How to build a tier-1 bank from scratch
If anyone knows about the failings of big banks, it’s George Magnus, who was one of the few economists to predict the financial crisis of 2007-8.
A key lesson from that debacle is that bigger is usually not better when it comes to banks, says the former senior economic adviser to UBS. “I’m not sure you can or should want to build a new tier-1 bank today to compete with say Goldman Sachs, J.P. Morgan or HSBC,” says Magnus. “These are the models we should be trying to move away from.”
Critics feel big banks have done too little to change their ways since the crisis, offer poor customer service and have failed to serve marginalised people shut out of the system. Some have also seen their profits languish in the last decade due to tougher regulation and intense competition.
Still, it is not hard to imagine that a newer, tech-based challenger could one day reach the tier-1 scale and, if they do, customers and investors alike will ask the same thing: can they avoid the mistakes of the past?
Magnus, who worked at UBS from 1995 to 2012, says the banking world is safer than in 2008, but not safe enough. Lawmakers missed an opportunity after the crisis to draw “thicker lines” between low-risk retail banking and higher-risk investment banking, and so many lenders continue to engage in both activities.
“Too big to fail is still a problem if there’s a systemic crisis,” he says, suggesting taxpayers might still be on the hook in the event of another meltdown.
“I could see creditors and shareholders having to carry the cross for a single bank that got into trouble, but if we were hit by a crisis that undermined the financial system as a whole and deposits were to flee, I suspect the ‘hit’ would be too big and sudden to allow.”
The pros and cons of being a small bank
This won’t cheer a small lender dreaming of entering the big league, particularly given the other financial hurdles they are likely to face.
Banking markets such as the UK’s are saturated and interest rates are at record lows, says Thorsten Beck, Professor of banking and finance at Cass Business School in London. That has left margins stretched and profits under pressure, something reflected in the large numbers of job cuts being made by the likes of HSBC and Deutsche Bank.
Smaller players must also overcome regulations that require them to hold a higher ratio of capital in reserve, along with trust issues due to their less well-known brands.
In such a tough set of circumstances, Beck says it would be tempting to try and expand quickly by buying up “bad legacy banks”, but he suggests organic growth, while much slower, is preferable.
“They should also look for niches where they can get a higher return using technology [to cut costs]. So do less small and medium-sized enterprise lending, which is high cost as you need to deeply assess the risk, and focus more on mortgage lending where you can automate the risk assessment process,” he says.
Big banks have a patchy reputation when it comes to customer service and innovation, unlike their more nimble fintech rivals that are gaining market share. So any new tier-1 bank would have to have innovation and good user experience at its core, particularly as tech giants like Apple and Facebook make further inroads into the sector.
“These Big Tech firms have the advantages of big data; they know so much more about us than any bank does and can offer much more tailored products,” says Beck.
Tech gives banks an undeniable edge
Tech-based providers have also started to tap into a market traditionally overlooked by the biggest banks: people shut out of the system who cannot open a bank account. When Facebook last year unveiled Libra, its blockchain-based payment system, it…
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