It is a time of clichés for banks as they currently find themselves caught in a Catch-22, stuck between a rock and a hard place. In the UK, government initiatives such as ‘Project Merlin’ have been put in place to encourage banks to lend more freely. At the same time, new regulations or initiatives such as Basel III, Recovery and Resolution plans and leverage limits are coming to the fore, increasing the capital adequacy and liquidity requirements for banks around the world. So how do banks walk the fine line between lending requirements, managing risk and capital adequacy?
Financial institutions are being asked to lend more therefore exposing themselves to additional risk and at the same time hold more capital which can reduce returns on equity. One consequence will be the need to make returns on lending by the way of fees and charges, as banks look at other ways in which they can optimise capital. A recent Capco/Swiss Finance Institute survey of the private banking industry found that 52% of firms plan to adjust their pricing strategies to share increased overheads with their clients.
But before costs are increased, there needs to be a reassessment of their current risk frameworks. If banks focus on qualitative frameworks as well as their current quantitative models, they will be in a better position to determine whether the composition of their portfolio is adequate. Senior management also needs to understand the scope of their models and think of other ways in which they can plan and test for risks.
The bottom line is that many regulations have yet to be implemented and therefore tested. Only time will tell whether these reforms will further complicate matters for banks. Clever financial institutions will be those that develop more comprehensive risk adjusted return-on-capital capabilities, to proactively manage current and future complexities in the lending market. Or to avoid closing the door before the horse has bolted, so to speak.