2023 financial services industry outlook has been saved
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Monica O’Reilly: You know, I think if the past two years have taught us anything, it’s that the uncertainty that executives are facing when they do their strategic planning or plan for new areas of focus, it’s not only about how the known issues will play out, but it’s [also about] what new issues will emerge. And there are going to be new issues. I think our outlooks have demonstrated that the industry overall has choices to make as they move through this uncertainty. And it’s those choices that will give them the opportunity to be successful.
Tanya Ott: Financial services firms are operating in a very uncertain world right now. We’ve got inflation and rising interest rates, Russia’s invasion of Ukraine, COVID-19 variants, and the potential for recession or stagflation. So, it’s no wonder that the financial services leaders surveyed for the 2023 Outlook report are taking a more cautious view of forward-looking revenue. Still, they’re increasing their spend in some categories.
Monica O’Reilly and Jim Eckenrode lead the survey. Monica is US Financial Services leader for Deloitte LLP, and Jim is director of the Center for Financial Services.
I started by asking for the big picture.
Monica O’Reilly: Generally, banks are in a position of relative strength coming out of 2022 and we see [that] capital buffers are strong, liquidity is good. But if you dove into a few more layers, you look at the commercial banks, where they’re continuing to have a loyal client base, but with fierce competition to win a greater share of corporate clients, and then high inflation, some of the recessionary concerns and supply chain challenges which could decelerate corporate demand for capital investments are top of mind. And our corporate clients’ demands are looking at digital solutions, specialized advice that will likely require banks to master new client-service models. So, we’re seeing this play out in the banking industry in different ways. Depends highly on the bank, the business model, the country, the region, and what the current environment is. I expect that that will continue through the next quarter and more as we see what the impacts may be of a recession or a global recession.
[With regard to] investment management, globally 60% of our respondents to our survey report concerns that both inflation and geopolitical landscape will negatively impact their firms over the next 12 months. And after a promising 2020, in equity managers in the United States and elsewhere, they’ve slid back toward historical averages in 2021. So, only about 20% outperformed the broader US equity composite on absolute returns basis for the one-year period ending 2021. However, our investment management outlook surveys show that many active portfolio managers are investing in capabilities that will help them enable the next generation where they’re striving to provide superior risk-adjusted returns to index investing. So again, a different play in investment management versus banking.
Jim Eckenrode: I think some of the economic variables certainly are at play in the insurance industry. For example, in property casualty, premium volume and revenues are increasing and prices are going up, which means the market is hardening. But inflation is also impacting the cost of operating an insurance company, particularly in property casualty where replacement costs, repair costs, and all of the things that are involved in claims settlement certainly are also going up. I would also say that on the life insurance side, there has been a long period where new markets have been difficult to develop. What we’re seeing in some of our research is that insurers are starting to look at new markets. Previously underserved and unserved markets, customizing value propositions, customizing life insurance products and innovation in distribution are really going to be key going forward. So, despite the fact that the economy is certainly in challenging times, there are opportunities to improve both top- and bottom-line results, in part by partnering with insurtechs, which themselves are also offering a new competitive dynamic that needs to be watched.
In the commercial real estate business, there’s a more balanced view in terms of forward-looking revenue prospects. Forty percent of respondents in this year’s survey expect the revenues to improve in the coming year versus 80% last year. So, we’re seeing a little bit more of a balanced approach. And a third are planning to cut costs versus only 6% last year. Where are the bright spots? Well, in the United States, certainly we see interest in logistics properties, although there has been some softening in the news in recent days and weeks. And, interestingly enough, not only in the United States and North America, but globally, our respondents are bullish on downtown and suburban office space. Now the question was asked in terms of risk-adjusted returns, so there’s a certain amount of risk associated with that and there are challenges in terms of redevelopment to make properties more attractive in this new hybrid work environment. Nevertheless, that was cited as an area of great interest going forward.
