The Next Era in Banking

The Next Era in BankingSenior executives on doing business amid post-crisis regulatory constraints

A report prepared by CFO Research Services in collaboration with Ernst & Young

The Next Era in BankingSenior executives on doing business amid post-crisis regulatory constraints

A report prepared by CFO Research Services in collaboration with Ernst & Young

The Next Era in Banking is published by CFO Publishing LLC, 51 Sleeper Street, Boston, MA 02210. Please direct inquiries to Jane Coulter at 617-790-3211 or [email protected].

Ernst & Young funded the research and publication of our fi ndings, and we would like to acknowledge the Ernst & Young team—Ian Baggs, Paul Bevan, Greg Derderian, Cait Fergus, Steve Ferguson, Debra Greenberg, Gary Hwa, JB King, Stephanie MacLeod, Hank Prybylski, and Bill Schlich —for its contributions and support.

At CFO Research Services, Celina Rogers directed the research and wrote the report, with contributions from Elizabeth Fry, Alison Rea, and Christopher Watts.

CFO Research Services is the sponsored research group within CFO Publishing LLC, which produces CFO magazine, CFO.com, and CFO Conferences.

May 2011

Copyright © 2011 CFO Publishing LLC, which is solely responsible for its content. All rights reserved. No part of this report may be reproduced, stored in a retrieval system, or transmitted in any form, by any means, without written permission.

Contents

Moving forward in the wake of crisis 2

About this report 4

Challenging—and varied—operating conditions 5

Less balance-sheet intensive businesses 6

Renewed commitment to customer relationships 7

Performance management at the enterprise level 9

Greater focus, improved effi ciency, optimized scale and scope 11

A key role for fi nance and risk functions 13

A new spirit of innovation 16

Sponsor’s perspective 17

1

© 2011 CFO PUBLISHING LLC MAY 2011

The Next Era in Banking: Senior executives on doing business amid post-crisis regulatory constraints2

Moving forward in the wake of crisisOn November 12, 2010, representatives of the G20 posed for the traditional “family photo” to document the conclusion of the Seoul Summit. As world leaders arranged themselves under the lights, media organiza-tions reported on a meeting marked by tense debate on trade imbalances, the summit’s headline issue. Measures to stabilize and regulate the global banking system received comparatively little coverage.

The fi nal declaration of the summit, however, devoted considerable attention to banking regulation, and well it should. As expected, the G20 endorsed a new framework governing capital, leverage, and liquidity, developed at its request by the Basel Committee on Banking Super-vision (BCBS). Although the moment passed with little fanfare, the framework known informally as Basel III—endorsed just two years after the global fi nancial crisis reached its peak in the autumn of 2008—represents a major achievement for the BCBS and the G20.

The initial reception of Basel III was cautiously positive, with many banks around the world welcoming progress toward greater regulatory certainty—and greeting the relatively long time frame to adoption with some relief. But as national governments take steps to overhaul fi nancial regulation in their jurisdictions, the variability and fl ux in global fi nancial regulation seems all too clear. In the United States, the Dodd-Frank Act was signed into law by President Barack Obama on July 21, 2010, but the bulk of that legislation will come into effect through a lengthy rulemaking process that could run for years. In the U.K., regulators introduced a tough regime aimed at governing liquidity well ahead of the Basel III schedule for adoption of new liquidity standards. Swiss regula-tors issued enhanced capital requirements ahead of the BCBS, for banks they deem systemically important. (The Committee is continuing its work on defi ning stan-dards for systemically important banks in preparation for the next G20 Summit, to be held in Cannes, France in November 2011.) Whether and how Basel III standards will be adopted locally—for example, in the course of the

Dodd-Frank rulemaking process in the United States—remains an open question. And there are already signs that a race to the top is beginning to form as banks maneuver to meet heightened regulatory standards ahead of schedule.

So it would be premature, at best, to declare the regu-latory landscape settled. Indeed, our recent interviews with senior executives at banks around the world confi rm that regulatory uncertainty—together with broad economic uncertainty—form the uncomfortable circum-stances in which banks must now plan their futures.

That said, some features of the operating and regula-tory conditions that banks will face are clear enough. Remaining government support for banks—including highly favorable monetary policies—will eventually be withdrawn. Capital and funding are likely to be more expensive and less abundant. Efforts to reform fi nan-cial regulation around the world are threatening to open up new pockets of regulatory arbitrage. Regula-tors, investors, and analysts are likely to continue to demand greater transparency from banks—up to and including virtually real-time reporting on banks’ expo-sures to a kaleidoscope of shifting risks. Investors will be more likely to reward simplicity and clarity in banking organizations, in banks’ business models, and in their portfolios. There is little appetite for the complex secu-ritizations that fueled fi nancial activities during the last boom.

Among customers, opportunities to lend and to provide services are shifting as well. In the developed world, fi nancial conservatism appears to be the order of the day among midsize companies, small businesses, and consumers. The same forces that underpinned fi nancial disintermediation in the years leading up to the crisis will continue to attract large companies to the whole-sale capital markets. And the brightest prospects for economic growth will rest with emerging economies, where demand for credit is likely to substantially expand in the years to come.

What does this set of regulatory and economic pressures mean for large banks around the world? Banks will make

MAY 2011 © 2011 CFO PUBLISHING LLC

3

their way forward amid a new, complex, and far-reaching set of regulatory constraints—constraints that have the potential to change their businesses profoundly.

As Patrick Flynn, CFO of ING Group, explains, it’s the Basel III framework’s three-pronged approach governing leverage and liquidity as well as capital—that makes the differ-ence. “Basel III is clearly a sea change in regulation for banks,” he says. “You’re now facing a scenario, in Europe at least, that banks are going to operate within that three-pronged constraint, and that requires careful navigation. Other regulatory changes may be costly, may be diffi -cult to implement, but they will not change the business model. This framework can change business models.”

Given how closely Basel III standards—in particular, those governing liquidity—go to the heart of the busi-ness of banking, the threat of uneven application of Basel III standards in various local jurisdictions is of particular concern. And, considering the challenges of coordinating national regulatory responses to the fi nan-cial crises of the past—Basel II, for example, has yet to be fully adopted in the United States (although it is currently in parallel run)—bankers’ concerns regarding the uniform application of Basel III seem well founded.

In a broader sense, however, lingering regulatory uncer-tainty is making it diffi cult for banks to move forward. On the one hand, the general direction of regulation is clear—banks will have to hold more capital, and they’ll have to match their assets more closely to liabilities. The path to compliance has already presented itself, and pressure is already building for banks to comply in fairly short order or risk their ratings. What persistent regula-tory uncertainty does not easily accommodate, however, is the kind of strategic decision making that will become increasingly important as banks seek to adapt them-selves to a changed regulatory and operating environ-ment. As Pieter Emmen, chief risk offi cer of Rabobank, observes, “Even though the rules may change in the future, we want to act prudently and make sure that we adhere to the current rules. Knowing that there might be some relief in the future only gives you extra space at that point in time.” He continues, “If you [face] some drastic decisions—for example, selling a business unit—then

you want to make sure that the rules are what they are. In that sense, it’s more diffi cult to take drastic measures. You have to [proceed] step-by-step, because of the uncer-tainty about the fi nal rules in the end.”

