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Bank Economical policy Euro zone

Fourth edition of the “Rencontres du financement de l’économie” (Financing of the economy conference) : the possible evolution of monetary policy and interest rate policy and the consequences on the economy and on banks.

Whereas the Euro Zone is at a crossroads and the governments of the member states are taking a close look at the way it works, Olivier Klein takes a look here at the possible evolution of monetary and interest rate policy in this context.

The possible evolution of monetary policy and interest rate policy and the consequences on the economy and the banks.

Are interest rates going to rise and what are the fundamentals which would justify it? What are the effects of the low interest rates on the economy and on the capacity to finance the banks?

An initial, rather general but fundamental thought: the very low interest rates are not a phenomenon due exclusively to the central banks. It can be seen that growth has started again, both in the United States and in Europe. This is good news. This will probably drive internet rates up. But since the financial crisis we have seen a period of very low growth with a global overproduction crisis, which has led to very sluggish supply and demand. Clearly low demand and a high level of saving combined with low investment are the manifestation of global overproduction. Similarly, low gains in productivity and declining global demographics – apart from in India and in Africa – are keeping supply sluggish. The simultaneity of sluggish demand and supply has resulted in very low growth rates and naturally reduces interest rates.

If the markets were working well and if the economy spontaneously self-regulated, interest rates would return to so-called natural levels. In economic theory these natural rates are those which equalise saving and investment at a level of full employment. It just happens that this is a rate which cannot be observed, it is a rate calculated by economists. And these calculations lead to extremely low interest rates. Sometimes it is even calculated that these rates should have been negative to equalise demand and supply, i.e. savings and investment, at a level of full employment. Particularly in the eurozone.

It can thus clearly be seen that it is not only the central bank which is pushing interest rates down.

This leads us to think that not so long ago we were in a period of secular stagnation, the effects and reasons of which we all know, in other words, at least since the crisis, a classic period of debt reduction with very low growth, which occurs after all the major over-indebtedness crises, such as that we witnessed from 2007 onwards. Both are possible at the same time, at least temporarily. In both cases this justifies extremely low interest rates.

To these considerations must be added the fact that the brutal financial crisis we have witnessed has brought us into a period of major deflagration with a very high risk of deflation. To fight against this deflation the central banks have pursued extremely aggressive but necessary policies. All the major central banks have acted by reducing interest rates even further than the markets pushed them to, in other words below neutral levels. As we know, the neutral level is equal to the actual growth rate plus the inflation rate, thus to the nominal growth rate. When interest rates are pushed below neutral rates this is done because we want to reinvigorate growth by pushing inflation up again – and thus avoid deflation – and, of course, in order to limit the risks of an over-indebtedness crisis to prevent the “snowball” effects on debt due to nominal interest rates above the nominal growth rate.

When there is extremely low growth and virtual nil inflation we face the zero lower bound. Monetary policy and self-regulation of the economy are thus constrained in principle by the impossibility of bringing interest rates below zero, whereas they should be to rebalance supply and demand at full employment level. In France, for example, the banks cannot propose deposits at negative interest rates, except to major institutional clients. We are limited to this zero rate. It can clearly be seen that this may be a trap for a lasting situation of under-balance. If interest rates cannot fall sufficiently low, the consequence may thus be to remain in a situation of under-balance, of under-production, with lasting under-employment and with a persistent risk of deflation. With interest rates which, although very low, no longer have enough spring to rise back, because they should be even lower.

If we now return to the effects on the economy of the very low rates, they are well known. In principle they drive growth back up by an in initial effect, the stimulation of consumption and investment and the reduction of the attractiveness of saving.

The second effect is the wealth effect. The drop in interest rates drives the price of wealth assets up, be it property or shares, which in turn bolsters consumption and investment for both households and companies.

In 2007 debt levels of private agents in the most advanced countries reached extremely high levels. This over-indebtedness crisis, which is the fundamental reason behind the financial crisis we witnessed in 2007-2009 led to an over-indebtedness crisis for countries. From 2008-2009 onwards countries ran up high levels of debt to meet this financial and economic crisis. This led a certain number of countries to situations of over-indebtedness, thus joining the situation of the private players.

This naturally led, as always in financial history, to great periods of painful debt reduction which potentially asphyxiate growth.

The effect of very low interest rates, lower than the neutral interest rates, enables these periods of debt reduction to be facilitated. As previously mentioned, this enables the well-known “snowball” crises to be avoided. If interest rates are above neutral rates and if there is a high level of debt, debt snowballs because the debt interest must be financed by increasing the debt itself. Conversely, if we have interest rates below neutral rates debt can be reduced less painfully. Obviously this is what the central banks have done by greatly reducing their short interest rates, down to zero. This is usual in monetary policy. The new feature by the central banks was to bring certain short interest rates below zero to avoid the zero lower bound. The ECB initiated a policy of negative interest rates on bank deposits at the central bank. We are at -0.40% today. If the ECB did it, it is probably because the natural interest rate in the eurozone is negative. It is also obviously a way of encouraging the banks not to hold on to cash reserves at the central bank but rather to use them to grant more loans. This is indeed what happened, moreover. The banks considered that it was better to grant loans, even at 1.50%, rather than lose -0.40% leaving cash in the central bank. This meant a differential of 1.90%. All the banks were therefore encouraged to grant more loans. And this pushed interest rates down again since the credit offer increased and competition between the banks was thus fiercer. So the banks lent more, within an intelligent central bank policy, even if it is not very usual and even if, obviously, it involved risks.

Moreover, as in the United States, but later, the ECB took more radical measures in the shape of quantitative easing, in other words developing its own bank balance by directly buying public and private debts. In reality this involved giving itself the means to control long interest rates, too, whereas the traditional practice of the central banks is to control the short rates. It had to control long rates to bring them to rates which were compatible, in particular, with the budgetary solvency trajectory of the nations. Between 2010 and 2012 we entered a major crisis in the eurozone, a highly risky period since a contagious defiance had set in where we had the following catastrophic dynamic: fear as to the solvency of the public debt which pushed interest rates on public debt upwards, which in turn reinforced the insolvency risk. The extraordinarily welcome policy of Mario Draghi was to initiate quantitative easing to reduce countries’ long interest rates, ending the vicious circles. Without this the eurozone would probably have exploded. His famous “whatever it takes” was a salvation.

We well know that quantitative easing has consequences on foreign exchange. The foreign exchange level may, however, under certain conditions, help increase the level of growth. There have been attempts to reduce the dollar or reduce the euro, etc. by the central banks concerned, via quantitative easing policies.

The question we are asking ourselves here, today, is how long can the very low, or even negative, rates continue and have we definitively moved into a phase of increased interest rates? And if the answer is positive, at what speed will this increase occur?

