Are US Banks on road to recovery?

With more than 38 million unemployed and the economy shrinking by 4.8% (per the US BEA data), the impact of the COVID-19 pandemic on the US has been unprecedented.

Even as the death toll crossed a psychological landmark of 100,000 many businesses across the US are planning a phased reopening, albeit with adequate precautions. 

However, this may hardly bring cheer to the banking and financial services industry that is facing a bleak H2 this year.

The high unemployment caused by the pandemic has imposed hardships on Americans and many will find it difficult to meet their financial obligations, despite the forbearance that lenders have provided them. The result will be a sharp rise in delinquencies and charge offs across lending products.

Further, the high expected losses will also force banks to apportion higher capital reserves against losses.

According to a recent McKinsey study, the expected losses to the retail lending business in the US in the short term (three to six months) could be between $15 -$25 billion. If unemployment hits 20%, the longer term losses could be over $150 billion over the next two years.

It is difficult to imagine such a huge loss staring at the retail banking industry. Whether this actually pans out or not will largely depend on how robustness of the recovery of the US economy and to some degree on how smartly lending institutions manage their credit risk policy during these turbulent times.

But all is not lost. There may be a silver lining that cannot be ignored. Available data points to an otherwise healthy economy prior to the pandemic.  Data published by the Federal Reserve Bank of New York (May 2020) shows that non housing debt at the end of Q1 2020 was flat, punctuated by a seasonal decline in credit card debt of $34 billion. This drop was significantly larger than the decline for the same period in 2019.

Obviously the data published by the Federal Reserve does not incorporate the impact of COVID-19 on the economy. But the point to note here is that as at the end of Q1 2020, there were no major concerns with respect to consumer debt.

The insight here is that if the US can manage an orderly reopening of the economy and reign in unemployment, even if slowly, there is every chance that the economy will recover faster than many are forecasting. That would be good news for the banking and financial services industry.

Is It time For Structural Realignment Of RBI?

The regularity of frauds at Indian banks has shaken the faith of the public in the banking system. The Reserve Bank of India (RBI) has attracted a lot of flak for the Punjab National Bank (PNB) fraud for the fact that it happened right under its nose and the fraudsters got away. Suggestions have poured in from well-meaning opinion makers and couch pundits – from replacing the RBI Board to privatizing the banks.

In this context, in what may be a rare occurrence, two governors of the RBI – one former and one current - hit the media spotlight and spoke about the issue.

Dr.Raghuram Rajan in an interview with a business news channel spoke more like a politician - all generalities and little or no specifics. He pointed fingers at the Prime Minister’s Office (PMO), conveniently forgetting that he was the governor when the fraud was being perpetrated.

On the other hand, Dr. Urjit Patel, the present governor, spoke of the need to privatize the public sector banks and appeared to deflect blame from the Central Bank. Many saw this as a response to Finance Minister Jaitley’s pointing fingers at the RBI for the scam.

RBI governors, in a time tested tradition, are known to be reticent and tend to shy away from media spotlight. But that may be in a bygone era and not in the new normal we all live in.

While there may be some truth in what Dr. Patel had said, the fact that he chose to speak at all on the topic and the timing were indeed bizarre. It is unclear why he chose to bring this up in public. Nor did Dr. Rajan cover himself in glory. The RBI and the Ministry of Finance, per an unwritten etiquette, never drop even the faintest hint of discord amongst them. This is because it has the potential to create turbulence downstream in the economy and could unsettle markets.

The RBI is a venerated institution that is deeply entrenched in the economy. In it’s over eight decades of existence it has requited itself extremely well. It has been at the forefront of expansion of bank branches and credit delivery. It had also played a pivotal role in the nationalization of banks in 1969 as well as in nurturing several developmental financial institutions.

To its credit, the central bank has embraced advances in technology to build a modern banking and supervisory infrastructure. It has adopted risk based supervisory model, a contemporary best practice in bank supervision worldwide. The key pillars of this model are a combination of onsite and offsite monitoring and greater reliance on backend data analytics to proactively gain insights into problem areas in the system. These early warning insights would enable the regulators to monitor banks better.

So, at least on paper, systems and processes were in place for effective supervision. Yet, the repeated occurrence of high profile frauds despite these innovations, only reinforce the common perception that the RBI and bank auditors have not lived up to the expectations of the country.

The real culprit here, of course, is the fact that India’s institutions and enforcement agencies, despite constitutional and legal guarantees, have long been rendered toothless paper tigers by vested interests. That was done deliberately so that scams like the ones at PNB could be committed with ease.

But the deliberate defanging of the watchdogs or the ownership of public sector banks by government raised by Dr. Patel, are secondary issues that need to be addressed separately. They should not obfuscate the principal responsibility of the RBI in securing the banking system. Given the stature and dignity of the institution and office, it does them no good to pass the buck.

Having said that, the truth however, is that the RBI carries an overload of functions and responsibilities that range from traditional central banking to other “developmental functions”. This was probably necessary in the early days after independence when the modern banking system was in its infancy. But today the situation is different.

Digital banking has rapidly taken root in every corner of the country today, thanks to technology and mobile phones. At the same time, it has also set the bar higher for customer expectations in convenient and secure delivery of banking services. This, in turn, has only accentuated the enormity of challenges in managing and regulating the burgeoning industry.

The fraud at PNB has exposed the vulnerability of the banks system in the new digital ecosystem. There are powerful lesson to be learnt here. Institutions that do not adapt and change with the speed of time risk becoming irrelevant.  Hence the need of the hour is a structural transformation of the Central Bank to meet the enhanced challenges in the new digital banking order.

