“The Paradigm Shift in Banking: Transforming The Rules of Engagement” is this year’s theme at The Banking Scene, and on January 30, we kicked off with the first meetup of the year. On that day we gathered in Luxembourg with 130 professionals, for a couple of more general sessions and a focus on private and wealth banking, to discuss how the rules of engagement are changing today.

One of the topics that regularly arose is what this blog is about: regulation and how it affects a bank’s engagement with its customers. Although we had an entire session about it, I decided to look at it with a more holistic lens and add some of the insights from other sessions as well.

Regulation is everywhere and affects everyone, especially in financial services. With every crisis comes a new set of regulations. In the past 20 years, the banking sector has been confronted with a Global Financial Crisis; the war on drugs and terror highlighted the challenge and importance of AML and KYC, and a few global banks were scrutinised for prioritising profits before customers. The recent fall of SVB increased attention on risk management and capital requirements once again. All of this led to additional measures to ensure the industry would “walk the line”.

I don’t need to explain that regulation has affected the banking industry, perhaps as much as changed customer expectations have over the years, for good and for bad. For the sake of this blog, let’s not dive too far into evaluating regulation but rather look at how all this has affected a bank’s engagement and conversation with clients.

Overall though, the feedback at the event was that regulation was more of a blocker than that it was an enabler for a better engagement with customers.

Regulation is an opportunity to change the rules of engagement

After many years of additional rules and directives, and many years of going into defence against mandated change, the financial services industry is changing its sentiment towards regulation.

Regulation is an opportunity. This was a frequently heard statement. In wealth management, a telling example of this was the mandatory KYC screenings. These screenings are relatively new and very administrative. Customers don’t like it; banks don’t like it either. It’s seen as unproductive time.

For a long time, it was seen as a necessary step in the process that didn’t add any value to customer relationship building. Over the years, this sentiment changed. On the one hand, digitalisation of the process reduced the time spent on KYC to a minimum. While on the other hand, banks have realised that this customer contact is a unique moment to retrieve much more information from the client, which can help to complete the client’s profile to improve the financial advice given to that client.

In this respect, regulation has pushed banks to look at the client with a more holistic view, ensuring better customer advice.

We see the same in respect of new regulation on the road to net zero by the way.

Regulation slowed down the digital roadmap

The customers will guide the suppliers in how they wish to be approached and engaged with. That explains why these rules of engagement are today much more digital than they used to be. People live their lives more online these days than ever, and they expect their banks to follow. So clearly the rules of engagement are, first and foremost, shaped by customer expectations.

The rise of fintech companies and Big Tech accelerated the urgency for huge digital transformation programmes. Banks, big and small, did their best to peel into a new self, starting with a gleaming front and then reinventing the middle and the back.

The speed of change was determined by the available budget and resources.

These budgets and resources needed to be distributed among an enormous list of priorities, including the necessary compliance, legal and risk measures. ABBL and EY published research a few years ago showing that banks in Luxembourg spent €548 million on regulatory matters in 2019 alone!

The regulation not only limited the resources but also set new rules for innovation, limiting the options, and forcing banks to evaluate the risk of every project before proceeding to production. Because of that, regulation delayed innovation and reduced the speed of change, slowing down the change of the rules of engagement.

This put a significant burden on banks and their operations, on smaller ones even more so than the bigger institutions. They all had the same regulations to implement, irrespective of the assets under management they represented. The same research found that in Luxembourg, large banks (67% of total assets) represented 52% of the total regulatory spending, compared to small institutions (2% of total assets) had 6% of regulatory spending.

That often meant that the most engaging banks, the ones that stubbornly kept their branches open to maintain contact with the local community, were the most affected. One could argue that regulation forced banks to rationalise their expenses, pushing them to reduce their branch network for cost reasons.

Regulation defined the digital roadmap

It’s not just the conflict of resources that slowed down the digital roadmap though. Many regulations directly defined how to build digital. Just look at the impact of KYC, KYT, PSD2, and soon PSD3, but also MiFID II, for example. It sometimes left little room for creativity.

We see the same today with the Green Deal, where the regulator issues many new guidelines and obligations for banks to implement. This currently often leads to more confusion than it positively affects the way customers allocate their investments. It is one of the examples where the regulator, with the best intentions, creates extra complexity in an already very complex environment, without much room for banks to digest, recover and evaluate how to comply in the best possible way, respecting both the law and the customer.

In the case of KYC and AML, people also noted that the urgency to implement new screenings and processes led to resource constraints and potential service limitations. Banks had the choice: to accept additional risks, or to slow down onboarding of new clients. Most banks obviously chose the second option, which unfortunately meant that the additional regulation negatively affected financial inclusion. Again, an example of regulation leading to less engagement to avoid hitting the rules of compliance.

How regulation reduced a bank’s engagement with customers

A very unfortunate example I will never forget from the day, is how IFRS9 is making banks more resilient by clearly regulating how to deal with non-performing loans. Before this tighter regulation, banks had more flexibility to manage them. No one is interested in a forced sale of a house linked to a non-performing loan, not the customers nor the bank. So, trying to find other solutions, maybe sometimes just giving enough time to the customer helped to resolve the situation.

Today, banks are restricted in playing their societal role because of regulation. After 90 days of delays in payments, the bank must sell the house to pay to recover the funds, leading to more stress for customers and additional costs for banks. On top of that, banks are more reluctant to lend money to people in a higher-risk category, giving fewer people access to the housing market.

Conclusion

None of the speakers were against regulation. They understood how it builds a solid foundation to restore trust in the industry. On the other hand, banks will need to do more to restore that trust. Good governance, above what is required by law, and transparent communication about it, are equally important.

Another message I will never forget about the event is that people asked for a more proportionate approach from the regulator, and perhaps a period of evaluation for the regulator, banks, and their customers.

Regulation forces banks to be more innovative, more resilient, better controlled, etc, but every once in a while, it’s good to also question the regulations to make sure they still fulfil the mission they were written for.