Tanya Ott: Jim, I want to jump on that idea of the interest in downtown office properties because as we were talking in previous years about the great resignation or the reshuffle or whatever it is you want to call it, there were some projections that there might be a move out of downtown spaces and a shift to smaller facilities because more people would be working remotely or hybrid. So, what do you take from these results this year?
Jim Eckenrode: It’s interesting because we’ve talked about return to office now for a couple of years. And I guess you could say that where we’re seeing things move is toward what you could call a new normal. There are some that are going to be insisting and have insisted that their employees be in the office all the time. Certain large investment banks and commercial banks have certainly taken that position. Others on the exact opposite side, where the expectation is work remotely, [and] come into the office occasionally during moments that matter. We’re also seeing the emergence of a class of super commuters that travel long distances.
Tanya Ott: Monica, did we see the great resignation that we anticipated?
Monica O’Reilly: There was certainly movement, and whether it was resignation or migration of workforce to other areas in search of a quality-of-life aspect, which is playing out in what Jim said around this super commuter profile that we’re now seeing, where this ability to work from home but then commute on a semi-regular basis to allow maybe a best of both worlds. A couple of things that I would highlight, though, Tanya, is it was clear from our survey results that there was something to be gained in culture and belonging and making sure that that existed. We saw in our [investment management] survey that 32% of the respondents were likely to adopt a hybrid workplace strategy, that their firm’s culture has become much stronger compared to only 13% who indicated that their firms are likely adopting a more “majority back as soon as possible.” And so, it’s interesting to see how this plays out.
I do think there are a number of other things at play. Irrespective of what financial institutions are asking for from their employees of work from home or hybrid work, one reality still exists and that is the competition for high-caliber talent. There’s still a gap in skilled workforce and we’re still seeing [that] unemployment remains historically low and the market for top talent is really competitive. As we see those realities continue to play out, there is a lure of the crypto fintechs, of the fintechs in general, that although [they] have experienced tumultuous times in the last three or four months of this year, it’s hard to resist for some of those folks with unique talents—[and] they are being lured into that economy. I do think we’re going to see [the] continued struggle of finding the right skills and talent in the market, of finding the right balance between hybrid and remote. But what is crystal clear from all of the financial services organizations that we surveyed is that culture is created when people are together, and the need to bring people together, to evaluate how they’re continuing to move forward in their careers, that’s going to remain. Just how that happens, we’re yet to foresee.
Tanya Ott: We have talked at length about the balance of power between the workforce and companies that are hiring. But as we look at perhaps going into recession, is that going to tip the balance a little bit out of the employees’ hands?
Monica O’Reilly: With unemployment remaining so low, I still think there is a need to recognize the needs of the employee. Yes, we are seeing some pullback on hiring. But with the skilled-labor shortage that we still see and [as] we are facing a retirement of the boomer generation, there is a view that there is more of a balance coming into play, but not yet a full reversal into the employer having more of the weight on the scale. I do think there will be pausing in hiring plans. I do think there will be some surgical cuts to teams that may have grown to become overstaffed. But there is a need for talent—specialized talent that the industry continues to look for.
Jim Eckenrode: Monica, we talked about the fact that the lines are blurring between financial institutions and other industries from a talent perspective. That actually goes both ways. Firms can look to other industries and focus on hiring, rather than on industry-specific knowledge and qualifications, [or] broader skills that might be required. I’ll give you one example. With all the regulatory focus on ESG (environmental, social and governance) and compliance, firms in investment management and elsewhere are looking to hire ESG specialists, which may not be specific to financial services but may have broader skill sets. There’s going to be some repositioning of the talent as well as reevaluation of areas where, as Monica said, there may have been an increase in hiring that may need to be repositioned going forward.
Tanya Ott: I want to pull the thread on [the] ESG conversation in just a moment but going back to this idea of looking to other industries: you mentioned fintech, Jim. Technology is another perennial topic that we talk about when we talk about financial services industries and this survey specifically. So, what’s the scene looking like right now?