At the peak of the crisis in 2008-2009 I was persuaded that the very low long interest rates would be lasting. I wasn’t totally wrong as we are in 2017 and they are still extremely low. For me they were lasting due to the context and the reasons I just explained. Why might we change our paradigm now and think that the rates may rise again?

I said it earlier. Firstly, because there is a return to growth and nominal interest rates are quite strongly determined by the nominal growth rate. With the nominal growth rate rising all over the world, this is a good reason to think that interest rates must rise.

In other words there are brakes and problems that may ensure extremely low or even negative interest rates may last a long time. The first brake is that the very low long rates policy may not work. It is not enough to reduce interest rates to encourage companies and households to borrow. This was indeed the case in France in 2014, when interest rates fell sharply. Lending did not return to growth straight away, and this was not attributable to the banks, which would have liked to grant more loans. There was simply a problem of demand for credit, because everyone was in a sort of depression where nobody wanted to borrow more. Finally, at the end of 2014 and in 2015 growth in the loan mass was seen in France, due to the very low interest rate policy. This brake no longer exists, therefore, since we have demand for credit which is, in our opinion, insufficient, but in any case at a good level.

In parallel, in principle, very low interest rates discourage saving. But interest rates must be compared to inflation. We have very low interest rates but also very low inflation. Overall savers have not been badly treated, at any rate less than in the years where interest rates were much higher than today but lower than inflation rates. But there is a psychological effect to having very low interest rates. Many households consider that they are not managing to constitute gradually the savings they would like to have when they retire because interest is not high enough to capitalise at a sufficient level to reach these amounts; they will possibly save more and consume less to ensure themselves the levels they want later. In this case, the effect of very low interest rates may be exactly the contrary of what is expected according to traditional economic theory. Today the effect is not clear-cut. We can clearly see that the very low interest rates have not significantly discouraged saving. But this effect may occur sooner or later.

The third brake on very low interest rate monetary policy is that the wealth effects, which are strong in the United States, are less strong in Europe, notably because the composition of household savings financial portfolios is not the same at all. It is based far less on shares. It is composed more of money market products and property, etc. Thus, the wealth effects are much less evident econometrically across Europe.

Two risks must also be taken into consideration. The first is to see the return of speculative bubbles. As interest rates are very low, it is easy to borrow to become a buyer on the wealth assets market. This could lead to the development of bubbles.

Today, and at least a few months ago, we could not really see signs of a bubble. No property bubble is apparent in Europe. Nor is there a clear bubble on the stock market, at least in Europe, even if, in the United States, I am not at all sure that certain sectors are not already overvalued. This risk, although not yet proven, nonetheless exists, especially if such a situation regarding interest rates were to continue further.

It can also be seen that institutional players are having difficulty in meeting the yield obligations they may have, whether it be pension funds, health mutual insurers or investment funds. The buying of much more risky assets than those made previously is also starting to be seen. As everything which presents little risk has a virtually negative return, a trend towards much more risky assets can be seen. The next change in the economic environment and market may result in loan and bond defaults. In short, more fragile balance sheets.

There is also a risk on the banks. We well understand that they need an interest rate slope to ensure profit margins. Why? Because, basically, they borrow money from depositors at interest rates linked to short interest rates and they predominantly lend at long fixed rates. A drop in interest rates during the transition period is not, in general, good for the banks. But after the transition the banks should be able to restore their margins. If we were, before the transition phase, at a 5% credit rate on average on stock and at a 2.50% rate on deposits, for example, and if we return, after transition, to 2.50% and zero respectively, the bank’s margin rate is indeed reconstituted. Since today all the long and short rates are all around zero, the credit rates on stock are falling incessantly in banks’ assets and the deposit interest rates can practically fall no more since they are practically at zero and they cannot become negative. We are faced with the zero lower bound phenomenon. And this is leading the commercial banks in France to see their margin rates, and thus their income, fall inexorably.

But there are other effects that the central bank highlights, and rightly so. According to it, because interest rates are low, the credit volume may bounce back up. That’s true. As I said, from the end of 2014-2015 onwards, that’s what has happened in France. We have seen a positive volume effect on loans which has enabled the negative interest rate on commercial bank net interest margins to be compensated. This was exactly the case in 2015. In 2015 half the commercial banks in France had a net interest margin which fell slightly, the other half which increased slightly and, in total, the banks saw an aggregate net interest margin which was unchanged. This was no longer the case at all in 2016. In commercial banking in France in 2015, Net Banking Income did rise by 1.8 %, because the volume effect compensated the interest rate effect, as we have just seen, and commission rose slightly. But in 2016 NBI fell by 4% on average because the volume effect was less than the cumulative interest rate effect, despite the increase in commission. Even if interest rates are now stagnating, or even if they rise very slightly, the drop in the stock interest rate due to the natural repayment of old loans or renegotiations, or early repayments, would lead to a falling interest rate on stock.

The commercial banks are thus entering very troubled waters. The European Central Bank replies, rightly, that thanks to the fact that interest rates are very low, which has also reinvigorated the economy and French and European growth somewhat, the cost of the credit risk has also fallen. It is right. In 2015, commercial banks in France saw the credit risk cost fall by 12.2%. In 2016, it fell by 14.2%. So, if I now take the NBI variation less the credit cost variation to analyse the overall effect, what do we see? For all the commercial banks in France, in 2015, a net positive effect of +3%; but in 2016, a negative effect of -3.3%. In other words, the drop in the cost of loans in 2016 was not sufficient to compensate the fall in NBI caused by the interest rate effect.

Also, the fall in the cost of risk cannot be lasting. The effect of the falling credit stock interest rate is lasting, however. The fall in the cost of risk is not lasting, in fact, since a mere slowdown in the economy would drive this cost upwards. We cannot wager on that compensating lower NBIs in the long term.

The question which can be raised is, fundamentally, whether this very low or even negative interest rate policy in Europe is desirable or not. Certain economists say that it was and is very dangerous. I do not share this judgement. I think it was perfectly desirable and that the favourable effects, as the ECB rightly says, have far outweighed the risks taken. The risks it took had to be taken, because the risks which would have existed if it had not carried out this monetary policy would have been far greater: deflation, prolonged stagnation, etc.

Where does that leave us today? Firstly, it must be acknowledged that the return to growth in many parts of the world legitimises an increase in interest rates, as we said earlier. The Fed is pushing them slowly upwards, but with fresh uncertainty over Donald Trump’s policy and its possible consequences for the American economy. The dollar rose but is now falling again. It can clearly be seen that the markets are uncertain regarding the success of the Trump policy or, on the other hand, the problems it may cause. And then the Fed is increasingly sensitive, rightly in my opinion, to the effect of an increase in interest rates in the United States on emerging countries. To a certain extent, it is the Fed which defines the monetary policy of emerging countries which very often have currencies linked to the dollar. It can clearly be seen that if the Fed increases its interest rates too quickly, it will partially cut the financing of emerging countries. It is a classic effect which means that when interest rates are very low in the United States, stakeholders borrow dollars there to invest them in emerging countries which have far higher growth rates and thus far higher interest rates, thus benefitting from a highly favourable transfer. If interest rates rise in the United States the money will be withdrawn from the emerging countries and return to the United States. This can, then, create profound crises in the emerging countries, as we saw a little over a year ago, when the Fed increased or threatened to increase its interest rates. So the Fed will be prudent in increasing its interest rates, I am certain, being very conscious of these two phenomena.

