Capco Institute Blog

The Office of the Comptroller of the Currency (OCC) recently published its Semi-annual Risk Perspective, Fall 2012. The report provides perspective on trends in the banking industry and highlights issues that it thinks merit attention, drawing on mid-year and year-end data from banks of all sizes across the country. The latest issue highlights several challenges that banks face going into 2013 and beyond. Some of the OCC’s key findings in this issue included:

Slow growth to continue: No surprises here. Based on the slow economic growth experienced in 2012, the report predicts the trend will continue into 2013. Considering the eurozone crisis, weakness in U.S. labor markets, the slowing of emerging market economies, and uncertainty about the U.S. fiscal situation, the report predicts that the unemployment rate will remain above acceptable rates in 2013. This estimate has been at least partially supported by the recent fourth-quarter GDP estimate that showed slightly negative growth (minus 0.1 percent). Although some of the latest unemployment numbers show the jobless rate improving, this improvement is mostly due to the large numbers of Americans leaving the labor force or being underemployed. The net takeaway for financial services firms is that this is likely to mean low spending by consumers and thus low loan growth for banks. Although low loan growth will not impact all banks the same way, it is safe to assume banks will continue to explore new markets and products to compensate for the weak loan growth.

Pressure on net interest margin (NIM) to continue: According to the report, this will be caused by near-zero nominal interest rates resulting in the retirement of older, higher-yielding consumer debt and its replacement by lower-yielding new loans, further compounding margin pressures. The key implication from this prediction is that banks are likely to be risk seekers to move their NIM to acceptable levels. Given limited revenue growth opportunities for large banks, these banks will also try to lower their costs by shedding overhead (i.e., branches, personnel) to meet return objectives. For smaller community banks, this will mean consolidation, as a low NIM makes their financial position as a stand-alone entity less viable.

Regulatory pressures: Regulators have been pressuring banks to improve their liquidity and capital positions. Although capital ratios have been improving, as shown in Figure 33 from the OCC report, this also means the costs of the increase are passed back to the relevant deposits business, causing a direct hit on deposit portfolio profitability. Increased capital requirements are likely to reduce the profitability of banking, especially for larger “too big to fail” banks, as they will be under tighter regulatory scrutiny. This may be good news for competing smaller banks and less highly regulated sectors of the economy, as more capital is likely to leak their way.

Focus areas for banks in 2013
Given the predicted business environment, we expect banks to focus on the following three key areas in 2013:

• Revenue growth: Expect to see more innovation in products targeting new customer segments, such as remittances and the immigrant community, mobile payments and the youth/content market, and so on. Given the low barriers to entry for many new products, we anticipate quick replication and commoditization of products due to the intensely competitive fight for market share. We also predict that medium-sized banks will join the fight in many product segments and no longer continue to cede ground to the larger banks. Smaller banks will look for consolidation opportunities.
   
• Cost reduction: Banks will look for new ways to reduce costs. Because there is not much room left to further reduce labor costs, the focus will be on harmonizing key operations such as origination and sales, service alignment in payments, billing and pricing systems, and a portfolio approach to product rationalization. This will be especially true for larger banks as their opportunities for revenue growth may be limited by their “too big to fail” status.
   
• Operational risk improvement: Regulators will be on the lookout for banks taking irresponsible risks, especially in new product innovation. This will translate into a regulatory focus on operational risk. This trend is already being demonstrated in the recent report that showed operational risk as one of the top categories of Matters Requiring Attention (MRA) for OCC-regulated banks. In a recent speech, OCC Comptroller Thomas Curry stated that operational risk has increased to the point that it is now a greater challenge for banks than credit risk.

Thus in this new economic climate, revenue growth and cost reduction objectives will have to be pursued while effectively managing operational risks.

What are the focus areas for your bank in 2013? Join the discussion.