Jim Eckenrode: I think the scene is one of continued focus on enhancing the customer experience and operational efficiency. Certainly, with the uncertainty in the economic environment, what we’re seeing is a lot more interest in technology spend that will impact the bottom line, whether that’s driving additional operational efficiency through cloud analytics and even cyber or other areas, along with enhanced customer experience, [or] deal-making revenue generation. Those are certainly areas that are seeing an increase in spending. I would also say that there is some cautious experimentation in certain other areas looking forward, like the metaverse.
Monica O’Reilly: I would underscore that, Jim, because as we looked at the insurance sector, everybody understands the transition to cloud platforms. It is certainly a well understood, significant technology, and an initiative that’s been driven over the last few years because of its potential impact throughout the value chain. However, I think they’re still struggling to realize the full potential and full value of a cloud infrastructure and the cost and efficiency gains that are part of it. This is often because parts of the legacy technology and now cloud-native applications remain in place. So, you see this juxtaposition. I think the focus [is now] on how you continue to drive the value and efficiency that is promised by the technology, [and] also investing in some of these emerging technology capabilities to ensure that you’re getting the best return on that value.
Tanya Ott: So, I was really intrigued by the phrase that you use— “cautious experimentation”—and you mentioned the metaverse. And I’m seeing that some banks have opened locations in the VR (virtual reality) and AR (augmented reality) space?
Jim Eckenrode: They’ve opened locations in metaverse properties like Sandbox, as an example, as an experimentation to learn and to engage with consumers where a certain segment of them are going. So, it’s about test and learn. Interestingly enough, when we asked our commercial real estate executives about interest in the metaverse, about one in five expressed no interest in anything metaverse-related, but over a third are researching further capabilities in the metaverse. I think there is a link to the metaverse in the real estate sector. We see dollars being committed to metaverse properties—real dollars. But we’re also seeing the metaverse [being] used for things like enhancing the process of design and construction of new buildings to allow potential tenants and others to explore properties, as well as an enhancement to existing conferencing capabilities that have to be included in the design of new office properties—so a metaverse-based teleconferencing capability as an example. Just in terms of other emerging technologies, one thing we note in the investment management outlook is that in North America, we’ve seen as much capital inflow for quantum computing in the first half of 2022 as we’d seen in the previous five years combined. So, there’s another thing that’s on the horizon that we’re starting to see money flow toward and financial institutions, I think, are in the early stages of thinking about how quantum could transform the business.
Tanya Ott: Interesting. So, you mentioned ESG a little earlier, and we do need to talk about regulation because regulation is a significant thing. And what are we looking at in terms of 2023?
Monica O’Reilly: I think particularly for ESG, we’re going to see more clarity around the regulatory activities and expectations. But similarly with digital assets and crypto, I think we’ll continue to see regulatory developments. There’s no dissipation of what’s happening from a regulatory perspective. Particularly for the United States, the regulators have a renewed focus on ensuring that they are keeping pace with emerging technology and emerging areas of risk and ensuring that there is a level of understanding of what the expectations are from the financial institutions of managing through that. From a global perspective, we’re seeing a renewed or reconnected regulatory landscape between the United States and around the world to create more smart, effective regulation on these developing topics and technology.
One area that I think we should delve into is [how] this regulatory perimeter is expanding. What we mean by that is with the ecosystem continuing to become a network, where fintechs are providing some services within [the] financial institutions environment, there is an expectation from the regulators of their ability to see into that business and what that business is doing. I do think we will start to see just how proactive the regulatory lens is into these other expanding business areas. But compliance and the related safety and soundness that come with it are going to still be one of the areas that’s going to continue to be a focus going forward. We see that many policy makers and stakeholders are making sure that they’re actively engaged in the ecosystem of what can create risk to the infrastructure within a financial services organization and how is it going to get managed and how is that going to be legislated or ruled within the regulatory environment.
Tanya Ott: What’s the risk of taking sort of a wait-and-see approach?
