Financial services industry faces tradeoffs in 2024

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We spoke with Monica O’Reilly, vice chair and US Financial Services Industry leader for Deloitte, and Jim Eckenrode, leader of Deloitte’s Center for Financial Services, on these and other topics in the wake of the 2024 financial services industry outlooks, published by Deloitte Insights. As O’Reilly says, “the pace of the change upon us is only ratcheting up and our abilities to ensure that amidst all of these challenges, we continue to look at the opportunity set ahead of us—I think we'll fare okay, but it’s certainly not for the faint of heart right now.”

Monica O’Reilly: I think there’s a bit of two worlds going on right now. There’s the economic pressures, the high interest rates, the high inflation, the cost of money. There’s the rapid evolvement of AI and technology. And so I think efficiencies and agility are absolutely on the minds of executives.

Tanya Ott: It is a challenging world for financial services companies right now. How leaders respond can affect the trust relationship with customers and, ultimately, the bottom line. We dig into that today on the Press Room.

I’m Tanya Ott—thanks for spending some time with us today. My guests—Monica O’Reilly and Jim Eckenrode—have spent decades in the financial services industry and have advised leaders through many turbulent business cycles. Monica is the vice chair and US Financial Services Industry leader for Deloitte, and Jim leads the Center for Financial Services for Deloitte. Each fall, they join us to talk about their projections for the industry going into the next year. But before we get to that, I asked Monica to reflect on what a ride this year has been.

Monica O’Reilly: It’s high inflation, high interest rates. The cost of money is higher than we’ve seen in a long time. And while there are individuals that have, probably in the financial services industry, lived through this before, I think it’s slightly different and nuanced from its historical past. This is an environment of pressure, an environment of significant change in the speed of change when you think about technology and the use of technology to provide customer interaction in a seamless, frictionless way at the push of a button.

And along with that pressure of the economy, you’ve also got the pressure from regulatory agencies who have very much got the consumer in the forefront of what they’re looking at. You’ve got an industry that’s continuing to change and drive toward future growth. And I think right now the likelihood of it being organic is slim. And so organizations are looking at the horizon around, where can they get growth? Is that going to be through acquisitions? Is that going to be through new business models, new alliances, new partnerships? I think all of that is on the table.

Jim Eckenrode: I would agree with that, Monica. And if you look at the dynamic environment around how industries are blurring and converging, private equity is getting into the credit business, becoming lenders—tech companies are now payment companies as well. You’ve got embedded finance that’s expanding in insurance and again in payments that presents an additional strategic challenge. You know, I think the lessons over the last several years have been that the industry has done a reasonably good job, indeed, perhaps a very good job, in responding to challenges—whether it’s the pandemic, hybrid work, or other situations—with agility. And I think as we go forward in a more challenging economic environment, where investments are going to be looked at very closely, agility is the skill developed that will become very, very important to maintain as we go forward.

Q: Jim, you talk about how challenging the environment is right now in terms of the economy. And Monica, you mentioned that we’ve seen some of this before, but this is going to be different. So let’s talk about that difference and how it’s going to change the way executives think about responding.

Eckenrode: Overall in advanced economies, the IMF (International Monetary Fund) was looking at a growth rate of about 1.4% in 2024. And inflation, while moderating, is still a challenge. I think what we saw in some of the very dramatic events in the banking industry in the United States [in 2023] is that technology allows consumers to make changes in their choice of doing business much more rapidly than they could before. We saw money moving out of the banking industry into other investment vehicles, as an example. And technology certainly fueled the acceleration and the ease with which customers can do that. And so while there’s the sense that in some ways, we’re dusting off old playbooks, in the same sense, you can’t rely on the same playbook because of the accelerating growth in technology.

O’Reilly: The forces that are being felt by all financial institutions, whether they be in banking, insurance, or commercial real estate, is how and where does work get done and by whom? What does that look like? I know we saw the hybrid work environment continue to evolve, there’s still a level of trying to understand, what are the implications for that on a workforce? And what does that look like in the next year and a half as organizations struggle with that?

I also think that you’ll see many of our organizations across the industry look at how they can do more with less—and the use of technology in that sphere to actually help drive efficiency. And so I think there’s a bit of two worlds going on in this right now. There’s the economic pressures, the high interest rates, the high inflation, the cost of money. There’s the rapid evolvement of AI and technology. There’s the continuation of risk being at the forefront of managing those risks and organizations trying to figure out how they do that in a way where they’re able to drive efficiencies. And so I think efficiencies and agility, is absolutely on the minds of all executives.

