Speech ‘Change in Banking’
Talk to Opening Dinner of Asian Pacific
Association of Banking Institutes Conference
I am grateful for this opportunity to welcome our overseas visitors to Sydney, and to say a few words at the opening dinner of your Conference. I know the Australian Institute of Banking and Finance is greatly honoured to be hosting this sixth gathering of its colleague organisations from the Asia and Pacific region.
I note that the theme of your Conference is the changing nature of banking and its implications for banking and finance education and training. These are matters of considerable interest to central banks, like the Reserve Bank, both because we have our own specialised banking operations and because of our supervisory responsibility for commercial banks.
I doubt that there's ever been a more important time for seeking to improve the education and training of people working in the banking industries of our countries.
Forces of Change
Banking is changing rapidly, in many respects, in response to the driving forces of deregulation, more intense competition and relentless technological change. Change itself poses challenges to banking education. These are even greater when one consequence of that change is to make banking more complex.
I would like to talk briefly about these changes and the forces behind them. Although the details vary from country to country, there are common themes which are prominent now, or will be in the future, for all of us.
Banks are today offering a much wider range of products and services than ever before, both in retail and wholesale markets. There are not only more options among the traditional products, such as deposits and payments facilities, but banks in many countries are also becoming more involved with ‘non-traditional’ services like insurance, funds management and securitisation. This broadening in the scope of banking tests managerial skills, as well as the abilities of line staff.
We are also seeing the application of more sophisticated technologies to product design, to service delivery and to information-processing. Nowhere is this more evident than in the payments system where electronic impulses and computer chips are gradually replacing paper.
And there is continuing growth in global linkages. These have, of course, been extensive in wholesale banking for some time. They are now becoming a feature also of retail banking – with innovations like the Internet and multi-currency stored-value cards.
Along with these changes, financial products are becoming more complicated. The obvious examples are derivatives. But the use of derivatives is allowing banks to include additional features and options in basic loans and deposits.
Bank staff are having to keep up with this changing world, while the higher expectations of customers – and associated consumer and investor regulations dealing with disclosure, complaints handling and so on – are creating additional layers of complexity and responsibility for them.
Of course, strong competitive pressures are driving many of these changes. Deregulation in Australia, and many other countries, has been a two-edged sword for established banks. It has allowed banks to enter new markets and engage in a wider range of activities. But deregulation has also made it easier for new firms – both banks and non-banks – to enter financial markets. At the same time, technological advances in delivery systems are helping these new entrants to attack the market share of existing banks without having to build large and costly branch networks.
Historically, banks have cross-subsidised some lines of business with higher interest rates or prices elsewhere. As it becomes easier for new players to enter markets, banks are particularly vulnerable to specialist competition in those activities. Meanwhile, capital markets are becoming deeper and more sophisticated in many countries, providing alternative channels of finance for corporate borrowers who had previously relied solely on banks.
An example of new specialist competition in Australia has been the emergence of non-bank mortgage originators which in a couple of years have taken 10 per cent of the home lending market. They have drawn their funding from the expanding capital markets, and taken advantage of lower operating costs to undercut banks' lending rates in a traditionally high margin line of business.
In responding to such competition, banks are having to alter their pricing strategies, rethink where their comparative advantages lie and adapt their operations to the changing shape of financial markets, all while trying to maintain and lift the quality of service to existing customers.
The End of Banking?
Some commentators, surveying this landscape of competition and change, often predict an end to banks as we know them. Although there is considerable exaggeration in such predictions, they also contain more than a grain of truth. As I've already noted, the nature of banking is indeed changing before our eyes, and banks – as institutions – are having to evolve with this.
This does not mean that banks have no place in the future. But their survival will depend on their adaptability, on their capacity to change with patterns of demand, to exploit their profitable activities, and to abandon the others.
Banking is fundamentally based on processing information about lenders and borrowers, and using this to manage the various risks associated with finance – credit risks, market risks, liquidity and so on. These basic tasks will continue to be fundamental in all financial systems – regardless of the technological changes which alter how they are carried out, and regardless of the opportunities for new entrants to participate.
The Challenge of Adaptation
In meeting the challenges of adaptation, banks in Australia and many other countries have considerable strengths to build on, including:
- generally healthy profitability and capital positions;
- strong commercial franchises, with high brand-name recognition;
- wide distribution networks;
- extensive databases of information about their customers;
- a fund of basic skills in risk assessment and risk management; and
- the capacity to offer packages of financial services to customers who want that.
These attributes give banks a powerful base from which to reshape their businesses as necessary – a base which few other institutions enjoy.