As for the ECB, I think it understands the challenges very well and that it has manifestly acted well until now. It must nevertheless face up to several new phenomena. The first is that the effect of the low interest rates is starting to fade and even become dangerous, as stated earlier. I took the example of France but it is also true elsewhere and the French banks are among the most solvent. They are in excellent health compared with Germany or Italy. But you can see that even the French banks are affected in their commercial banking business in France.

At the same time, let’s not forget that we are asking the banks to increase their solvency ratios very significantly. In general, since Basel III, they have been asked to double their so-called “hard” equity. It is difficult, however, to ask the banks to greatly increase their solvency ratios, and thus their equity, at the same time as reducing their profits. Growth must not, for example, take off again more strongly while the banks are caught in a trap, unable to sufficiently follow the excess credit demand which would result from this.

Fundamentally we clearly understand that the ECB thus initiated this policy – even if it does not say so – to facilitate the budgetary solvency trajectories of the various eurozone countries, as we have observed. In reality it has bought some time. The ECB “deal” is clear. It is carrying out an extremely low interest rate policy pending two things from the nations. The first is that they carry out the structural reforms necessary to increase their growth potential and reduce their structural deficit, thus facilitating their future budgetary trajectory by protecting their solvency. The second is that they constitute the institutional conditions of a viable eurozone. We know today that the incompleteness of the eurozone is manifest in terms of institutional arrangements, in other words the ability to make the zone work without it necessarily always being up to the countries doing least well to incur the cost of the necessary adjustment, with the consequences on votes that we know. The ECB is saying to the member states: “Quickly organise the eurozone a little better”.

The problem we face today and which leads me to question the increase in interest rates in the eurozone, is that the countries which should have done so have not done this work. The structural policies have virtually not been carried through where they were necessary. This started in Italy but was stopped following the failed referendum. In France we have not done much. There will be no capacity for exiting the dangerous solvency areas of the countries concerned if there are not, on the one hand, these structural policy efforts and, on the other, the completion of a more complete, better regulated eurozone which works better, in other words less asymmetrically.

The Germans, however, severely criticise the ECB’s monetary policy which is not necessarily favourable to them. They have a higher growth rate; they therefore do not need such low interest rates. Furthermore, these rates reduce the return on Germans’ savings who, as we know, have a much older population. They thus need a higher return on their savings, even more so for institutional investors who had, in the past, sold annuities at fixed rates.

The head of the ECB is not wavering from his policy. As for the Germans, they are obsessed with the question of the moral hazard, insofar as they do not want the solidarity factors necessary to the eurozone. They refuse, and this can be understood, to be the only ones to pay for everyone if the others do not make their structural reforms, thus finding themselves sooner or later in a situation of being dependent on Germany in the long term.

Exiting low interest rate policies is therefore conditioned by the fact that France in particular is carrying out structural reforms which reassure the Germans who would thus accept a much better institutional arrangement for the running of the eurozone, with intra-zone solidarity factors so that the cost of the adjustments does not weigh on the weakest countries.

This is where we currently stand. The European Central Bank, it seems to me, is going to exit negative short rates sooner or later because this position is becoming difficult to maintain today. But exiting a very low interest rate situation will depend fundamentally on the capacity of countries to carry out their own reforms and simultaneously integrate the reforms of the eurozone necessary for its future. In 2019 when Mario Draghi’s term of office ends, everything will depend on the relative strength of the countries and on their respective abilities to be heard, in other words to have triggered the structural policies sufficient to be credible. This credibility of the major countries conditions the possibility of increasing the viability of the eurozone, by developing several federalist elements, such as the mutualisation of part of the sovereign debts or tax transfer elements, as exists between states in the United States. To support temporarily those going through asymmetric troubles, without asking them to act only by austerity measures.

Which would enable interest rates to be increased much more easily. If we increase them significantly without having done that the intrinsic risk of the eurozone is increased. If we don’t raise them, the risks of a very low interest rate policy described earlier will become increasingly strong, whereas growth is beginning to rise again, along with, to a limited extent, inflation.

Without thinking of a significant rise, what is most likely, in my opinion, is that we shall, at least, see a moderate increase in interest rates from the end of 2017 or early 2018. Short interest rates could come back from their negative territory towards zero. And long interest rates could be managed towards neutrality by the central bank, in other words between 2 and 2.5%. This would be compatible with the level of growth and inflation that we can currently anticipate. This moderate increase will stop facilitating countries’ debt reduction, without, however, propelling them into a snowball effect.

Categories
Bank

Transformation required from financial institutions in an uncertain market

Roundtable discussions participants:
– Séverin Cabannes, Deputy CEO, Société Générale;
– Yves Perrier, CEO, Amundi, and Deputy CEO, Asset Management, Insurance and Real Estate, Crédit Agricole S.A.;
– Olivier Klein, CEO, BRED, and Professor of Economics & Finance, HEC. 

What changes must the banks face in their new major challenges ?

What is the fundamental role of the banks?

The principal role of a bank is to bear financial risk in the place of other actors in the economy. Banks manage such risk in a professional and regulated manner. The three risks banks take on behalf of other actors in the economy are counterparty risk, liquidity risk and interest rate risk.

Were the regulator to excessively restrict banks’ ability to play their role due to the dangers of them taking on a significant proportion of such risks, even though this is their very raison d’être, the risk would inevitably fall elsewhere. In the economy, households, companies and other economic players with financing capacity exhibit the propensity to invest over the short term in the interests of maintaining liquidity. Such funds, via banks, notably in Europe, are placed with other households and companies, which generally seek to borrow over the long term. This inevitably generates credit, interest and liquidity risk. Were the banks no longer to bear such risk, or only do so to a lesser extent, by definition the risk would be transferred directly onto the public and companies, or indirectly via institutional investors.

It is therefore important to ensure that regulation, which is fully legitimate in the financial domain as finance is procyclical by its very nature, does not introduce additional risks. Were it to impose too many constraints on the banks, it could shift the risk initially taken on by the banks to less regulated areas. With the possible consequence of generating new systemic risks. Insurance companies are generally subject to strict regulation, but this does not always affect credit activities, even though their expertise in this area is not as developed as that of the banks. For their part, funds are not regulated in terms of either credit or liquidity.
Such shifting of systemic risk must therefore be viewed by the regulator from a global standpoint. Any excessive restriction of the risk borne by the banks would be to underestimate their fundamental economic role. This does not mean that bank solvency ratios should not be increased or that liquidity and other ratios should not be introduced in response to the crisis of 2007-2008. On the contrary, but it is all a question of degree.