It is certainly an opportune time to review and offload some of the regulator’s functions. One recommendation would be to carve out the Board for Financial Supervision (BFS) into a separate organization. The BFS was constituted 1994 as a committee of the Central Board of Directors of the RBI “..to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions and non-banking finance companies …”. It enjoys enormous powers under the Banking Regulation Act, 1949. In the light of repeated frauds, the BFS must be reincarnated as a more agile and results driven body.

An expert committee could help with the finer details and setting up of this new entity. Suffice it to mention here that this new institution must rise well above the turf battles between the RBI and the Ministry of Finance. It must be on par with other institutions like the Election Commission of Indian (ECI) and the Comptroller and Auditor General of India (CAG) to prevent the institution from being bludgeoned into submission by vested interests. 

But given the current preoccupations of the government, the much needed administrative reforms for governance may not happen in the current term of office. Many pundits and analysts believe that the Modi government may have already prepared a blueprint for comprehensive reforms that will radically change the civil, police and judicial services in India. Redefining the role and function of the RBI must find the pride of place in the administrative reforms that is long overdue.

Creating this new entity will show the government’s determination in delivering safe and secure banking services to all Indians.

Power of Analytics

I was reading this book “Competing on Analytics –The new science of winning”; It is a must-read for number crunchers and ambitious bankers in particular. The authors (Davenport & Harris) have delightfully brought out how analytics can turn a company into a winner. According to the authors (Davenport & Harris) the following four factors are vital for successful “analytical companies”

Supports a strategic capability

Enterprise wide

Commitment of senior management

Company makes a strategic bet on analytics

Analytics – as any number-cruncher knows – has always played a key role in decision making in banks and financial services. It is not something new. However, more and more companies are leveraging this today to propel themselves into big league.

The obvious example of use of analytics in banks and financial services is in the development of custom scorecards to predict default. The larger banks have dedicated “decision sciences” teams to handle this. While smaller banks buy credit scores from the credit bureaus, the larger banks develop and deploy a  wide array of  score cards that are designed to serve specific business purposes.

But the larger more prevalent deployment of analytics is in performing ad-hoc analytics to find answers to specific business problems. These vary in complexity and the type of problems they are trying to address.

For example credit risk departments in retail banks have used the power of analytics in approving/providing lines of credit to customers.  In making these loan decisions, banks usually compute debt to income ratios, number of other loans, regularity of repayments, any unpaid and past due loans,  membership on rewards databases, loyalty to the bank etc.  to help make prudent credit decisions.

Marketing also is a key user of analytics. An example is how banks monitor existing customers who shop to refinance their mortgage or auto loans. This is helped by “triggers” from credit bureaus. So if you have your home mortgage financed by bank A but would like to shop for better rates, Bank A will get a trigger from the credit bureaus that your credit was pulled by Bank B;  Now Bank A , using analytics can and provide a counter offer to you.

Technology impact on analytics

Analytics is now helped in a big way by new developments in IT and Business Intelligence. The new buzz words in technology - Big Data, Cloud, Social media & Mobility have greatly impacted analytics.  For example new BI tools that leverage the 64-bit architecture can help process huge volumes of data in-memory that has not been possible earlier. This enhances the speed and depth of analytics.  

Mobility adds a key dimension to delivery of analytics. It can now reach top management 24/7. The iPad is rapidly changing board meetings by providing depth and ease to business leaders. New visual analytical tools can help managers perform scenario analysis during meeting and provide useful insights almost instantaneously.

Social media analytics is now emerging as a new discipline by itself. For example bankers are finding out that people with similar credit risk “like” similar friends on Facebook.  While this definitely needs more empirical data to be broadly accepted, it is making significant inroads and will be closely watched in the coming months.

The US economy is slowly emerging from recession.  I think analytics will be a key player in helping Banks to find their way back to profitability.

Social Media and Banking – Sibos Video

This is video presentation on Social Media and Banking I found on Youtube;  Would highly recommend it;

http://www.youtube.com/watch?v=akdKEW_VYQU

Thanks  JJ Hornblass

Fee Income – Different Strokes by different Banks

I just read that the Senate voted let the Federal Reserve limit debit card swipe fees to $0.12 average per transaction, down from $0.44 average per transaction.  

The debit card fee has been a contentious issue that witnessed lobbying by retailers/ merchants and counter lobbying by Banks. Today’s news is a victory for merchants in a long-running fight with banks.

According to the Oliver Wyman report published earlier the Fed’s proposal could trigger a 73% decline in financial firms' fee revenue, from $16.2 billion in 2009 to $4.4 billion. 

No wonder the issue was contentious.

While banks and credit card companies have been losing fee income in post crisis regulations, this Senate vote has only added to their woes.

The innate strength of the banking and financial system has always been its ability to innovate and find new solutions to its challenges. How have Banks and financial services companies responded to loss of fee income?  

Well, different strokes by different banks.

Banks have responded to reduced fee income in different ways.  For example earlier this year, Bank of America introduced four new accounts where users pay fees unless they keep minimum balances, make regular deposits, use credit cards or take advantage of online services. I would definitely not call this innovation!

But I think the best innovation in fee income that I liked came from M&T Bank.  The bank recently announced the launch of new tools for customers to manage all finances and see their credit scores from a single screen. Finance Works enables account holders to view all financial accounts - credit cards, loans, checking, savings and retirement accounts while Credit Score for a monthly fee of $2.99 enables the account holder to see their credit score, refreshed on a monthly basis. These service offerings represent new and creative way to engage the customer, while one service brings in fee income.

While it is true that banks are facing pressure on fee income due to new regulations such as the new debit card fees limit imposed by the Fed,  smart players are leading the way by innovation. 

Greater the challenge, greater the innovation. So I definitely expect to see more innovative service offerings from banks and financial services in the coming months.