A focus on your business model and strategy

A focus on business model and strategy

The SSM’s focus on Business Model Analysis (BMA) comes about as a result sluggish ROE and therefore compromised sustainability of a number of European banks.

This is reflected in data provided by the ECB on European banks, as cited from a recent ECB publication. The data suggests that banks expect profitability to improve gradually after 2017, with the aggregate RoE reaching 7.4% in 2019 against 3.4% realised RoE in 2016. However, only 25% of these banks expect to reach at least 8% RoE by that time.

Business model and profitability risk has been identified as the top supervisory priority by the ECB’s Single Supervisory Mechanism (SSM). The core supervisory tool for assessing this area is BMA, one of the four elements of the SREP methodology.

The primary objective of BMA is to assess whether a bank is able to generate adequate profitability in the medium-to-long term (1-3 years), and therefore whether their business model is sustainable. BMA supervision will focus on a bank’s key vulnerabilities, which if left unresolved could lead to its failure.

Challenges facing the banking industry

Traditional business models are constantly being rivalled by disrupters. Key risks and challenges facing banks are set out below:

• Technological advancements. In order to remain competitive banks should adjust their business models, especially with the influx of financial technology firms (fintechs) and technologies such as blockchain gaining momentum. Customer expectations have and continue to evolve due to the onset of mobile technology, social media and e-commerce, making them more demanding with a desire to be served instantly.
• Low interest rate environment. The prolonged low interest rate environment has proven to be challenging for a number of banks across Europe, particularly those reliant on net interest income. In an attempt to return to pre-crisis profitability levels, banks have been forced to find innovative ways of becoming cost-efficient. Furthermore, regulators are concerned that in their ‘search for yield’ banks are moving into higher risk asset classes, such as leveraged finance, that may threaten their resilience.
• Non-Performing Loans (NPLs). Post-financial crisis, the level of NPLs across Europe has remained significantly higher than countries such as the US and Japan, causing a drag on both profitability and credit growth. In an attempt to reduce the level of NPLs, the SSM launched an initiative requiring high-NPL banks to submit a NPL strategy.
• Money laundering risks. In recent years the regulatory framework around anti-money laundering and the countering of terrorism financing has been enhanced. In addition to ensuring that procedures and monitoring systems are fully compliant with AML regulation, banks must also look to defend the sustainability of their correspondent banking relationships which are being threatened by the perceived increase in money laundering risk.
• Regulatory developments. The sophisticated regulatory regime, as well as upcoming regulatory developments such as Basel IV, puts additional pressure on banks. Keeping up to date with regulatory developments is challenging, and furthermore, compliance generally requires adjustments to business models and governance set-ups. Trump’s proposed deregulation also creates uncertainty on the predictability of future European regulatory developments.

Critical business model success factors

In this challenging era of banking, what can banks do to remain competitive and continue to earn adequate profitability year-on-year?

Amidst gloomy profitability prospects there lie constant outperformers, which have consistently recorded healthy RoE results for the past 3 years. While there is no singular feature that differentiates these outperformers, one can observe some common critical success factors (CSFs).

Optimising balance sheet management and funding mix.

• Higher operating efficiency and tighter cost/income ratios can be achieved through better balance sheet management.
• Banks need to be strategic about their funding base, particularly in a low interest rate environment. A bank’s business strategy should place much emphasis on funds transfer pricing.
• NPL optimisation is also core to good balance sheet management. NPL optimisation implies that banks need to be strategic in the design of lending products, (i.e. to ensure lending products are tailored to their customers’ repayment ability), in applying robust sanctioning processes, and in ongoing credit monitoring and granting of forbearance.

Mitigating cyber risk

• Banks should ensure that they are cyber resilient, and have the appropriate risk management procedures in place to withstand cyber-attacks.

Bolstering data quality

• Banks require high-quality data in order to ensure effective risk management and decision-making. Outdated legacy systems and poor data governance models are common across the banking sector, and they hinder access to accurate, consistent and appropriate data. Replacement and upgrades of legacy core banking systems continues to be a strategic priority for many banks.

Investing in the right people

• Some banks have found themselves searching for talent in advanced analytics and new technologies such as blockchain and customer experience design. These people are needed to avoid not keeping up with a fast paced financial services landscape.
• Risk and finance professionals are also very much in demand, and banks are having to invest a lot to bring the right individuals on board.
• On the other hand the surge towards new technology digitising bank processes continues, and some roles are slowly becoming obsolete. Banks therefore need to align their HR strategy to bring in the right people at the right time.

Ensuring a better customer experience

• The main driver of this is the new digital age. Re-engineering processes and customer interfaces should be done with the customers’ perspective in mind. Some factors to consider are service channel ease of access, efficient payment applications which should be PSD 2 compliant, product value for money and good online and face-to-face customer service.

Many banks are adopting the strategy of partnering with fintechs, utilising Application Programming Interfaces (APIs), and third party vendors. This raises some challenges for banks, e.g. that of ensuring end-to-end control over all processes and complying with outsourcing regulation.

How we can help

Deloitte’s Banking Risk Advisory team specialises in industry-specific risk, regulatory and strategic consulting.

SREP Transformation

• Business Model Analysis. Assistance in the preparation of a ‘business model analysis model and report,’ to help you defend and demonstrate the viability and sustainability of your business model and strategy to the regulator.
  
• Internal governance. Gap analysis aimed at bringing your governance policies and procedures in line with EBA guidelines; also tailored training solutions to ensure that board members are up to date with the latest risk and regulatory developments.
• ICAAP and ILAAP. Diagnostic on existing ICAAP and ILAAP processes, as well as model validation and enhancement of your stress testing framework.

Credit risk management

• NPL reduction plan. Assistance in the preparation of NPL reduction plans in line with Banking Rule 09 and ECB guidance on NPLs.
  
• IFRS 9. Implementation of Finevare - a comprehensive IT solution developed by Deloitte to support banks in their transition to IFRS 9; Gap analysis on accounting policies to ensure that they are in line with IFRS 9.
  
• Credit On-site Inspection readiness. Assistance in achieving readiness to undergo either a full-scope or a targeted AQR-type assessment in line with the ECB AQR methodology.
  

Data quality

• BCBS 239. Detailed diagnostic to ensure compliance with Basel principles on risk data aggregation and risk reporting.