What short term changes to financial institutions’ operational models are required?

The banks must adapt to three major changes in their operational activities: as mentioned earlier, stricter regulation as well as very low interest rates and digital technology.

Regarding regulation, ultimately the reforms will have imposed a near doubling of bank equity for the same level of inherent risk, i.e. in order to perform the same activities. Since 2007, we have observed that European banks are following this course given that they have already increased their total equity by nearly two-thirds. On the one hand, increasing equity with the same levels of business activity and risk naturally means lower profitability. Currently this is systematically reducing return on equity below the cost of capital. In such a scenario, either the cost of capital must fall, with the markets accepting that the banks are less profitable, as by definition they are carrying less risk, or we will be confronted by a perennial problem which must be resolved, one way or another.

On the other hand, we must accept that if the banks fail to adequately increase their equity they must naturally reduce their activity levels. Is this happening? Fortunately, notably in France, up to now the banks have continued to issue credit without rationing. This is less true in Southern Europe. Having said that, for its part the demand for credit has not yet reached the previously high levels of growth. Should the demand for credit rise, the banks would without doubt encounter difficulties. And here arises the question of the financing of growth. In France, if we added to Basel III what is currently being planned for Basel IV in terms of solvency ratio, as things currently stand credit production would suffer. Although it may appear reassuring to believe that market finance could mitigate this effect, it should be noted that in Europe this market is in reality very small in the overall financing of the economy. Bank financing offers a number of advantages, notably the greater stability of the financial system and the financing of the economy as the banks are well regulated and supervised. Nor, indeed, did French banks suffer worst from the crisis of 2007-2008. Furthermore, the European model would need time to adapt in order to further develop market finance. In the meantime there would be a risk for growth, which represents the best of the solutions to the problems of over-indebtedness. Overall, the large global banking groups have in reality been forced to exit certain activities, or at least to review their portfolio of activities in order to comply with the higher regulatory capital requirements. Anything not identified as being sufficiently synergistic may be disposed of, which obviously partly restructures the banking and financial landscape, notably in terms of activities not in the banks’ domestic territory.

Another issue is interest rates. The very low, and even negative, interest rates disrupt the banks’ operating conditions. Simply by observing changes in net interest margins among all French banks in 2015, we see that half of them saw a fall in net interest margin while the other half experienced stagnation or a slight increase. The explanation can clearly be found in the highly negative impact of interest rates on banks’ net interest margins and also by a volume effect able to offset the rate effect. If we view the banks as a whole, the trend in 2015 was very slightly positive with a favourable volume effect, partly due to the action taken by the central banks. Lower rates therefore played a role in re-energising growth and supporting credit. However, in the first half of 2016, with the continued fall in interest rates and the wiping out of net interest margins, taken as a whole the NBI of commercial banks in France fell. The volume effect was not sufficient to offset the interest rate effect.

However, a number of factors need to be taken into account: the negative rate effect which may also produce gains in the event of fixed-rate bonds in the balance sheet, but this factor is not fundamental; lower cost of credit risk due to the slight economic upturn. This last factor was very visible in 2015 and even more so in the first half of 2016, when it was able to offset the negative rate effect and insufficient volume effect. In other words, had there not been a lowering of the cost of risk in the first half of the year, aggregate results of French commercial banks would have seen a fall. But this did not happen as the cost of risk fell faster than the net interest margin. This dynamic is not recurrent and the cost of risk cannot fall indefinitely, while the effect of long-term interest rates, should they continue to stay low, would be recurrent. For different reasons, including the one just mentioned, we must hope that the central bank gradually raises rates, yet without waiting too long. Yet it is also possible to retain low rates, without approaching zero, should the growth situation so require, but while recreating an adequate slope of the rate curve. On the one hand, the effect of very low, and even negative, rates appears to be running out of steam from the macro-economic point of view, while on the other hand, if the results of the banks are affected over the long term, they will be less able to offer the necessary credit while at the same time complying with higher solvency ratios.

The last point, and none the less interesting, is the impact of digital. We are all observing fewer customers visiting our branches, but does this represent a problem or an excellent opportunity to establish strengthened relationships with higher added value? Customers visit the branch less frequently because they perform fewer transactions there (transfers, paying in cheques, cash withdrawals, etc.) and because digital solutions enable them to perform so many transactions by mobile phone or other remote device, just as ATMs enable them to do so without speaking to an advisor and without waiting. In Europe, certain banks are based on essentially transaction-oriented models. Such banks have good reason to be concerned and to reconsider the future of their network, as they have not been set up nor do they possess the culture to develop other activities. If we consider the case of banks in France, they are generally structured around a model based on a high level of interaction and transactions. Automation and digitalisation of transactions could therefore present an opportunity to increase their commercial productivity and to much better deploy their sales personnel around a model of global client relationships, enhancing interaction with high added value based on providing advice. This would clearly require significant investment in digital as it enhances and facilitates the day-to-day activities of our customers, sales staff and middle and back offices alike, while improving commercial added value by exploiting the power of big data and artificial intelligence. We will then progressively increase the capacity of our sales staff to produce added value. As far as imagining a model where advice would be provided without sales personnel, for the reasons of the global relationship model and customer psychology, we are not convinced that such a scenario could become operational in reality. What I like to call “the human augmented by the digital” probably has a great future.

The right policy of optimising distribution and reorganising the branch network as a vehicle of reinforced added value associated with a restructuring of the banking interaction model, which require significant transformation and investment in both human capital and digital, could enable us to maximise results without necessarily significantly reducing the number of branches and sales staff. Of course, serious consideration needs to be given to Fintech developments with their capacity for “uberisation” and circumvention of the banks, but it is our conviction that the bank based on personal relationships within a global relationship model is in a strong position as it already has the clients. Provided it is able to further improve its data management in order to further improve the global relationship model. Especially in a digital world, wealth is created by the capacity to maintain a high number of customers whose data is effectively exploited in order to provide them with greater added value, leading to greater loyalty. This is the key. In the Fintech sector we are also noticing the first serious difficulties, notably in the USA, due to the lack of their own customers, even though some of them have a promising future ahead of them, particularly when working in collaboration with the banks. Conversely, the banks have a very great strength based on their customer capital which enables them to be offensive, and possibly to integrate Fintech providers and develop digital processes. This enables them to formulate interesting service and advisory products for their customers. Yet alongside this banking model, many others are already emerging and may soon coexist within the same territory.

Even though there are many headwinds, there also exist many opportunities for success. But regulation must not introduce too many more constraints, or even review certain existing requirements, in order to avoid simply shifting the causes of systemic crises. We must also exit the world of very low rates or at least see an upswing in the virtually flat rate curve. Finally, digital technology presents a real opportunity to redevelop an attractive banking industry while improving its operational efficiency and its global relationship model, this latter element being one of the strong points of French banks on which we can and must capitalise. Even if we must coexist with other banking models in the future.

