The financial sector has changed hugely since the financial crisis. In order to understand the pressures shaping the financial sector, we interviewed more than 150 C-suite executives of global banks, insurers, reinsurers, asset managers, hedge funds and financial technology firms. These in-depth interviews captured how these corporate leaders perceive risks now and into the future.
The findings, published last week in our Willis Financial Institutions Risk Index, identified 6 megatrends. These are long-term drivers of change, operating at a macro-level. These overarching forces create new risks or amplify existing risks within the financial sector. The 6 megatrends are:
Regulatory Changes and Complexity
Regulatory pressures arising from the financial crisis have increased the cost of capital, promoted large-scale divestment, reshaped attitudes towards risk and redrawn the boundary between retail and wholesale banking.
Digitalisation and Technological Advances
Technology is fundamentally altering customer interaction and challenging traditional financial institutions. Customers are engaging online, through smart phones. New entrants are disrupting the financial playing field through digital platforms, which have slashed costs and are more in line with modern customer behaviour. Traditional financial institutions are investing heavily in IT in order to keep up, but the costs can be significant.
Changes in Investment and Capital Sources and Returns
Traditional financial institution profitability is under pressure, as banks hold more capital, curtail lending, set aside reserves to meet regulatory investigations, legal fees, financial penalties and stress tests—not to mention invest in IT and acquire new compliance teams.
All the while non-bank financial institutions and FinTech firms are bringing fresh capital into the sector, lending directly to new consumers, creating investment opportunities, searching for yield and attracting further investment.
Business Operating Model Pressures
Regulatory pressures and the cost of capital have placed pressure on traditional operating structures. Online-only services have raised questions about the efficacy and profitability of traditional models and created a viable alternative paradigm. New entrants are bypassing traditional intermediaries and offering services directly to customers or are targeting specific constituents with specialist financial services.
Demographic and Behavioural Changes
Today’s customers are very different from yesterday’s customers. Millennials have their own expectations; older customers are increasing in number, are working longer and putting further pressure on pension funds, whilst in LatAm and Asia-Pacific there is a rise of middle-classes, alongside a highly skilled and educated workforce.
Global Talent and Skills Race
New leaders will be required to manage emerging risks and respond to an evolving financial landscape in innovative ways. Regulatory pressures are creating stress, with many moving to lightly regulated firms or leaving the industry altogether.
The Financial Institutions Risk Index
The megatrends are only part of the picture. We also asked our financial leaders to rank specific risks associated with each megatrend, which were ranked in terms of severity of risk and ease of risk management.
We can learn much more when the 31 risks are compared. The Risk Index displays the megatrend rankings, the risks, and their overall impact, dictated by the size of the bubble on the Risk Index below. The dotted line across the screen denotes the average score.
The Top Ten Risks provide an insight into the issues discussed within the boardroom and which trouble our C-Suite leaders the most. The ranking of the risks is not as one would expect. The top risk, as identified by the C-Suite, is macroeconomic factors (impact of deflation/inflation and QE) (see chart above). The right economic conditions are clearly necessary for financial institutions to thrive.
The second risk, as ranked by financial leaders, is the risk of increasing costs associated with IT upgrades, as financial institutions manage outdated systems and invest in IT upgrades. The risk of a cyber-attack ranks fourth in comparison. Regulatory pressures prompting people to leave the financial sector is a top-three risk. Regulation features again in the fifth risk; the challenge posed by businesses exploiting light-touch regulatory regimes. C-Suite leaders are concerned they are disadvantaged by regulatory burdens, enabling nimbler firms to gain a competitive advantage.
The Future of Financial Institutions
Which megatrends will continue to shape the financial landscape over the next 10 years? According to the financial leaders, there are 2 megatrends that will continue to increase in significance:
- Regulatory changes and complexity
- Digitalisation and technological advances
This suggests they believe the regulatory pendulum has further to swing and the impact of technology is far from over.
The Global Talent and Skills Race Megatrend remains low even though 3 of the risks in the Top 10 relate to talent. This suggests our financial leaders may not have given sufficient consideration to their greatest asset – their people.
There is a wealth of information in the Risk Index and to fully understand the future of our financial institutions you will have to read the Willis Financial Institutions Risk Index!
This post was originally published January 29th 2015.