Regulation to continue eating into banks' margins

According to a KPMG report out last week, banks may never see a return to pre-crash profitability. The five largest lenders in the UK are once again making money, but the report warns that burgeoning regulation will have a structural impact on banks’ profit making capability. The report suggests that the return on equity drop – from 20 – 25 per cent to seven – ten per cent is a permanent fall and points the finger at regulation.

The fact that this fall in profitability is projected be a permanent state of play is particularly jarring, because of the prospect of long-term global economic damage. And the proliferation of domestic and international regulation is the cause. The costs of international and investment banking have been significantly impacted by capital requirements and jurisdictional constraints.

No sooner have the banks complied to a PRA compliance diktat than there is a new ECB initiative on the horizon. Banks’ capacity for dealing with regulation is being stretched to its very limit. This is particularly true of the smaller players. It’s tough for the big guys, but at least the resource they can plough into their regulatory pushes is relative to their size. This isn’t the case for smaller banks. The cost of regulation is even bigger for them.

Regulation – as we’ve said before – is a cost centre, not a profit centre. Customers couldn’t care less whether banks are compliant or not. Adhering to MiFID isn’t going to improve customer service. It’s a necessary cost and a considerable one at that. From conducting the changes within the business, to building the requisite systems and creating audit trails, the price of regulation is a significant one.

Take capital ratio requirements. The changes banks have had to make to their businesses to ensure they comply with Basel III and capital ratio directives are significant. The change in banking strategy we talked about earlier is a case in point. Banks are pulling out of all sorts of risky investments – commercial property is set to be a big one. This all impacts their ability to make money.

So what can they do? Well, they have no choice but to adhere to regulation. But they can look at ways to ease the cost of complying and work in a more cost effective way. Regulation is not an area banks compete on – so can they start to work more collaboratively to face it together? Sharing systems, resource and best practice could be a start; building a regulatory shared service centre might be an option; working with partners who understand the issues but won’t charge the earth. Whatever the solution, pulling together to face down the regulatory demons will be a step in the right direction.