Categories
Bank

“The future of banking in the digital age”, published in La Correspondance Économique, april 2016

During a round table organised by the law firm CARLARA led by Mr Edouard de LAMAZE, counsel at the Paris Appeal Court, partner and joint manager of the law firm Carbonnier, Lamaze, Rasle et Associés (CARLARA), Ms Marie CHEVAL, inspector of finances, CEO of Boursorama, and Mr Olivier KLEIN, CEO of BRED Banque Populaire and Professor of Economics and Finance at HEC, discussed the future of banking in the digital age.

Read the article – The future of banking in the digital age – Marie Cheval & Olivier Klein

Categories
Bank Economical policy Euro zone Finance

Institut Messine – Thoughts on an economy with negative interest rates

SUMMARY

Acknowledgments

Foreword by Michel Léger

General introduction to the issue of negative interest rates by Michel Aglietta and Natacha Valla

Robert Ophèle, Deputy governor of the Banque de France

Maya Atig, Deputy CEO of the Agence France Tresor’s

Jesper Berg, CEO of the Financial Supervisory Authority of Denmark

Philippe Capron, Deputy CEO of Veolia, in charge of finance

Jean-Jacques Daigre, Professor emeritus of Banking and Finance Law

Ramon Fernandez, Deputy CEO of Orange, in charge of the group’s finances and strategy. Ramon Fernandez was previously Director of the Treasury and President of Agence France Tresor’s

Marc Fiorentino, Founder-Director of Euroland Corporate

Hervé Hannoun, former Deputy CEO of the Bank for International Settlements

Philippe Heim, Chief Financial Officer of Société Générale

Denis Kessler, CEO of SCOR SE

Olivier Klein, CEO of BRED, Professor of Financial Economy at HEC

The point of view of Olivier Klein*

What is your opinion on the conceptual complexity of negative growth rates? As a banking “boss” and Professor of Economics, did you ever think you would ever experience such a situation?

The very concept of negative rates rather worrying and so specific that I never thought I’d ever have to deal with it. Certain economic players are adapting quite well to it: some of our institutional customers are now investing money with us at negative rates. They prefer to place it with us at -0.15% rather than at -0.20% elsewhere[1].

Negative rates can be explained by the current macroeconomic set-up. The European Central Bank (ECB) is trying, with these negative rates, to find a balanced level of savings-investment which is more conducive to growth to ward off what some people are describing as the threat of secular stagnation. But this is also “just” an adjustment period after a phase of excessive debt as has often been observed since the 19th century after financial crises. In any event, what the ECB is trying to encourage agents not to just let money sleep and invest and encourage banks to extend credit, but also to encourage debt reduction, by maintaining low rates compared to the nominal growth rate.

The use of negative rates is currently limited to the field of transactions between institutional and financial professionals. This is not yet the case for businesses in France – whereas businesses are also beginning to deposit at negative rates in some European countries.

It also affects a very material limit of the capacity of the system to pass on lower rates throughout the economy: neither the banking system, which needs deposits to make loans, nor the authorities, for fiscal and security reasons, can afford to neglect the appeal that cash could have, especially for households, as an alternative to negative interest bearing deposits. France seems to be relatively preserved from this risk compared to countries like Germany, where the cash culture is much more developed.

Why do you think that there was a need to introduce negative interest rates in the euro zone, while the United Kingdom and the United States, which have nevertheless resorted to unconventional policies, have not had to introduce them?

I believe that this can be explained by the existence of a risk of deflation that is greater in the euro zone than in the United States, that the ECB, quite rightly, wanted to ward off. One reason is the crisis in the euro zone, which led to a second economic downturn just after the 2008 crisis, due to the incomplete nature of our monetary union which creates a slight “deflationary bias”. It is also possible to invoke the lesser impact of the “wealth effect”: in the United States, lower rates quickly led to a recovery in asset values,especially the stock market, which resulted in a reconstruction of the value of household savings – which is, across the Atlantic, much more invested in the markets because of the importance of pension funds. In all, it was necessary to hit even harder on rates in the euro zone. But it is a quantum issue, not an issue of principle: the ECB did not enter into negative territory just for the sake of it, but to cut rates as much as needed, and the Bank of England and the Federal Reserve did not remain in positive territory to avoid negative rates, but because the zero rate was sufficient in their respective cases.

How is the profitability of retail banks impacted by the environment of negative interest rates?

We have to distinguish between the effect of interest rates which are decreasing and that of negative rates. Structurally speaking, banks lend long-term and refinance short-term. In general, as we lend in France, at fixed rates, in the very short-term there is less hysteresis in bank liabilities than in assets – in other words, if rates fall at the same pace for all maturities, the cost of a part of our resources immediately decreases, whereas the product of loans only decreases over time, as our loan portfolio is gradually renewed. An homothetic drop in the rate curve will therefore play in favour of the banks in the first year. Nevertheless, this situation is only temporary, because very quickly, the portfolio entry of new loans granted at lower rates and the amortisation of old loans at higher rates, but also the mortgage renegotiation requests made by private customers, cause a decrease in the rates of our assets which is faster than that of our liabilities, that contain a lot of resources indexed at regulated rates which vary less rapidly. This brings us to a deteriorated intermediation margin rate, but in an acceptable and manageable quantum. Then, eventually, when the rate curve stabilises, if the slope of the curve remained constant, the net interest margin will gradually recover.

What is happening today is different. First of all, the net interest margin is compressed, through the evolution of the differential rate between the long and the short rate, that is to say the slope of the rate curve. For the last two years, central banks have indeed been looking to govern and bring down not just short rates, which they always set more or less directly, but also, which is new, long rates, through policies of quantitative easing (QE) and by clever management of agents’ expectations in the context of forward guidance. This policy works well, leading to a compression of the rate curve, and thus of the interest margin of banking institutions.
Negative rates introduce an additional element, which is frustrating for our business model. Since, for the most part, we do not pass on lower rates below zero to our depositors, the falling cost of our resource comes up against an obstacle.

In summary, the product of our loans, correlated with falling long rates, decreases, while our refinancing has a cost that can no longer decrease in parallel with it, considering the impossibility of getting the bulk of the interest paid on deposits into negative territory. The rate slope is therefore compressed even more. It is easy to see that this situation is very unfavourable for the profitability of our institutions. Our net interest margin, which was able to reach almost 6% in the early nineties, has been levelled off at 2% for years and since 2014-2015 we have entered a further phase of gradual decline, which is going to further accentuate in the next few years, with the amortisation of our old loans at higher rates and the entry into force of new loans at very low rates.

