Series 7 Episode 4: Financial services in transformation - banking and capital markets

Transcript

Tessa Norman: Welcome to this episode of Risk and Regulation Rundown, the podcast where we share our views on financial services, risk and regulatory hot topics. Today we're recording another episode of our mini series, in which we're taking a deep dive into industry sectors. In this episode we're focusing on banking and capital markets, we'll be exploring the regulatory and market drivers of change in the sector, and talking through how firms can navigate the resulting challenges and opportunities. We're going to be reflecting on a number of issues that are reshaping financial services as a whole, from geopolitical uncertainty to digitisation, and digging deeper into the specific impacts of banking and capital markets. I'm delighted to be joined by two expert guests today. I'm joined by Mark Batten, who's PwC's Banking and Capital Markets leader, and Conor MacManus, who's a Director leading PwC's Financial Services Regulatory Insights team, and whom regular listeners and viewers might recognise as a returning guest to the podcast. Mark, let's start by setting the scene in terms of the environment that banking and capital markets firms are operating in. What are the key forces and trends that you see as driving change in the sector?

Mark Batten: Sure and thanks Tessa for having us on the podcast. Statement of the obvious, we live in an extraordinarily volatile global environment, and where do I start to pick out some of the key themes from that? Economic pressures here in the UK and across Europe, we of course have the impact of the US administration. That is often at the moment thought about in terms particularly of the whole tariff situation, but there's a lot of wider geo-economic disruption and changes in some of the global social order that that is causing. We have a volatile economic environment, partly the impact of things like tariffs, but direction of interest rates and inflation. More broadly, we have a wide range of social dynamics, home ownership, ageing population, some of those trends that are playing through. Here in the UK from a financial services perspective, we've seen considerable amount of consolidation in the UK banking sector, and of course we can't go more than five minutes without talking about the disruptive impact of technology. When you take all of those things together, you've got some very immediate shocks and stresses in the system, you've got some fantastic opportunities, from things like technology, but also a super dynamic geopolitical environment globally.

Tessa: Brilliant, and you've touched there really well on the economic and geopolitical context, I think that would be worth exploring that a bit more before we get into some of those other drivers. Conor, can you tell us a bit more about the UK political and regulatory agenda and how that's shaping change in the sector at the moment?

Conor MacManus: The regulators, the government, they're responding to all of these trends as you might expect, and there's a lot going on, there always is. It is very busy at the moment. We've got the Mansion House speech on 15th July, which is obviously going to be a really important set piece occasion for the government's financial services policy. But if I was going to just take a step back and think about what are the key themes that the regulators are focusing on, clearly growth and competitiveness is very high up on that list. It's the government’s central mission to get growth going. Clearly the fiscal environment is quite challenging at the moment, there's more focus on pulling regulatory levers, to try and stimulate growth. We've seen a number of proposals and initiatives from the PRA and the FCA, just recently FCA focusing on mortgage reform, which speaks to some of the societal issues that Mark focused on, but that focus on growth and competitiveness is going to continue. I think though, as Mark very clearly set out, there is a lot of risk out there, and the regulators wouldn't be doing their jobs if they weren't focusing on those risks, and they really are. We've seen much more discussion around things like geopolitical risk and how the banks are managing that, a lot of focus particularly from the PRA around risk management capability and how banks are managing what is a very unpredictable, broad risk environment, where risks crystallise from unpredictable sources, which is a challenge, but a fair one from the regulators. Then the other point, which is both an opportunity and a risk to some extent, is the emergence of technologies like AI, quantum computing, blockchain. All of these things that we're increasingly talking about, and the regulator is taking quite a positive approach. The FCA is talking about itself as a tech-positive rather than tech-agnostic regulator now and doing a number of initiatives to encourage the adoption of technology, but clearly, as you'd expect also looking at what risks can emerge from these technologies. A really interesting point from a political and regulatory perspective at the moment.

Tessa: Mark, how are you seeing banks starting to think about the role that they can play in the government's growth agenda?

