Financial Institutions are having to decide whether to make deep budget cuts or invest heavily in digital transformation

The world is said to have experienced the most dramatic crash in history. Now, as the crisis slowly eases, financial institutions find themselves at a crucial crossroads.

On the one hand, there is deep concern about the economic recession, falling interest rates, increased risk of bad debt, and slowdown of financial activity. It is anyone’s guess how long the pain will last. Not to mention the dismay felt by many FIs as they watch their share prices languish at levels not seen since the 2008 Lehman crisis.

On the other hand, despite the severity of the crisis, many FIs remain strongly capitalized and highly liquid. This is because a majority were on a much better footing going into the crisis than in 2008. Euromoney estimates that the largest banking organizations in the US were holding US$1.3 trillion in common equity and US$2.9 trillion in high-quality liquid assets pre-crisis. Evidence of this ample liquidity are the many mortgage repayment holidays and significant loan extensions offered by banks. JPMorgan alone approved US$26 billion worth of loans to consumers and small businesses in the first 40 days of the pandemic.

A Conundrum

This mix of good and bad news has put FIs in a tricky position. There are certainly more options on the table than back in 2008. But a decision on the way forward requires strong conviction and urgent action.

Now, as the hump of the virus outbreak flattens, and a new way of doing things emerges, it is becoming clear that FI options for the future fall into three main (and hugely contrastlng) buckets. 

Option 1: Scale Back

This option, as exemplified by HSBC, is to respond with the knife. Last month, it was reported in the FT that the HSBC Board favoured even deeper cost and job cuts than the US$4.5 billion and 35,000 already announced earlier in the year.

In fact, Gartner expects IT budgets across all industries globally to be squeezed by US$300 billion in 2020, a drop of 8% year on year. Some companies are expected to cut big IT projects altogether, or press the pause button on some major project elements in an attempt to save money.

Option 2: Digital To The Rescue

Other banks are more optimistic about their near-term future. For example, according to S&P Global, the disruption risk to banks in Singapore and Hongkong is expected to be relatively low.  They attribute this to the fact that these banks started their digital transformation processes several years ago, leaving them in a good position to weather the storm.

The S&P Report concludes that ongoing heavy investments in technology by large domestic banks, driven by collaborations with fintechs and technology companies, is on the cards. These investments will protect against fresh crisis events as well as upcoming competition heralded by new entrants.

This was borne out recently by OCBC CEO Samuel Tsien. At the bank’s virtual AGM in May, he informed shareholders that the bank would increase its adoption of digital services, a move that was expected to lead to higher net operating profit in the longer term.

Option 3: Net Neutral

Straddling the two approaches is Deutsche Bank. Already in the midst of a restructuring programme pre-pandemic, the bank looks set to press ahead with redundancies as a way to fund its digital transformation spend. While 18,000 jobs, that is, a fifth of the bank’s global workforce is set to disappear, Deutsche has already drawn up plans for EUR13 billion worth of technology spending, focusing particularly on cloud, AI and ML innovations.

Christian Sewing, the bank’s CEO, said the Covid-19 crisis only served to reinforce digitalisation as the new currency for all industries, including banks. In his view, a bank’s success or failure going forward is determined by how much it holds of this currency.


Double or Nothing?

It should not be assumed that amid the current chaos, all FIs will resort to major cost cutting, especially on IT costs. The lesson of the lockdown experience is that FIs can achieve far better cost-to-income ratios and productivity gains from digital services than they had previously imagined. Many CIOs and CFOs are now baking in these new numbers into their future projections to justify increasing their IT expenditure.

However, the stakes have also risen. Ratings agencies such as Fitch and S&P warn that those FIs offering sub-par digital capabilities face increased risks given the change in competitive dynamics brought about Covid-19.  Their message seems to be, if you’re going to do it, do it well.