Developed Economies: A Smaller Winner’s Circle
Perhaps the most profound and enduring effect of the crisis will be the death of the business principles and models born 75 years ago with the Glass-Steagall Act in the United States. Markets will become significantly more concentrated in deposits and assets; investment and commercial banking institutions will continue to converge. This will lead to lower reliance on leverage in investment banking business models. And it is already setting the stage for the emergence of new boutique and niche models, operating independently of “large organization” cultures, and requiring limited capital.
The financial-services survivors in developed countries seem to be largely retail banks and wealth management companies. They are gaining significant market share — by attracting customers who seek security and quality and by taking advantage of opportunities for acquisition.
Three factors have helped them. First, they avoided the excesses of fast growth. Instead, they built strong franchises. The insurance companies among them relied not on investment returns but on innovative operating models. The retail and commercial banks maintained sound risk and capital management practices. The investment banks kept their exposure in check, close to their underlying assets.
Second, these surviving institutions have maintained strong capital positions and diversified funding sources. They have high levels of deposits and strong cash flows, plus a range of short- and long-term wholesale sources of funding in different markets. Additionally, they have maintained open communication channels to other potential sources of funding, such as sovereign wealth funds or institutions from less-affected markets such as Japan and the Middle East.
Third, they have communicated effectively with their boards and the market. Even the players with solid fundamentals can suffer if they are tainted with negative perceptions. The strongest players have avoided this.
These financial-services institutions are proactively restructuring their businesses to make the most of their new opportunities. They are divesting assets to raise capital, boosting their positions in emerging markets, raising capital through rights issues, simplifying their portfolios, increasing their productivity and performance, and looking closely at their risk management practices. We expect to see further consolidation.
Emerging Economies: Rapid Opportunity
In the faster-growing BRIC economies, challenges and opportunities vary by locality. Most large banks in these markets have escaped the worst effects of the crisis. In a few countries, like Russia, financial institutions face substantial challenges because of weaknesses in their home markets. But in most emerging nations, banks have very limited direct exposure to the asset classes in crisis, and they face limited risk of contamination from the U.S. and western Europe.
Moreover, most of these institutions have experienced rapid growth thanks to the real economic growth of their home countries and to the large numbers of new consumers using banking services for the first time. Of course, in the next year or two, this growth may slow down a bit. The weakened global economy could lead to lower export rates and reduced credit and liquidity. In China, a number of bank share offerings have already been postponed.
But for the first time, countries like China, India, and Brazil have strong internal markets and a robust institutional and regulatory apparatus. Financial institutions in these countries will be more resilient than in times past. Their greater economic diversification in recent years and structural competitive advantage in commodities will also help corporate risk profiles.
The strongest financial institutions in these markets will return, in the short term, to local financing, often with a focus on retail banking. As they manage their own fast credit growth environments, they will improve their risk controls and governance mechanisms. The wisest of them will partner with governments to develop new regulatory frameworks that are conducive to market growth and market security. Some of them, as they build scale and maintain market capitalization, will diversify and internationalize, taking advantage of their strong capital positions to merge with or acquire financial institutions in other parts of the world.