Bridging the Profitability Gap

For a period spanning almost 3 decades, the banking sector has enjoyed extremely high profitability. This elevated level of RoE was facilitated and sustained by three main factors: deregulation, strong global macro-economic conditions and high leverage.

However, owing to a number of structural changes in the industry, global banking RoE has now been reset to materially lower levels; essentially, a profitability gap has opened up. There are four main structural changes that have driven down RoE: tougher regulation, especially in the form of higher capital requirements; changing customer behavior, putting pressure on pricing at the same time as raising cost to serve; increased funding costs, stemming in particular from a relative shrinkage in the wholesale lending market; and, more intense competition arising chiefly from new market entrants.

This paper discusses how core banking renewal could provide the levers for banks to grow RoE. Since modern core banking systems are integrated, flexible and scalable, they can help banks to improve RoE in four key ways.

• By providing complete and real-time information, they can help banks to improve the level of cross-selling and lower the level of non-performing loans.
• By improving the level of automation and straight-through-processing, they can help banks to reduce operational and IT costs.
• The inherent scalability of the systems allows banks to extract economies of scale from organic growth and acquisitions, particularly in operations, processing and IT.
• The flexibility of the systems allows banks to adapt very quickly to changing market conditions such as launching new products.