The viability of universal banking – where banks provide the full scope of financial services, from retail to investment banking, in all markets – has been called into question many times over the years, most recently at the Annual World Economic Forum in Davos in January. Therefore, while the argument may not be new, it does have new-found vibrancy.
Certainly, increased regulatory scrutiny, capital requirements and mounting compliance costs are forcing many international banks to reassess which services and products they wish to offer in which markets. Therefore, the universal banking model, if not dead, is under considerable pressure. Today, financial institutions are starting to retreat into their respective areas of competitive advantage, allocating capital and liquidity to the areas where they feel risk is best understood. One such example is the Swiss banks, which are specialising in their core competency of wealth management – gradually moving away from the universal banking model that had been in place for over two decades.
Yet, there are a number of consequences from banks turning to focus on their most profitable areas of business; particularly with respect to the provision of banking services to high-risk institutions and economies. This could have a far-reaching impact – not only for financial institutions, but also for trade and the wider global economy.
Compliance costs start to bite
Of course, the immediate priority for banks has been to comply with the wave of new regulatory requirements. However, this crackdown on compliance from the regulators is forcing banks to perfect their due diligence at a high cost or face significant penalties and reputational damage for any infringements. The cost of failure to comply with Know Your Customer (KYC) regulation, in particular, can be punitive, as a number of high profile cases have recently shown.
Banks now have to perform stringent checks each time they set up a new transaction with another bank; not only do they have to screen their bank counterparties, they also need to screen every single subsidiary of that bank. The price tag for all internal costs can be as much as US$50,000 in order to complete adequate due diligence on a single client.
For a global bank like Commerzbank, with 5,000 correspondent banking partners, the cost of maintaining these relationships is significant. But given that large banks process hundreds of thousands of trade transactions a year, the economic benefit associated with their large networks makes the cost justifiable. However, for smaller banks that may process a few thousand transactions at best, maintaining a large correspondent banking network may not be as feasible. As such, these banks may end up trimming back their networks to focus on their most profitable relationships.
If banks are forced to restrict their relationships on the basis of cost, working in perceived high-risk countries is also likely to become less attractive. The ultimate doomsday scenario is that this leads to entire countries becoming unbanked as all the global players pull back. Certainly, if an international bank deals with 10 banks in Pakistan, for instance, it is hardly likely to reduce this number to two, given that investment in trained staff and resources will still be required to ensure the bank has an in-depth understanding of the market. This may mean that such countries become increasingly cut off from the international banking system, threatening their economic future.
Avoiding the unintended consequences
If these emerging market economies become unbanked, the unintended consequences for globalisation could be dire. Therefore, promoting better understanding of transaction banking by regulators and taking a collective approach to KYC inefficiencies will be vital to ensuring that the wheels of global trade continue to turn.
In this respect, banks have begun to work together with each other, as well as SWIFT, to reduce the time, effort and cost related to gathering and sharing information among correspondent banks. They are doing so by using a centralised repository, the KYC registry, which was launched in early 2015 and which maintains a standardised set of information about banks required for due diligence processes.
But, most importantly, banks also need to ensure that they find alternatives to maintaining proprietary banking networks on a truly global basis. In this respect, Commerzbank, for example, is keen to help smaller players stay involved in global trade by allowing them to leverage its own network and trade processing facilities. By the same token, for larger banks that may be considering focussing their strategy outside the trade arena, Commerzbank also provides a platform to concentrate trade business flows, which can offer economies of scale.
Correspondent banking networks, and their provision of trade finance, are vital to enabling global trade – as such, small and medium-sized banks will need to find economically viable alternatives to carry on servicing the needs of their corporate clients, particularly in the face of mounting cost and compliance pressures. Global economic growth relies on it.
