Trends and challenges of global banking industry in 2016

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Banking Industry
Overview: 2016
State / Regulations / Trends / Challenges

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Summary
w Economic Outlook: what’s happening in the world
3
w Regulatory Outlook: what regulators are doing and how banks will address
13
w Key Trends: what the global banks in 2016 are up to
22

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Economic Outlook

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Summary

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Economic Outlook Summary for 2016: unstable slowness
w 2015-2016: Slight economic growth after crisis, with low inflation, low interest rates
w We have slowest economic recovery in recorded history
w Developed markets have very slow unsustainable growth
w Emerging markets still in trouble: 3.2% median growth
- It is the slowest EM growth since the 1998 crisis
- China growth is slowing (10% à 7% à ~5.5% forecast)
- Many EMs are in deep recession: Brazil, Russia
w Impact of declining oil price is negative (still too much oil)
w Forecast is not improving: divergence of economic
growth across the globe continues to increase
Source: International Monetary Fund (data 2015-2020 based on IMF projections)

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Banking Industry: no longer a Klondike after 2008
w Return on Equity (ROE) felt below 10% for top-10 global banks: no more “easy” money
Source: Roland Berger

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Banking Industry: the new post-2008 reality
w Regulatory tightening: US / EU / APAC regulators do not want
a new “2007-2008 crisis”
w Investors expecting ROE ~9% over 2015-2017 instead of
previous 16-20%, and this is still below cost of equity:
shareholders are losing money on banks’ stock shares
w The need for deleverage (reduce debt and
risky assets / businesses) because Capital
Ratios (RWA) effectively doubled under
new regulatory demands
w Much higher expenses for restructuring,
litigation and regulatory compliance
PROFIT
REDUCTION
Source: AF Capital, Roland Berger

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w Litigation costs (regulatory fines and client settlements for market
misconduct) are severely driving Cost / Income (profitability) ratios down
w Fines exceeded US $230+ billion (US $120+ billion for U.S. mortgages,
others are for FX trading misconduct and LIBOR manipulation felonies)
Litigation charges: the price to pay for 2000’s sins
Source: AF Capital,
Roland Berger

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Investors sell banks… again
w Investors sell bank shares and de-value stock price multipliers: banks “Price / Book Value” ratio
reduced by 50%, shares dramatically fell
Source: YCharts.com

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… and banks are responding
w Banks are responding and trying to improve profitability and share price:
- Optimize certain business lines (e.g., Deutsche Bank re-structures Rates business);
- Exit certain activities (e.g., UniCredit exits Equity business, Deutsche Bank exits Commodities and
CDS clearing);
- Refocus on a more profitable business (e.g., UBS focuses on Wealth Management);
- Sell assets which require much capital or non-core assets (e.g., Deutsche Bank to spin off Non-Core
Operational Unit);
- Optimize operational and IT costs
w These single steps are insufficient and more complex strategies are required by investors
(e.g., Deutsche Bank’s “Strategy-2020”)

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Example: Deutsche Bank’s “Strategy-2020”
Source: Presentation of Strategy-2020 execution by John Cryan (CEO) and Marcus Schenck (CFO), London, 29 October 2015

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Regulatory Outlook

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Basel 4: Planned RWA inflation in 2019
w RWA (Risk-Weighted Assets) is the sum of all bank’s assets weighted by its riskiness
w Basel 3 (current): bank must hold reserved capital > 8% of RWA; Basel 4 needs more RWA
w Example: Deutsche Bank needs to reduce RWA by ~20% (EUR ~90 bln) before 2020
RWAplannedtarget,EURbln
Source: Presentation of Strategy-2020 execution by John Cryan (CEO) and Marcus Schenck (CFO), London, 29 October 2015

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Basel 4: Minimum required capital ratio (CET1) is still above
w Tier 1 capital ratio = <bank’s core equity capital> / <total risk-weighted assets (RWA)>
Source: Presentation of Strategy-2020 execution by John Cryan (CEO) and Marcus Schenck (CFO), London, 29 October 2015
Example: Deutsche Bank needs grow CET1 capital to achieve target capital ratio, EUR bln

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Basel 3 (E.U.): Leverage ratio (CRD4) to reduce by 2018
w Capital Requirements Directive IV (CRD4) is a supervisory framework in the EU which reflects
Basel III rules on capital minimum standards
w CRD4 is in force since 1st January 2014 but needs its full implementation by 1st January 2019
w Leverage ratio = <Tier 1 Capital> / <Total Exposure> and it must be >= 3%
CRD4exposure,EURbln
Source: Presentation of Strategy-2020 execution by John Cryan (CEO) and Marcus Schenck (CFO), London, 29 October 2015
Example: Deutsche Bank needs to reduce CRD4 exposure

