What are the Forces Reshaping the Banking Industry?

The information age has brought many major changes in the banking industry. The banking industry does not escape from the stimulus and challenges of this age instead, the industry has adapted, changed, and evolved so as to remain competitive in the 21st century. According to S. Scott MacDonald / Timothy W. Koch, Management of Banking, 6th Edition, Thomson (2006), intense competition has arisen from the five fundamental forces which are reshaping the banking industry today.

The banking industry is highly regulated by the government and central banks all across the globe. In Malaysia, Bank Negara Malaysia (BNM) regulates the banking industry through the Banking and Financial Institutions Act (BAFIA), 1989. However, recent intense competition and the breakdown of the Glass-Steagall Act that separate the commercial and investment banking in the United States, brought deregulation and reregulation in many countries. Deregulation is the process of eliminating existing regulations while reregulation is the process of implementing new restrictions or modifying existing controls on banking activities. Generally, deregulation and reregulation address pricing issues, allowable geographic market penetration and offering new products and services. The pricing regulations have focus on removing price control such as maximum interest rates paid to depositors and the rates charged to borrowers. The banks are also allowed to expand product choices such as insurance and brokerage services. Thus, these changes will generate greater opportunities to the banking industry. However, the deregulation and reregulation also brought opportunities to the non-bank institutions enabling them to conduct commercial banking activities and thereby creating direct competition between non-banks and banks. Examples of these institutions are Merrill Lynch, GE Capital, and Prudential Insurance.

Besides that, financial innovation which is the process of change in instruments, institutions and operating policies that also determine the structure of banking system. New instruments are created to provide liquidity such as unit trust funds. The banks also use option, swaps and future contacts to hedge interest rates and foreign exchange risk. New delivery system incorporate technological advances to facilitate funds transfer such as ATMs, Internet banking, and electronic funds transfer systems. This will allow the banks to widen their distributions at lower costs compared to open a branch. Through advances in information technology, banking institutions also acquire the ability to handle larger number of transactions with the same amount of manpower which brought a storm of mergers and acquisition. For example, Bumiputra Commerce Bhd and Southern Bank Bhd merged with CIMB.

Loans are one of the primary sources of income for banking institution. But if a bank holds to many loans, its capital requirements increase and this will make the bank less liquid. The bank’s solution is to substitute interest income from loans with fee based income by the means of securitization. Securitization is the process of converting loan assets to marketable securities. A bank will combine some of its loans and sell pass-through certificates, which are secured by the interest and principal payments on the original assets. The original bank will charge service fees in collecting the payments. Securitization enables banks to clear these loans from its balance sheet and thus reducing the bank’s capital requirement and at the same time reducing interest rate and credit risk. Securitization however comes with a price because most banks bundle together loans with high credit risk and loans with low credit risk. As a result, when the subprime bubble burst in the United States of America, some of the European banks who bought the securitize loans were affected also.

Globalisation and internationalisation also plays an important role in reshaping the industry. There is now as never before a general freedom of inflows and outflows of foreign direct investment. Globalization greatly affects the banking industry by removing the traditional geographic barriers and enabling foreign banks to penetrate deeper into local markets. Citibank for example has opened a few new branches in peninsular Malaysia. Furthermore, globalization reduces the barriers to entry and enables foreign non-bank institution to compete with local banks. This will again increase the friction between not only foreign and local banks but also bank and non-bank institutions. Another example of globalization would be in Japan where Japanese investors shift their investments from the Japanese Island to mainland China as a result of Japan’s zero interest rate policy. Besides that, globalization also creates intense price competition in the banking industry as a result of the easier movement of funds across borders. As a result, an action by a bank on non-bank institution several thousand miles away might also affect local banks.

Last but not least is the advancement of technology. Technology had has the biggest impact on efficiency, effectiveness, and productivity. Computerisations enable the banks to reduce costs, widen their access to customers and providing greater convenience. For example, Internet banking allows the customers to do their banking transactions without going to the branches. This greatly decreases the cost per transaction of the bank. Besides that, advancement in technology enables international trade to run more smoothly and therefore have a similar impact as globalization. However, some banks like Citibank have begun cutting jobs that are unnecessary as a result of automation.

As a conclusion, as Charles Darwin, the father of evolution once said, ‘it is not the strongest species who survive but the species most adaptive to change. Similarly, banks should identify the upcoming forces and challenges that are affecting the banking industry and develop products with which they have a competitive advantage. One think is for certain, the time is right for innovation in the banking industry.

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