This development will be lasting, and banks must resign themselves to surviving for quite a long time in a context of very low interest margins: the movement cannot, in my opinion, be reversed for at least two or three years since the “renewed steepening” of the rate curve will only take place just in time, given the low potential growth rate of the Euro Zone, and its beneficial effects for us will only be felt through the renewal of our loan portfolios. The very specific monetary conditions we are experiencing – negative rates and QE – seem genuinely welcome to me in terms of the general economy: the ECB had no other choice. But we must be aware that they are specifically unfavourable to banks… But also to insurers, pension funds and all those who need a return on their assets to be able provide the services expected of them.

Are banks therefore being forced to seek new sources of income?

There is no doubt that the decline in interest margins that I have just mentioned has caused us to diversify our sources of income. Of course, the banks can first try to compensate for the erosion of margins with a volume effect on outstanding amounts, but we cannot go very far in this area: either we try to gain market shares – which, by definition, not everyone can do at the same time – or the banks, as an aggregate, rely on the general expansion of the volume of loans in the economy – which is highly seasonal due to the low level of growth.

Banks, if they are considered as an aggregate, can therefore think about playing on higher commissions, that is to say, looking for better and fairer billing for their services. Indeed, we have seen a slight shift in this direction in the past few months. But once again, it’s not as easy as people often imagine.

First of all, the supervision of our activities by the various consumer protection mechanisms limits the opportunities. But, in addition, there is keen competition which does not give much leeway. Furthermore, the context of low interest rates hangs over certain types of commission. It is understandable, for example, that “placement commissions” in the field of life insurance cannot be the same in a context in which contracts make 2.5% or 3% as when the standard remuneration for savers was 5% or 6%. The same applies to asset management. We can therefore see, with many products, our commissions fall progressively with falling interest rates.

The new services still remain. My feeling is that their spectrum is limited by the objective needs and expectations of customers with regard to their banks and through the necessity of maintaining a coherent and fair offer. So we would not seem to be very legitimate as a travel agency or computer salespeople, for example.

That is why many players, who are unable to increase their revenues to offset the erosion of interest margins, are now trying to reduce their operating costs, such as by reducing the number of bank branches. A new, more financial argument now needs to be added to the “technological” argument – the usefulness of branches is eroding since customers are using our digital platforms more and more intensely: if we cannot remunerate the conversion of deposits into loans by a sufficient margin, the cost of large networks of branches becomes prohibitive. If this vision, which I do not necessarily agree with, was to prosper over time, thousands of jobs would potentially be at stake in retail banking. So we can see that the operational impact of the monetary context we are discussing is not negligible! So although there are potential strategies for “coming out on top” for specific banks, the industry as a whole is doomed to have to deal with real profitability difficulties.

Is the compression of returns also forcing banks to take more risks?

You might think so, but this is not the case. The new prudential regulations in fact leave less and less room for taking risks[2].

What are your specific thoughts on the role of prudential ratios in the context of low growth and very low, or even negative rates, that we are currently experiencing?

As a banker and professor of economics, I have long been convinced that it is necessary to implement prudential rules and macro-prudential policies for the simple reason that markets do not self-regulate themselves – this was highlighted in many theoretical contributions, but above all, unfortunately, in practice, with the crisis of 2008. Finance is intrinsically procyclic. The potential for regulation therefore plays a crucial role in avoiding financial instability as much as possible.

But it turns out that the prudential standards put in place since the Basel 2 agreement, which are well founded on many points, also incorporated a problematic procyclic character. The risk calculated by RWA (Risk-Weighted Assets), based on historical measurements, with equal volumes of credit, in fact lowered during the euphoric phase of the cycle, which, all things being equal, made a rise in the leveraging effect of banks and the accompaniment of the increase in the general demand for credit possible.

This then promoted the build up of weak financial situations for both households and businesses, in a context in which the euphoria specifically led borrowers and lenders to underestimate the risk. By the same token, at the time of the turnaround, the established risk reappeared in bulk in the books of banks, which naturally weighed on their willingness to lend, but in addition, the constraints of prudential ratios stretched because the increase in the cost of the risks recorded resulted in a rise in RWA through an equity shortfall, thereby leading to an even stronger decrease of the capacity to lend. This method of banking regulation could then encourage the formation of bubbles, then their bursting, and accentuate the financial cycles. It was therefore necessary to rebuild them, which is what Basel III did, particularly through creating a countercyclical capital buffer.

Are prudential measures also a risk factor, as they contribute to creating a type of bond bubble, particularly with government Securities?

Banks have progressively been faced with a tightening of regulations with stricter solvency ratios since Basel 3: they are being asked to hold more equity for the same RWAs and the weight of the risk in calculating RWAs is stronger than before, especially for loans to businesses or for market risks. In the case of a stronger upturn in the economy, this could be a risk of the insufficient capacity of the banks to support the recovery. Furthermore, the liquidity ratios undeniably favour the fact that banks are investing in sovereign bonds.

Do you mean that the prudential regulations are ultimately leading to credit rationing for businesses?

Up to this time, people have really been wrongly accusing the banks in France. There has been no credit rationing to businesses, and the Bank of France and ECB indicators clearly demonstrate this. Let’s go back to the course of the seven years that have just passed. Much of the decline in the distribution of credit seen in the years following 2008 can be explained by a lower demand for credit: businesses cut their investment spending and borrowed less, because of the changing unfavourable economic conditions which they were facing and their lack of trust in the future. Even today, however, very low, or even negative rates, are not enough alone to make people want to borrow.

It is true, however, that when the real economy was on the ropes after the financial crisis, we were able to observe, for some months, less of the general reluctance to lend that the banks were accused of and greater selectivity, which is, for that matter, is perfectly understandable. Not lending to businesses whose future is seriously compromised is a part of the normal role of banks. It is an economic function of the profession, that it must fully assume: if banks do not fully exercise “monetary restraint”, granting loans to businesses that were destined to disappear, they would generate distortions in the markets of their customers and harm the proper development of other businesses that are healthy and sustainable.
We have now left this period behind. However, with the new liquidity and solvency ratios, it will now be progressively more difficult for banks to follow a trajectory of the demand for credit which would improve significantly.

Why do we find ourselves in this situation, even though the objective of the political and monetary authorities is to facilitate granting credit by any means to promote growth?

The truth is that banks were considered as being at fault for the crisis, which is, in my opinion, a vision that is at the very least fragmented, and doubtlessly false in Europe in any case, even if we can argue that they were inevitably a factor in spreading the crisis. As such, we are now in a post-crisis historically conventional phase of “financial repression” of indebtedness, marked by very low interest rates and tougher demands placed upon banks: we are saying that we must “avoid this” at all costs in the future. This concern is reflected in a number of new or tougher regulations, at the very moment when, in fact, a monetary policy aimed at reviving credit with the use of novel instruments, just like negative rates or quantitative easing, is being mobilised.

