Business Model Analysis in a Time of Continued Stakeholder Scrutiny
Philip Leech, Senior Manager, Risk Advisory, Deloitte
For many of us, the beginning of a new year triggers a period of reflection which prompts us to take stock of our successes and failures from the previous year. It stimulates the setting of new objectives and the development of ambitions and aspirations as we ponder the year to come.
As banks in Ireland and across Europe reflect on their performance and consider any necessary strategic changes, they’ll recognise a familiar set of persistent profitability challenges impacting their business model which they will again need to navigate in 2018. In this context, and with the dawning of a new year, Boards and Senior Management teams should be spending time:
- preparing for the assessment of the viability and sustainability of their business models by regulators and investors in light of the on-going challenging environment; and
- analysing their business models to ensure they are maximising shareholder value.
At the top of the agenda for many banks will be Business Model Analysis (BMA), a cornerstone of the Supervisory Review and Evaluation Process (SREP) for banks and an area of increased stakeholder focus for all financial services firms.
In this article, we consider two key drivers incentivising and forcing increased focus from financial services firms around Business Model Analysis. In addition, we outline how institutions can prepare for the assessment of their business model by others and highlight a number of factors firms should consider when analysing their business model. While the focus of this article primarily relates to banks, the issues discussed translate to other sectors in many cases.
Two key drivers incentivising firms to actively review and assess their approach to BMA are:
- increased regulatory scrutiny (BMA assessment undertaken as part of the Supervisory Review and Evaluation Process); and
- the need to maximise shareholder value in challenging market conditions.
Define your approach to assessing your business model
From a banking perspective, the European Central Bank (ECB) continues to assess business models and profitability challenges faced by banks and has identified the area as one of its key priority areas for 20181. The regulator will complete its two year thematic review into the viability and sustainability of business models in early 2018 and Irish banks will inevitably see themselves benchmarked against peers across Europe. The ECB’s focus is not just on Significant Institutions (SIs), with a number of Less Significant Institutions (LSIs) being asked in 2017 to provide the SSM with data on profitability forecasts (124 LSIs were included in the information request).2
Despite the ECB’s assessment of business models accounting for a quarter of the overall SREP ‘score’, many banks are concerned by a lack of transparency in relation to the SREP process and uncertainty in relation to BMA.3 Regulatory expectations around this area are not yet clear and ‘good practice’ around firms’ business models is yet to be defined by regulators.
Those who aim to be strategic about regulatory engagement should consider being proactive in outlining that they have in place a robust approach to analysing their business model. Firms can benefit from defining how they approach the analysis of vulnerabilities and how this informs strategic decision-making. An overarching BMA framework helps banks illustrate that they are forward thinking in this area by defining how:
- the firm’s business model is analysed (use of peer analysis, assessment of vulnerabilities and threats, particularly from disruptive competitors);
- the analysis of their business model is integrated with other key processes (ICAAPs/ILAAPs/Stress Testing, Recovery Plans); and
- the firm embeds the outputs of this analysis into strategic decision making.
How Irish firms can tackle Business Model Analysis
The list of continued profitability challenges facing Irish firms – the prolonged low interest rate environment, ongoing Non-Performing Loans (NPLs) issues, conduct issues, disruptive competitors and increasing regulatory complexity – goes on and on. Irish firms should ensure that they are actively analysing how the above challenges continue to impact their business model and what processes they can put in place to help them combat long term profitability issues which these raise.
In order to ensure a robust assessment of their business model, firms should consider whether their BMA processes focuses on a number of critical factors:
- Management Information: the quality of the information supporting Board and Senior Management team strategic decision making (e.g. risk-adjusted profitability metrics);
- Modelling Capabilities: the level of sophistication of their balance sheet management capabilities (e.g. strategic balance sheet management capabilities, comprehensive Funds Transfer Pricing);
- Innovation/Technology: the analysis of vulnerabilities and opportunities posed by technology and how these impact the business model (efficiencies from investment in system developments, acquisition of innovative and dynamic competitors etc.);
- Flexibility: business model flexibility and the ability to adapt to changing external conditions based on information resulting from their analysis.
In summary, BMA continues to be an important aspect at the forefront of firms, regulators and investor minds.
- Both SI and LSIs will be subjected to ongoing assessment of their business models by regulators over the coming year.
- In order to position themselves well, firms should define their approach to how they analyse their own model.
- The analysis should ensure the integration of outputs from key financial, risk and strategic planning processes to assess their business model (particularly its vulnerabilities), which in turn should strongly inform the institutions strategic decision-making.
- There are a number of key factors that firms should focus on in their analysis, including Management Information, modelling capabilities, innovation/technology and flexibility.
3 The 2017 Deloitte Banking Union Survey https://www2.deloitte.com/ie/en/pages/financial-services/articles/gx-deloitte-banking-union-supervision-survey.html
This article first appeared in Finance Dublin