trump may not go through with the policies exposed by candidate Trump. It may be demonstrated to him, once in office, that the NATO security blanket may be worth keeping, even if the European partners don't pull their weight, that America's security depends upon the security of the European nations. It may be that President Trump rows back a bit on the rhetoric of candidate Trump over trade with Europe. After all the US and the EU are each others largest trading partners. Prosperity in the US is intrinsically linked to prosperity in Europe. However, in all of this Europe will be on the back foot.

Candidate Trump promised to 'Make America Great Again'. If this lessening of American influence is the result of other nations developing (the 'Rise of the Rest' argument), then one way to achieve this would be to do down other nations. It seems that President Trump will have to do very little to weaken Europe. It is perfectly well doing that of its own accord. All he would have to do is to nudge Europe further along the path it is already upon.

In that sense, Europe has been Trumped.

Stephen Aguilar-Millan

© The European Futures Observatory 2016

How Did We Get To Where We Are?

This has been a shocking year for the Establishment. First, there was the Brexit vote in June. Neither the Establishment in the UK, nor in Europe, could conceive of the impossible - the British public voted to leave the European Union. Now we have the election of President Trump, who had to overcome two sets of established figures - the Patrician Republicans to secure the nomination, and then an established Democratic Washington insider to secure the office. To the urbane liberal elites, their world appears to be ending. But is it?

In many respects, both of these events were relatively predictable, as they represent the convergence of a series of long term trends. Over the past 20 to 30 years, we have seen a huge transfer of wealth in the global economy. The rise of the middle class in Asia - predominantly in India and China - has been at the expense of the stagnation of living standards of the middle class in Europe and North America. For a long while, the middle class in Europe and North America could disguise this stagnation by incurring ever greater levels of household debt to maintain their living standards, but that bubble burst rather abruptly in 2007.

This has had a number of unfortunate consequences. The course of this decade has been to expose the precarious nature of middle class prosperity in Europe and North America. It has been blamed, with a good deal of cause, upon globalisation. It has been exacerbated by the apparent indifference of those who have done well from globalisation in Europe and North America - those characterised and demonised as 'the 1%' - and it has now reached a point where people are angry enough to want to do something about it.

In many respects this was quite foreseeable. Since 2009, policy has been to return the economy back to 'business as usual'. To a very limited degree, this has been successful. However, 'business as usual' cannot deliver the levels of prosperity to placate an angry middle class - a point that is important when we think about going forward. In many communities, the standards of living are still worse than they were in 2006 - a lost decade of reduced living standards. In the face of this, the established political structures seem unable to do anything about it, and electorates are now turning to those who they believe can - the disestablished political fringes.

We are concerned about the future rather than the past, so what does this mean going forward? There are two key uncertainties that we currently face. Will Brexit occur? And will President Trump deliver his campaign promises? We can look at the worlds in which one occurs and the other doesn't, but that isn't entirely interesting. We can look at a world in which neither occurs, but that would imply a continuation of current trends. That might be an exercise worth pursuing as an alternative future.

Or we could look at a world in which Brexit does occur, and where President Trump delivers his campaign speeches. This is the world where we ought to focus our attention at the moment because this is the world in which our expected future appears. We are planning a series of pieces on how this future might unfold in coming weeks.

As always, people want to know immediately how the future might unfold. It is, however, worth taking our time over this. After all, it is not easy to divert a long term trend, which is what Brexit and a Trump Presidency both promise to do.

Stephen Aguilar-Millan

© The European Futures Observatory 2016

We're back!

After a break of some time, we have decided to re-start our futures Blog. We have two sources for out back catalogue:

Our previous Blogger site: http://eufo.blogspot.co.uk/

And our blog page on our web site: http://www.eufo.org/the-futurist-blog

In the coming months, we plan to add content on this blog on a regular basis. Most of the posts will be about global geo-politics and the global economy, which is where our interests lie.

I hope that you enjoy our thoughts, even if you might not agree with them.

Stephen Aguilar-Millan

© The European Futures Observatory 2016