Journal of Financial Economics

REF 118 The on-going changes in the financial industry

Michel Albert était un homme de foi. Foi religieuse bien sûr, qui l’animait et qu’il portait avec ferveur, mais sans ostentation. Foi dans le projet européen dont il avait été l’acteur de 1963 à 1970 à la Banque européenne d’investissement et dont il fut toujours un vigoureux défenseur. Foi dans l’économie mixte, ce curieux mélange qui a permis à un fonctionnaire dans l’âme comme lui de devenir président de l’une des plus grandes compagnies d’assurances françaises, les AGF, de 1982 à 1994...

L’année 2014 a été marquée pour la Revue d’économie financière (REF) par le lancement d’une rubrique d’histoire financière coordonnée par Claude Diebolt. L’année 2015 s’ouvre sur une autre innovation : le lancement d’une rubrique « Recension »...

Along with many others industries finance is facing the entrance of new comers, new retail channels, new consumers behaviours and new business models. If every actor in finance is concerned, banking in its most traditional activities such as loans, deposits, and payment is the most hit because of the setting of new regulations and the arrival of FinTechs companies. Banks still have numerous advantages to face this new environment but have nonetheless to rethink completely their operating models.

Since 2007, European banks have had to cope with a very unique environment. After the crisis management phase (2007-2012), they had to learn how to navigate in a dramatically new and unstable context, whether on the economic, monetary or regulatory front. They were forced to follow defensive medium term strategies. Priorities were management of regulatory ratios, control of liquidity, reduction of costs, and rebuilding of the most impacted business models. In this new cycle, planning technology has become more sophisticated. But it is unlikely that this will lead to more dynamic and diverse strategies without a more normalized environment. This is not creating an optimal situation for the working of the banking sector and more broadly for the financing of the economies.

The increasing penetration of digital technologies in Corporate and Investment Banking (CIB) implies a triple revolution. First, an industrial revolution: new opportunities for growth and cost reduction emerge with the growing automation of core banking functions – connection, both with clients and between employees, innovation, processing of operations, decision making. Then, a market revolution: specialized new entrants are able to disintegrate value chains. Besides, digital pioneers can reinvent their business models and fundamentally transform their markets’ structure and dynamics. Finally, a managerial revolution, as digital disruption involves developing whole new skills and mindsets among employees.

The accounting and prudential norms that regulate financial intermediation have significantly evolved over the last twenty years. They have become aligned with the industry’s best practices, thereby gaining in sophistication and complexity. This generated procyclicality and created room for massive regulatory arbitrage. This in turn contributed to a large extent to the 2008 crisis. One can foreshadow two issues with current attempts at fixing this regulatory environment. First, the asymmetric tightening of banking and shadow-banking regulations may induce a massive migration of lending towards the more unstable shadow-banking system. Second, moving back to overly simplified prudential rules, such as the leverage ratio, may create important distortions in the allocation of capital. The most appropriate response to the crisis pertains to supervision rather than regulation in my view. An important investment in the human capital of supervisory authorities and a shift from « box-ticking » regulation towards more supervisory discretion are in order.

The universal banking model, well spread in Europe, is facing a lot of challenges from regulator’s new toolbox in their way to reach a stronger and more sustainable banking system. Banks have first changed to offset the costs linked to the sharp increase of capital ratio in investment banking areas and to the introduction of liquidity and leverage ratio. Banks all around Europe have curb costs and exited or downsized the most capital intensive businesses. Core profitability, excluding litigations and legacy issues, is now back to level in line with cost of equity (8 %). However the slow growth environment should force European bank to continue to restructure. Banks could gain in efficiency through an increase in size in their relevant European markets segment but they have to deal with the systemic charge of size (avoid the ‘too big to fail’ subsidy). Then banks have to make complex arbitrage within market activities and corporate lending, relying on less profitable retail activities due to low interest rate environment. In the tomorrow Banking Union landscape, universal banks should be more integrated and more selective.

Information on individuals behavior has never been so important and available thanks to the numerous data (big data) provided by the web and the power of computing and analysis (advanced analytics). Mastering data and analytics is now a competitive advantage giving rise to opportunities: optimizating existing operating models, breaking present value chains and building new business models.

Even if big data is potentially a threat for banking business models by lowering entry barriers and reducing information asymmetries, banks can nonetheless rely on strong assets such as numerous, secured and reliable data. What is at stake is building a performing, responsible and ethical use of personal data so as to supply customers with relevant and customized offers in a proactive way through the retail channel.

With its spectacular growth and yet unleashed potential, crowdfunding raises technical, economical and regulatory issues, specifically when it comes to marketplace lending: regulators hardly figure out how to deal with this new model, incumbents as traditional banks may fear it but some of the most agile of them already take it as a profitable opportunity, and platforms strive to build efficient and liquid marketplaces. Crowdlending envisions a new approach of the asset and liability allocation based on data and technology that naturally leads traditional players to worry about its developments. By making direct financing for small businesses easier, crowdlending brings concrete solutions to secular issues of the financial industry and its ability to finance the economy.

