Ten year anniversary of the financial crisis: What’s changed?

In 2007 the US sub-prime mortgage crisis triggered a deep global recession and forced long term change for banks and financial institutions. The intervening years from 2007-2017 have seen massive change across all sectors and in how we live and interact. Back in 2007 the world’s largest tech companies were phone manufacturers Nokia, Motorola and Blackberry, Facebook was novel, Twitter didn’t exist and companies still had strict dress codes and fixed office hours. And there were five high street banks in the UK who operated between the hours of 9am-5pm, Mon-Fri.

Fast forward to 2017 and the technology and data driven tech giants are multi device creators like Apple and Samsung, the king of algorithms, Google, and the chieftain of commerce, Amazon. And the financial ecosystem is a chatter with fintechs, brand purpose and overt commitments to putting the customer first.

So if 2017 looks, feels and sounds very different, what has changed in financial services since 2007 and in what way is it safer, simpler and fairer?

A recap on the crisis

Although the financial crisis of 2007 began with the US mortgage market the shockwaves soon spiralled internationally as it emerged that banks and unregulated shadow banks were massively exposed in the market for derivatives and did not have enough capital when losses started to mount.

In the UK the unthinkable happened, when key high street names scrambled to stay afloat. Northern Rock collapsed early on, while Royal Bank of Scotland and Lloyds Banking Group were forced to accept billions of pounds of state aid and the government oversight that came with it. Survival strategies included sales of branches - such as Royal Bank of Scotland divesture of 318 branches to Santander - through to Barclays’ foreign investment from Qatar (with the former CEO and four executives subsequently charged with fraud in June 2017). Weaker players such as Alliance & Leicester and parts of Bradford & Bingley were snapped up by Santander, while Halifax was rescued by Lloyds. The result was a banking system saved by tax payers and growing public resentment at bailing out bankers who were perceived as risk-taking and greedy. Root to branch change was required.

Invention is the mother of necessity

As the saying goes, invention is the mother of necessity. With banking reputations in tatters, out of the crisis arose the first challenger bank. In July 2010 Metro Bank, the first High Street bank to launch in the UK for more than 100 years opened its doors. Dog friendly, offering lollipops and Sunday openings the real difference was a business model based on service rather than price.

Safer through increased scrutiny, accountability and protection

The crisis has led to toughened up regulation and mitigation against the risks that arose outside the core banking system and away from effective supervision. In the UK the Independent Commission was created to make UK banking system safer. At its heart is the idea of a ring-fence to separate retail operations from riskier investment banking which led to the Financial Services (Banking Reform) Bill. Banks that fail to separate investment and retail arms can be broken up. In addition the bill now ensures the ranking of retail deposits (but not pension liabilities) ahead of the claims of other bank creditors in the event of a bank insolvency, as well as requiring banks to hold a sufficient capital buffer so that if they do fail, losses can be absorbed.

In June 2010 the Chancellor announced a levy on banks operating in UK – an annual tax on their balance sheets – which was a joint move between UK, France and Germany. Initially a temporary measure, in 2012 this was made permanent.

For savers, the level of protection has more than doubled. In 2007 the maximum payout for depositors was £31,700 per person. Now it is £85,000 under the Financial Services Compensation Scheme (FSCS).

Dec 2010 also saw European regulators announced tough restrictions on the bonuses that banks can pay their staff. New rules mean bankers can only receive 20-30% of their bonuses in immediate cash, the need to defer 40-60% for 3-5yrs and to pay 50% in shares (rather than cash). Regulators have also encouraged ‘claw back’ pay, where it is possible to reclaim compensation if an individual’s performance is later not deemed worth the pay. In addition, greater transparency has been enforced by the rules around formal panels to interview would-be top executives, as well as the requirement to publish pay details for ‘senior management and risk takers’.

An empowered watchdog

Crucially financial responsibility has been passed on to the Bank of England. In April 2013 the Financial Services Act abolished the old financial ‘light touch’ watchdog, the FSA, and created two new regulatory authorities, the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA).

The FCA is responsible for around 26,000 firms across the whole industry, as well as the prudential supervisor for around 23,000 firms not regulated by the PRA. Its primary purpose is consumer protection, integrity and effective competition. It has the power to regulate the marketing of financial products, able to specific minimum standards and to place requirements on products. It also has the power to investigate organisations and individuals. Ultimately it has the power to ban financial products for up to a year with the ability to instruct firms to immediately retract or modify promotions felt to be misleading. It is also responsible for regulating the consumer credit industry.

The PRCA is responsible for promoting the safety and soundness of banks and insurers and is the prudential supervisor of around 3,000 firms. These 3,000 firms are dual regulated: the FCA for conduct and the PR for prudential issues.

Global stability

On a global level, the creation of the Financial Stability Board (FSB), the body created by the G20 group of developed and developing nations in 2009, serves to recommend ways of remedying the flaws in the system that the crash exposed. Chairman Mark Carney’s recent address at the G20 in July stated, ‘the largest banks are considerably stronger, more liquid and more focused’.