Indeed, regulatory uncertainty is particularly diffi -cult to tolerate at a moment when banks have been keenly sensitized to the tight nexus between stability, growth, and the creation of value. “If you take it at the level of fi nancial management, what the crisis told us is that you can generate profi tability, you can generate returns, you can generate value, but you will not get an increase in your market valuation if you are in default of the constraints—constraints being liquidity constraints, capital constraints,” observes Stefan Krause, CFO of Deutsche Bank.

“Basel III is clearly a sea change in regulation for banks.... This framework can change business models.”

The regulatory regime that gradually emerges in the coming years doubtless will set a much higher bar for bank capital and liquidity in pursuit of greater stability. The expectations not just of the market, but of banks themselves, have adjusted sharply toward conservatism in the immediate aftermath of the crisis. The challenge for banks will be to fi nd a path that honors both the growth imperative and the stability imperative in a business that, by its nature, rewards risk.

How will banks seek to create value in the context of a gradually settling—if still uncertain—regulatory environ-ment? What opportunities do they see, and what threats are they preparing to negotiate? And how will the fi nance, risk, and treasury functions, in particular, contribute to banks’ efforts to move forward? We interviewed 15 senior executives from fi nancial institutions and rating agencies around the world to learn about the future of banking.



About this report

In the winter of 2010−2011, CFO Research Services (a unit of CFO Publishing LLC) conducted a series of interviews with top executives at some of the world’s largest fi nancial institutions. Our goal was to gather and report global fi nancial-services executives’ views on the future of banking: What responses are banks formulating to a changing regulatory and operating environment? And what changes are they making now to secure their future success?

This study is the fi fth in the CFO Research/Ernst & Young Bank Executive Series. It builds on fi nd-ings from our prior study, Capital Management in Banking (June 2010)—that regulatory reforms around the world will pose substantial challenges to banks (particularly global banks) and their business models. In this research program, we asked bankers and other authoritative observers to consider the impact not just of heightened regula-tion of capital, leverage, and liquidity, but the features of their respective operating environments that pose challenges—and opportunities.

CFO Research interviewed senior executives at large banks in North America, Europe, Asia, and Australia for this study. We also conducted background interviews with other knowledgeable individuals at banks, rating agencies, and other organizations. We supplemented material gathered through interviews with extensive secondary research to develop our conclusions.

We interviewed executives at the following

organizations for this report:

• Bank of Baroda• BNY Mellon• Citibank Australia• Deutsche Bank• DBS Group Holdings (DBS)• Fifth Third Bank• Fitch Ratings (London)• ING Group• KeyCorp• National Australia Bank (NAB)• Rabobank• Raiffeisen Bank International• Standard & Poor’s (New York)• Zions Bancorp.

Because this report is based on desk research—including reports from regulatory bodies, fi rm-issued public statements, and media reports—and background interviews, the statements and fi ndings presented here are based on a variety of qualitative sources and do not represent the views, practices, perceptions, or statements of any named participant in the interview program, unless specifi -cally attributed.

“Even though the rules may change in the future, we want to act prudently and make sure that we adhere to the current rules. Knowing that there might be some relief in the future only gives you extra space at that point in time.”


5

Challenging—and varied—operating conditionsBanks exist to serve customers and create value for their shareholders. Like other enterprises, they respond to demand. And in the decades leading up to the fi nancial crisis, customers wanted credit—more and more credit to serve a growing appetite for consumption and for investment. Deposits proved insuffi cient to fund enough credit to meet that demand—not, at least, at a price competitive with the wholesale capital markets. So banks had to adapt. “In the past, there was extreme demand for credit,” says James Abbott, director of investor rela-tions at Zions Bancorp. “There was a lot of demand, and the banking system couldn’t fund it. The whole banking system for 30 years tried to fi gure out how to get assets off the balance sheet. The junk bonds of the 1980s and the mortgage-backed securities market—both a func-tion of loan demand exceeding deposit supply.”

Even as large banks made use of these fi nancial innova-tions, funding their activities through wholesale markets and distributing large amounts of credit in part through a range of off-balance-sheet vehicles, their balance sheets ballooned. By 2008, the Royal Bank of Scotland was the largest company in the world by asset size, with total assets of more than GBP1.9 trillion. As profi ts and competitive pressure mounted and regulatory restric-tions relaxed, leverage soared: the median leverage ratios for U.S. banks reached 35 to 1 on the eve of the crisis; in Europe, median leverage ratios among large banks reached 45 to 1.

Once the crisis broke, banks geared down quickly, slashing assets and building capital and liquidity buffers well in excess of minimum regulatory requirements. Corporate and individual borrowers, too, adapted swiftly to an environment of scarce credit as they paid down debt and cut expenses to meet the demands of a lengthy downturn. The result? Until economic recovery in the United States and Europe gains greater traction, loan demand is likely to remain low. And many banks in the developed world are currently facing a problem quite different from the one the banking system solved (for

better or worse) in the decades leading up to the crisis. “For the fi rst time in 30 years—at least on a sustained basis—we have a supply-and-demand imbalance, where we have too few loans and too much funding in the form of deposits,” Mr. Abbott says.

“For the fi rst time in 30 years—at least on a sustained basis—we have a supply-and-demand imbalance, where we have too few loans and too much funding in the form of deposits.”

While pockets of excess capacity can surely be found under the current regulatory regime, even in the markets most affected by the recent fi nancial crisis, low loan demand and diminished bank balance sheets are, in another sense, roughly in sync: fewer companies and consumers are choosing to borrow, while banks have less capacity to offer credit. Over the longer term, as the demand for credit in the United States and Europe recovers—but balance sheets remain relatively constrained—banks may be hard-pressed to meet increased demand at competitive prices. And in the short term, weak loan demand and a relatively fl at yield curve have the potential to lead some banks—despite their renewed resolve to avoid excess risk—to seek risky, high-yield investments that, as one banker put it, “throw into question the risk/reward dynamic.” Many banks are already working through a fundamental tension between one of the key lessons of the recent crisis—that banks should ensure that they are fully compensated for the risks they’re taking—and the pressure to cut prices to compete.

That competitive pressure isn’t limited to the strained markets of the developed world. In Asia and Australia, where robust economic growth is fueling demand for credit, banks are focused on meeting that demand—and on protecting their market share as U.S. and European banks pursue more business in emerging markets. In



India, “the economy looks to be growing at the rate of 8 percent—and may continue to grow at that rate for some time,” says Rajiv Kumar Bakshi, executive director at Bank of Baroda. “The challenge is managing compe-tition in this evolutionary phase. The Indian banking sector will be opened up to more competition—there is debate under way about granting licenses to new banks and allowing foreign banks to set up subsidiaries with more open branches.”

