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Emerald Group Publishing Limited
Copyright © 2005, Emerald Group Publishing Limited
The new regulatory challenge
The pendulum is swinging. Not for a generation has regulation played such a central role in the destiny of financial institutions. In the 1970s and 1980s, the walls that separated different activities of financial institutions were torn down in an era of great liberalizing reforms. A period of rapid and sustained transaction activity changed the financial services landscape.
Today, the confluence of an avalanche of regulations, ill-prepared IT and compliance procedures, and a low-growth-low-inflation environment is likely to bring about a new watershed. What is different is that the walls have not been reconstructed; rather, regulators are using the levers of market practice and capital management to shore up financial services markets. As a consequence, four issues are likely to flow from this confluence of events that will reshape the financial services landscape:
1. Regulation has entered the boardroom
First, the confluence of a regulatory avalanche and new business economics has brought the financial services industry to a major turning point. Arguably, not since the wide-ranging liberalization of financial services activities in the 1980s has regulation driven such dramatic change. The shift from bull market and high inflation to uncertain stock markets and low inflation was already changing the economics of financial services. But wide-ranging regulation is adding further pressure. With little evidence of a strategic shift in thinking towards regulation from compliance to business issues, a continuing piecemeal response of many financial institutions could prove fatal. A large proportion of senior management is not being briefed in key areas around regulations and the pace of implementation needs to be quicker. Banks and insurance companies need to adapt their business models to the new environment. By 2010 the financial services landscape will look very different, and this change will accelerate from 2005.
2. Post-watershed, size may become an advantage
Second, as financial institutions move to a new regulatory environment, some firms will have distinct advantages over others. Broadly speaking, the high ground belongs to the large, diverse companies with captive distribution and capital strength, although some niche organizations will benefit from their focus and ability to move swiftly. A combination of current capabilities, past business legacies, and management action will cause a polarization in fortunes. The banks have a natural edge, while all but the largest life insurance companies may struggle for success unless they evolve. There will be consolidation amongst intermediaries. Transactions will be driven by new capital regimes. There will be more cross-border competition.
3. A capital-hungry transition
Third, making the transition to the new environment requires capital whether defined by Basel, Solvency II, economic capital or rating agencies. For all types of FSIs, adapting to a regime in which lower-margin products have longer pay-back periods requires capital. In the case of life insurance, this is happening at a time when balance-sheet capital is already in short supply. This points to a continuation in the trend of life companies raising capital – often in innovative ways. We also expect that many smaller (life) insurance companies may have difficulties generating an acceptable return on capital.
4. Policy challenges still remain
Finally, expect to see new policy issues arise in two areas: the provision of medium- and long-term savings products, and consumer choice. First, the general public is likely to be offered a narrower range of standardized savings products with less access to quality advice. The proportion of the “unsaved” within society could grow. Second, the combination of pressures is likely to force firms to differentiate even more between different income groups, with the lower income groups being offered even less advice and, possibly, more expensive credit products.
The key for all financial institutions lies in the alignment and balancing of investments and operational activities around the three Cs – capital, cost, and customers. None of the three Cs is new to financial institutions. However, what is new is that the changing environment requires a much greater degree of interdependency within the business. The three Cs provide an appropriate lens. For instance, Financial Services Authority (the UK regulator) guidelines around treating consumers fairly demands that a financial institution not only reorganize the interaction with customers over the lifetime of a product, but also develop a detailed understanding of the cost to serve that customer and the capital efficiency of operating in that marketplace.
All in all, the new regulatory challenge means the financial services sector is likely to look radically different by the end of this decade.
Chris GentleDirector at Deloitte. He can be contacted at firstname.lastname@example.org)