Treasury Risk Management
To,
Chief Investment Officer (CIO),
European Hedge Fund
Subject: “Challenges / opportunities of the changing global interest rate environment”
Respected Sir,
There has been a significant impact of financial crisis on the banking sector globally. In order to overcome the impact of financial crisis, the euro area has taken several reforms and adopted metrics, but the Euro area banks are still underperforming compared to their international peers due to presence of some challenges (European Central Bank, 2018).
The cyclical and structural challenges are one of the key challenges that are affecting the banks’ profitability and also changing global interest rate environment.
Due to cyclical changes, it is becoming difficult for the banks to enhance their revenues in the low interest rate environment. However, there is a sportive impact of the credit growth on the economic conditions but it is not sufficient to manage the low interest rate margins (European Central Bank, 2018).
The balance sheets of the banks are adjusted to overcome the negative impact of cyclical factors over time. The impact of adverse or sluggish economy may impact the banking industry considerably.
But at the same time, it can be opportunistic for the banks also. It is because the banks need to focus on the effective market research to determine the cyclical changes that can be effective for them to determine better strategies to overcome the impact of the financial crisis and future aspects.
It can also be effective for the banks to consider all the changes in the economic conditions through pattern analysis and historical data to develop effective approaches to handle any adverse situation in future.
At the same time, structural challenges are also significant challenges that are being faced by the banks in relation to changing global interest rate environment. These challenges are also affecting the profitability of the banks. These aspects are different in different countries and banks that also cause the need for the adjustments in the business model and cost inefficiencies and capacity enhancement (European Central Bank, 2018).
Due to these challenges, the non-performing loans may remain high at some banks. Apart from this, the increasing competition from the non-bank financial sector and “Fintech” and increasing role of technology are also affecting the market share of the banks in the changing global interest rate environment.
There are several financial and non-financial institutions along with the banking sector that create high competition to each other. After recession, the customers are becoming more price-sensitive and the online emergence also has raised the opportunity for the customers to select the cost effective banking services.
For this, it has become challenging for the banks to handle the increasing competition that also has affected their revenues and market share significantly. It is mandatory for the banks to add value to the products and services to attract more customers and compete with other banks in the organization.
The inclusion of emerging technologies causes issues for the banking sector to update the employees by providing training that causes extra expenses to the banks (CBI, 2019).
At the same time, it is hard to find the techno-savvy people who can operate these technologies to handle the banking operations. It causes the extra costs in relation to the pushing of the technology, training costs and recruitment costs for the new employees who are capable of operating these technologies in banking operations (CBI, 2019).
The regular changes in the banking technologies also cause challenges for the banks to handle the technology based risks like data breach, data privacy and confidentiality, etc. that can cause major impact on the bank reputation as well as the customers trust.
In addition, it may also cause the financial exclusion because many customers do not how to use the technologies to do the banking operations that exclude them from the industry and its growth. Moreover, there is lack of informed decisions in launching the financial products because there are no face to face contacts with the customers to make good decisions.
In addition, the use of artificial intelligence and robotic process automation on traditional workforce can bring the higher efficiency and effectiveness in the banking operations, but it can also cause challenge for the banks to develop a competent workforce that could handle these technologies and integrate in the routine operations (CBI, 2019).
But at the same time, the adoption of the technologies in banking can be opportunistic to deliver the services easier and quicker. It can be effective to reduce the delivery of banking services to the customers and enhance their convenience to use the banking services.
Through this, the customers can be benefitted by selecting the greater choice of the products and services. It provides opportunity to the customers to select the right choice as per their needs and requirements as well as to compare the existing products with the competitors to make a better and cost effective choice (CBI, 2019). It also increases convenience to the customers by using the services regardless of location.
So overall, it creates better opportunities for the banks to adopt the cost effective services and attract more customers to maintain the revenues and profits even in the changing interest rate environment. In addition, there is no need for the banks to invest money in the physical infrastructure like a branch network that enable them to offer the cost effective services to the customers.