“[Our clients] are accessing those growth markets. Our strategy is really to follow them.”

Rapidly changing demographics in India, including continued growth in the country’s middle class, are creating opportunity—and may also act as a magnet for competition. “These [foreign] banks are coming from more-mature markets—they have a richer product profi le that would perhaps suit higher net-worth people,” Mr. Bakshi says. Bank of Baroda is pursuing a range of investments in IT infrastructure, risk modeling, and organizational improvement in response to these challenges.

Australian banks came through the recent fi nancial crisis in a sound position to compete for market share in emerging Asian markets. Eric Williamson, group treasurer of National Australia Bank (NAB), points out that “Asia has good local banks” that are meeting local demand for credit and for fi nancial services well. At the same time, he says, “Australia and Asia are becoming inextricably linked. Seventy percent of our trade fl ow is with Asia, and there’s an increasing amount of capital fl owing in both directions. That creates a lot of oppor-tunity.” Mr. Williamson continues, “[Our clients] are accessing those growth markets. Our strategy is really to follow them.”

Less balance-sheet intensive businessesOperating conditions for banks may vary, but concern about the new capital, leverage, and liquidity require-ments that will constrain them is universal. Banks have crossed a great deal of ground in recent years in their efforts to raise capital and stabilize themselves, but they are currently by no means overcapitalized in the eyes of investors and analysts. “In the U.S., banks have done a tremendous job in raising capital,” says Vandana Sharma, director of the fi nancial institutions ratings practice at Standard & Poor’s in New York. “But it’s one thing to say that they’ve raised a lot of capital and been successful in paying off some higher-cost liabilities, and it’s another thing to say that capital is strong. Despite having raised a lot of capital, our view is that the sector at best is adequately capitalized, not overcapitalized,” she says. And capital and liquidity adequacy are likely to come under even more pressure at banks around the world as Basel III and other regulatory changes come fully into effect.

When the Basel III framework was endorsed, media outlets were quick to point out that many banks were already operating at or near its capital standards, suggesting that banks would be able to build buffers fairly easily through retained earnings over the long time horizon to adoption. These reports tended to over-look the profound effect of Basel III’s new deductions to capital, the disallowance of a number of capital instru-ments, and the increased risk weightings that threaten to massively infl ate banks’ risk-weighted assets. “As Basel III is implemented—and probably pulled forward by investors and perhaps even by regulators—risk-weighted assets are going to be key,” says Todd Gibbons, CFO of BNY Mellon, “and Basel III specifi es a very onerous defi nition of capital itself.”

In addition, the calculation of both capital and risk-weighted assets is likely to be “much more challenged” and “much more volatile” under Basel III, Mr. Gibbons says. That volatility, compounded by uncertainty concerning the consequences of a breach, will make


7

it more challenging for banks to manage their capital. Assets with relatively high risk weightings will become correspondingly less attractive. “There will be a change in managing those risk-weighted assets now; they’re going to get expensive to hold. That will favor balance- sheet-light businesses,” Mr. Gibbons says. “I think this is going to be very interesting, because I think what may end up happening is that regulatory capital will trump the economic risk in an asset. A bank will have to price an asset high enough in order for it to make sense to hold, and there will be other investors that aren’t exposed to the same regulatory capital issues that would prefer to hold it,” he observes. “It may become uneconomic for banks to hold a lot of types of credit assets.”

“Banking will have to become more of an agency business.”

As balance-sheet intensive activities become less economically feasible under new regulatory stan-dards, banks will adapt themselves accordingly. For example, “bank loans—short-term loans that tend to be extended to sub-investment-grade companies—have traditionally ended up on bank balance sheets. Those may get very costly to hold, so banks would have to raise their pricing quite a bit, and, as a result, asset managers would probably fi nd a way to become investors in those kinds of assets. Banks will be arrangers,” Mr. Gibbons predicts. “Banking will have to become more of an agency business.”

Renewed commitment to customer relationshipsOf course, banks with a strong presence in less balance-sheet intensive businesses—wealth management, asset management, treasury services, and so on—will fi nd it easier to make that shift than others.1 Barriers to entry in these businesses are staggeringly high, which will help to protect banks seeking to further develop these areas from casual interlopers and downward price pres-sure. But among banks seeking to compete in these types of agency businesses, strong relationships with customers—close engagement, superior service, and a thorough understanding of the full spectrum of their needs—is likely to be a key differentiator.

Close attention to customer relationships, of course, is hardly new in banking. Bankers are relationship-manage-ment masters. As Stephen Roberts, chief country offi cer of Citigroup Australia, puts it, “One of the most fasci-nating lessons of the recent crisis has been the consis-tency of our relationships with clients. Even in tough times, we maintained dialogue with them. It’s a service business, and if a bank loses track of that, it’s fi nished.”

At DBS Group Holdings (DBS), CFO Chng Sok-Hui says that the bank did well in standing by its customers through the crisis. “When we were going through the crisis, we were very clear that we would stay close to our customers and support them through the crisis. At a time when a lot of banks were withdrawing from Asia or deleveraging their balance sheets, we were there for our customers.” She continues, “We are now reaping the benefi ts of the strategy, which has cemented a lot of our customer relationships. Our loan growth has been very strong on the back of that positioning.” Banks that withdrew from markets in Asia, however, have returned to “fi nd that competition is much tougher now,” Ms. Chng says.

1 Meanwhile, fee-based revenue streams are coming under regulatory pressure from new measures intended to protect consumers and merchants. These measures, too, promise to alter competitive dynamics and business mixes as the sector absorbs their full effect. In the United States, for example, fi nancial institutions are lobbying for the repeal of the Dodd-Frank Act’s Durbin Amendment as this report goes to press.

Smaller regional and community banks are particularly concerned that the Durbin Amendment’s cap on interchange fees will force them to cut service levels, raise fees for depositors, or even reduce lending, making them less competitive against larger banks that are in a better position to absorb the curtailment of revenue.



To the extent that some customer relationships became attenuated in the course of the crisis, banks have had ample motivation to repair and strengthen them—not least because their competitive strength will rest in part on their ability to cross-sell (and up-sell) services to meet customer needs. Furthermore, as they prepare for a future of enhanced regulatory constraint and fi erce competi-tion, we found that banks are approaching relationship management more systematically. Efforts to gain more complete data and analysis of customer behavior—which have been under way at many banks for some time—are certainly consistent with this more systematic approach. But banks are also taking steps to understand the total economic value yielded by a given relationship in the context of enhanced regulatory requirements. “We are increasingly focusing on our relationship management with customers, so that we look at a customer relation-ship in terms of not just profi t but also how much capital they use and whether they are providers of funding as well as taking loans,” says Mr. Flynn of ING Group. “We have built, and are seeking to build out further, our capabilities to assess the economic return from our relationship with [a given corporate] customer—both in terms of profi t and in terms of capital usage, leverage, liquidity.”