This is because, since 2007 the largest banks are now required to have up to X10 more of the highest quality capital than before the crisis and are subject to greater market discipline as a consequence of globally agreed standards to resolve too-big-to-fail entities. With $1.5tn of capital the largest internationally active banks now meet minimum risk-based capital and leverage ratio requirements.

With toughened up regulation the FSB believe that the financial stability risks from the toxic forms of shadow banking at the heart of the crisis no longer represent a global stability risk. And they continue to monitor the rapid growth of the asset management industry, with particular emphasis on the vulnerability of emerging and developing countries to sudden outflows of funds.

A simpler system

With the complex and fragile derivatives web between banks untangled and a split between investment and retail banks now viewed as best practice, many financial systems are also much simpler.

The simplifying benefits of the technology advances are also coming to fruition. Blockchain, although developed in 2008, is now in the last couple of years bringing with it simpler, faster and more secure ways of transacting and securing documentation, with the banks collaborating around standards and best practice to embrace the benefits that it can bring.

The biggest impact of the decade’s technological development has been the astonishing acceleration of fintechs who are redefining the financial ecosystem with their focus on the customer with offers of simpler and more accessible financial management platforms and tools. With the UK sector now worth an estimated £66bn in annual revenue, they are celebrated by consumers, government and industry alike.

Many new entrants, such as TransferWise and Atom Bank, have launched as challengers, overtly and aggressively taking on the status quo and the established players. Using technology the new fintechs and insurtechs have a shared aspiration to remove uncertainty, inefficiency and hassle to create a simpler, seamless customer journey that makes things better for users. As the marketplace matures early players will begin to broaden services to scale the business (such as TransferWise’s move into borderless multi-currency bank accounts), consolidate with similar services or pursue partnerships such as the recent tie up between Revolut (fee-free global transfers app and spending card) and Trussle (online mortgage broker) which now allows Revolut to offer a real alternative to traditional banks through their app screen.

Determining which growth strategy to pursue, from services and products to partnerships, requires a clear understanding of purpose. A brand positioning based on what you are not is ultimately a short term strategy that eventually runs out of steam. As competition increases within the fintech players, knowing what the brand stands for within the hearts and minds of your hard won audience will be critical, as is the ability to continue to meet future needs. Where fintechs have an advantage over established players is their tech roots and natural affinity in capturing and leveraging data and fusing it with behavioural insight. Without legacy systems and processes fintechs have proven their ability to simplify, with agile through tech-enabled new product development and most importantly, through their open, collaborative mindset.

A fairer system

Redressing the crisis to make it fairer, the past ten years have seen legislation in place to ensure that tax payers never again pay for failure, with the onus for payment of failure now on the investor. Short term selfish thinking is no longer possible. Pay is under scrutiny and cash bonuses are in instalments over years and can be clawed back.
But the recent customer focused legislation, the Payment Services Directive 2 (PSD2) and General Data Protection Regulation (GDPR), are the game changers for creating a fairer, more transparent system, that will put consumers in control of their financial data and ensuring more choice and competition.

PSD2 is forcing banks to open up their systems to third parties including non-traditional FS companies. Coming into play in Jan 2018 it is enabled by Open Banking and Application Programming Interface (API) technology. Open Banking was set up in September 2016 following the Competition & Markets Authority’s (CMA) investigation into UK retail banking. Concluding that older, larger banks do not compete hard enough for customers’ business, Open Banking will allow customers to be able to compare their bank deal. Giving customers real control of their financial data, the new open banking standards will allow customers to select services from a wide range of companies without disrupting their existing banking arrangements. The result will enhance comparison services, automate financial advice and create an array of innovative, constantly evolving services.

The impact of Open Banking will be significant. The competition will intensify to provide customers with well-priced choice, delivered with great customer service. And the strongest competition is going to come from data rich, customer experience driven non FS players, such as Amazon or Facebook. This legislation is going to force existing providers to up their game and will hasten partnerships as new players strive to scale, and consolidation as weaker players struggle to survive.

GDPR which comes in May 2018 is going to bring data into the regulatory net and greater transparency obligations. More than an EU compliance tick box exercise, with a heavy fine of up to 20m euros or 4% of global annual turnover, the legislation is going to ensure businesses act in the best interest of their customers. The legislation tightens conditions for data use, provides individuals with greater control over their information and standardises the rules across markets and borders. The Data Protection and Privacy Impact Assessments requirements mean that brands can build privacy considerations into their business models, from new product development to take to market communications strategies. GPPR actually presents the opportunity for FS brands to create a value exchange out of privacy, one that customers will appreciate and will be willing to pay for.

The Government is encouraging fairness through their recent announcement of the scrapping of credit card surcharges from Jan 2018. Currently up to 20% can currently be added by businesses for customers using cards or services such as PayPal, with surcharges estimated at £483m according to the Treasury. These new rules will support fairness and transparency for using cards and is in addition to the previous capping of costs that businesses face for processing card payments.

