BANKING BUSINESS MODELS , DIVERSITY AND THE FUTURE OF REGULATION
     

BIS (Bank for International Settlements) distinct business models: the characteristics that matter. A retail-funded commercial bank, a wholesale-funded commercial bank and a capital markets-oriented bank. The first two models differ mainly in terms of banks' funding mix, while the third category stands out primarily because of banks' greater engagement in trading activities. On average, retail-focused commercial banks exhibit the least volatile earnings, while wholesale funded commercial banks are the most efficient. On the other hand, trading banks struggle to consistently outperform the other two business types.

Banks' profiles evolve over time in response to changes in the economic environment and to new rules and regulations. We find that transition patterns changed around the recent financial crisis. While several banks increased their reliance on wholesale funding prior to the crisis, in its wake more banks have adopted more traditional business profiles geared towards commercial banking.

     
CEPS - ECRI co-hosted 8 December 2011 an event to provide a venue for discussing the effects that Capital Requirements Directive and the respective regulation will have on banks' business models. The 'one size fits all' approach of Basel III poses the same requirements for all banks with retail business models that have an important role as lenders to the economy.

As the current discussion around bank regulation also emphasizes the banks' role in promoting economic growth, a special focus was placed on business models with a cooperative focus. The diversified banking models have shown to have acted as a shock absorber in financial crisis, which is iwhy its importance is expected to increase in the post-crisis era. Therefore, in addition to analysing the challenges that the current regulatory proposals pose to the business models of banks with different risk profiles, the event aimed to make reflections to the future of bank regulation.

The new Basel III/CRDIV requirements are likely to have significant impacts on the banking sector, with capital and liquidity requirements increasing the cost of capital and changing the banks’ balance sheet structures. The banks can react to these tightening conditions in several ways, such as by changing credit strategies or portfolio compositions, or through financing decisions.

Whatever the strategic action that the bank decides to pursue, the adjustment of the business model is a common feature to all. This event co-hosted by CEPS and ECRI will provide a venue to discuss the different business models in the face of new banking regulation.

To a large extent, the business models can be distinguished by the scope of activities and funding strategies banks engage in, both of which were increasingly diversified in the years leading up to the financial crisis. This development, however, also has had decreasing effects on diversity, bearing a systemic dimension to consider. Most retail-oriented banks, such as a number commercial, savings and cooperative banks provide traditional banking services to the general public, bearing high importance to the economic growth. The diversified banking model, which have kept retail as a core business, have indeed shown to have acted as a shock absorbers in financial crisis, which is why its importance is expected to increase in the post -crisis era.

The first session of the seminar assessed the advantages and weaknesses of different business models and ownership structures of financial institutions. The panelists also addressed the risk performance and governance characteristics of different models. By analyzing these issues from the perspective of individual banks as well as the whole economy, the panel discussed the future of banking and its role in the real economy given the new regulatory conditions.

The second session focussed on the specific impacts that the new banking regulation is likely to have on business models and ownership structures. A ‘one size fits all’ approach of Basel III/CRD IV poses the same requirements for all banks regardless of their risk levels and structures. This raises concerns especially from the perspective of retail business models that have an important role as lenders to the economy.

Overall the upcoming changes in the banking regulation are likely to induce slower growth in banking, higher costs and lower profitability, reflecting in lending to the real economy. How can the future regulation tackle these challenges and promote diversity in banking to achieve sustainable economic growth?