“Even in tough times, we maintained dialogue with clients.”

Investment in information technology is integral to this more systematic, comprehensive approach to under-standing and serving customers. “It is, fundamentally, a fi nance/IT modeling system capability that we have developed and are looking to develop further,” says Mr. Flynn. “It’s a tool that empowers the businesses to look at the relationship and say, ‘Well, does this work in a Basel III world?’ It brings it down to a customer level.” Obtaining a more complete view of the economic value generated by a given relationship, in turn, can help ensure that a bank’s decision making—including the allocation of capital and funding—refl ects and responds not just to customer demands, but to the full scope of the banking relationship.


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Performance management at the enterprise levelWhile banks work to equip managers with more-complete information on the economic consequences of their decisions, they’re also working to implement more-comprehensive frameworks to guide that deci-sion making—and to manage performance—from an enterprise level. These initiatives, too, are geared toward optimizing increasingly expensive (hence increasingly precious) capital and funding across the enterprise, in service of its broad objectives.

These performance-management initiatives are tech-nology intensive by nature. “We have changed our framework for managing the business performance quite substantially,” says Deutsche Bank CFO Stefan Krause, and “therefore obviously we need the new [fi nancial] systems to support the reporting around this new busi-ness performance management.”

What makes the time and expense worthwhile? Mr. Krause says that the catalyst for this overhaul at Deutsche Bank “is [what] we learned in the crisis…. You could have the best business performance, as we had, but if the market believes that you don’t have enough capital, your business performance does not translate into value creation. You could have the best risk manage-ment in town. If your liquidity ratios are not in line with what market expectations are, it doesn’t pay for you.”

Leading up to the crisis, “I think banks had, to some extent, the luxury of inexpensive balance sheets,” Mr. Krause says. “It was easier for banks to sometimes allocate capital to less profi table or higher risk busi-nesses, where the risk/return paradigm didn’t work. I think in that area you will see that’s what [heightened regulatory standards] will require from us—to be much better at managing and allocating capital to yield supe-rior value creation and returns.”

At Deutsche Bank, improving the management and allo-cation of capital to create value is part-and-parcel with the bank’s new systems for performance management.

The bank needed more than traditional performance metrics to manage for value within a new, more strin-gent set of constraints, Mr. Krause explains. “We learned that we have to add to ROE and the other typical value-creation metrics that are used to run a bank. You need to manage your constraints better: risk-weighted assets, capital allocation, liquidity, the mix between stable and unstable profi tability, and so on.” The bank tested more than 120 key performance indicators (KPIs) on their predictive power for market capitalization and value creation, eventually settling on “a set of 12, plus 2—the ones that best describe how you create value with a bank.”

“You could have the best risk management in town. If your liquidity ratios are not in line with what market expectations are, it doesn’t pay for you.”

At Raiffeisen Bank International, the recognition that “allocation of resources has to be done even more accu-rately and precisely than in the past” has led the bank to implement “a refi ned KPI steering tool,” says CFO Martin Grüll. “In our case, the tool is based on four dimensions—profi tability, growth, constraints, and business mix. All in all, at group level we have 14 KPIs allocated to those four dimensions. We back-tested KPIs with results of other large banking groups, and fi gured out which KPIs had the strongest correlation with the stock-market performance.”

What does “business mix” mean as a dimension of bank performance? Mr. Grüll says, “It means to have a balanced mix which strictly follows the defi ned strategy. When we say we will have x percent of retail customers, or y amount in retail banking profi ts fi ve years from now, this must be refl ected in the KPIs and in the budgets. Not just opportunistically booking whatever looks attractive today, but really having a road map to a business mix, a portfolio mix, for the whole enterprise—and really



targeting this desired business mix in line with the overall strategy. We had this in the past, but it is now much more refi ned. It specifi es a certain volume of customer loans, a certain volume of proprietary trading or investment banking—really to get to a clear target scenario.”

“People understand conceptually...that the world has changed. They’re pleased that there’s a planning and an IT framework to help them navigate it. But I think the challenge will be to actually apply this going forward.”

ING Group has implemented an enterprise-level planning model to help the bank optimize its capital and funding resources within Basel III’s three-pronged constraints. “In the past, it was not uncommon for businesses just to grow, grow, grow and worry about the funding and the capital later. Banks could allow businesses to grow and fetter to some extent, and pick up the funding and capital and leverage at a later date, because there were not hard regulations. Now there are,” Mr. Flynn says. “So what we’ve done is built modeling—which is core to our planning process—that allows each of the businesses to see where the constraints lie and to optimize within them. It allows the businesses to ensure that they are growing in a manner that is compliant with the three levels of regulation we’re going to face.”

The output of this modeling has concrete consequences, Mr. Flynn continues. “So [at some point], to certain lines of business you’ll have to say, ‘No, you can’t lend any more than a certain appetite within this particular line,’ or, ‘OK, you can lend more here, but then you’ll have to raise more deposits there.’” And that moment, Mr. Flynn points out, is when any such framework is truly tested. “I mean, you asked about improving information systems and gover-nance. Yes, we’ve done it. And it’s probably the easy bit.”

What, then, will prove to be the real challenge? “Perhaps getting businesspeople to understand that the world has changed, that the modus operandi of the past will not be the same going forward, that there will be a far tighter frame-work around what they can grow, where they can grow,” Mr. Flynn says. “Banks may fi nd scenarios where there is a business which in the past was considered acceptable, but which will lead them into a point where, for example, the leverage ratio will be breached. And, therefore, [the busi-ness] will have to turn it away. That type of scenario hasn’t been faced before.”

With the crisis still fresh in memory, business-line managers genuinely welcome the new planning and IT framework, Mr. Flynn continues. “People understand conceptually—certainly the business leaders understand conceptually—that the world has changed. They’re pleased that there’s a planning and an IT framework to help them navigate it. But I think the challenge will be to actually apply this going forward. Culturally, to help people to live within that frame-work as time goes on may be a bigger challenge.”


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Greater focus, improved effi ciency, optimized scale and scope

Amid all the uncertainty in banking—uncertainty about economic prospects in large swathes of the developed world, uncertainty about regulation, uncertainty about whether (and when) markets will fully refl ect the value of greater stability in the fi nancial system—banks, inves-tors, regulators, and analysts alike are certain about one thing: it’s about to get a lot more costly to operate a bank.

From a bank CFO’s perspective, it is probably fair to say that this is an uncomfortable state of affairs—especially when compared with the years of seemingly limitless growth in the banking sector that led up to the crisis. For, as one banker put it, “there is no view yet gener-ally in the market of how a bank investment will work in the future. That’s the bottom line.” In the absence of a well-understood and long-tested model for investment in banks, it falls to CFOs to articulate a new one and persuade investors to adopt it.

