Driving Change

At the dawn of 2017, expectations for markets, global trade, geopolitical stability and the political climate across many territories on the continent, and beyond, were concerning. The US had just sworn in a new administration, with an agenda that many saw as idiosyncratic and with concerns about a slide towards protectionism. Across the Atlantic, the UK had caused a collective holding of breath as the vote to leave the EU continued (and continues) to fuel uncertainty. In South Africa, markets awaited the ANC’s December elective conference—which at the time seemed a distant prospect—before contemplating the idea of much-needed policy certainty.

Fast forward to present day, and things look different. As we note in our recent publication, PwC South Africa’s Major Banks Analysis: “A positive path”—which analyses the aggregated financial results of South Africa’s major banks and identifies common trends facing the industry—the performance of the banking industry is, as always, often tied to the broader macroeconomic context and operating environment in which banking is conducted.

ECONOMIC CONTEXT

When all the data is in, 2017 will almost certainly turn out to be the best year the global economy has seen since 2010. This rising tide is not just an overall macroeconomic phenomenon; it is balanced across regions. Most of the world’s major economies are experiencing positive growth in contrast to their experiences of a few years ago.

Global commodity prices appear to have stabilised at a moderate level. Russia and Brazil have returned to modest growth following recent recessions brought on by plummeting commodity prices and political unrest; China is doing well, and the Euro zone has mounted a steady recovery that looks set to continue in 2018. Even the UK economy, while slowing over 2017, has not yet been severely impacted by Brexit—or at least not at the levels foreseen at the time of the vote in 2016. As for the United States, the domestic economy is chugging along at around three per cent growth.

After recovering from technical recession in early 2017, South Africa’s economic growth remained slow for a fifth consecutive year. Supported by firmer global commodity prices and a recovery in agricultural production following protracted drought periods, economic growth in the country rose from a revised 0.6 per cent in 2016 to 1.3 per cent in 2017. In various markets on the continent, economic growth improved somewhat, supported by global commodity price recoveries, improved rainfall and continued infrastructure investments. However, key fiscal issues remain a challenge to growth in several African markets, notably Mozambique, Ghana and Zambia, while interest rates cuts were broad-based across several of these territories.

Following a sharp decline in economic growth during 2016 due to weak commodity prices, growth in Sub Saharan Africa (SSA) recovered to an estimated 2.4 per cent in 2017. This was driven by an improvement in metal prices and agricultural production supported commodity exporters, while economic growth was relatively stable in non-resource-intensive countries as infrastructure investment continued. On balance, the recovery in regional economic growth last year was slightly weaker than initially projected due to a softer than expected recovery in Nigeria (the region’s second-largest economy after South Africa) during 2H17. International Monetary Fund (IMF) research indicates Sub Saharan Africa GDP growth expectations of 3.4 per cent for 2018.

WHAT’S KEEPING BANKING AND CAPITAL MARKETS CEOS UP AT NIGHT?

Against this economic context and an ever-evolving technological landscape, key findings from our 21st Global Annual CEO Survey note that Banking and Capital Markets (B&CM) CEOs find themselves in a “good but not great” mood this year. More than half report being bullish about economic growth—57 per cent believe the global economy will improve over the next 12 months, compared to 30 per cent the year earlier. Yet that economic optimism hasn’t necessarily translated into increasing confidence in their own prospects.

Our global survey shows that B&CM CEOs view their industry as one of the most disrupted in the global economy and that technology is the main gamechanger— not surprising as this has been the reality for some years now. Globally, some B&CM organisations are, of course, faring better than others. As our survey findings underline, the big differentiator is digital transformation, and the breakthrough innovation and growth that stem from it. Those that get this right will find opportunities to positively transform the customer experience and put space between themselves and competitors.

While accelerating digital transformation holds the key to boosting innovation, differentiation and growth, many banks are finding it difficult to get up to speed. In some ways, this challenge is acute on the African continent—where many banks are constrained by legacy systems and infrastructure, mixed economic contexts, and an operating environment fraught with change. What is clear is that the pace of technological change is now up there with over-regulation on banking CEOs’ list of concerns.

