The European Banking Authority(EBA)has publishedthe findings of its research into banks’actions in response to the limits on variable pay imposed by CRD IV (i.e. 100% of fixed pay, or 200% if shareholders approve). It expressed the view that the annual ‘allowances’ some banks were using to supplement executives’ salaries and other fixed pay should not qualify as fixed but should instead be treated as variable.
Re-categorising these allowances as variable pay would mean the banks concerned will almost certainly have breached the CRD IV limits on variable pay if, as will be the case for many, full use had been made of those limits.Consequently these banksmayhave been making illegal payments to the executives concerned.Furthermore,some may also be acting outside the powers given to them by their shareholders (e.g. if they have obtained shareholders’ permission to extend the limit from 100% to 200%). Unsurprisingly the EBA has indicated that it expects national regulators to put a stop to these practices immediately.
Inevitably, given the size of our banking sector and the historical prevalence of variable pay practices here, many of the so-called offending institutions are in the UK.However the UK’s Prudential Regulation Authority (PRA), in a practical mood, has said that it is too late to change things for this year.
So that’s all right then?
Not really.The first depressing aspect is the apparent level of surprise and outrage being expressed by commentators and various EU bodies. In order to preserve their underlying cost base and at the same time retain key staff, banks had no real choice other than to follow the path they did – any other route would have risked compromising cost flexibility, pay competitiveness and even the scope for clawing back variable pay in the event of any future problems.This now seems to be a likely reality. Plenty of people (us at Hay Group included) warned that this would happen and that the industry would have been better advised to fight the proposals from the outset rather than attempting to circumvent them once they became law.
The second depressing aspect is the collapse of the UK’s legal challenge. The UK’s success record at the European Court of Justice is poor and the Chancellor has clearly concluded that this fight is not worth taking further.
Thirdly, the debate adds to the uncertain and unhelpful atmosphere surrounding the banking sector as a whole. Although the results of the lateststress test seem to be both the best and most robust yet, the outlook for the European banking sector still looks far from rosy.
What’s going to happen?
Unfortunately our politicians and regulators seem set on discouraging new investment in European banking operations byimposing an ever more inflexible staff cost model, making it difficult to pay high performing staff appropriately, and adopting a penal regime requiring responsible executives to rebut a presumption of guilt in the event that something goes wrong.
If nothing changes I would expect to see a gradual shift of business away from European banking centres such as London, Paris and Frankfurt towards the US and the Far East. I say gradual because it is less likely that operations will shift wholesale overnight than new investment will go that way. Part of this drift willinevitably be driven by the faster growth of Far Eastern economies (primarily China) but part will certainly flow from an uncertain regulatory regime that has becomeincreasingly unfriendly towards financial services and bankers in particular.
So what should we do?
Executive pay is a symptom of the industry’s problems not their cause; banks must get the key issues right including their business models and the nature of their services. Positive changes are being made on these fronts but they attract much less focus and airtime than bankers’ pay and there is therefore a risk that they may fail to have the impact needed to rejuvenate the sector and create a financial services industry that is both profitable and socially useful.Get that right and executive pay should ultimately follow.
In the meantime however, companies in the sector should pay close attention to their changing business models. To the extent that regulations allow, pay structures should support changes made to these models and reward behaviours and outcomes that move their companies’ businesses in the right direction. Oh – and banks will clearly want to see the final guidance from the EBA concerning the definitions of fixed and variable pay due in early 2015!
Simon Garrett, Director, Hay Group
Swedish Bank Stress Tests in Line with Recent Rating Actions
The Swedish Financial Supervisory Authority’s (FSA) latest stress test results show major Swedish banks’ robust ability to absorb credit losses. The results support Fitch Ratings’ view that short-term risks have abated in recent months, and are in line with Fitch’s assessment of major Swedish banks’ capitalisation at ‘aa-‘, which was a factor when Fitch removed the ratings of Handelsbanken, Nordea (not covered by the FSA’s stress test) and SEB from Rating Watch Negative in September.
The FSA estimated about SEK130 billion of credit losses over 2020-2022 for the three largest banks (Swedbank, Handelsbanken and SEB) under its stress test. This represents about 220bp of their loans, or about 70bp annually. However, the banks’ pre-impairment profitability in the stress test could absorb credit losses of up to about 110bp of loans annually. Fitch’s baseline expectation is for credit losses below 20bp of loans in 2020 and 8bp-12bp in 2021.
Capital remained strong under the stress test. The average common equity Tier 1 (CET1) ratio fell by only 2.8pp (1.9pp if banks did not pay dividends) from 17.6% at end-June 2020. The capital decline was not driven by credit losses, which could be absorbed by pre-impairment profitability, but by risk-weighted asset inflation.
The three banks’ 3Q20 results showed that capital has been resilient despite the coronavirus crisis. The banks had a CET1 capital surplus over regulatory minimums, including buffers, of almost SEK100 billion (excluding about SEK33 billion earmarked for dividends). SEB had a CET1 ratio of 19.4% at end-September, Handelsbanken’s was 17.8% and Swedbank’s 16.8%.
The SEK130 billion credit losses under the latest stress test are lower than under the FSA’s spring 2020 stress test (SEK145 billion), which also covered a shorter period of two years. However, they are still larger than the actual losses incurred by the three banks during the 2008-2010 crisis. This is despite tightened underwriting standards by the three banks in recent years, including, in the case of SEB and Swedbank, in the Baltics, the source of most of their loan impairment charges in the previous crisis.