“Always when I meet with investors, they say, ‘Stefan, we don’t understand how the new math is going to work,’” Mr. Krause of Deutsche Bank says. “‘Your profi ts are going to be lower. Your capital requirements are going to be higher. Your monitoring is going to be greater. You’re going to be restricted in terms of your mobility of capital around the world, your funding around the world. There will be taxation issues. There will be compen-sation restrictions. You’re faced with so many restric-tions on the math that has worked so far. So how is this new math going to work?’ That’s exactly the big question out there.”

How does Mr. Krause answer that question? “Our view is that it will work—a very clear statement,” he says. “I think people are underestimating the levers. I think, as an industry, banking has quite some room for effi -ciency improvements.” As the former CFO of BMW, Mr. Krause suggests that banking, like other industries

that have come under pressure, will respond with a renewed commitment to a range of management disci-plines. “[Banking] will go through the cycle that every industry has gone through when regulation got tougher. It will require this industry to become more effective, to become more effi cient. It will require this industry to allocate capital more effi ciently. It will require this industry to do a better job in deciding geographically where to book assets, where to run assets, where to run capital, where to run operations. It will drive consolida-tion. I personally am very positive that there is so much room to maneuver, and also that in Deutsche Bank, we will get this new math to work.”

Other bankers we spoke with agree with Mr. Krause’s assessment, although many of our sources point out that regulatory uncertainty currently makes it diffi cult to make dramatic changes to their business profi les. As we have seen, however, banks are establishing more-robust, enterprise-level performance-management frameworks in part to support this level of decision making. And, to the extent that regulatory uncertainty permits, our sources report that banks are already taking steps to focus their efforts, realize effi ciencies, and optimize their scale and scope to make that new math work.

“[Banking] will go through the cycle that every industry has gone through when regulation got tougher. It will require this industry to become more effective, to become more effi cient.”

Why specify that banks are seeking to “optimize”—as opposed to “grow”—in scale and scope? First, because the sharp point of heightened regulation’s arrow is aimed pretty squarely at the target of complex global banking. This is wholly to be expected, considering that the profound interconnection of global fi nancial markets was revealed in the course of the biggest fi nancial melt-down in generations. But heightened regulatory standards



(not to mention ballooning regulatory complexity) are already placing the global banking model, with all of its geographic and organizational scope, under pressure. Furthermore, a fl urry of consolidation at the height of the fi nancial crisis has substantially narrowed the options—at least among the world’s largest banks—for scaling up rapidly through acquisition. 2

“All banks must become more selective. What does that mean? First, they have to allocate resources mainly to their core business. And the second most important conclusion is that size and scale matters all the more.”

Second, our interviewees suggest that banks are contin-ually reconciling the need for increased scale with the need to direct resources, attention, and effort to the core banking activities at which they excel—in short, with the need to focus.

At Raiffeisen Bank International, for example, CFO Martin Grüll sees an opportunity for the bank to enhance its presence in the growth markets where it is already well positioned. “The economies in Europe are growing at a slower pace; however, it’s worth noting that, post- crisis, GDP growth rates in our core markets in Central and Eastern Europe [CEE] are likely to be around two percentage points higher than those in the eurozone. This is very important,” Mr. Grüll says. He continues, “All banks must become more selective. What does that mean? First, they have to allocate resources mainly to their core business. And the second most important conclusion is that size and scale matters all the more.”

What are the implications of these observations for Raiffeisen Bank International? “First of all, it confi rms

that our business model makes sense, because we have been focusing on this region, CEE, over the past 20 years,” Mr. Grüll says. “But secondly we have to look for effi ciency, size, and also scale, to try to grow our pres-ence in those markets.”

At the same time, banks are expected to grow with less complexity and more transparency in their organizations, their operations, and their instruments—because, as the saying goes, complexity begets undue risk. And in the eyes of investors, the global fi nancial system is already complex enough. “Today there is a whole different view on ‘contagion’ or ‘correlation’ or ‘interdependence,’” says Vandana Sharma of Standard & Poor’s. “It’s pretty clear that the world has realized that there’s a globaliza-tion, if you will, of the fi nancial sector, and that genie is not going back into the bottle. What that leaves us with is a world where people are going to look for a lot of simplicity. So complexity needs to be taken out, both in the institutions themselves and in their products.”

Of course, banks themselves are seeking to simplify and streamline their business portfolios—not just to divest themselves of businesses that they believe will be less economically viable under the new regulatory regime, but to align their efforts and resources more closely with their core strategy and strengths. KeyCorp, for example, recently made an adjustment to its business portfolio, in what is perhaps an object lesson in the way that increased regula-tory burdens can tip the balance against retaining certain businesses. “Our private-equity business has been a very good and successful business for us, but we decided that there are enough rules and requirements around it that we should spin out the business,” says chief risk offi cer Charles Hyle. “A number of fi rms have started to move in that direction. Some companies have divested themselves of investments in similar types of businesses. I think regula-tory change is not the only driver, just as Dodd-Frank was not our only driver in making the decision we made with our private-equity organization. But it certainly added weight to the scale as we were making our decisions on what to do about that particular business.”

2 At the regional and local level, however, the story is different. Smaller banks have fewer revenue sources over which to distribute the cost of rising regulatory burdens, creating pressure for further consolidation among regional and community banks.


13

“At a time when capital is precious, we have to think about how we deploy that capital.”

What other factors added weight to that scale? “Our capital requirements are going up. Private equity is not a core business for us. We’ve been in it for many, many years, and we’ve been very successful in it, but it doesn’t link to anything else we do. At a time when capital is precious, we have to think about how we deploy that capital,” Mr. Hyle says. “While we’ve made historically a good return on private equity, we get no leverage out of it, in the sense that it doesn’t help us in any of our other businesses. I think many fi rms would say that private equity is a nice side business to be in, but if you’re looking at the core strategies of a banking institution, is it really germane to that business?” Mr. Hyle concludes that, while regulators continue to work through the details of the new regulatory regime (including the fi nal risk weightings), “I think the bigger issue for most banks is the overall capital numbers—the need to create a return on that capital will be a higher standard for all banks, not just in the U.S., but around the world.”

A key role for fi nanceand risk functions If banks will indeed be held to a higher standard for generating value—and everything we have learned in this, the fi fth study in our Bank Executive Series, suggests that they will be—it is equally clear that the fi nance and risk functions play a pivotal role in helping their banks achieve that value.

Both the fi nance and risk functions have gained organi-zational standing and infl uence in the aftermath of the global fi nancial crisis. “I think the role of fi nance is really changing. The psychology of [the post-crisis environ-ment] has put us into a more powerful position,” says Deutsche Bank’s Stefan Krause. “What we need to do is to [come to the point where we] are able to challenge the business,” he continues. “For a long time, the fi nance function in investment banks was seen as a service func-tion that provided data and reporting. I need to move it to be a challenging function that really questions and helps the business—that partners with the business to develop along the value-creation framework.”

