2019 Banking and Capital Markets Outlook Reimagining transformation2019 Banking and Capital Markets Outlook: Reimagining transformation 2Brochure / report title goes here | Section title goes here 02 Table of contents Calmer waters: A decade after the financial crisis, the banking industry is on firmer ground 1 Regulation: A new era of global regulatory divergence 5 Technology: Creating a symphonic enterprise 8 Risk: Strengthening the core with new-age defenses 11 Retail banking: The digital leadership race 13 Corporate banking: Digitization and a new credit discipline 16 Transaction banking: Modernizing operations with a focus 18 on improving the client experience Investment banking: New client engagement models 19 and ecosystem orchestration Payments: The imperative to diversify growth, 22 bolster security, and restructure the organization Wealth management: Balancing business growth 24 with product rationalization and transparency Market infrastructure: Harnessing the power of data 26 and technologies to drive a competitive growth agenda 2019 Banking and Capital Markets Outlook: Reimagining transformation 1 Calmer waters A decade after the financial crisis, the banking industry is on firmer ground The global banking system is not only bigger and more profitable but also more resilient than at any time in the last 10 years (figure 1). According to The Bankers Top 1000 World Banks Ranking for 2018, total assets reached$124 trillion, while return on assets (ROA) stood at 0.9 percent. Similarly, tier 1 capital ratio as a proportion of assets rose to 6.7 percent, significantly higher than in 2008. 1 But the recovery since the financial crisis has not been uniform across regions. US banks, compared to their European counterparts, are ahead on multiple measures. Aggressive policy interventions and forceful regulations helped propel US banks to health more quickly. And more recently, favorable GDP growth, tax cuts, and rising rates have further bolstered the state of the industry. Total assets in the United States reached a peak of $17.5 trillion. 2Capital levels are up as well, with average tier 1 capital ratio standing at 13.14 percent. Return on equity (ROE) for the industry is at a post-crisis high of 11.83 percent. 3Efficiency ratios also are at their best. Similarly, on other metrics, such as nonperforming loans and number of failed institutions, the US banking industry is robust. However, the same cannot be said of the banking industry in Europe. Structural deficiencies, overcapacity, low/negative interest rates, and the absence of a pan-European banking regulatory agency have all likely contributed to European banks experiencing persistent profitability challenges. Figure 1. Growth of the global banking industry In the last decade, the top 1,000 world banks have grown Assets ($T) Return on assets (%) Tier 1 capital/assets (%) Sources: Danielle Myles, “Top 1000 World Banks 2018,” The Banker, July 2, 2018; Danielle Myles, “Top 1000 World Banks 2017,” The Banker, July 3, 2017; Charles Piggott, “Top 1000 World Banks 2009,” The Banker, June 24, 2009. Bigger More profitable Better capitalized $96.4 2008 2017 $123.7 2008 2017 .1% .9% 2008 2017 4.4% 6.7%2019 Banking and Capital Markets Outlook: Reimagining transformation 2 Many European banks have become smaller, retrenching from international markets and exiting former profitable businesses. Consider the fact that profits of the top five European banks dropped from $60 billion in 2007 to $17.5 billion in 2017. 4However, European banks are showing some improvement. ROE for Western European banks in the top 1,000 world banks grew to 8.6 percent in 2017, compared with 5.5 percent in 2016. 5In the Asia Pacific (APAC) region, the growth of Chinese banks has been the most stunning development in the last 10 years. The Chinese banking industry has surpassed that of the European Union (EU) in terms of size. The worlds four largest banks in 2018 are Chinese; in 2007, none of the top 10 banks in the world were Chinese. 6Chinese banks are also doing well in terms of profitabilitythe larger banks reported a 15.3 percent ROE in 2017. 7However, the concern with economic growth and the tariff war with the United States are already affecting prospects. 8Meanwhile, Japanese banks, which escaped the financial crisis, have long suffered the effects of slow domestic growth and low/negative interest rates. 9 Despite this overall optimistic picture for the global banking industry, uncertainties loom on the horizon. Real GDP growth forecasts from the International Monetary Fund (IMF) point to a deceleration in all regions, including China and Emerging Asia (figure 2). In the latest forecast, Deloitte economists are predicting a 25 percent probability of a recession in the United States in 2019. In this scenario, tariffs and dilution of the stimulus effect could weaken US economic growth in late 2019 or early 2020. 