In addition there are numerous examples of established and new players heralding increased fairness within the FS system, including:

• TSB are calling on rival banks to attract more women in the industry and to ensure they are paid the same as men by making public their ‘pay gap’. With a gender pay gap of 31% it is committed to tackling the imbalance head on.

• Fintech player Moneybox is making investment in stocks and shares more accessible for all through the ability to invest spare change from everyday purchases.

• For first time buyers and renters Lemonade insurance is leveraging blockchain, artificial intelligence fused with behavioural science to make insurance not only simple, fast and flat fee based affordable, and also knits commitment to social good into their business model through their Giveback feature for the users chosen charity.

Future risks

For all the positives that the past ten years have brought to the financial system both in the UK and globally, risks continue.

In the UK, finding the right regulatory balance is still being sought. For instance, with fintechs the FCA have tried to find a compromise between not being too heavy handed and interventionist whilst new classes such as crowd funders establish themselves. And yet there are calls for faster intervention to curb the growth in consumer credit, in particular affordability checks into car financing.

• In May 2017 the FCA agreed to grant full authorisation to the peer-to-peer (P2P) lending industry. This establishes P2P lending as a separate activity, distinct from both asset management and banking. This means P2P platforms can now compete to lend retail funds but can do so without having to carry the banks’ regulatory capital burdens to protect against the possibility of loss or mishap. And because the funds supplied by retail investors are not pooled, P2P platforms are not to be regulated as if they were an asset manager. This lighter touch is to allow the market to grow new areas e.g. Innovative Finance ISAs.
  Now the regulator is looking at crowdfunders, who raise equity capital for SMEs and start-ups. Whilst not yet required to have full authorisation, because the offer is complex and unclear, the FCA have called for greater comparability and transparency, to allow investors to compare platforms.

• Protecting against the growth in consumer credit is a critical focus for the Bank of England and FCA. Consumer credit (which excludes mortgages), grew 10.3% to April 2017, the fastest rate since 2005. Total amount owned on personal loans, overdrafts, car finance and credit cards is more than £198.4bn. With consumers now owing £68.1bn on credit cards, up 9.7% over last year the Bank of England and FCA are currently preparing tougher guidelines on credit cards and personal loans. To protect against easy credit, the Bank of England have ordered the banks to raise an extra £11.4b over the next 18mths to protect themselves. Concern also exists around contactless technology. In June 2017 household spend on contactless was up 150% on previous year. Critics say contactless is encouraging guilt-free spending as consumers don’t need to withdraw cash or even a PIN.

• A further risk is the £58bn that drivers owe on car financing in 2017. According to Bank of England this is an increase of 15% since last year, where about 85% of cars were bought on finance last year, comparted to just over half in 2009. Currently two thirds of private new cars are purchased through personal contract purchase (PCP), usually from car makers but often from banks. Thus the risk lies with the banks rather than the borrower. The value of car loans has almost trebled to £31.6bn between 2009-1016 according to the Leasing and Financing Association. Some of the car leasing loans have been packaged into investments called ‘asset-backed securities’ and sold on to investors such as pension funds. Falls in the value of this type of investment were a major reason behind the 2007 financial crisis. However this time the investments are backed up by cars instead of houses.

Financial experts, members of the Treasury Select Committee, the Bank of England are now calling on City watchdogs to introduce tighter affordability checks for car financing deals, similar to those for mortgages, to stop consumers signing up for deals that they may not be able to afford later. The FCA and PRA are due to publish new affordability rules to make sure customers are likely to be able to repay their debts. The consumer credit part of these new stress tests will be revealed in September, earlier than the usual November date as the situation is deemed to be relatively urgent.

Globally, future risks include the unwinding of Quantitative Easing. QE could lead to sharp falls in the market as a year ago the central banks in the US, Britain, Japan and the ECB bought the equivalent of all the new debt issued by governments. Although mainly neutral in their purchases in 2017, next year they will be out of the market and it will be up to the financial institutions and pension funds to absorb the stock on offer.

This is a huge change and the implications have not yet been grasped by the markets according to Harvard economist Professor Martin Feldstein. Finding buyers for that much stock will need a bigger rise in interest rates than current expected. The shock of any rate hike could create sharp equity market correction that could be quite large, with an inevitable fall on Wall St inevitable that will send shock waves.

Additional risks emphasised by the G20, include cyber-attacks, due to the vulnerability of digital systems as well as G20 reform fatigue. Despite the obvious benefits of increased global co-operation and systems standardisation, this could be jeopardised by an erosion in willingness of G20 members to rely on each other’s systems and institutions, and in the process, fragment pools of funding and liquidity, create inefficiencies and friction, reduce competition and diminish cross-border capital and investment flows.

A final risk worth highlighting is that of data security. An inevitable consequence in the rise of big data it is increasingly taking centre stage as the business imperative as GDPR comes in early next year. From biometric processing to the emergence of eDNA, the race is on to redefine how customer data security is managed in financial services. Central is the question of how much data is actually required and how far security can enhance the user experience. For all FS brands, understanding and retaining customer confidence in storage and usage will be paramount.