“I need to move [fi nance] to be a challenging function that really questions and helps the business—that partners with the business to develop along the value-creation framework.”

A deep understanding of operations and an intuitive grasp of downsides, as well as upsides, is contributing to the risk function’s infl uence, observes BNY Mellon CFO Todd Gibbons—himself a former chief risk offi cer. “I think the role of the chief risk offi cer has certainly risen in the organization,” he says. “CROs have to be very well grounded in the operations of the institution, and in the risk associated with those businesses. I think that’s a great background to understand the business,”



he continues. “It’s in the risk culture to think about the implications of investment decisions—not just single scenarios, but the possible collateral implications of those decisions. I think that’s a very good training for business development, for M&A,” Mr. Gibbons says.

The crisis has pointed to the need for stronger risk-management skills at the very top of banking organi-zations. “Certainly at the board level there is a greater demand for directors with more-specifi c risk-manage-ment backgrounds,” says Mary Tuuk, CRO of Fifth Third Bank. “In the banking industry, you’re also going to see additional thought about what is the best-practices career path for a CEO. You’ll see more and more rotation in and out of enterprise risk management divisions.”

“It’s in the risk culture to think about the implications of investment decisions—not just single scenarios, but the possible collateral implications of those decisions. I think that’s very good training for business development, for M&A.”

Even as fi nance and risk functions around the world seek to exert this renewed infl uence for the benefi t of their broader institutions, they’re balancing a long list of priorities: the need for greater transparency, the need to improve effi ciency and reduce complexity, and the need to manage performance within the bounds of stability.

Ensuring transparency. In the past four reports in this series,3 we have documented at length the fi nance and risk functions’ efforts to respond to demands for greater transparency in banking. In the wake of the crisis, regu-lators and investors have required reporting concerning every conceivable dimension of banks’ risk positions and performance. In the years leading up to the recent crisis,

“there was what I would call the ‘Emperor’s new clothes’ concept in banks,” says Bridget Gandy, co-head of the EMEA Financial Institutions team at Fitch Ratings in London. “The more complex they could make an instru-ment, and the less easy it was to understand where the risks were—the less transparency there was around what was actually going on. Sometimes it seemed as if things were being made complex just for the sake of it, so that nobody asked any questions.” The years since the crisis have seen improvement on that score, however, Ms. Gandy continues. “Although by necessity some [instruments] have to be complex, there’s a lot more will-ingness to explain and to answer questions,” she says. “But there is also a lot more questioning going on, because people have realized that the Emperor wasn’t wearing any clothes—so they can start asking questions. It’s a two-way conversation: hopefully, one that will continue.”

Our sources universally acknowledge that investors’, analysts’, and regulators’ demands for greater transpar-ency are wholly justifi ed, understandable, and necessary. At the same time, meeting these reporting requirements is time-consuming and resource intensive. Not only are many fi nance and risk executives struggling to source data from strained patchworks of legacy IT systems, they are also working hard to explain that reporting—and, indeed, their businesses—to regulators and investors. As the need for their internal management guidance intensifi es, fi nance and risk executives are sensitive to the cost of lost opportunities.

“There will be a lot of reporting requirements and regula-tions coming at banks,” says one CRO of a large European bank, “so that means we need a lot of people working just at meeting these requirements. Those people can’t work at managing the bank, because there’s a difference between box-ticking requirements from regulators and really managing the bank. It will be a very busy time for fi nance people and risk people going forward.”

3 The Finance Operating Model Matters (February 2008), Aligning Risk Management, Finance, and Operations (December 2008), Banks’ Moving Target: Sourc-ing, Analyzing, and Reporting Data in Challenging Times (January 2010), and Capital Management in Banking (June 2010)


15

Further investment in technology systems, the CRO notes, will help to ease the human-resources burden of these new requirements, but IT investment for compliance pres-ents an opportunity cost of its own. “We need to adjust our IT systems, but if we have to adjust our IT capacity for reporting requirements, we cannot use that IT capacity for business opportunities,” he says. “It will reduce the options banks have in changing their business models or their product portfolios going forward, because it’s not only fi nance people working on requirements. IT depart-ments also have to work on them. A lot of time will go that way, and less time and fewer resources will be available to manage the business.”

Driving effi ciency; reducing complexity. In banking, as in industry, the fi nance function is an authority on cost reduction and effi ciency improvement. “Of course, that is one of the key roles of any CFO,” says Mr. Grüll. “Given the lower growth momentum that we are currently faced with, a CFO has to look at the bank’s cost base.” Our sources also point out that the fi nance function is taking the lead in improving administrative and other effi ciencies. “Slower growth means a CFO also has to look at further stan-dardization, further centralization,” Mr. Grüll notes. “One example of centralization is setting up a shared-services center for the entire group, which we did. We did all these things in order to become more effi cient, given the lower growth expectations.”

“We do want to continue to provide complex products, but we don’t necessarily have to have this complexity in our systems, processes, administration, and organization.”

The sheer complexity of banks’ operations and adminis-tration suggests that streamlining could yield substan-tial savings. At Deutsche Bank, for example, “after analyzing the cost base of the bank and understanding that the bank has a complexity-cost problem, we’ve

started a complexity-reduction initiative, which is aimed at reducing a lot of complexity we built in our back-offi ce operations,” Mr. Krause says. “We do want to continue to provide complex products,” he continues, “but we don’t necessarily have to have this complexity in our systems, processes, administration, and organi-zation.” At Deutsche Bank, the savings promise to be substantial indeed: the bank’s internal analysis suggests that its complexity-reduction initiative “is going to take out a billion euro of run-rate costs from the bank,” Mr. Krause says.

Managing performance within tougher constraints. In the four previous reports in this series—written as the global fi nancial crisis gathered, broke, and fi nally began to ebb—one theme weaved and threaded its way through nearly every page: If the business of banking hinges on putting money at risk, then banks must take steps to ensure that they are compensated for the risks they take. Downsides—not just upsides—are important in that reckoning.

At the enterprise level, the work of risk management is to ensure that revenue rewards are gained at a reason-able cost—and never to the detriment of stability. The fi nance function, too, has a critical role to play in ensuring that capital is allocated for optimal growth within the bounds of stability. Hence we fi nd that, as the contours of the new regulatory landscape gradually emerge, banks are working to bring fi nance and risk into ever-closer alignment to support and inform their opera-tions. At DBS, for example, “what we have done is really to infuse this understanding of return on risk-weighted assets throughout the business,” Ms. Chng says. “We are no longer measuring businesses by just absolute profi ts. Businesses are measured by more-granular metrics, including return on risk-weighted assets, through a scorecard that we’ve had in place for more than 12 months. This scorecard helps the businesses to understand that they need to bring in not just the abso-lute returns, but returns calibrated to the risks that they are taking.” She continues, “We also have business-aligned controllers who partner with the heads of our major business lines—institutional banking, consumer banking, and treasury and markets. They work with the

10


The Next Era in Banking: Senior executives on doing business amid post-crisis regulatory constraints10 The Next EEra in Banking: Senior execuutives on doing buusiness amid post-crisis regulatory connstraints16

business heads to understand the drivers of their growth, to present business reviews, to help them understand capital implications and help them monitor their score-card.”