10 Figure 2. Real GDP growth by region, 20132023 In the last decade, the top 1,000 world banks have grown 2012 2018 2015 2021 2013 2019 2016 2022 2014 2020 2017 2023 Forecast -2% 2% -1% 3% 6% 0% 4% 7% 1% 5% 8% 9% European Union MENA Emerging Europe China Emerging Asia Japan LatAm USA Source: World Economic Outlook, October 2018, International Monetary Fund.2019 Banking and Capital Markets Outlook: Reimagining transformation 3 And on the regulatory front, global divergence shows no signs of abating as governments continue to buck previous post-crisis trends of synchronization. To spur economic growth, local jurisdictions are increasingly implementing their own standards, sometimes in patchwork. While net new regulations in the United States appear unlikely, the reprieve has largely been confined to smaller and midsize banks. Large banks, despite potential relief from the Volcker Rule, are expected to continue to operate under the same regulatory agenda. In the technology arena, the promise of exponential technologies seems more real than ever. While the wild enthusiasm with blockchain has tapered off, the industry continues to sail toward a blockchain future. However, the energy might now lie with artificial intelligence (AI) and cloud, as they are already transforming many aspects of banking in significant ways. But for any of these technologies to have maximal impact, data is key. Although data is plentiful, it is often not easily accessible, clean enough, nor integrated. Meanwhile, the relationships between banks, fintechs, and bigtechs are evolving rapidly. Fintechs are increasingly no longer seen as scrappy adversariescollaboration with incumbents is more the norm. With increasing industry convergence, the relationship between the banking industry and bigtech can be characterized as a bit guarded. Banks typically need bigtech, and in some ways bigtechs also need banks, as the banking industry remains a big revenue source for many technology companies. Last year, we urged banks and capital markets institutions to accelerate their transformation, particularly digital transformation. No doubt many banks have embraced digital transformation across the banking and capital markets value chain. But how much of this change is purposeful and strategic? Change for changes sake typically only begets disappointment. Banks should bolster their conviction and reimagine transformation as a holistic, multiyear process and “change how they change.” The world is becoming too volatile, and external change is happening more rapidly than before. Taking a traditional approach in confronting these challenges may not work. “Change the bank” initiatives should move to the fore and could essentially become the new operating model for “running the bank.” This transformation should fundamentally start with banks reaffirming their role in the global financial system. What do they want to be in the next five or 10 years? Banks should discard grand visions of becoming “a technology company” and instead focus on customers, enhance trust as financial intermediaries, facilitate capital flows, and provide credit to the global economy with data as the bond that sustains the amalgam of technologiesAI, automation, cloud, core modernization, etc.best suited for the purpose. 2019 Banking and Capital Markets Outlook: Reimagining transformation 4 Future-proofing the business Our main message, though, is the following: There may be no better time than now to reimagine transformation. Economic fundamentals are stronger than at any time in the last decade. The regulatory climate is not going to get any more challenging. And, technologies to enable transformation are not only getting more powerful but also more readily accessible, easily implementable, and economical than before. Indeed, there appears to be a new kind of promise in the banking industry. We urge banks not to become complacent. The economic/ credit cycle is bound to turn at some point. Use recent fortunes to invest wisely, and pursue change with clarity and conviction. In this reportthe 2019 Banking and Capital Markets Outlookwe discuss the need for strategic transformation in the following areas in 2019: regulatory compliance, tax, technology, risk, privacy, and talent. We then lay out our expectations in seven primary business segments: retail banking, corporate banking, transaction banking, investment banking, payments, wealth management, and market infrastructure (figure 3). Figure 3. Reimagining transformation in banking and capital markets Reimagining transformation Retail banking Market infrastructre Regulations and tax Talent Risk and privacy Technology and data Corporate banking Wealth management Transaction banking Payments Investment banking C u s t o m e r c e n t r i c i t y C u s t o m e r c e n t r i c i t y Source: Deloitte Center for