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How banks make money and why it's shifting in 2021

Nikolai Hack is Head of Strategy & Partnerships at Nucoro where one key aspect of his role is to keep a close eye on the developments within financial services. His recent focus has been to examine the market shift in realising the opportunity for financial institutions in moving savers into investors. In this blog, Nikolai explains the macro factors driving this change.

For the majority of our lives, the answer to the question “how does a bank make money” seemed to be an obvious no brainer. Accordingly, the definition of Commercial Banking on investopedia.com couldn’t be clearer:

Commercial banks make money by providing and earning interest from loans [...]. Customer deposits provide banks with the capital to make these loans.

Traditionally, money earned in the form of interest from loans often accounts for up to 65% of a banks’ revenue model. However, to anyone who has been paying attention to central bank activity and monetary policy across the world, this definition poses a somewhat puzzling picture.

The shifting state of the economy

Central bank interest rates have been in a decade long freefall and are now at unprecedented historical lows. While the Bank of England and the Fed are still holding rates just barely north of nil, in the Euro area, Switzerland and Japan, banks are already being charged to deposit money at their central bank.

The consequences for consumers and debtors generally are severe. On the one hand, in the Eurozone most notably, it has become the norm to find 10-year and longer term mortgages for less than 1% interest. Soaring real estate prices and an over-indebtedness of private households are the result. On the other hand, the annual yield even on fixed term deposits rarely goes over that same 1% threshold anymore. With saving being so unattractive, ever more money finds its way into other asset classes like sky high stocks and riskier bonds.

But what about banks: how do banks make money?

Here, the macro shifts have definitely also left their mark. Not only has it become increasingly harder to generate margins from core products but a global pandemic has now added insult to injury. With a lot of business activity still on hold in many countries, there is significantly less need for FX and corporate banking services. At the same time, the costs for compliance and regulatory affairs continue their trend of an increasingly steeper upwards trajectory. To put it bluntly, the honest answer to the question “how do banks make money” is by now probably: It’s complicated...

While these developments present the industry with very challenging conditions, there are strategies to deal with them. This will be especially relevant as there is no reason to believe that interest rates will go up anytime soon. If anything, in times of expansive government debt financing of central banks, it is more likely that they will go negative even further.

Key strategy banks must adopt to future-proof their bank operating model

For banks, a key aspect of the necessary transformation is to diversify away from the core products that they have traditionally focussed on: deposits and loans (accounting for up to 35% and 65% respectively). This is important for two reasons. Primarily of course to increase the income streams from alternative activities and unlock additional revenue, but more importantly to reduce the weight of a bloated, yet revenue dormant balance sheet. More deposits and loans mean more regulatory capital. In consequence this results in a reduced return on equity if the achievable margins don’t increase at the same rate.

The benefits of launching an investment proposition

Not surprisingly, of all the options of diversification, we believe that launching an investment proposition achieves the most objectives at the same time. By offering investing, through a robo proposition, self-service trading or in the form of advisory services, otherwise idle funds are shifted off the balance sheet into custodial investment and cash accounts. At the same time as the capital base is decreased, the activities related to asset management allow for a range of fee models. From traditional structures of annual charges to subscription-like flat fees, the additionally generated income significantly boosts the cost income ratio and return on equity. Especially important will be the guidance that is necessary to get clients from their existing savings to the new investment offerings, as only 8 out of the top 30 European Banks currently succeed at this. Holistic experiences that break down the barriers between the two can help to increase adoption and open up opportunities for cross and upsells later (think about the next step from investing to pensions or protection). Importantly, consumers are demonstrating the need to be supported by their banks. With more than a third of UK citizens vowing to manage their money more wisely in the future and 40% of millennials stating their interest in robo-advice.

Regardless of the path that a bank choses, zero or negative interest rates are here to stay and have to be accounted for in the retail banking strategy. And if done right, the question “how does my bank make money” might just be a little more straightforward to answer in the future.


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We recently ran a webinar 'The rise of the digital retail investor' where our panel of financial experts had an interesting discussion around the opportunity to convert savers into investors. If you'd like to listen, you can access the recording here.

Key Ideas

  • Unfavourable central bank activity and monetary policy are leading consumers and debtors from saving into other asset classes
  • Banks are increasingly struggling to generate margins from core products, FX and corporate banking services
  • Banks need to diversify away from core products by offering products that shift idle funds off their balance sheets into custodial investment and cash accounts

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