The most paradoxical thing is that, although they are aware of this contradiction, central bankers now seem, in order to get out of this, to be inviting the development of disintermediation and securitisation, which were held up to public obloquy a few years ago, purely because of the role they actually played in the accumulation of bad risks in the United States, which ultimately led to the crisis. So we are now seeing hedge funds, assets managers, insurance companies, mutual health organisations and pension managers lending to businesses, even though they do not have the historical expertise of the banks to do. There is a considerable asymmetry of information between these new lenders and those to whom they are lending. Some of them, such as hedge funds, are also barely regulated or not regulated at all.

Should we not, however, be pleased to see that some businesses, particularly some great intermediate size companies, finally have access to the market, particularly through the development of the Euro PP?

In theory, yes. My feeling is, however, that we need to be very careful, because not all medium-sized companies can effectively withstand such financing without endangering themselves, especially because of the depreciation method for such loans. Banks usually ask small and medium enterprises to make one annual repayment by providing them with depreciable loans. This is sound practice: the company therefore knows that it must dedicate part of its annual cash flow to repaying its loans and monitoring its management ratios. Euro PPs are very different because, by using them, businesses can be financed for as long as five years with bullet loans. The system is even more attractive today as both rates and spreads are very low.

In the case of large companies, which issue bonds as part of high annual issuance programmes, financing with bullet loans is in some ways similar to a redeemable loan, since we can see a kind of an amortisation schedule: if, for example, the average horizon of the bonds issued annually is seven years, then 1/7th of the outstanding borrowings must be repaid each year. However, only certain types of medium-sized companies are able to issue Euro PPs on a regular basis. Most therefore create a unique and extended due date ahead of them, which effectively means that when the time comes, they may find themselves facing a wall of debt that they can only overcome if they are able, at that time, to re-borrow the full amount of the loan that they have to repay all at once. There are two disadvantages: firstly, nobody knows what situation the company will find itself in that time and, secondly, over the duration of Euro PP, the cashflow constraint was lifted for it – which in some cases could be crime-inducing.

you mean that only the banks are capable of distributing credit without taking or running undue risks?

I quite obviously believe in the usefulness of banks and market financing coexisting! But I don’t think that the market is suitable enough for smaller companies. The role of banks cannot be reduced because banks have a good knowledge of borrowers and because they keep the risk on their balance sheets, which brings them, in their own interest, not to lend any old how and to “monitor” their customers over time.

We also know that, in the United States, securitisation was one of the factors that facilitated excessive indebtedness in the early 2000s: banks were partly responsible because, by not keeping risks on their books, they were less selective about borrowers and did not “monitor” them afterwards. There is a major problem of incitement to selection in market financing as soon as we leave the case of very large borrowers who can, through credit rating agencies, as well as through a lot of communication on their own situation, afford the cost of financial reporting, thereby reducing the asymmetry of information. This intrinsic fault in securitisation has partially been corrected by some of the Basel 3 provisions, which requires banks to maintain a quota of risks associated with the loans that they securitise.

The momentum towards greater disintermediation that we are currently experiencing could be a factor for increased financial instability, while bank credit itself is a factor of stability if it is properly regulated. In my opinion, the share of banking intermediation determines the level of stability of a financial system as a whole. Indeed, banks do not just mobilise savings to serve investment: these are centres of risk. They take counterparty risks in the credit act and interest rate and liquidity risks in the conversion act upon themselves (converting short maturity savings into longer maturities with average credit). Risks are not created by the banks, but managed by them, so that they provide relief to the economy. They manage them carefully, professionally and in a regulated environment. Markets are useful to the economy, but they leave interest rate credit and liquidity risks to lenders or borrowers, which is quite different!

By increasing the share of disintermediation, we will not reduce the risk, we will move it to a multitude of players that are less well equipped than the banks to manage it. The issue of the proportion between banks and markets, between intermediation and disintermediation, is therefore crucial for financial stability. Just like the quality, relevance and scope of the prudential regulation itself, which are also highly crucial.

However, as you said earlier, sociological and technological developments on the one hand, and the monetary context on the other hand, seem to be threatening the very purpose of banks, on the consumer market at least. Will the retail banking business model survive these shocks?

There are undeniably profound changes to our activity. This invites us to return to the economic constants that justify our existence, while ensuring the changes needed to take account of the “customer revolution” caused by the technological revolution. Private customers have, and will always need, a reliable and professional advisor to talk to them about their life plans and advise them about their main loans – with property leading the way- their savings, their retirement protection… But private customers now require greater convenience in their relationships with banks, such as with the strongly developing use of the Internet and Smartphones. They also want greater relevance of the advice that is given to them. But they still want to have access to a qualified contact person who knows them when they have to make important decisions. Building on human capital, giving more convenience and greater added value to banking advice, while using the technological revolution for both the use of its customers and to redesign their own organization, is certainly a crucial industrial and human challenge in retail banking that must be addressed quickly.

[1] This interview was conducted in November 2015.
[2] The new prudential rules prohibit banks from “playing” on markets with their own funds.

Categories
Bank

“Banking and new technologies : the new reality” ; published in La Revue d’Économie Financière, december 2015

New technologies create a new relationship with the world for everyone. A new way of thinking about time and space. Another way of designing information, knowledge and autonomy of action. In fact, they induce a series of revolutions, in both our daily lives and business.

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Categories
Bank Management

How are new technologies transforming customer relations?

It’s a sociological fact that new technologies have changed our lives. What has been the impact on companies?

Olivier KLEIN: It cannot be denied that new technologies have redefined the world order. They have given rise to a series of revolutionary chain reactions in our day-to-day existence, and especially for companies. The first is a commercial revolution, one which has transformed the balance of power between producers, sellers and consumers. It comes from power being transferred to the consumer as a direct result of new technologies: more aware and better informed, consumers enjoy a far greater freedom of choice.

Sellers can emerge stronger than ever if they are able to understand their customers and earn their loyalty. Supported by the effective management of the data they have about each customer’s behaviour and by the long-term relationships they are able to establish, sellers must find the right product-service combination in terms of both price and quality that best meets individual customer needs, creating solutions with each and every one of them.

What must be stressed in this new balance of power is that any absence of added value in the consumer’s eyes, namely any lack of quality in the advice provided or of offers for improved and customised product-service combinations will lead directly to the complete digitalisation of the customer-supplier relationship. This means the disappearance of the seller’s economic role, with the emergence of a direct producer-consumer relationship or the emergence of pure players based on the internet, a low-cost channel for establishing customer relationships.

The behaviour of producers, sellers and consumers is changing. What about employees?

