An IBM survey of over 2750 banking executives worldwide forecasts a new world order for the financial services industry, characterised by a shift to specialisation, more transparency and lower overall returns.
The study predicts significant consolidation in segments wrought with over-capacity - such as investment banking, asset management, and wealth management - as firms adapt to a new lower-margin landscape where they will need to specialise around services that clients value rather than continuing to provide a full range of in-house services. Enhanced regulation and transparency will also eliminate opacity, with previously high-margin activities becoming commoditised.
To compete effectively, IBM's analysis suggests that most firms will have to cut their costs by another 20%, over and above the economies they realise from redundancies and divestitures. This could prove difficult, as many of the financial institutions that went through the recession at the start of the decade have already implemented the most obvious cost-cutting measures. Moreover, Only 12% think that their firms are effective at capitalising on new technologies, even though 39% believe that this is a key attribute.
Radical action will be needed, says IBM, with a clear emphasis on realising economies of scale, the integration of IT and business strategies, and disposal of non-core assets.
Indeed, 60% of the industry executives whom IBM interviewed favour outsourcing non-core activities, compared with just 30% of those interviewed in previous years.
The study predicts three specific areas of specialisation that are likely to emerge from the new economic condition:
• Beta transactors: the majority of financial markets firms will concentrate on utility services (trading, asset management, etc) that provide the infrastructure required to facilitate market-making in the same way that water companies provide the reservoirs, purification processes and pipes required to deliver clean water.
• Advisors: a smaller number of firms will concentrate on providing advice - such as wealth management or mergers and acquisitions advice.
• Alpha seekers: a handful of private equity firms, hedge funds and boutique investment houses, none of which are 'too large to fail', will focus on generating high returns from high-risk investments.
Shanker Ramamurthy, global managing partner for banking & financial markets at IBM Global Business Services, comments: "The new industry will not only lack some of the great brand names of the past, but will also lack many of its past characteristics - from excessive risk taking, opacity and leverage, to massively high returns and bonuses."
Respondents to the survey said that improved client service and efficiency will be critical for competitive survival in a new lower-margin financial order, a finding consistent with other more mature industries, suggests IBM.
In the future, firms will need 'smarter' systems that can continuously assess their risks and returns across each line of business and adjust their business mix accordingly. At the same time these systems will also enable firms to refine client service through improved understand of profitability by business line and product as well as by individual client.
Although growth is expected to be sluggish through 2012, some obvious winners and losers emerge says the study. For example, hedge funds (and their prime brokerage service providers) will come under severe pressure as transparency reveals that the majority of funds are not delivering on their 'alpha promise'. Meanwhile flow businesses (derivatives in particular), passive investments and infrastructure providers such as custodians, clearing firms and exchanges will grow as a result of increased transparency and a movement away from risk assumption towards risk mitigation.