Mark: Great question and to pick up on some of Conor's comments, it's a really exciting time for financial services and banking here in the UK. Clearly we have the growth mission, we have the Mansion House speech coming, almost a tipping point, for financial services in the UK to double down on that incredible role it's played historically as a top-tier global financial centre. In the context of that growth mission and some of the challenges we face, think about some of the issues back to the geo-economic, global landscape. The importance of energy security, the need for infrastructure finance. The emerging focus on defence finance here in the UK and across Europe. There's definitely great opportunities for financial services, banks in particular, to lean in and play that role in supporting, enabling the growth agenda, and also helping the country meet some of its most important societal needs. Sustainable finance, as we continue to focus on the importance of climate change, the availability of transition finance, but also playing this role in infrastructure finance, defence financing and some of these other topics. There's a real piece for me in there about how that ecosystem of financial services and non-financial services sectors come together, whether that's banks working with private credit providers, unlocking funds from pension funds, another hot topic. Great opportunity, lots of moving parts and great opportunity for financial services to play its role in society.

Tessa: Absolutely, and you've both talked really well about just how complex and unpredictable that geopolitical landscape is at the moment. Can you tell us a bit more Mark, in terms of how is the tariff uncertainty, for example, how is that really impacting banks on a day-to-day level?

Mark: I'll comment in a minute a bit about tariffs. I think the tariffs have been a lightning rod, because it's been such a visible impact on non-financial services sectors and then a cascade through into financial services, where it's more of a secondary exposure. I think that step back is to think about this in a context of these wider geo-economic, geopolitical disruptions. I feel like for many years we've talked about the importance of horizon scanning in risk management, looking out to those second and third-tier risks that might be emerging on the horizon. Its never been more important for financial services organisations, and all organisations, to build more of that geo-economic capability, so that you're factoring that into your planning, into your scenarios, into both risk management but also importantly, where opportunity might emerge. We live in a complex world, particularly as we see more convergence across sectors, both within financial services and outside financial services, so understanding how that ecosystem works is super important. Fascinating to see how the role of global institutions will change and as global political trends play out, what that will mean for regulation, potential regulatory divergence.

On the tariffs piece in particular, of course driven a lot of volatility in global markets for organisations, banks with trading desks, that can often lead to upside, lots of portfolio rebalancing, hedging activity, volatile markets, more profits for trading desks. Perhaps of course suppressing M&A activity, again for the wholesale banks we're seeing a little bit less M&A in that uncertain environment, but opportunity as well. Trade finance will be a great example and all those associated hedging-type products. Then I'll just take you back to that importance of building out this horizon scanning, risk management capability. We live in an uncertain world, we can't define a path with certainty. The importance of scenario analysis at the global level and then cascading that into an organisation's own balance sheet, financial performance and risk management, is super important for me.

Tessa: Absolutely, and you've talked about the convergence and consolidation trends that we're seeing, both within the banking sector itself, but also more broadly within financial services. Can you tell us a bit more about what's driving some of those trends and what are some of the areas of opportunity that that's opening up as well?

Mark: Yes, it's certainly been an interesting time. Of course we've seen a reasonable amount of consolidation in retail banking and you only have to read the media for one or two other scenarios or potential moments of consolidation that we might see here in the UK banking market. We always speculate on further consolidation in the European financial services. Alongside that, we've seen pretty significant growth of digital banks, perhaps not having a huge impact yet on the relative or comparative financial performance of the majors, but really important in terms of changing customer expectations. As customers look for these seamless digital customer experiences, always on platforms, ability to operate across multiple channels and really competitive provision of things like foreign exchange and payments. Consolidation driven by that need to find scale, perhaps funding advantage and access to cheaper funding, in scale. Going forward there's a real opportunity for financial services organisations here in the UK, banks in particular, to think about how they operate and how they service customers. That's digital transformation, but there's also something in there about focus. We did a recent piece of thought leadership which is on our website that we called the reinvention of retail banking. That really focuses on the performance dynamics we've seen in the UK banking market over recent years, and particularly with interest rates high, really strong performance from their interest margin and really solid return on capital, but going forward, how do these organisation unlock the money, unlock the capital to really drive out technology modernisation to deliver these seamless customer experiences that people are beginning to get used to, from both non-financial service product provision, but some of these digital banks that offer this seamless digital customer journey? In that we really unpack, is there an opportunity to focus more on where you play, both in terms of customer segment and in terms of product offering? For example, is there an opportunity for organisations to hone in very much on particular segments or to be very thoughtful about where they play in the value chain? For example, are you all about product origination and distribution, or are you about distributing other organisations products? Some really interesting competitive dynamics. It's an interesting period of consolidation and in our perspective, an opportunity for banks to think about where and how they're going to play, and of course it always comes back to technology, the need to deliver customer experience and to invest in technology modernisation, to deliver that customer outcome.