Financial Services analysis.2019 Banking and Capital Markets Outlook: Reimagining transformation 5 Regulation A new era of global regulatory divergence Last year, we predicted a stabilization on the regulatory front after years of intense scrutiny by regulators around the globe. Much has happened since then. Growing divergence in global regulatory standards remains a fact. As countries look for ways to spur economic growth, many are increasingly showing a willingness to take a fragmented approach, bucking the previous trend of post-crisis synchronization. In the United States, the focus on refining or even replacing existing regulations remains. A new bill, the Economic Growth, Regulatory Relief, and Consumer Protection Act, amending certain provisions in the Dodd-Frank Act was signed into law. Notably, the statutory systemically important financial institutions (SIFIs) asset thresholds for enhanced prudential regulations, such as stress tests and capital and liquidity ratios, were increased, giving the most relief to banks with assets between $50 billion and $100 billion. As for the Volcker Rule, several changes are still pending. The proposal intends to modify the scope of applicability based on trading size, amend proprietary trading provisions, and simplify compliance reporting. It also offers some relief to foreign banking organizations (FBOs). 11 The Community Reinvestment Act (CRA), requiring banks to serve the credit needs of their communities, may also be revised. The Office of the Comptroller of the Currency (OCC) has begun seeking public comment on ways to amend this act. 12The Department of Labors (DOLs) fiduciary rule, requiring financial institutions to act in the best interest of their clients, was overturned, but a new best-interest rule from the SEC is still a possibility. Meanwhile, enforcement actions by the Consumer Financial Protection Bureau (CFPB) have declined. As of September 2018, the CFPB had announced only five enforcement actions since February 2017. 13 While the pace of new regulations has decelerated under the current US administration, the role of the states may grow in prominence. As an example, California passed the Consumer Privacy Act of 2018, which establishes new data protection rights for consumers. Other states are likely to follow suit. In Europe, the General Data Protection Regulation (GDPR), the first of its kind to provide sweeping data protections to EU citizens, will continue to reshape privacy and data ownership policies. Meanwhile, even though the implementation of Markets in Financial Instruments Directive II (MiFID II) has hit some speed bumps, the drive toward fee transparency will only accelerate. On the other hand, Payment Services Directive II (PSD2) has had the intended effect of promoting innovation and competition in payments. Additionally, the European Commission (EC) continues to work on completing a single, harmonized regulation rulebook and on finalizing the banking union. However, it has faced headwinds in establishing the banking union because the global trading book capital standards it seeks to incorporate from the Basel Committees Fundamental Review of the Trading Book are in flux. 142019 Banking and Capital Markets Outlook: Reimagining transformation 6 In the United Kingdom, as the March 2019 Brexit deadline rapidly approaches, much uncertainty remains. Many banks have already established contingency plans, possibly preparing for the worsteither a no- deal or hard Brexit. Depending on what ultimately happens, these plans could be put to the test. In the APAC region, conduct and culture were high on the regulation agenda in 2018. Chinas banking regulators issued extensive guidelines on employee conduct management, while Malaysias central bank proposed an accountability framework for senior officials in financial institutions. In 2018, APAC regulators took a closer look at foreign investment and recovery and resolution planning. Indias central bank, for instance, introduced a new framework for the resolution of stressed assets, and Hong Kong updated its recovery planning legislation in accordance with international norms. 15Meanwhile, in China, the historic step to merge banking and insurance watchdogs might help Chinese regulators better tackle the mounting risk in its financial system. 16 Despite growing global regulatory divergence, regulators in the United States and abroad seem to be encouraging experimentation by fintechs and welcoming them to the fold. The OCC announced in July 2018 that it would begin accepting fintech bank charter applications. 17Meanwhile, the United Kingdoms Financial Conduct Authority (FCA) announced plans for a network of global regulators dubbed the Global Financial Innovation Network (GFIN) to establish a global regulatory “sandbox” that can foster innovation among technology companies. 18 The Monetary Author