Managing the Seven Deadly Transitions

By Furash, Edward E. | ABA Banking Journal, July 1997 | Go to article overview

Managing the Seven Deadly Transitions


Furash, Edward E., ABA Banking Journal


Understanding and dealing with difficult transitions will be key to effective bank strategies for at least the next five years. Seven elements make up the transition "black hole" that threatens to engulf today's financial institutions. Each is discussed below along with how bank strategies should address them.

1. Balance sheet to off-balance sheet intermediation

The securities market now dominates the intermediation process. Consumer loans and mortgages are securitized. Money market mutual funds dominate funds gathering. Loan price ceilings and funds price floors are now set in the securities marketplace--not by banks. Thus, the traditional bank dominated intermediation process of taking deposits and making loans is under attack.

As intermediation moves increasingly out of banking, bankers must decide how they will play in this new environment. Some banks are choosing to migrate rapidly to off-balance sheet investment- or merchant-banking activities, others are stressing volume origination that they can securitize and then manage for a fee, and still others are emphasizing keeping deposit intermediation alive by cutting costs, merging with cheaper deposit sources, and underwriting loans that in the past would have been seen as "risky."

The success of this transition depends on how long the bank can keep its deposit intermediation viable. Banking's intermediation advantage, although declining, still lies in its superior underwriting skills. These skills must be exploited to carve out a special role of banks for the future intermediation process.

2. From capital adequacy to capital efficiency.

Traditional regulatory and market measures of capital adequacy will transition from today's fixed ratios for loan categories to an evaluation of whether a bank has found the most efficient use of its capital to support its new business mix. Thus, as deposit intermediation declines, capital will be freed up for other uses.

Capital will need to be deployed into those businesses that require less capital--such fee activities as loan servicing or investment management--giving substantial opportunity to shift to more efficient capital use. In effect, future plans must include the fluid use of capital, an approach that has been called the "just-in-time balance sheet" management, in which capital flows quickly to its most efficient use. This transition in how capital is used and how much capital is needed will become a significant factor in return-on-equity strategy for years ahead, and strategic plans must execute this kind of approach.

3. From savers to investors

It's almost boring to cite once again that consumers are now mainly investors, not savers. Banks have been aware of this transition for more than a decade; they have also known that they need to broaden product lines into the complete buffet of investment products that consumers want, and to create the marketing skills and sales force required to sign up consumers.

At this point, securities companies and mutual funds are far ahead of banks in selling a buffet of investments to consumers. Banks have advantages in their image of trustworthiness and their extensive distribution systems, but have not really turned these to a marketing advantage. Banks, in consumer eyes, have yet to transition into being investment managers, according to numerous consumer surveys. The work needed to make banks successful competitors in this field is still substantial. Few banks are attacking the problem or selling investments with the same commitment of nonbanks.

4. From banking to financial services

A larger, concurrent transition to expanded investment sales is for banks to evolve their businesses from banking to financial services. To make this transition, banks must broaden consumer product lines. They must shift commercial lending activities to merchant banking. Many banks still focus on maintaining traditional balance sheet intermediation while downplaying the need to migrate to a broader set of financial activities in a rapidly homogenizing financial services industry. …

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