O.K.: That’s right. Another consequence for companies is the change in employee behaviour. The technological revolution places employees at the heart of the company, which has an impact on the organisation. Nowadays, for example, managers are no longer credible – and are unable to lead their staff – if they do not base their authority on the added value they bring to their teams, as opposed being a repository for information which, in today’s world, circulates freely and unhindered throughout the company.
All the more so as employees are increasingly demanding greater autonomy, sustained and driven by the very same technological revolution. Developing an entrepreneurial spirit has become a major challenge for large companies. Nowadays individuals – and especially company employees – aspire to understand their contribution to the company: they wish to buy in to the strategy and the organisational structure in order to feel that they belong.

Does this mean that traditional organisational structures will have to change?

Clearly, and unless they have been able to modernise, the highly hierarchical and vertical structures born in the 50s and 60s have become less effective and more difficult to manage as the lack of managerial proximity makes it harder to motivate employees. Such structures are more rigid and less flexible and are no longer in sync with a world and business environment that have become ever more complex and fluid. Conversely, companies organised in a network structure, one linking different parts of the company or even between different companies, are more adaptable and more agile, better able to absorb shocks and to manage complexity.
And then there is the social factor. This has to be taken very seriously, as society has become a real stakeholder for the company, thanks to the impact of the internet and social networks. CSR, involvement in wider society and corporate reputation have become key success factors.

In short, to be heard in this new world we have to follow, and even anticipate, how people use technology. This is the very crux of the matter: we are not talking about two different worlds, namely those of the digital and the pre-digital. New technologies have fundamentally changed the way we act and our relations with the outside world.

Greater managerial proximity, a better understanding of customer needs, receptiveness to the entrepreneurial world and an enhanced capacity to absorb shocks, upheaval and complexity; these are the essential ingredients for the modern company. And how do banks feature in all this?

O.K.: Banks are also companies… and, what’s more, the driving force behind the economy. The bank as a company, and more specifically the commercial bank, is not immune to such upheaval, in fact quite the opposite, due to its place at the heart of economic activity.

Whether it’s online banking, mobile banking, payment methods and, more generally, the relationship between the bank and its retail customers, the acceleration of the digital revolution begs the question whether there is still a place for the high street branch. For me, the answer is in the affirmative.

But we must examine the evidence: new digital tools have changed two parameters, namely the time factor and the distance factor. The relationship between the customer and the bank has become direct and the purchase of bank products and services is now performed remotely. The customer is visiting the branch less and less, now typically only to deal with significant projects. And this is the central issue.

The bank has to reinvent itself, and without delay. But the distinction must be made between outdated practices and those that remain indispensable through constituting the very essence of the profession. Two invariables are the pillars on which commercial banking is based. Firstly, demand for banking services is not reducing in volume: it is being expressed differently with new requirements. People do not need banks any less.

Secondly, the personal relationship remains a fundamental element of the role of the high street bank. Banking is not a business that produces products as such, it is all about human relationships based on the ability to offer good advice and good service at the right time, irrespective of which channel is being used. Banks deal with long-term personal and corporate projects, which presupposes a personalised and sustained relationship with the relevant bank advisor. This is precisely what our customers are telling us.

So what is to be done? Should online banking services be set up, without human contact and to the detriment of the branches?

O.K.: Our goal must be to reinvent the high street bank. I stress that the personal relationship between the advisor and the customer is non-negotiable, especially for a banking group composed of regional high street banks.

Our strength lies in our ability to promote what I call “non-remote” banking, as opposed to remote banking which assumes that a complete range of banking services can be provided without a branch network.

What is the basis of this concept? Quite naturally, what customers are demanding with the technological revolution but without curtailing a strong personalised relationship: greater convenience. Maintaining strong relationships with their banking advisor but via the channel of their choice, whether by phone, e-mail or physical appointment, depending on the matter at hand and the time of day… But this also demands a better response to the need for advice that is better thought through, more relevant and more appropriate. It’s the end for products that banks have wanted to sell via a succession of poorly differentiated campaigns.

Provided that it is more agile, more interconnected and more proactive, the branch network has everything it needs to maintain its fundamental relationship with the customer by combining its strength – proximity – with new tools, such as the internet, tablet and smartphone. This means combining the best the traditional bank has to offer with the best of the online bank.

In practice, in each branch each advisor must therefore become a multi-channel agent. As I have already said, this means offering customers the possibility of approaching their regular advisor in order to deal with their important issues in the manner of their choosing, whether face-to-face, by phone or by e-mail, without having to change location. And above all, this must be always with the same advisor. As for the rest, namely day-to-day banking, this can obviously be conducted by mobile phone. Of course we can also develop online banking alongside the branches, with named advisors for highly mobile customers or those with little availability.

What are the risks of developing such a corporate strategy?

O.K.: The greatest risk of all would be not to admit that change is vital. But it must be done in harmony with certain basic and unchanging principles. We must also mention the amount of investment required. Such a model of “non-remote banking” automatically means higher wage costs than those associated with low-cost remote banking. This will require the bank to focus its resources – beginning with its employees – on providing added value in order to justify the costs of the services offered. And, consequently, to exploit our human capital, the bank’s only real differentiation factor. Competence, reactivity and proactivity are all key. As is the intelligent and non-intrusive use of pertinent CRM (“big data”) in order to best anticipate individual customer needs. But also, and above all, we need to profile the networks to make them more agile, distribute expertise better and optimise physical and digital structures. The branch is not dead, far from it. But in the future it must combine two concepts: the e-branch and the physical branch, i.e. the best of modernity and the best of tradition. It has to be more mobile, more alert.

The point is to ensure that we come out on top. This can also be achieved through new technologies. They do not simply a threat. In an environment where banking revenue is showing a clear downward trend in macro-economic terms, the major challenge of such a model is strategic. Should we fail to meet customers’ expectations, they will naturally move to the cheaper pure-player banks online, without a qualm.

So the issue is internal transformation, namely to increase each advisor’s added value and our ability to make our network more responsive. New technologies will be able to help us in return.
But we cannot bury our heads in the sand: this new direction implies a number of long-term development projects. In broad terms, we need to redesign systems to support sales staff and review processes using digital to redefine the customer experience, extending from front to back office. This means, for example, that the lives of our customers and of our employees must be made easier while keeping a lid on costs, that customers must be included in and must be able to benefit from the development of new product contracts, that we must be able to offer e-signature, etc. A genuine process of organisational reform is underway.

Which element would you like to stress in order to gain the commitment of your employees to the project?

O.K.: Our employees understand that, more than any other bank, we must be receptive to the new modes of behaviour and new technologies used by our customers and in wider society, all the more so as, once again, it is our focus on the relationship and the quality of the service provided that set our bank apart from the competition. So this is vital.

But the reforms will also enable each advisor to develop a role as the manager of their own portfolio. In practice, this technological revolution will offer a level of freedom that will empower our sales personnel. A career in banking is becoming more and more exciting. And the position of branch manager will regain a real sense of purpose. Could there be any greater motivation? We must bear in mind that the bigger the institution, the more it needs proximity – in terms of both customer relationships and the management of its employees.

November 2015