To illustrate: I've noted that the growing sophistication of capital markets and the appetite of institutional investors are making it easier for corporations to borrow directly by issuing securities. This could mean borrowers' bypassing the banking system altogether. But banks are in an excellent position to keep an important, though different, role by using their skills and knowledge to help design securitisation programs for these borrowers, and to underwrite and place raisings with investors. This business does not appear on a bank's balance sheet but it can contribute as much to profits as traditional lending, particularly since it is probably less capital-intensive.
In many countries, households are wanting to have a larger proportion of their savings in managed investments rather than bank deposits. Where it is permitted, as in Australia, some banks have very successfully built funds management subsidiaries to tap this market. Some of the funds gathered can be recycled for use in the bank.
We see particular examples of adaptation in connection with the non-bank mortgage originators in Australia. Although they are popularly regarded as competitors, a few banks have actually played a key part in the success of the originators – by temporarily financing the loans they make, and then arranging ultimate funding through securitisation vehicles. Now some banks are competing with the originators by offering cheaper basic housing loans using the telephone, rather than branches, to reach their customers. Others are taking advantage of the bigger market for mortgage-backed securities to securitise loans already on their balance sheets and economise on capital. More generally, of course, our banks have had to cut interest rates on home loans and look for alternative sources of profit.
While the successful banks will continue to perform the same basic functions, their shape is changing – as I've already described – and will no doubt change further. Some will build large diversified organisations, such as bancassurance conglomerates, to supply a full range of financial services; others will specialise in investment and capital markets activities; still others will find profitable niches in regional retail markets, trading on local knowledge and customer loyalty. The smaller banks in particular, but perhaps also larger ones, will increasingly outsource ‘non-core’ activities such as cheque processing and computing to specialist suppliers who can take advantage of scale economies.
Coming back to my original theme – for an industry which is changing quickly, becoming more complex and under continuing competitive pressures, the importance of well-trained and competent staff is clear. And training must also be ongoing, as innovations flow steadily and technical skills are made redundant more quickly.
There are some extra challenges for banking education in these circumstances. Seeking higher efficiency and profitability, banks are working hard to cut their operating costs. In this environment, training budgets can be at risk. I believe that the short-term savings and the long-term costs of budget-trimming in this area need to be weighed carefully. Furthermore, staff reductions are often a part of cost-cutting programs or are consequences of technological innovation. It can be an especially difficult managerial task to maintain staff motivation and skill levels while this is occurring.
Interests of the Bank Supervisors
I have said a good deal about the challenges for banks and their staff. What are the particular interests of banking supervisors in the changing shape of banking?
The basic challenge for supervisors is to ensure that minimum standards of bank safety and reliability are maintained and that the integrity of financial systems is protected, while leaving banks sufficient flexibility to respond to tougher competition and take advantage of new technology.
I think that there is growing understanding internationally of the problems which come from overly prescriptive and restraining supervision. So bank supervision is evolving, along with banking.
For instance, there is recognition of the different risks which banks face. Credit risk and liquidity risks have historically been the main areas of focus for supervision, but attention is now being paid also to market risks and to operational risks.
Many banks face the danger that financial problems in an associated institution will cause direct or indirect damage to the bank itself. This is often called ‘contagion risk’, and it is more of an issue as banks become more involved in conglomerates with insurance and funds management companies. Consequently, greater attention is being given to how financial conglomerates can be supervised effectively and contagion risk contained. This, in turn, is requiring banking supervisors to work more closely with insurance and securities regulators.
There is also increased focus on risk management. Perhaps the main lesson that supervisors have learnt from high profile ‘problem banks’ in recent years is the importance of strong internal risk management systems. If these are ineffective, then prudential supervision requirements can be subverted. Moreover because the risk profile of a bank can change quickly in today's volatile markets, the careful monitoring of historical liquidity and capital ratios might not provide much protection against serious problems. Increasingly, therefore, supervisors are looking for assurances that a bank's systems are capable of coping day-by-day with such volatility.
Of course, where a bank has strong internal controls it may be possible to adopt a less intrusive, less prescriptive approach to supervision. There is an example of this in the Basle Committee's new market risk guidelines which allow banks with strong management systems to use those for calculating capital requirements.
Finally, supervisors are encouraging banks to disclose better financial information publicly, so that market discipline can be a more effective complement to the work of bank supervisors.
These trends in supervision – especially greater emphasis on the quality of each bank's risk management arrangements – mean that supervisors have a close interest in the quality of bank staff. A critical component of any effective risk management system has to be the people who work within it. While systems can look very impressive on paper, they will work in practice only if the staff responsible for them are professional and ethical.
So it seems that in whatever direction you look, the need for professional, well-trained and highly motivated bank staff is clear – and fundamentally important to the future of banking.
I wish your Conference every success in pursuing that objective over the next few days.