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U.S.: Intermediate Holding Company (IHC) to launch in 2016
w Each non-U.S. financial organization having U.S. legal
entities with >$50 bln assets must have an operating
IHC
w IHC is a fundamental change to non-U.S. banks’
governance model in USA
w IHC must be capitalized and operational by July
2016
w IHC to participate in CCAR in April 2017 (private)
and April 2018 (public)
Source: Davis Polk, USBasel3.com

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U.S.: Comprehensive Capital Analysis and Review (CCAR)
w CCAR is a regulatory framework introduced by the Federal Reserve (USA) in order to assess,
regulate and supervise large banks
w Assessment is conducted annually and consists of two related programs:
- Comprehensive Capital Analysis and Review (CCAR)
- Dodd-Frank Act supervisory stress-testing
w Core part of the program assesses whether:
- Bank has sufficient and adequate capital
- Capital structure is stable under stress-test scenarios
- Planned dividends are acceptable and will not bring the breach of minimum capital requirements

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E.U.: MiFID 2
w The second version of MiFID directive
w Extends MiFID coverage onto new asset classes and markets where centralized bid/offer
markets and pre- and post-transparency have never existed
w Tremendous impact on how OTC markets operate in Europe
w Summary of MiFID 2:
- Addition of previously-unregulated organized trading facilities (OTFs);
- New customer safety for algorithmic (Algo) and high-frequency trading (HFT) activities;
- Additional supervision of derivatives markets (coordinated with ESMA);
- Stricter requirements for portfolio management, investment advice
- Other investor protections

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Other regulatory upcomings in 2016
w Basel Committee: Net Stable Funding Ratio to be obligatory in USA
- Need to hold cash to cover potential losses during the year
w Federal Reserve: Enhanced Prudential Standards in to force in USA
- Need to build independent risk management function instead of Middle Office in business lines
- Each banking fin.org with U.S. legal entities with >$50bln assets must have an operating IHC
w Financial Stability Board (FSB) and Basel: Culture and Ethic Standards in banking into force
w Dodd-Frank (USA): Living Wills are mandatory for banks with >$50 bln assets – a detailed
trouble resolution financial plan
w Enhanced consumer protection in USA
w Emerging detailed requirements to care about Cyber risks in USA

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Banks to build controls to avoid further litigation burden
w Implement better AML
w Implement better KYC
w Review client relationships in risky
countries
w Ethics code to be introduced and
accountability for conduct issues
across the bank is the key
w Align reward system to better reflect
ethics and conduct
e.g., DB Letter to Shareholders, March 2016:
Source: Deutsche Bank Annual Report 2015

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Key Trends
in banking
for 2016

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Trend 1: Disruptive players (FinTechs)
w Fintech firms are targeting profitable aspects of the banking business. Banks
are scared!
w More than 20% of financial services business is at risk to FinTechs by 2020
Source: PwC, Capgemini

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Trend 2: Banks focus on investments into innovation
w Technology is evolving so fast that banks must adapt to retain customers

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Trend 3: Banks invest into Cyber-security systems
w Banks are facing unprecedented challenge of data breaches

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Trend 4: Digitalization
w Banks are leveraging digital technologies to enhance customer experience
w Saving on personnel and physical branches for the sake of better and integrated customer
channels
Source: Juniper Research

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Trend 5: Banks are using Clouds for core activities
w Banks are investing heavily into cloud services for its core business activities
w Those who adopted earlier have significant benefits in cost savings, IT agility, scalability
Source: Gartner, Capgemini

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Trend 6: Banks are simplifying architecture and rid of legacy
w Increased regulation requires more IT platform agility and sometimes near-real-time data
w New channels and products require fast time-to-market which legacy systems can’t provide
Source: AF Capital, Capgemini

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Trend 7: Blockchain and distributed ledgers
w Bitcoin demonstrated the strength of distributed ledger idea
w Blockchain technology is expected to reduce banks’ infrastructure costs by ~$20 bln p.a. by 2022
Source: AF Capital, Capgemini, Santander InnoVentures, Oliver Wyman
w Deutsche Bank is researching
the use of blockchain for AML
and KYC
w Citibank, HSBC and other 40
banks have partnered with
R3CEV (Blockchain tech Co.)
w RBS is developing blockchain
PoC as part of £3.5 bln IT
upgrade
Since 2015 industry is moving:

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Trend 8: Big Data and advanced analytics
w Basic BI using traditional DWH now takes only 28% of all data initiatives
w Advanced analytics include predictive analysis, data mining, Big Data, simulation, optimization,
location-based intelligence
Source: Gartner, Capgemini

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