New strategies, new risks?
Economic theory tells us that specialization offers many benefits. By focusing the firm on where it can better compete, executives may gain improved returns and more sustainable capital deployment.
Other potential advantages include increased scale efficiency, more complementary business relationships, and improved brand alignment. A more focused company may also bring benefits from reduced complexity in terms of simpler management and strategic clarity.
Yet just because an institution is specializing, there is no guarantee it will result in a more efficient, nimble, and profitable organization. A number of factors might hinder the transformation into a more specialized institution.
As banks change the scope and scale of their operations, previously marginal risks may come to the fore. The risks from complexity may decline, but new risks from concentration can become more prominent. Perhaps most importantly, strategic choices resulting in increased specialization (whether an intentional outcome or not) may have consequences for banks’ ability to generate consistent performance by reducing the diversity of their income streams.
In addition, operational and execution risk, reputational risk, and investor risk may deserve special attention as specialization alters the business and operating models of banks.
This paper explains these considerations for bank management, likely risks flowing from specialization, and the actions banks might take to mitigate these risks.