Q: You mention AI, and also in that bucket is quantum computing. There’s so much excitement around that right now. But how much of it is real versus hype in financial services? Do you see institutions going all in next year, or are they actually easing off the gas a little bit, given budgetary constraints?

O’Reilly: You know, I don’t know if they’re easing off the gas right now, Tanya. There is still a lot of exploration going on. I think obviously AI and generative AI have sort of stolen a little bit of the limelight right now and indeed are living up to the hype that we see and hopefully will be able to drive even more innovation.

When it comes to quantum computing, I think investment management probably has most of the evolution there and are looking at it in how it can be used to really help drive opportunities, particularly in portfolio optimization and complex derivative calculations to stay ahead of the competition. I do think there is exploration going on. How fast that will appear on the horizon over the next year and a half is complicated by the fact of the current economic environment we find ourselves in.

Eckenrode: This is a great example of the twin challenges of managing in a much more revenue-constrained environment. For example, our surveys in the Investment management and Commercial real estate outlooks suggest that expectations for revenue growth are much more muted going forward over the next year than they have been in previous year surveys. And as a result, cost containment is certainly on the agenda.

At the same time, you’ve got technology trends like generative AI, quantum, and others racing ahead. For example, in a recent series of the predictions that we published, we forecast that the amount of spend on quantum in the financial services industry is likely to grow from US$80 million [in 2022] to US$19 billion by 2032. As Monica said, some firms are starting to experiment. There are postquantum cryptography algorithmic standards that are being advanced by NIST [National Institute of Standards and Technology] in anticipation of continued growth in quantum. So, these things are moving forward and leaders—this is part of the agility that we were talking about earlier—are going to need to navigate between the challenges in the short term around revenue and the longer term challenges and opportunities that these accelerating technologies that are going to present.

Q: One of the trends that we’ve been seeing over the last several years is convergence. No one organization is just doing one thing anymore. Insurers are in asset management. Tech companies are in banking. What are some of the trade-offs that come with that?

O’Reilly: I think the big one on the radar is regulatory. Organizations, particularly maybe those incumbents that haven't been part of the financial system ecosystem before, will find that the cost of keeping up with regulations and compliance may be even somewhat prohibitive to entering into this industry or these sectors.

However, I do think that given the size of the institutions either in insurance, investment management or in banking that are already well aware of how to manage regulatory compliance, their ability to take advantage of alliances or even acquisitions of some of those capabilities in maybe fintech organizations and help them realize not just the value of what that's offering, but also do it in a regulated environment, I think that’s still on the table.

We are seeing convergence particularly in the payments space where you’re seeing a lot of tech companies that are now payment companies and vice versa. And so I do think the trade-off with regulatory is there. But the opportunity for engagement, the opportunity for being in a much more real-time engagement with your customer, I think those are expectations that are just now table stakes. And so organizations are going to have to identify how to do that in a safe, secure, and trusted way.

Eckenrode: Yeah, I would agree with that, Monica. If you look at open banking as an example, there have been recent regulatory initiatives in both the European Union and the United States, as well as other areas, to define what open banking means, what the particular regulatory and supervision constraints are, and expectations around open banking platforms, which to describe briefly is the technological approach that allows for consumer data, particularly banking data, to be shared with others so that others might be able to provide banking services to their customers. And so, the point about regulation is one that we’ve seen emerging over the last couple of years and will continue around the regulation of activities rather than entities. And when you’ve got the convergence of industries and platforms like Monica was describing, that notion of regulation of activities is going to be a challenge for those companies that have not traditionally been under the supervision of banking or financial services regulators.

Q: Where are companies going to look to drive growth in the near term?

O’Reilly: I think, Tanya, that one of the most important questions for all organizations right now is where is growth going to come from, particularly in this current environment? I think it’s safe to say that we haven’t seen as much in the M&A space over the last year and a half, but that potential is there, and we anticipate that, absent any further economic deterioration in 2024, we expect that we should see M&A activity. And that will ratchet up again across all of our sectors.

