Banks’ strategies and business models: capital myths and realities

Capital myths and realities

This paper unpacks six myths around regulation and their impact on banks’ strategies and business models.

Senior Advisor, EMA Regulatory Centre of Excellence

KPMG in the UK


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Responding to regulatory policy and managing supervisory expectations continue to be high on the agenda at many banks. Banks must continue to manage the complex suite of new rules enacted – or still being formulated – by global, regional and national policy setting bodies, while also navigating an uncertain economic and competitive landscape.

This is complicating – and in some cases inhibiting – strategic, business model and operational decisions by banks that need to change their strategies and business models in order to address fundamental issues around profitability, viability and sustainability.

Regulatory reform should be nearing completion. Nine years after the start of the global financial crisis we should be seeing:

  • the completion and consistent implementation of the regulatory reform agenda across jurisdictions
  • banks completing their adjustment to these new regulatory requirements
  • no further increases in regulatory capital requirements
  • economic growth supported by the lending capacity of strongly capitalised banks
  • capital markets and new entrants to the banking sector filling any shortfall in bank lending and other banking services.

The reality looks very different.

The regulatory reform agenda remains incomplete. Although considerable progress has been made, some important initiatives remain at the design or calibration stage.

International standards have not been implemented consistently. The new standards have not been implemented in all jurisdictions. Implementation to date has been inconsistent. In some cases super-equivalent requirements have been added by national authorities.

Banks have strengthened considerably their capital and leverage ratios. Most major banks now meet the Basel 3 capital and liquidity standards. But these data do not tell the full story.

Many banks continue to experience low profitability, high non-performing exposures and high cost to income ratios, although these weaknesses are unevenly distributed within and across countries.

Many banks still need to adjust further to meet the other regulatory reforms (‘Basel 4’) being introduced in addition to Basel 3. Some of these additional reforms will place significant further demands on banks’ capital positions. Banks also need to meet the demands of more intensive and more challenging supervision.

Regulatory and other uncertainties create challenges for many banks, impairing their ability to launch new strategies and business models; to make the necessary investments to upgrade or replace ageing IT systems; and to respond to the competitive pressures from new bank and non-bank entrants and from financial technology disruption more generally.

These pressures and uncertainties also continue to constrain the ability of some banks to increase their lending in support of the wider economy, although the extent of this differs significantly across countries and regions.

In Europe, bank lending remains subdued. Banks in Europe have strengthened their capital position (CET1 capital ratios of major European banks increased from around 6.5 percent in June 2011 to just below 12 percent in June 2015), but this was achieved in part by banks reducing the size of their balance sheets and by shifting out of riskier lending and trading activities (risk weighted assets fell by nearly 20 percent over the same period). Elsewhere, banks have continued to expand their balance sheets at the same time as improving their capital ratios.

Capital markets can fill only some of the gaps. Smaller companies in particular face challenges where alternative lending platforms and bond markets may not be available as an alternative to bank lending.

Myths and Realities

This paper unpacks six myths around regulation and their impact on banks’ strategies and business models. These are:

  1. There is no Basel 4, and there will be no further significant increase in capital requirements.
  2. The regulatory reform agenda is almost complete.
  3. International standards provide a level playing field globally.
  4. Banks are in a strong position because they have adjusted to meet Basel 3 requirements.
  5. Banks with stronger capital ratios lend more.
  6. Capital markets can fill the gaps left by the banks.

In practice, the reality looks very different. Basel 4 is coming, and will have a significant impact on banks’ capital requirements; the regulatory reform agenda is far from complete; the global playing field is uneven; and many banks still need to address weaknesses that threaten their viability. Banks that fail to identify and implement clear strategic priorities within this environment will struggle to succeed.

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