So, as banks begin to grasp how new regulatory stan-dards will circumscribe their activities, we fi nd again that improving risk management—and incorporating risk considerations more deeply into business deci-sion making—is at the very top of banks’ management agenda.

At the same time, banks aren’t in business to manage constraints. They’re in the business of serving customers and creating value for shareholders. And as they do so, banks also fi ll a critical role in society—ideally, as one senior bank executive put it, “facilitating wealth creation” as opposed to “creating wealth as an objec-tive.” How, then, will banks go about serving their customers, creating value for shareholders, and fulfi lling their broad social role? Or, put another way, what about the growth dimension of growth within constraints?

“There’s just a rhythm to the business of banking. What it ends up taking is remarkable discipline.”

A new spirit of innovationSoon after the global fi nancial crisis broke, Todd Gibbons—then chief risk offi cer of BNY Mellon—traveled through the bank’s offi ces in Europe and delivered 10 “lessons learned” from the crisis. One of the lessons, Mr. Gibbons told us, was an inversion of the great counterculture slogan of the 1960s: “You can’t trust anybody under 30.” Why not? The reason had nothing to do with the competence, dedication, or good intentions of young bankers. It was simply a matter of experience. “The reason is that they hadn’t seen anything,” Mr. Gibbons said. “They hadn’t seen the 1989−1990 cycle. They hadn’t seen where interest rates went in the late 1970s. They didn’t know how bad it could get, and therefore I thought that they really needed a few gray hairs to fully grasp risk.”

But now, in the aftermath of the crisis, Mr. Gibbons says he feels differently. “Now I’m afraid it’s the other way around. Now I’m concerned that the younger people who have gone through this crisis in their formative years are going to be too risk averse.” And every banker knows the problem with that. “If this country were completely risk averse, we would never have done anything,” Mr. Gibbons says. “Risk taking is a good thing, as long as it’s controlled and reasonable, you’re paid for the risk that you’re taking, and you understand the risk that you’re taking.”

Indeed, banks will not just have to continue taking controlled and reasonable risks to make their way through the post-crisis landscape. If they are to grow, banks will have to innovate new methods of distributing credit throughout the global economy. And, of course, they will have to inno-vate within the constraints of stability—not just their own stability, but the stability of the global fi nancial system.

If banks are successful in internalizing the lessons of the global fi nancial crisis—the primary importance of sound underwriting, the need to consider downsides as well as upsides, the need to preserve stability while pursuing growth in order to create value—then we can expect that the next era in banking will not be one of unfettered and ill-considered growth, nor will it be one of timidity cloaked as conservatism. It will be an era of disciplined innovation. As Mr. Gibbons puts it, “There’s just a rhythm to the business of banking. What it ends up taking is remarkable discipline. Not necessarily remarkable smarts, but remarkable discipline.”

The Next Era in Banking: Senior executives on doing business amid post-crisis regulatory constraints


17

Sponsor’s perspectiveIn April 2011, Celina Rogers of CFO Research Services inter-viewed four leaders in Ernst & Young LLP’s Banking and Capital Markets practice on the results of this study, the fi fth in the CFO Research/Ernst & Young Bank Executive Series.

Ms. Rogers spoke with Jack Chan, Managing Partner, Financial Services Offi ce (FSO), Ernst & Young China; Andrew Harmer, Partner, Financial Services Risk Management, Ernst & Young Australia; Robert Melnyk, Lead Partner, FSO Advisory Performance Improvement EMEIA, Ernst & Young GmbH; and John Weisel, FSO Global Advisory Leader, Ernst & Young LLP. An edited account of those conversations follows.

Celina Rogers: One of the themes we explore in this report

is the “sea change in regulation,” as one of our sources put

it, that banks around the world are facing. Based on what

you’ve seen so far, how should banks go about reconciling

compliance—a fundamentally reactive set of activities—

with the more proactive work of identifying and pursuing

growth opportunities?

Robert Melnyk: The changing fi nancial landscape pres-ents risks for banks, but there are opportunities as well. We think banks need to understand, combine, and link regulatory requirements with the opportunities that might fl ow from those changes in a more comprehensive manner. They need to identify and evaluate their regulatory and business needs—including their operating- and capital-cost drivers—to discern the growth opportunities in their businesses, markets, and product lines.

John Weisel: Reactive and proactive responses must coexist. Banks that are in a position to mobilize quickly and effect change in areas such as technology, operations, and reporting will be most successful in responding to a shifting regulatory landscape. But compliance investments should also be designed to streamline operations. And I absolutely agree with Robert: banks are going to have many opportu-nities to grow. Assets are going to move, and there will likely be an increase in mergers and acquisitions. Banks should be positioning themselves to respond to these opportunities as they respond to new regulatory requirements.

Ms. Rogers: What role will the fi nance, risk, and treasury

functions play in these efforts to pursue growth while

responding to regulatory change? Our sources in this

study report that fi nance, risk, and treasury have gained

profi le and infl uence in banking over the course of the

crisis.

Andrew Harmer: I think it’s not enough for fi nance just to be the “scorekeeper” anymore. Banks need, for example, a more reliable forward-looking view on their performance—that’s clearly in much greater demand, although I think that shift was happening even before the global fi nancial crisis (GFC). The crisis simply highlighted the need for better, more accurate forecasting. But perhaps an even more important consequence of the GFC is that it brought the fi nance and risk functions together more closely. Finance doesn’t own an activity like forecasting by itself; the risk function also has a role to play with, for example, stricter scenario testing and better-quality information about risk. Finance can only respond to demands for better-quality, more forward-looking information on future fi nancial performance and alternative scenarios by linking more closely to the risk community. These demands don’t just apply to fi nance; they apply to the risk function as well.

Jack Chan: In China, the banking sector as a whole is under-going a transformation in terms of risk management. The four or fi ve largest banks are more or less Basel II compliant [and looking toward Basel III]. Most of the Tier-Two banks are also moving in that direction. The Tier-One and Tier-Two banks are focused on enhancing their management standards and management capabilities, but I think smaller banks are facing some challenges. For those smaller, often rural commercial banks, internal controls and risk manage-ment system are relatively rudimentary. But there’s a high demand for loans, especially in the rural areas.

That’s why it’s very important for Chinese banks to strengthen their risk-management controls and also their fi nance functions, especially among Tier-Three and Tier-Four banks. This is one of the top priorities that the key regulator in China, the China Banking Regulatory Commission (CBRC), is emphasizing.


