Financial Services: The day after tomorrow

BANGALORE: The global financial landscape has reshaped significantly, states a new PwC paper, “The Day after Tomorrow’’, released this week. The paper analyses the emerging themes and new models as the fallout from the credit crisis continues and financial services (FS) providers grapple with a new environment.

According to the PwC paper, a distinguishing feature of the new landscape is an accelerated shift of economic power towards the East; a simpler more transparent form of banking based on a more classic banking model; Governments “inside the tent’’, raising significant conflicts of interest; a stricter governance structure based on national and international regulation and the need for sustainable business models that move financial institutions from survival to longer term strategies.

Commenting on the new financial services world order, Jeremy Scott, global financial services chairman, PricewaterhouseCoopers, said: “Financial transformation of this kind is unprecedented and as the financial crisis has developed it has become clear that the only thing you can expect is the unexpected.  Consequently, old ways of working may no longer apply in some instances and wholesale change across the sector can be predicted.  The interdependency of the global markets combined with the vast array of stakeholders: Government, regulators, management and shareholders with interests in returning to less volatile times, make it ever more vital that action to deal with uncertainty is taken.”

Key findings include:

Shift in global power towards the East

The shift of financial power from the West to the East has accelerated. The credit crunch has burst the asset bubble predicated on the investment flows generated by the macroeconomic imbalances in a US-centric global economy. The new patterns of world trade and investment that emerge from this fundamental rebalancing will look very different from the US-centred system.

According to Nigel Vooght, central cluster (which includes India) FS leader, PricewaterhouseCoopers, “We are moving to a multi-polar world where Western financial centres could be bypassed. Successful globalisation has always followed its customers and therefore banks will follow their customers’ natural trade routes.  As the East invests to protect the natural resources it needs to fuel its economies, the banks will follow this investment.’’

 The Rise of Nouveau Classic banking

A smaller, more tightly regulated banking system and the dominance of the universal banking model will be central features of a new banking landscape. The shadow banking system will largely be dismantled. Banks that relied heavily on capital markets for their liquidity and that were specialist rather than universal are having to restructure.

Jairaj Purandare, India FS Leader, PricewaterhouseCoopers said; Banks will move towards customer acquisitions more innovatively. They will have to be more transparent with products, services, prices, will have to continuously explore ways to augment capital and, more importantly, preserve it. We find it sobering that these themes continue to be important. Banks would need to revisit their cost structures and stick to core banking. Wealth management activities would be repositioned from wealth creation to wealth preservation. More than exotic risk models, a combination of strong corporate governance and adherence to processes would help manages risk better.

Government “inside the tent”

Governments are expected to intervene more heavily in the way the financial system operates, in order to stimulate worldwide economies. This intervention is already evident in the US and UK, with pressure being applied to state-supported banks with respect to re-possessions and foreclosures and SME lending. More conflict should be expected as Governments reflect society’s wishes and exert influence on banks’ governance, tax, dividend policy and compensation. After such a massive bail out, society expects that the banks will adjust their behaviour to reflect the wider public interest and not necessarily shareholder interests.

"In India, the regulator has issued guidelines easing the non performing loan (NPL) norms for some sectors. The regulator has taken many proactive steps to ensure adequate liquidity in the system at an acceptable cost," says Purandare.

The pursuit of “zero-risk” regulation

The fundamental weaknesses in the regulatory regime have been exposed, and material, substantive changes to the regulatory environment will be made. There is recognition that regulatory shortcomings cannot be dealt with on a national basis alone. The G20 has already outlined an Action Plan for Regulatory Reform. However, while establishing one regulatory college would be fraught with conflicts of interest, it is an approach that must be strongly reviewed.

The on-shore sector will have more regulation in more areas. Overall, financial stability will be the primary concern and anything that affects it will be regulated in one form or another. This will be aligned with a greater influence from Government over state-supported banks’ strategies.

According to Charles Ilako, lead partner global FS regulatory practice, PricewaterhouseCoopers,  “The concept of regulatory colleges is not new, but giving more authority to the lead supervisor would strengthen the concept. At the very minimum, the idea of a college of supervisors must be pushed to the limit, with a strong lead supervisor with the mandate to direct local regulators.”

Unprecedented fiscal pressure

Tax implications will be great for Western Governments that will face intense fiscal pressure as the recession and the decline in asset prices both reduce tax revenues. Banks will face a short-term reprieve but, in the longer-term, taxes will have to go up. Given the importance of financial services to the economies of the developed world, it is natural that Governments will seek to tax the sector more heavily.

Punit Shah, India FS tax leader, PricewaterhouseCoopers, said: "Regarding the banking road map of Reserve Bank of India, the regulator has envisaged the opening of M&A activities for the foreign banks in India with effect from April 01, 2009. Similarly, FDI Cap in the insurance sector is proposed to be raised from current 26% to 49 percent. It remains to be seen whether this liberalisation takes place or not in the near future.

It may also be appropriate for the Government to consider extending further tax breaks to the financial institutions to undertake M&A activities to address the current situation.

From survival mode to sustainable strategy

Financial institutions must resist the temptation to become completely reactive at the expense of longer-term considerations. At the same time, they must adjust to the realities of doing business in a world where the interest of multiple stakeholders – Governments and society in general – have become more important.

“To get financial institutions working, a sustainable business model is needed. Most institutions are stuck in survival mode, when their executives need to be taking decisions now on where the business will be in two or three years’ time. My concern is that a lot of organisations won’t address the problem now, which will put them at a competitive disadvantage in the future", concludes Scott.