Low Interest Rates, High Uncertainty in Banking
Earnings season is upon us, and banks are once again parlaying the global headwinds they face and their industry’s intensifying competitive factors into a quarterly report worth celebrating. Thus far, results have been mixed. Incumbent institutions are competing not only with each other for market share, but also fintech challengers who are disrupting the industry. Additionally, heavy regulation, ultra-low interest rates, and weak trust combined with strong expectations among customers have forced banks to rethink and rebuild their value proposition and revenue streams. Regarding this second component, the implications of long-term low interest rate levels are certainly being discussed by financial media outlets.
Tale of the Tape
Earlier this week, Bank of America (BofA) reported that near-zero rates impacted its second quarter bottom line, lowering profits by 20 percent year over year. “Our results were impacted by a significant decline in long-term interest rates,” Chief Financial Officer Paul Donofrio said. “We were able to offset some of this impact by focusing on the things that we control and drive, such as growing loans and deposits, managing risk and expenses and delivering for our clients.”
Meanwhile, JPMorgan Chase & Co followed a similar earnings pathway, though its year-over-year slide was just one percent. Over the short-term, lending seems to be the quickest and easiest way for banks like BofA and JPMorgan to increase revenue flows, offsetting the lackluster returns that low interest rates yield, but even that model shift isn’t entirely sustainable.
First, since mortgage rates are essentially at their lowest levels already, the pool of borrowers that can refinance is finite. Second, aggressively expanding personal and business lending further pits banks against nonbank or fintech entities like SoFi, a company popular among Millennials and as much about lifestyle as it is lending. Businesses like SoFi issue loans at rates lower than those of traditional banks because their overhead isn’t nearly as high. This latter difference exists primarily because nonbanks don’t operate brick and mortar storefronts and package the entire customer experience in a digitally customized interface, with time and intrinsic value seen as equal to product marketing and account establishment.
Because of these recent earnings reports and mounting internal and external threats, one would presume that banks are concerned about growth over the long-term. However, a recent KPMG report suggests otherwise. Sixty percent of surveyed executives within larger banks predicted zero to five percent revenue growth in 2016, with 74 percent of them believing that their digital capabilities are above average, even with the existence of fintech companies. To this latter point, 60 percent of those surveyed did not see fintech as a threat or were unsure of it as one.
Contrast this with the fact that 73 percent of Millennials cited within the report would consider banking with tech companies like Google or Apple, and 53 percent of them saw their current banks’ offerings as nearly identical to those of peers. A reason for this lack of legitimate differentiation could be that 57 percent of banking respondents said their institutions were only either in the evaluation or planning stage of upgrading or replacing their legacy IT systems. Since such an investment and process can take upwards of three years, the technological divide between customers and banks should only worsen, potentially creating a vacuum for new entrants and a mass exodus of customers.
With the groundwork for diminishing future returns in play and an uncertain competitive landscape ahead, it’s imperative for banking institutions to consider new technologies and digital pathways that will allow them to compete in an age of low rates and, more critically, provide current customers with an efficient, omni-channel experience. Such an adoption will help prevent an increase in customer attrition and attract new ones from banks that lag behind the industry benchmark for 21st century banking.