18 The Next Era in Banking: Senior executives on doing business amid post-crisis regulatory constraints

Ms. Rogers: One of the bank CFOs we interviewed says he

aspires to make fi nance a “challenging function,” which

he describes as a function that “questions and helps the

business—that partners with the business to develop

along [the bank’s] value-creation framework.”

Mr. Melnyk: For fi nance and for risk, going forward it will certainly be one task to cope with the regulatory environ-ment. But as your source said, and very rightly, the role of fi nance and risk should change to be a more challenging one, as it might be in the manufacturing industry. I think this will represent a real change in banking. In recent years there has been an evolution in the fi nance function, from a more accounting-oriented role to “business partner” or “perfor-mance adviser.” Nevertheless, in most banks, fi nance has not been a challenging function so far. It has functioned mostly to enable business-line managers to understand their businesses better and to make better decisions—but fi nance has less often proactively asked the business lines whether their strategic direction is the right one. The next step for fi nance and risk at many banks is perhaps to give recommendations where the bank could engage in even more profi table businesses, for example.

Mr. Weisel: I think of the fi nance- and risk-management functions in tandem. It’s clear that the role they play is far more important than it was even several years ago. Finance and risk need to be out in front of regulatory change.

Every large fi nancial services organization in the world is rethinking its risk, fi nance, and treasury functions. These are not inconsequential programs. Organizations will spend hundreds of millions of dollars to build the capabilities that they’re going to need, not merely to respond to current changes in regulation or reporting requirements, but to change fundamentally how they manage their fi nancial performance, and risk and capital positions of their organi-zations.

Ms. Rogers: And part of that overall effort involves

building more fl exible IT and operating platforms that

will help banks respond more nimbly to change?

Mr. Weisel: Yes. But the fundamental challenge, in its simplest terms, is information. Underlying data is commonly fragmented across these organizations. Most large banking organizations have grown inorganically through acquisitions. Banks are considering how to validate the integrity of their data, how to create a “golden source” of data—and how to move data into a construct that is easily accessible and can be used on a recurring basis. This is very diffi cult as each business has unique needs in terms of data requirements and attributes. These changes are going to take several years to implement. It’s not an over-night undertaking.

Ms. Rogers: We’ve heard from sources that escalating

(and increasingly ad hoc) reporting requests from regu-

lators and investors are generating some opportunity

costs. I should emphasize that every banker we’ve ever

spoken with absolutely recognizes that regulators and

the investment community are entitled to the information

they’re seeking. But these ad hoc responses are absorbing

some of the resources that would otherwise go to more

strategic, long-term improvements. In this environment,

how can banks lay out a coherent investment strategy for

these large-scale improvement initiatives?

Mr. Melnyk: Regulatory change is very much an external factor; it is often a challenge for banks to synchronize external factors with internal business priorities. I think banks need to increase the speed of their investment deci-sion making, and they need to be more fl exible in repri-oritizing IT investments or other investment programs. There’s also another dimension, which involves identifying the overlaps, correlations—the win/win situations—in which banks can combine change in response to regula-tory requirements with the changes they need to make from a business or functional perspective. Rather than viewing regulatory shifts, such as IFRS 9 or Basel III, as separate compliance exercises, banks should consider how IFRS 9 and fi nance transformation initiatives fi t together, for example, or how they might combine Basel III with a new approach to risk management and risk-management systems.


19

The positive side of looking at compliance and business requirements through the same lens is the opportunity to identify overlaps and synergies between the two. On the other hand, taking a more holistic view on projects often means increasing the size and scale of the project, which certainly increases the implementation risk as well. So banks have to balance the benefi ts of looking at projects or potential investments holistically with scaling projects so that they’re executable without taking on unreasonable implementation risks.

Ms. Rogers: How can banks begin to gain control of such

a complex decision-making process when they’re essen-

tially aiming at a moving target? The regulatory environ-

ment is in fl ux, organic and inorganic growth opportunities

are emerging that will take many banks onto unfamiliar

ground—and at the same time banks are responding to a

raft of ad hoc reporting requests.

Mr. Weisel: How do you effectively plan for and execute a global program that cuts across every line of business, multiple functions, and operations and technology? This is among the most complex change-management situations that a bank can face.

The most successful banks will do several things to change. First, they’ll make sure that the goals and objectives of the business users and the operations and technology organi-zations are aligned. Everyone needs to band together.

Second, successful organizations will defi ne their business architecture thoughtfully. The architecture should address what process improvements are needed, what technology infrastructure is required, what applications are needed, and how data will be managed. Banks that implement change on this scale effectively begin with a view of the end-state outcome and defi ne what will be required to satisfy end-user needs, whether those end users are in fi nance, risk, or treasury.

Third—and probably the most diffi cult step—successful organizations will determine the right sequencing for imple-mentation: Should the retail business be addressed fi rst or the investment bank? Should the change effort start with risk or with treasury?

Ms. Rogers: At the same time, our sources over the course

of this series have pointed out that changing the culture of

banking—guiding and helping business-line personnel to

innovate within more robust regulatory constraints over

the long term—is, if anything, more challenging than

the waves of organizational, process, and technology

improvement that banks are currently pursuing.

Mr. Harmer: It’s a new way of thinking and working for operating staff. That’s a dimension of change management that I think over the past fi ve years is something that we at Ernst & Young have a much greater perspective on now. There’s nothing like learning through experience.

Ms. Rogers: Very true. We propose in the report that the

next era in banking will be one of “disciplined innovation”

that stems from that experience. In the future, what will it

mean for banks to innovate in a way that’s sensitive to risk

and to long-term performance, especially since “fi nancial

innovation” has taken on such a negative connotation in

mainstream discourse?

Mr. Melnyk: Yes, the term “fi nancial innovation” has taken on a negative connotation in most markets for fi nancial institutions. Nevertheless, innovation does not only need to come from fi nancial products. Certainly banks can innovate in how they segment and approach their customers. Banks can also be innovative in terms of their own business models—in the ways they struc-ture their businesses and execute their operations. There will also be opportunities for innovation in terms of how banks will cover the globe, including emerging markets, and in the ways they leverage opportunities between different business units and product categories. I think there are different dimensions and levers for innova-tion. Going forward, perhaps the sole focus will not be on innovation in terms of engineering fi nancial products.


20 The Next Era in Banking: Senior executives on doing business amid post-crisis regulatory constraints

Ms. Rogers: How will innovation manifest itself in the

fi nance function, in particular?

Mr. Weisel: Banks will have to approach innovation as an ongoing process, not as an aspiration. Continuous improve-ment of fi nance, risk, and treasury capabilities will be a part of that process. Innovation of the fi nance function will require more signifi cant use of technology. This will require architectural discipline—building a foundation to support the needs of the fi nance function, which allows a consistent set of systems to support the function across businesses, products, and geographies. By undertaking these improve-ments, banks are innovating the way that the fi nance func-tion supports the organization.

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The Next Era in Banking