Along with this, the use of new technologies also creates the opportunities for the banking sector in form of data collection. The collection of large data of the customers through advanced technologies allows the banks to provide more personalized products and services to the customers and enhance their satisfaction level to achieve higher profitability and revenues.
In addition, the use of advanced technologies like crypto currency and artificial intelligence can be effective for the banking sector to make the banking services safer and more productive by providing the better services to the customers. These technologies will also enable the banks to integrate the services more efficiently and serve the customers effectively (European Banking Authority, 2018).
There is a significant impact of the increased competition in lending, payments and investments on the revenues and profitability of the retail banking areas. It causes the price competition and also affects the revenues for the banks on the overdrafts and payments.
There is a need to make better structural changes and focus on financial stability to reach the full potential. The ECB has introduced many non-standard monetary policy measures to overcome these challenges (European Central Bank, 2018). The liquidity needs can be fulfilled by the banks by lending and borrowing from each other in the interbank market. Non-standard measures were based on the maintenance of liquidity to the banks to make them functional.
The offering of unlimited credit to banks known as fixed-rate full allotment provides the opportunities to the banks to grow in such environment. After this, the addressing the markets’ malfunctioning and reducing the differences in financing conditions are other approaches that are used by the ECB to provide opportunities to the banks to grow in the changing global interest rate environment (European Central Bank, 2018).
The changing interest rate environment focuses on the quantitative ease that has facilitated the flow of the cash through financial institutions and addressed the impact of financial crisis on the banking sector.
It also helped to avoid the credit crunch and to reduce the impact of crisis on the Eurozone economies. But at the same time, it can cause again the issue related to housing bubble because people may use that credit to purchase the houses that may cause an increase in pricing of the houses and can cause housing bubble lading to financial crisis.
It can be drastic for the economy due to possibility of non-performing loans in future if the housing bubble bursts. It is because people will not be able to pay these loans that are available at low interest rate in today’s environment (European Central Bank, 2018).
The impact of Brexit is also a big challenge for the banks in the changing interest rate environment. It is because there is uncertainty in the market as the people are not confident regarding the investment or saving. It is causing difficulty for the banks to attract more customers due to possible impact of Brexit on their investment decision (Deloitte, 2018).
The uncertainty in the financial markets and among the business community due to Brexit also causes a challenge for the banking industry. It is difficult for the firms and individuals to predict the market conditions and economic events that cause uncertainty among them for the investment and also affect the banking profitability and revenues (EY, 2018).
The uncertainty level due to Brexit has caused the banks to delay the full inception of execution activities. The forthcoming exit of the UK from the EU can affect the investors and employees and customers of the banks as well (Centre for Economic Performance, 2016).
It can cause relocation of the financial centres and their activities to the EU or elsewhere that can affect the revenues for the UK banks. It will also impact the bank investors as the changes in organizational structure due to Brexit will cause relative disadvantages and loss to the market share of the banks (European Banking Authority, 2018).
There is an opportunity for the banking sector as the Basel III agreement and its implementing act in Europe can be helpful to improve the conditions for the banking sector.
In relation to this, the European Banking Authority (EBA) will impart a significant role for implementing the new regulatory framework in the European Union that will contribute to the banking sector. Basel III is a comprehensive set of reform measures that will bring the improvement in the banking sector in even the changing interest rate environment (CFA Institute, 2018).
These regulations will strengthen the supervision, regulation and risk management in the banks that will help them to overcome the adverse financial situation and sustain their growth for long.
These measures will also be helpful for the banking sector to enhance its ability to absorb shocks due to financial and economic stress and improve the risk management and governance. Apart from time, it will also improve the transparency in banks and their disclosures (European Banking Authority, 2017).
It will also contribute to the sounder and safer financial system. The focus on these rules and regulations after the financial crisis has created opportunities for the banks because all these regulations will be crucial for the banks to avoid the situation like financial crisis in future and overcome the existing situation related to financial crisis.