Obviously [in] the banking industry, the implications for organizations that are going to have to weather the depository costs, the focus on capital stress testing, many of these things may create much more barriers to growth, which could indicate opportunities for acquisition. The same in insurance: M&A activity in insurance has been on the decline since Q2 of 2022. However, we do believe we’ll see an upsurge in deals again there, in particular, when you think about insurtechs and the opportunity again for customer interaction. And then I think in investment management, one big trend is customer satisfaction as a way to continue to grow and acquire customers and manage their expectations. The focus on personalization, the frictionless interaction with them, all of those activities are going to be paramount for growth.

Eckenrode: You know, we talk about M&A, and you were speaking of the investment management industry. One recent survey that we talked about in our outlook was the fact that one of the challenges that IM leaders are seeing with regard to M&A is regulatory approval. And so there you start to see another aspect of the convergence of regulatory and growth opportunities and strategy.

I would also highlight some opportunities from a product or revenue perspective. For example, in banking, we forecast more opportunity in noninterest income, advisory, underwriting fees, corporate banking fees as opposed to net interest margin going forward. In insurance, we’re starting to see some increased interest in different kinds of insurance products. For example, parametric insurance, where claims are paid out automatically if certain parameters are satisfied and observed without the necessity of submitting a claim. Certain specialty lines also might see some growth. Monica mentioned investment management and more customized portfolio construction, focusing yes on ESG, but also emerging technology and science, as well as active ETFs and direct indexing. And then in real estate, certain property types are expected to have greater than average risk-adjusted returns, for example, in digital economy, cell towers and data centers, single-family rentals and build-to-rent. A lot of discussion right now around housing and affordability, and as well as senior care and life sciences.

Q: One of the things that both of you mentioned was trust. I want to go back to that and talk a little bit about how trust and the role of financial services industries have changed or maybe stayed the same.

O’Reilly: Trust has evolved. I think it does continue to rest on the reputation of the organization. And so the reputation of the organization is paramount. I still think that the financial services industry can be a catalyst to help with positive change and progress around the responsibility to both the economy and society as a whole, because the two are very interlinked. And so trust permeates everything. It permeates how an organization presents itself, the work that it does, the products it participates in, the investments that it offers to its shareholders—all of that has increased expectations with the shareholders and stakeholders that interface with that organization. And in fact, I think if organizations were to lean into how trust could be, frankly, a competitive advantage to them, in their brand and how they interact with customers, I think that would lead to even future growth.

Eckenrode: It's an important point when you consider the technology advancements that we were discussing earlier. So, for example, as data and artificial intelligence become much more of a competitive play and the responsible use of customer data and analytics, certainly as part of that, the financial services industry, that has a long history of safeguarding assets, has a role to play in safeguarding the use of those assets as well. And so FSI can certainly play a role in providing trust, especially when you look at surveys that suggest that consumers increasingly are less trusting of traditional organizations, whether it’s the media or government or other types of companies or sources of support and are looking to business leaders to fill that gap. And financial services certainly can play a role there.

Q: Yeah. As it gets incredibly more complex both on the side of companies, but also in the types of products that consumers are interacting with, I imagine that trust issue is going to become even more critical. So we’ve covered trust, we’ve covered technology. We’ve talked about regulation. What else should we be thinking about? Are there any nuggets from the 2024 industry outlooks that you want to highlight?

Eckenrode: Well, I think we have to talk about talent again. You know, obviously, we’ve been in a very dynamic environment over the last several years, whether we’re talking about hybrid work or whether we’re talking about new capabilities that will need to be brought into the industry to support some of these technological advancements. And retraining and upskilling is part of that. So, for example, when you look at the commercial real estate industry, 30% of new hires recently have been baby boomers, as opposed to 10% that are Generation Z. Another study that we looked at, 45% of the current talent base in the commercial real estate industry is the age 55 and above versus 4% under 25. And we see this in other sectors in financial services as well, that need to replenish talent and bring in and develop younger talent potentially with new skills in artificial intelligence, data science, etc.

O’Reilly: One thread that I would lean into, on top of what Jim mentioned around the upskilling of talent, is we are seeing a trend across the industry right now relative to moving talent around within the organization. What I mean by that is taking employees who may have a skill set in one part of the organization and applying it to another, which allows not just for great cross-pollination of information and perspective, but also organizations that are doing this are starting to see a level of efficiency grow because you are now helping all individuals see processes end to end, helping them understand where there could be opportunities to change or create efficiencies by changing a process. And that has only just started. And we’re seeing this view of taking a generalist-first model, but then moving that talent around the organization to get a level of depth of knowledge about what happens and what's valuable to that organization. I think we're going to see that trend continue to manifest throughout the industry.

