This article first appeared in The Edge Financial Daily, on January 7, 2016.
NEW YORK: Financial technology (fintech) can help banks do a hard reset on costs. Lenders have little to look forward to in 2016, and face pressure from a variety of start-ups. However, the revolution the new players threaten could actually revitalise traditional institutions.
Most big banks fail to earn a return on equity above the 10% usually seen as their cost of capital. Only JPMorgan, Wells Fargo and US Bancorp do so regularly — and even then, not spectacularly. Nor is there much room to grow. Interest rates rising slightly will help profitability, but only a bit, and rising credit costs could increase bad loans.
So returns will not budge, unless banks begin to co-opt the best of fintech. That could mean buying fintech outfits, building home-grown equivalents on their own or with other lenders or simply purchasing their services.
There are plenty of inspiring examples. Alternative lenders use sophisticated algorithms to better assess would-be borrowers, and companies like Bill.com and Viewpost are rationalising large chunks of processes such as small-company invoicing and cash management. Viewpost, which partners with banks, claims its technology can strip out enough costs to cut current fees by more than 90%.
Elsewhere, technology could allow banks to provide a more personal phone service yet cut costs by as much as two-thirds, according to digital communications firm Xura. It could also help combine support functions, like so-called know-your-client data gathering, which could shave up to a tenth off back-office costs, according to the Boston Consulting Group.
All told, the results could be dramatic. US Bancorp, with US$400 billion (RM1.75 trillion) of assets, is the most efficient big bank, spending around US$54 of each US$100 of revenue on expenses (ROE). Nevertheless, suppose it could eventually cut 15% of its bills. That would boost its ROE to 17% from the recent 14% level, Breakingviews calculations show.
Similar cutbacks would add around 3 percentage points of ROE to both JPMorgan and Citigroup’s returns, boosting them to 13.7% and 10.7% respectively. Higher earnings will also let Citi use its US$48 billion of crisis-era tax losses faster, reducing its capital and further bolstering returns.
Granted, banks will have to spend heavily on kit and on redundancies, so any gains would take time. However, fintech can help a stagnant sector reboot itself. — Reuters