Influenced by reforms of the regulatory framework that originated in the post-crisis context, and the quick technological and demographic transformations, retail banking activity in the United States proves to be in a state of profound transformation. Such changes are characterized by a stronger dichotomy between systemic and non-systemic institutions but also by the expansion of alternative providers. They are stimulated as well by the possibilities of regulatory arbitrages and the perspectives that new technologies offer. Nevertheless, assessment of such shift remains difficult. The perspective of a wider access to banking services at a lower cost through a more competitive sector, on one hand, seems to be balanced by the perspective of a greater segmentation between customers, based on age, incomes or geographical localization, on the other hand. Moreover, this shift could draw the attention to concerns about financial stability and systemic risk prevention, raising ultimately the question of the adequacy and relevance of the institutional supervisory framework.

Three forces are transforming retail banking. The first force, a legacy of the crisis, is a change in the structure of the industry as banks de-lever, as regulation responds and as customers see banks in a new light. The second force is a shift in the financial needs of an ageing population. The third force, and probably the most important, is the digital revolution, which will transform what customers expect of their bank and open up retail banking markets to new forms of competition.

Of these forces, new technology is probably the most important because of the impact it can have on what customers’ experience, on competition and on bank business models. However, its impact might not have been so large had it not been for the crisis, which has weakened customer trust in existing players at the same time as burdening those players with new regulatory demands and legacy costs. It is not at all clear what the retail banking world will look like in ten years’ time. But the change will be profound and profitability lower.

To identify the contribution of asset management companies, relatively new players in the European institutional landscape, the first section of this paper gives a brief description of its main functions and its economic utility. In a comparative approach, taking into account the countries of the euro area, Sweden, the United Kingdom and the United States, the second section analyses the level of involvement of resident investors on their capital markets, and some features of their behaviour regarding their financing needs. The third section explains the contribution of asset management companies through their investment in equity and debt securities. This paper aims to show in fine money management involvement in the financing of the euro area economy. For this, it uses at least two types of measures: the holdings rate of management companies compared to the stock of securities issued by residents, and an estimate of existing home bias in the portfolios of asset managers.

As liquidities have never been so abundant worldwide, very few of them are invested in financing innovation. This is especially true in Europe. If governments have tried to direct these capital flows towards innovative firms and projects, flows remain scarce and modest. This is really a matter of concern because innovation is at the root of tomorrow’s growth and Europe now has to act quickly if it does not want to lie far behind the United States in the future.

The central banks’ unconventional policies (quantitative easing through asset purchases and forward guidance) drew all bond yields downwards, even below zero for a number of them. Low margins, negative flows, yield-free risk instead of risk-free yield, fixed-income asset management is all the more complicated and the investor has to take in more risks: longer-termed bonds, riskier issuers, foreign assets, or diversification towards stocks or real assets. This is by the way what the central banks wished for, and this will end with the very success of these policies: economic recovery should bring higher yields without compromising the strength of the stock market.

Dans une économie moderne, l’assurance sert d’abord à réduire la pauvreté. Elle permet en effet de couvrir des risques qui sans elle pourraient conduire de nombreux ménages sous le seuil de pauvreté. Faire relever les risques systémiques de la pauvreté de la protection sociale et les risques individuels aléatoires de l’assurance permettrait de
simplifier un système actuellement complexe et d’y instaurer la confiance. Ce serait l’occasion de réinventer le modèle de l’assurance. Il importe en particulier que les transferts de risques réduisent la vulnérabilité des populations les plus pauvres, notamment dans les pays les plus touchés par ce phénomène.

The economics of insurance has demonstrated that information is at the core of the insurability problem, and more generally of the allocation of risks in the economy. In this article, I show that improving the quality of information generally has an ambiguous effect on the efficiency of risk sharing. But one can expect that the digital revolution will reinforce insurance through various positive channels: reduction of the costs of marketing and indemnification, weakening of adverse selection and moral hazard problems, reduction of the ambiguity of the loss distribution. On the contrary, information erodes the ability to mutualize risks, by transforming risk into inequalities.

In this paper, we review the changes in the insurance industry involved by the implementation of the new risk based regulation like Solvency 2 and SST. The move from managing the companies through their cash-flows to managing them through their risks is described and discussed through capital management, economic valuation and the internal model. The Enterprise Risk Management (ERM) is explained along with its implication for the company organization and the role of actuaries in insurances. We point out the limitations and difficulties of this approach. The risk/return relation is becoming a central element of the company management and is taking over the traditional P&L vision.

For more than 200 years loans repayments have been the forgotten component of households savings. However the effects of debt on households consumption have become an important issue in the aftermath of the Great Recession. Such a long omission is mainly due to the lack of data. Loans repayments are not included in national accounts. As for France, a new estimate indicates that “reals” repayments – those not financed by new loans – amount to around 40 % of the households’ annual savings flow. Gathering numerous and still lacking information is needed to confirm this estimate. Only when central banks publish long temporal series of “real” and “false” repayments, will original econometric works improve significantly the knowledge of economic and financial households’ behaviour.

This paper investigates green bonds, an innovative financing scheme implemented by local authorities. Based on the conceptual framework of financial intermediation theories, the objective of this research is to understand the foundations of this financing method and to identify the related control mechanisms. It is grounded on empirical qualitative research work conducted within the French Regions.