Monica O’Reilly: [laughs] Well, I think a wait-and-see approach depends on, Tanya, the area you’re waiting to see. I do think we have a bit of a wait and see around what will be legislated when it comes to cryptocurrency and digital assets. I think there will be an expansion of what the rules and regulations will be around sustainability, climate risk, etc., as well as financial inclusion and diversity and equity and inclusion as well. So, there are areas that we know are on the radar. And so, wait and see is typically not the best approach until enforcement actions [materialize] in certain areas that have already been legislated. I would advise that all of our clients continue to pay attention to the regulatory environment and ensure that they’re meeting the compliance expectations; however, as we know these other things are emerging, I think it behooves the industry to look at where they can lean into and make some sound business changes or implementations that will uphold what we see coming down the line, particularly in the areas of financial inclusion, payment regulation, and ESG overall.
Tanya Ott: So, let’s dig into that a little more deeply in terms of ESG and DEI. What should executives be thinking about as they are looking at 2023?
Monica O’Reilly: I think what they should be looking at is how to not only look at ESG as something that they must do. I think it’s going to be important that they are engaged in it because their stakeholders are going to expect them to be engaged in it. You know, for instance, in our real estate outlook, I think last year there was a view that ESG regulation would sort of be a defensive area, but now, looking at how do you create value added.
Jim Eckenrode: We’ve been talking about these issues for a little while now, with a perspective of the future of the financial services industry. We talk about a higher bottom line and a mission to serve, to do good while doing well. We see that there are opportunities to address major economic and societal issues like reducing inequality, obviously addressing the climate situation, health and wellness, development of alternative energy, and all of those sorts of things. When we think about how firms ought to confront these challenges and opportunities, instead of thinking about E and S and G in a siloed fashion—in other words, from a compliance and reporting perspective—think about it strategically. If there are goals, for example, to address the energy situation, that particular challenge touches not only environmental through things like financing renewable energy, but also social aspects around lowering energy costs for disadvantaged populations through carbon-trading. Or, from a governance perspective, the financial institutions own processes around procurement, consumption, LEED certification, and other things like that. It’s not a one versus another, but more of a comprehensive view of how we address these societal challenges and opportunities through a lens of the role that financial services can play in the future.
One of the things that clearly emerged from last year’s outlook that I think leaders can take confidence in is the unprecedented agility with which the industry responded to the pandemic, unlike anything we had seen before—at least in the 40 years that I’ve been in the business. And so, take confidence in the fact that the industry was able to pivot on a dime and continue to serve clients, manage risks, manage costs, perform well through [the] enablement of new processes, quick shifts in operating models, all of the things that were required during those early days. Lots of lessons were learned through that period. Monica, to your point that you raised earlier, take confidence in the fact that if you’ve done it once, apply those same lessons going forward because it’s another uncertain time and lots to confront. But I think the industry has demonstrated [that] it has the wherewithal to not only navigate through it, but to do so successfully.
Monica O’Reilly: You know, I think if the past two years have taught us anything, it’s that the uncertainty that executives are facing when they do their strategic planning or plan for new areas of focus, it’s not only about how the known issues will play out, but it’s what new issues will emerge. And there’s going to be new issues. I think our outlooks have demonstrated that the industry overall has choices to make as they move through this uncertainty. And it’s those choices that will give them the opportunity to be successful.
Tanya Ott: Great. Well, I think that’s a good way to end it. Monica, thanks so much for joining us today.
Monica O’Reilly: Thanks, Tanya.
Tanya Ott: Jim Eckenrode is managing director of the Deloitte Center for Financial Services, and Monica O’Reilly leads the US Financial Services Industry Group with Deloitte and Touche LLP. You can read their 2023 financial services outlook at Deloitte.com/insights.
We’re on Twitter at @deloitteinsight (no “S”) and I’m on Twitter at @tanyaott1 (spell out). Thanks for listening! I’m Tanya Ott. Have a wonderful rest of your day.
This podcast is provided by Deloitte and is intended to provide general information only. This podcast is not intended to constitute advice or services of any kind. For additional information about Deloitte, go to Deloitte.com/about.
Cover image by: Natalie Pfaff