Eckenrode: With all of the advancements in technology, artificial intelligence, gen AI, quantum, etc., the challenge that many financial services institutions face is that their existing infrastructure really isn’t designed or suited to make the most effective use of these emerging technologies. For example, in the insurance industry, in a recent survey, we did show that while most have begun the journey of modernization of their middle and back office, the core systems, only about a third have completed even some or all of those efforts. And to be able to take advantage of new sources of information, alternative data in investment management as an example, the back-end systems have to be able to support that. And so, that really provides a constraint on the industry's ability to really take advantage of that.

Q: Jim, following up on that, how do [more senior people] not get left behind? I mean, the world is moving pretty quickly right now, especially technologically.

Eckenrode: Yes, it’s a great question. I think that there continues to be significant interest in transformative investments, but rather instead of at a kind of a big-bang level, doing it on an evolutionary path: Demonstrating small wins along the way. Being able to take advantage of these technologies and test and learn as you implement them. The spending and the budgetary constraints are going to be a significant factor, but they have to continue to look at where investments in new technology can really be brought into the environment and the infrastructure and where those can be deployed more easily, at least in the short term.

This notion of agility. We’re talking about being caught between the forces of rapid advancements in certain parts of the economy and society and others that are creating a drag on that. And I think part of the challenge that you’re going to see is that there’s going to be—and there [already] is—kind of a separation between those firms with more resources that are going to be better able to take advantage of these changes and others in the middle market, smaller institutions that are exposed to certain types of risk at a greater level. For example, in the banking industry, a lot of the commercial real estate lending, particularly in the office space, is concentrated among the middle-market banks, and that’s certainly challenging in the current environment. And so, you’ve got this potential for strategic separation between the largest firms that can continue to invest and move forward and the ones in the middle that are going to have to take a much more deliberate path, at least in the short term.

O’Reilly: Leaders in this industry are no strangers to a dynamic environment. But the pace of change is substantial. As I look across what choices are out there for leaders that are faced with this pace of change, it's probably around three things.

One, differentiation of their organization. How are they going to demonstrate differentiation, either through the products they offer, through the experience they offer, or through the reputation of their organization, or maybe all three?

Two, where does work get done? By whom or by what, when you think about AI and generative AI and its capability set and the ability to use the value of your workforce in a very different way and in a more agile way.

And lastly, growth. Where is growth going to come from? If it’s not organic, it's going to have to come through acquisitions. It’s going to have to come through partnerships and alliances, and the opportunity to look at different ways of doing business, business models, and leaning into those.

And so for leaders in this industry, I would say those that have seen this environment before, maybe have a foot ahead of those that have not. But the pace of the change upon us is only ratcheting up and amidst all of these challenges, we continue to look at the opportunity set ahead of us—I think we’ll fare okay, but it’s certainly not for the faint of heart right now.

Q: Well, thank you. I think that’s a good place to end our conversation today.

Eckenrode: I do too.

O’Reilly: Appreciate it, Tanya.

Q: Monica O’Reilly is the vice chair and US Financial Services Industry leader for Deloitte, and Jim Eckenrode leads Deloitte Center for Financial Services. If you want a deeper look into the conditions Monica and Jim think are most likely to play out over the next few months, you can find their 2024 financial services outlooks at deloitte.com/insights.

Don’t forget to subscribe or follow the show so when we release a new episode it’ll drop to your device automatically, so you don’t miss a single thing. And please check out a new podcast I’m working on, Government’s Future Frontiers, which looks at how the private, public, and nonprofit sectors are coming together to address some of the stickiest problems we as a society are facing today. You can find it—and like and subscribe—wherever you get your podcasts.

I’m Tanya Ott. Thanks for listening and have a great day!

This podcast is produced by Deloitte. The views and opinions expressed by podcast speakers and guests are solely their own and do not reflect the opinions of Deloitte. This podcast provides general information only and is not intended to constitute advice or services of any kind. For additional information about Deloitte, go to Deloitte.com/about.