Banks modifying business models.
Diversification of business activities not only serve as a better protector of a universal bank against external shocks that impact individual lines of business. But it also increases the likelihood of intra-firm contagion on account of external factors.
Universality as such does not complicate the lender-of-last-resort role of central banks. However, problems may arise when universal banks are typically large. If large institutions run into solvency problems, central banks may be confronted with the dilemma of "too big to fail". The "too big to fail" dilemma is related to their size and not related to the universality.
Universal banks not only enjoy benefits of large scale operations but also face complex regulatory challenges. Universal banks face enormous regulatory challenges in recent times. Some Universal banks had to pay penalties and fines for lapses in oversight and controls, deficiencies in risk management, non-compliance with money laundering issues and violation of sanctions. Universal banks have become "too big to handle" on account of the regulatory challenges.
The global regulatory reforms and the transformation in global financial architecture after the crisis impacted Universal Banking Groups. The Dodd-Frank Act in US came into law in 2010 and the Volcker rule placed restrictions on proprietary trading. Rules on transparency and centralised clearing for over-the-counter trading markets were introduced. The regulatory reforms under the Dodd-Frank Act had kept proprietary trading and significant hedge fund investing outside the group and moved derivatives activities to affiliates.
The Vickers's commission in UK came with the recommendation of ring-fencing of UK banks' retail banking operations from higher-risk investment banking activities. The Volcker rule and the Retail-ring fence are designed to face the problem that arises from the integrated business models of financial institutions. In the Volcker rule it will still be challenging to separate market making and underwriting proprietary trading when assessing banks' exposures to securities markets. Similar challenges can also be faced in ring-fencing.
Basel III set consistent standards for capital and liquidity -- which is critical in times of market stress. Basel III also provided a consistent 'level playing field' for banks around the world -- that's essential in a globally interconnected system. Universal Banking is efficient but should develop safeguards as part of its current structural reforms. The structure of universal banks should be clear so that it would simplify the governance of banks and improve risk management. The responsibility and independence of the management is enhanced if business lines are separated to legal entities.
Universal banks which operate both retail deposit-taking business and wholesale global markets trading under the same roof are looking at ways to modify their business models to improve the return on capital. Universal banks are taking a capital-centric look at their business model and questioning which activities will be profitable. Balance sheet is scarce mainly in OTC (Over the Counter) products. There is a strategic rethink among universal banks about where best to deploy scarce capital for the benefit of their clients and shareholders.
Universal banks have abandoned business and locations, through forced disposals or severe cost--cutting. Some of the universal banks have extended their corporate lending activities and maintained their retail networks, while modifying their capital markets operations to optimise balance-sheet consumption. The large universal banks which dominate the most liquid markets benefit from the reduced risk appetite and trading activities of smaller players. They are also revisiting their strategies in business lines such as equity derivatives and fixed income. Some of them focused on asset management while others exited or rebalanced the equity business. The destruction of shareholder value after the crisis has eclipsed the benefits of financial supermarket. There is indication of reduced wholesale trading activity, particularly in fixed income, currencies and commodities. This will continue to emerge as regulation is phased in and shareholders increase scrutiny around capital usage.
The writer is a group chief executive officer at Doha Bank. Views expressed by him are his own and do not reflect the newspaper's policy
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