Through this, these banks will be able to make the operations more transparent and reduce the non-performing loans to achieve high revenues and profits. Moreover, it can also be beneficial for the banks to adopt these rules and regulations to enhance the trust among the customers and reduce the impact of the economic crisis in future t improvise the results (European Central Bank, 2018).
There is also growing demand of shadow banking that is related to bank-like activities (mainly lending) outside the traditional banking sector. It is also known as non-bank financial intermediation or market-based finance (CBI, 2019). It is quite similar as the traditional bank lending in function. It includes bond funds, money market funds, finance companies and special purpose entities. It is helpful to reduce the dependency on traditional banks as a source of credit.
It also generates the extra source of finance and diversifies the financial system. However, it can cause challenge in form of risk due to too much lending and case harmful downturn. The shadow banking sector is growing that creates vast opportunities for the banking industry. But at the same time, it also causes challenges for the sector in form of the risk to the financial system and the economy too (Bloomberg, 2018).
It is because the availability of more loans through this banking system can cause threats to the banks due to possibility of more amounts of non-performing loans. However, the flow of the cash in the banking sector can also have a positive impact on the growth of banking sector and contribute to the revenues and profits even in changing interest rate environment.
One of the big challenges is the rising indebtedness for the banks in the changing interest rate environment. At the global level, the consumer debt is increasing due to acquiring the assets and supporting the aspiring life by the people. At the same time, the growth in indebtedness can be seen with the growth of the selling and financing of the automobiles and mortgages and consumer durables.
It can raise the need of increasing liquidity of the banks due to fulfilment of the credit requirement of the customers (European Central Bank, 2018). But at the same time, it also creates opportunities for the banks to increase the revenues trough interests obtained from the loan taken by the customers.
With the increase pressure on efficiencies and demand of the stakeholders, banks are inclined to serve the customers and differentiate themselves by focusing on the varieties of the products and services. The banks are competing globally by developing capabilities and serving the customers effectively (European Banking Authority, 2018).
Even some niche banks are offering the special products and services that are designed as per the needs and requirements of the customers. All these banks will compete with based on size and risk taking capability that will be helpful to develop competitiveness globally. Apart from this, the cost sensitive approach of the customers in current time will also create challenges as well as the opportunities for the banks.
It is because the banks will offer the best prices to their customers and leverage the direct channels in a cost effective way (European Central Bank, 2018). This focus will enable them to meet the needs and requirements of the customers in relation to the price.
Conclusion
The increasing concern towards the multiple challenges is also a challenge as well opportunity for the banking sector in the changing interest rate environment. The banking services are shifting from the brick and mortar to the multiple channels. There is a significant change in the business model after the emergence of new technologies.
This shift will be effective to provide the seamless purchasing experience to the customers and develop better connectivity with the customers. Overall, all these challenges will be faced by the banking sector in changing interest rate environment but it will also create opportunities or them to grow their market.
Yours sincerely
References
Bloomberg (2018), Shadow Banking. [Online] Available at: https://www.bloomberg.com/quicktake/shadow-banking (Accessed: 16 April 2019)
CBI (2019), Explainer – What is “fintech” and how is it changing financial products? [Online] Available at: https://www.centralbank.ie/consumer-hub/explainers/what-is-fintech-and-how-is-it-changing-financial-products(Accessed: 16 April 2019)
CBI (2019), Explainer – What is shadow banking? [Online] Available at: https://www.centralbank.ie/consumer-hub/explainers/what-is-shadow-banking (Accessed: 16 April 2019)
Centre for Economic Performance (2016) BREXIT 2016 Policy analysis from the Centre for Economic Performance. [Online] Available at: http://www.kenwitsconsultancy.co.uk/wp-content/uploads/2016/09/BREXIT-2016-Policy-Analysis-from-the-Centre-for-Economic-Performance.pdf#page=40(Accessed: 16 April 2019)
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