Tessa: Absolutely, and Conor you touched on earlier, how the regulators are taking slightly different approaches to technology. We're obviously seeing a strong focus on supporting innovation from both government and the regulator. How are you seeing the regulators respond to some of these trends that Mark's talked through?

Conor: As I mentioned, there are two lenses here. There's opportunity and risk, and the regulator is probably focusing more on the opportunity side, but obviously being very cognisant and focused on the risks. The general approach that we're seeing is on a topic like AI, let's not bring in very prescriptive, specific regulations around AI, because I think the view in the regulators here is that one, those regulations will be out of date pretty quickly because the technology is moving so quickly, but also that more prescriptive approach might constrain innovation and use of technology. Generally speaking, that's welcomed by the industry. Some people like the certainty of rules, but generally speaking that more principles-based approach is one that's welcome. The other area is looking at pieces of regulation that might not have been updated for a long time. The Consumer Credit Act for example, the FCA and HMT looking at that, to make sure that it's fit for purpose in a very different system. The way in which banks operate and interact with their customers has changed significantly. We need a regulatory framework which allows them to innovate and serve customers in that way. The other important point is not just the regulation of technology, but use of technology to meet regulation. We're seeing a lot of organisations start to invest quite significantly in those capabilities, whether it be using AI, other data analytics for horizon scanning, for tracking, for producing rules inventory, right through mapping to controls and governance that you need to meet regulatory requirements. There's huge potential to use technology to meet regulation, to reduce cost and we're really at the start of that becoming much more embedded in terms of banks' operations.

Tessa: Absolutely, and I think, as we talked about, a really important aspect of that digital transformation is the need to deliver on a lot of the changes that we're seeing in customer expectations, their preferences, also some of the social shifts and changes that you referenced earlier on, Mark. How are you seeing banks evolving to meet those changing customer preferences and expectations?

Mark: So much of this perhaps depends a little bit on the nature of the organisation. If you're a digital neo bank, it's obviously very different to if you're an established major, but in banking, financial services, we talk so much about legacy technology, the need to modernise those legacy stacks and to get the benefit from new technology, which often is a real challenge. For me, and reflecting on some of the work and conversations we have with our clients, a couple of things are really important there, it's actually around skills and leadership. Do you have the skills within the organisation to deliver on the promise of modernised technology, and particularly then things like cloud and AI, and do you have the right leadership in place? That's about framing transformation and change programmes around business outcomes. What we see with our clients, if it becomes a technology project, we're implementing a new technology because it's there, or we're leaving it solely the responsibility of the CIO, then it's harder to deliver those outcomes. Those organisations that are successful, it's really about defining the business outcome, and that might be where in terms of modernising customer journeys, the outcomes that customers can expect, and as Conor said, align with regulatory expectations, particularly things like Consumer Duty. Having those business outcomes in mind and then making sure you've got the right skills from across the organisation and critically the right leadership. So you're relentlessly focused on the business outcome and the customer outcome you're looking to do, leveraging things like agile methodologies and moving away from those for the historic waterfall-type delivery models. Clearly an opportunity for organisations to leverage some of the emergent software-as-a-service banking platforms, depending on your size, scale, geographical footprint. Rather than trying to rebuild or build native, you can go and look at what other third parties are providing, fully integrated sales banking platforms. And of course, how do we get the benefit out of generative AI? We could never have a consulting firm conversation without mentioning gen AI, of course. If we're going to get the benefit out of that, so much of that is going to then be reliant on modernising legacy technology architecture. Having your data in the right place, having it well organised, meta level tagging. Getting it into cloud so you can layer the technology on top of that, that enables you to get the benefit of gen AI. A real imperative to deliver on that modernisation if we are to get the benefit, deliver those outcomes for me.

