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