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why us banks needs a new biz model

'why us banks needs a new biz model'
1 J A N UA RY 2 012 Why US banks need a new business model Investors want radical plans to boost ROE above the cost of capital. Toos Daruvala, Hasan Malik, and Fritz Nauck f i n a n c i a l s e r v i c e s p r a c t i c e 2 This autumn, many US banks reported a respectable improvement in earnings for the third quarter: more than 80 percent of the largest beat the market’s consensus forecasts, and a similar proportion showed year-on-year increases. The second quarter was equally impressive. So why have the stocks of large banks declined by more than 20 percent since the beginning of the third quarter—nearly three times more than the broader stock market—to the point where four out of five now trade below book value? Many commentators blame Europe’s sovereign-debt crisis and fears of a double-dip recession. But three additional factors also weigh heavily on investors: the new bank capital requirements introduced under the Basel III international-banking regulations, the impact of new US banking regulations responding to the financial crisis, the Dodd–Frank Act, and the unwinding of consumer debt. All three undermine banking’s traditional business model. By business model, we mean how banks actually operate—how work is done, the degree of automation, the pricing and design of products, and underlying compensation systems. In the market’s view, the threats are so strong that it won’t be enough to trim the sails, refocus investment, or cut costs a bit here and there. Our estimates show that if banks maintain their existing business models, their average return on equity (ROE) would fall to 7 percent by 2015, from its current level of 11 percent, against a cost of equity projected to be more than 9 percent. Investors want to see the management teams of banks propose credible, far-reaching plans to close this gap. The message that investors are now sending—shares of banks will be valued at levels implying that they will not earn their cost of equity—has profound implications for a US economy dependent on a healthy banking system to support recovery and fuel growth. Of the three threats, the most significant comes from the Basel III requirements, proposed by the Basel Committee on Banking Supervision. Without mitigating actions, they could reduce the ROE of some banks by as much as five percentage points. While the details are still being determined, we estimate that the US banking system will need an additional $500 billion in retained earnings or new equity to meet the new capital adequacy standards (assuming the current asset level and mix). The second threat is the continuing deleveraging of consumers. The history of the past 100 years suggests that when excessive borrowing is a principal cause of a recession, consumers and businesses spend the next seven to eight years rebuilding their balance sheets. On that basis, we are in only year three of a much longer journey. There is 3 little prospect of a quick return to the heady consumer-borrowing leve
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