Tessa: Brilliant, thank you. You've both articulated well just the sheer scale of change and transformation that we're seeing in the sector. A lot of what we talked about are both today challenges and opportunities, but also future challenges and opportunities. If we conclude our discussion by looking at a bit further ahead. Given all of what we talked about today, what do you think will most differentiate the banks that thrive over the next five years or so? Conor, I'll come to you first.

Conor: I think investment in technology, and leveraging that has to be top of that list on so many different levels, whether it's, we talked about regulation, but also engaging with customers. I think clearly we're already seeing those organisations who are doing better, whether it be in the retail or the wholesale side, are the ones who have invested, and that's going to become even more important I think going forward. The point around banks are there to manage risk, that's their business model. You could look back over the past however many hundred years and seen risks crystallising the banking sector, that's just inherent in the model. Those organisations that have survived and been able to anticipate where those risks might crystallise, will be those who will continue to do well. Then I have to add in a regulatory one, don't I? Just taking a step back, from what is a really busy regulatory agenda, and articulating what it means for a firm's strategy I think is going to be really important. It's too easy to be reactive. It's understandable because there's so much going on, but we are going through quite an important period from a regulatory perspective and anticipating how that will shape business models and market opportunities will be important.

Tessa: Absolutely, and Mark, what would you add to that?

Mark: Great comments from Conor. I'll go back to something I said a few minutes ago, I think we're at quite a pivotal time for the UK economy. We've got this huge energy behind the industrial strategy, the need to derive growth. I think financial services really focusing on the role financial services and banks can play in delivering on that growth journey. Conor, we have a lot of conversations, don't we, with industry participants. The access that early-stage, innovative companies can have to capital is a great example. We have this great track record of research and innovation here in the UK, but sometimes those businesses then are acquired by international players. We cede that innovation to other territories. How do we take those great ideas, fund them through scale, ultimately, hopefully, listing on the UK market? So, what role does financial services play there? What role can they play in, as I said, infrastructure financing, energy security and finding those ways to collaborate across the UK system? Of course as Conor said, so often technology, technology, technology. That modernisation of legacy technology to continue to evolve those customer journeys and outcomes, and also to be able to deliver that at the right level of operating costs, because of course cost's so important for overall return on equity, return on capital. Also just go back to that, our piece on the reinvention of retail banking and to your point Conor, on strategy, working out where you want to play in the ecosystem, working out where you want to play with technology and what customers you want to serve and with what products. Is it sustainable to try and do everything to everybody, with a highly integrated value chain, or are there opportunities to pick your sweet spots and then work with other ecosystem players to service customer needs?

Tessa: Thank you both. It's clearly a really exciting time in the sector and as you said earlier on, Conor, lots more to come, even just later this month with the government's Mansion House announcements and their financial services strategy, lots more for us to be talking about and returning to. Thank you again for joining us and for sharing your insight, I think it's really brought to life the imperative for firms to consider those strategic and cumulative impacts of all the trends that we've talked about in our discussion today. To our listeners, I really hope you've enjoyed this episode and if you'd like to hear more from us on risk and regulation, you can subscribe to future episodes. You can also access our regular publications on our website, which we'll link to you in the show notes. I look forward to speaking with you again soon. Do look out for the third and final episode in this mini series, which will be coming up and that will be focused on the insurance sector. Thank you.