As the banking regulatory overhaul over the past decade has shown, there are no quick solutions to implementing complex and far-reaching changes. It’s generally not the technology itself that creates difficulties—systems are becoming  more powerful, more intuitive and easier to implement and use. Rather, most of the problems stem from the familiar snags of process fragmentation and IT incompatibility. Unless these deficiencies are sorted as part of a digital transformation, no amount of investment can deliver real benefits.

Not surprisingly, our survey reveals that overregulation is the threat most commonly identified by B&CM CEOs as making them “extremely concerned”. This trend of “over-regulation” is particularly relatable in an African context. For some time—and what appears to now be increasing urgency – many territories on the continent have been abuzz with speculation of proposed increases in regulatory capital requirements, possible moves to risk-based capital frameworks (Basel II/III) and evolutions in supervisory practises to more risk-based regimes.

While these developments bode well for increased safety and soundness of financial systems both in these territories and regionally—and with it potentially greater levels of investor confidence—such changes present significant implications for banks.

As these developments play out, banks on the continent and their regulators will need to reflect deeply on a range of questions, including: Is the industry in these territories ready and capable of implementing complex, globally-aligned approaches to capital management? Have supervisors equipped themselves to ensure effective supervision, based on sound risk-based approaches aligned to international best practices? How will the implementation of these capital management regimes impact on the real economy of the countries? What impact on economic growth will the implementation of these regulatory frameworks have, in particular on small to medium enterprises?

Alongside regulatory developments, on 1 January 2018 the much discussed IFRS 9 Financial Instruments accounting standard went live, following intense implementation programmes by many banks to ensure that data, controls, models and systems are properly in place to produce IFRS 9-compliant measures of expected credit loss (ECL).

WHERE ARE BANKS FOCUSING?

In many ways, banks on the continent are broadly aligned with the longer-term, strategic focus areas of banks globally. We see continued focus on a set of strategic themes consistent with our observations and trend lines over recent years—including digitising legacy processes through robotic process automation efforts, replacing and upgrading legacy system architecture, and channel and product innovation with a view to enhancing customer experiences.

Meanwhile, a number of evolving global industry trends are underway:

Trust in the machines—Globally, there is a fundamental behavioural shift underway toward digital channels. A case in point: our 2017 Digital Banking survey in the US found that 46 per cent of customers skipped bank branches altogether, relying instead on smartphones, tablets and other online applications. The need to balance openness and protection in a connected world will likely be a major theme in 2018. By opening platforms to third parties through application programming interfaces (APIs), leading banks may unlock newfound value from data, create synergies with partners, and develop new cloud-based services more quickly.

Plug and play—Many global banks now find they can replace entire functions with fully digital cores that supply standard offerings such as transactional accounts in ways that weren’t possible a few years ago. This can be more efficient than endlessly patching legacy infrastructure and often lead to surprise at how much ‘buy’ can now edge out ‘build’ in banks’ investment decisions.

Beyond buzzwords—In 2017, global financial institutions were busy finding productive ways to harness the mountains of data they collect. For example, many global banks already use heuristics to analyse marketing campaign results, improving the return on marketing spend. Ultimately, the devil is in the detail, or perhaps ‘in the data’.

For organisations with varying account structures and naming conventions, finding the right data is rarely simple. In 2018, many leading global banks will prepare data for machine learning, making it a priority to label a lot of data. This means sourcing, organising, and curating unstructured data, while they may even make more—creating ‘synthetic data’ that mimics real client profiles to help train systems.

RPA 2.0—After gaining maturity in operations and finance, areas such as risk, compliance and human resources are next on the list of robotic process automation (RPA) opportunities. Our 2017 RPA survey found that 30 per cent of respondents are at least on the way to enterprise adoption. But the path hasn’t always been smooth. Some banks uncovered risk, control and people issues they hadn’t expected. As we enter 2018, financial institutions face some tricky questions and are asking themselves: What controls should we apply to AI systems that decide and act in nanoseconds? How much authority should AI have? How do we make sure machines uphold their fiduciary duty? What about regulators? What if things do not go as planned? We expect leading banks to place more emphasis on these issues in 2018.

Blockchain: are we there yet?—We’ve been reading about the promise of blockchain technology for several years now. Many sceptics are beginning to wonder if the ‘year of blockchain’ will ever really arrive. As has been well documented, blockchain isn’t a cure-all, but there are clearly many problems for which this technology is, or can be, the ideal solution.