In its baseline economic forecasts, the FSA assumes a harsher shock to Sweden’s GDP in 2020 and 2021 (-6.9% and 1%, respectively) than Fitch’s baseline (-4% and 3.4%), although it assumes a similar recovery by end-2022. It also assumes real estate price corrections, which appears particularly conservative in light of a 11% housing property price increase over January to November 2020.
The ratings of Handelsbanken (AA), Nordea (AA-) and SEB (AA-) are on Negative Outlook due to medium-term risks to our baseline scenario. The rating of Swedbank (A+) is on Stable Outlook, reflecting significant headroom at the current rating level following a one-notch downgrade in April due to shortcomings in anti-money laundering risk controls.
Future success for banks will be driven by balancing physical and digital services
Digital acceleration due to COVID-19 has not eliminated the need for bank branches
Faster service (23%), smaller queues (26%) and longer opening hours (31%) are among customers’ biggest asks of their bank branch, new research from Diebold Nixdorf today reveals. But with 41% consumers saying they would be comfortable to engage with all banking services via an app, it is vital that banks respond to the full spectrum of customer needs – balancing and evolving their offerings on multiple fronts.
A third (35%) of customers say they will always want access to physical, in-branch banking services in some capacity and one in ten (10%) consumers will never bank predominantly online in the future. This demonstrates that there remains an important role for the services a branch provides. This role, however, continues to shift away from purely transactional banking:
A quarter (26%) value face-to-face advice when it comes to their banking needs
One in five (18%) seek advice on different products
17% want to speak to the staff or other customers.
Matt Phillips, Diebold Nixdorf vice president, head of financial services UK & Ireland, said: “The majority of banks have spent the last decade focusing on their digital strategies and investing in improving – or establishing – their online customer experience. However, the data shows that there is still an essential role for physical branches. Banks now increasingly face the challenge of continuing to provide customers with access to a range of physical and as well as digital services, giving them the flexibility to choose the best service for them at any given moment in time.”
When looking beyond the impact of COVID-19, planned branch visits by customers are expected to rebound to 28%, following a dip to 11% during lockdown. And when asked about the new services they’d like to see inside their bank, sixteen percent of respondents said more self-service machines would improve their in-branch experience.
Matt Phillips continues: “In a world that is fast evolving and where the future is digital, there’s no doubt that high street banks must, and are, responding to the needs of highly digital customers. But not every customer requirement is digital. There is still a strong need for physical bank branches and the interaction and services they offer, and striking this balance between physical and digital is where the industry must come together to provide solutions. For example, building a strong, leave-behind strategy is something we’re seeing across the board when banks have to close branches, ensuring customers have access to self-service machines to complete all their transactional needs.”
RegTech 2020: The rise of Open Banking
This month on the RegTech 20:20 podcast, host Alex Ford is joined by industry experts Gavin Littlejohn, Chairman of The Financial Data and Technology Association (FDATA) and Jamie Leach, Regional Director of FDATA ANZ and Founder of Open Data Australia, to discuss developments in Open Banking, and the place of RegTech.
Today, the focus is on the digital customer experience and the insight offered indicates that there has been a major shift in the FinTech ecosystem as a source of potential innovation for banks, rather than being a direct competitive challenge.
In the podcast, Alex quizzes Jamie on the concept of sharing data and the impact of the introduction of Open Banking rules under the Consumer Data Right (CDR) in Australia. Jamie shares that it is an exciting time to be involved in the sector:
“…what we really need to consider is that Open Banking in Australia is very different to Open Banking in the UK. Really, what has spurred Open Banking in Australia under the Consumer Data Right is the pursuit of creating greater competition and greater innovation, while allowing consumers to do more with their data.”
Gavin, who has many years of experience in the industry and, as well as his role with FDATA is also a key member of the UK Open Banking Implementation Entity, speaks on the theme of advocating Open Finance in the UK.,’
Delving deeper into Open Banking, he highlights the fact that it has been an interesting journey and states that “the important thing to understand is the difference between the UK’s Open Banking order and the wider payment services directive.”
Not only concentrating on Australia, Jamie also works across the sector in the UK and, also looking at its evolvement here, she suggests that the people creating the rules are now taking notice, adding: “We are just getting started – the UK has been at it for nearly three years and it is still gaining momentum.”
With regards to future predictions, Jamie believes “It’s going to take 12, 18 or 24 months before we see any mainstream major adoption and where the potential of Open Banking can go in this market”
Moving to the differences between Open Finance and Open Banking. Gavin defines the latter as “payment initiation and access to payment data, which enables a third-party provider or fintech with a customer relationship to initiate a payment and get access to the data relating to transactions.”
“…the concept of Open Banking is a bit like electricity – you don’t use it directly; you use an appliance that uses it. This could mean loans, money management apps, or cloud accounting platforms, which all use Open Banking.”
Throughout the episode, both guests provide interesting insights and hint at the significant potential of Open Banking.and the connection to RegTech within this domain.
It is clear that what we see today is only the beginning. Despite the industry still being in the early stages of implementation in almost all cases, there is increasing interest in moving beyond this to include a far broader spread of financial products.
You can listen to the full episode at https://www.encompasscorporation.com/regtech2020-podcast/ or across all major platforms, including Apple Podcasts, Google and Spotify.
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