Large institutions may suffer hit to normalized earnings as a result of re-regulation

Deloitte identifies five key industry drivers to impact global financial institutions

For the first time since the 1930’s, the global finance services industry is on the edge of reinvention, according to a Deloitte report entitled ‘Evolving in response to global re-regulation’. With numerous global regulations surfacing, such as International Financial Reporting Standards (IFRS), Foreign Account Tax Compliance Act (FATCA), Basel III, capital shortages of financial institutions adversely impacted by the impairment of assets, will alter that way in which they conduct their breakeven analyses, manage their cost structures and approach systemic operational risk.

“Large institutions will be impacted the most, taking a hit to normalized earnings as a result of re-regulation. In the Middle East, banks and insurers started preparing for these changes and have already begun to implement global regulations which are expected to increase in the next couple of years along with the FATCA implementation, said Joe El Fadl, partner in charge for the Financial Services Industry (FSI) at Deloitte in the Middle East. “Such global changes may also mean that banks will be challenged by the increased costs of doing business coupled with increased competition” he added.

Senior executives and boards of directors are now most concerned with regulatory uncertainty, trying to find ways to implement regulatory requirements yet not sacrifice sustainable earnings. As such, to thrive in this changing environment, banks and insurers must take several steps, beyond the norm, which include how to exit what were once key businesses, introduce new product categories, expand their definitions of risk to include issues such as talent management and reconfigure their operating models. This requires an in-depth understanding of the ways in which the emerging global regulatory framework will affect their strategies and operations.

As such, Deloitte has identified five key industry drivers that will impact global businesses. They include:

Regulatory uncertainty and regulator intervention
Despite the lack of a uniform global regulatory framework – and government delays in enacting legal changes or converting them to concrete regulations – regulators are engaging in more coordinated oversight, sharing leading practices while mandating financial institutions to provide greater evidence on the effectiveness of their risk management practices. As the consequences of non-compliance can be severe, leading organizations have begun to appoint senior managers to head up their regulatory affairs functions and strengthen communication with national regulators.

Geopolitical realities
In countries hard hit by financial crises and/or natural disasters, some banks and insurers may find that they are financially incapable of meeting today’s costly compliance mandates. Yet this international disparity creates opportunities for organizations in so-called “winner” countries – such as Canada, Australia, Brazil, India and China – which continue to emerge as strong global contenders within the financial services industry. Over time, these geopolitical realities are bound to result in a shift in power for the industry as a whole.

The individual view of risk
While regulators continue their attempts to eliminate risky behavior among financial institutions, risk cannot be regulated out of existence. To meet investor and stakeholder expectations, banks and insurers must continue to take calculated risks. At the same time, they can mitigate risk by adopting an enterprise wide risk management culture, enhancing their operational risk practices, monitoring exposures against a range of stress scenarios to project potential impacts on key risk indicators, allocating capital in a way that optimizes their risk-adjusted profitability and entering cross-institutional data consortia to help manage, track and mitigate common risk factors.

The law of unintended consequences
Despite the stated intent of new regulatory standards, unintended consequences are already emerging. Risk is migrating to less regulated areas, mergers threaten to create “too large to fail” institutions, talent is migrating away from the industry and organizations may be overspending (rather than conserving) in advance of regulatory deadlines.

The need to adopt compensating strategies
To respond to shifting regulatory realities, financial institutions need to rethink their fundamental operational strategies by determining whether or not to engage in mergers and acquisitions, what approaches to adopt to rebuild customer loyalty, which business lines to invest in and how to enhance data management to meet regulatory demand for transaction level reports. Before being able to direct their efforts to the most appropriate strategic pursuits, however, organizations must understand the extent to which regulatory changes affect their business – both at the enterprise and business line level.

“Whilst each of these regulations applies to different institutions in different ways, common regulatory themes have emerged. For example, banks and insurers around the globe are increasingly expected to hold larger capital buffers to ensure better consumer protection and mitigate risks derived from financial instability,” said El Fadl.

Insurance companies on the other hand, the Deloitte report finds, will need to further strengthen their capital management and risk practices, which may have a negative impact on product access and affordability.