AFTER CRISIS, BANKS´ MODEL FACES DISRUPTION / THE WALL STREET JOURNAL

After Crisis, Banks’ Model Faces Disruption

Lenders are more profitable than ever, but margins are shrinking, regulations are pinching and nimble competitors are swirling

By Max Colchester and Margot Patrick

From a cramped office in East London, Tom Blomfield, a 30-year-old Brit, is preparing to take on the banking sector with a lender that employs a handful of people, charges no transaction fees and probably won’t make that many loans.

Mondo, a snazzy mobile checking-account app, will, however, be very cheap to run. Lumbering traditional banks should be worried, says Mr. Blomfield. “There is a massive change coming.”

Following the financial crash, lenders have broadly been able to repair their balance sheets.

Globally, banking has never been more profitable. Total bank profits in 2014 hit $1 trillion, a record high bolstered mainly by growth in Chinese banks, according to global consulting firm McKinsey & Co. The banking sector is also near its 2012 peak, with roughly $135 trillion in assets.

But for established lenders, cracks have appeared in their business models. Margins are shrinking. Rock-bottom interest rates have pinched profits, new regulations have jacked up costs and a host of nimble competitors threaten to chip away at their businesses. Meanwhile, global economic growth looks muted and worries are increasing around China. “We are in an environment where nothing is good,” Andrea Orcel, president of UBS AG’s investment bank, said recently.

Big banks spent the past five years wading through regulatory reforms. Now a main battlefield for banks is how they can squeeze profit growth out of lower-cost operations and put their balance sheet to work. Return on equity, a key measure of profitability, crashed after the crisis as banks digested pools of bad loans and restructured their operations. Average pre-crisis returns of 14% have given way to the new normal of around 9% for big global Banks.  

Faced with investor pressure to increase returns, the response from most developed banks has been to slash headcount and refocus resources, eliminating whole swathes of activities that regulators deem risky. More than 100,000 jobs have been cut at U.S. and European banks since 2012.

HSBC Holdings PLC, Europe’s biggest bank by assets, has exited 15 countries and around 80 businesses since 2011. European investment banks including Barclays PLC and Deutsche Bank AG are beating a global retreat and shedding unprofitable clients. In the U.S., J.P. Morgan Chase & Co. has cut its balance sheet as regulators pressure lenders to become more manageable.

“We have seen banks reduce their proprietary trading, reduce their investment-banking operations and cut back on the activities that really give rise to heavy exposures,” said David Strachan, a Deloitte LLP partner and former financial regulator.

As banks fall back, others are gradually taking up the slack. The so-called shadow-banking sector has boosted its share of the world’s financial assets, according to a November Financial Stability Board report. Insurers are increasingly funding long-term loans for infrastructure projects. In some cases traditional bank lending is being bypassed almost completely. Since 2009 eurozone banks have cut lending to companies by €590 billion but financing via bond markets grew by €415 billion, says Morgan Stanley. Loans also make up a smaller portion of U.S. bank balance sheets since the crisis, data show.

A new breed of competitors are circling bank customers, offering cheaper and easier ways to get loans, make payments and transfer money. “There’s growing anxiety that digital disruptors will skim the cream and pinch banks’ profits whilst many banks struggle to move fast enough to re-engineer legacy systems,” said Huw Van Steenis, head of European bank research at Morgan Stanley.

Faced with the disruptive threat, some banks have entered into a tentative embrace with the tech companies that challenge them. For instance, J.P. Morgan will start using online lender On Deck Capital Inc. to help make loans to some of the bank’s roughly 4 million small-business customers. Others are just buying up the competition. Spanish bank Banco Bilbao Vizcaya Argentaria SA bought mobile banking app Simple.

The danger is still on the horizon. So far the new breed of fintech companies has been “remarkably undisruptive,” said Anshu Jain, Deutsche Bank’s former co-CEO. The sector is still small and most of the new players have shied away from taking risk onto their own balance sheets.

Worryingly for banks, the results from cost cutting have been mixed so far, says Carola Schuler, a managing director at Moody’s Investors Service. Many banks appear to be standing still in their efforts to improve their ratios of cost to income. “Cost cutting may just offset shrinking margins here and there,” said Ms. Schuler. “High regulatory costs and [fines] also have the potential to offset some of the cost-cutting efforts that have been taken by banks.”
 
Based out of an office once occupied by a venerable London broker, Mondo is hoping it can ramp up pressure on banks. The startup hopes to get its U.K. banking license by the end of this year, says Mr. Blomfield. “We will see what happens.”