European banks are at risk of being disrupted if they fail to keep up with the fast-paced digital revolution, according to Jupiter Asset Management’s Guy de Blonay.
De Blonay, who oversees the £597m Jupiter Financial Opportunities fund, said US banks have been among the first to embrace new technology, while European banks have been slow off the mark.
“In recent years, technological developments, new regulations and the rise of digital-savvy millennials have combined to form an irreversible trend towards innovation in the global financial sector,” he said.
“The US banking sector has generally been the most willing to adopt new technology. In contrast, the European banking sector appears to be most at risk of disruption [with Nordics being the exception].
“Due to the burden of years of negative interest rates, European banks have generally underinvested in technology as low rates have eaten into their profit margins.”
Interest rates for eurozone since 2006
Source: St Louis Fed
Unthinkable before the financial crisis of 2008, the European Central Bank (ECB) cut interest rates below zero in 2014, a move aimed at encouraging lending and reinvigorating the economy.
This, de Blonay said, posed challenges for those European banks that had pre-crisis business models.
“No banks with pre-crisis business models could survive in a negative interest rate environment, so every bank had to cut their costs to make sure they could meet the lower revenue every year,” he said.
“If they didn’t cut their costs, they were under pressure of having to raise capital because they didn’t generate enough to meet their capital requirements from the regulator.
“Sometimes it was not because of a shortfall of earnings that they were in trouble but because they had a big fine they needed to settle with a different authority or a different market.”
He added: “What happened in 2016 was that we had markets responding from the stimulus that we had from central banks but some banks, like those in the US, were far more advanced in cutting their costs, in settling their fines and getting their capital in order.”
As a result, de Blonay – who also oversees the €91.7m JGF Jupiter Global Financials fund – said US banks are already far ahead when it comes to investing in new technologies.
However, European banks are still struggling with paying fines or understanding where the ECB wants to go with interest rates, which is making it difficult for these financial institutions to assess whether the business model is “the right one” going forward.
“We have a very uneven landscape, and as we know we certainly have a positive interest rates environment the American banks are benefitting from,” the Jupiter manager explained.
Interest Rates for the US over 10yrs
Source: St. Louis Fed
“We also have growing global markets that are quite supportive for these banks to generate the earnings to continue to spend on technology, but also you have threats and challenges coming in in areas that are still protected by the lethargy of customers.”
According to de Blonay, although banks globally are allocating increasing capital to technology and innovation, they only spend on 10 per cent of their revenues on IT, on average, and 15 per cent of their total costs.
Furthermore, the FE Alpha Manager noted that just 36 per cent of the total spending on IT is allocated to front office and to initiatives that will change the banks, with the rest spent on back office and regulatory or compliance requirements.
“With established customer bases, licences and brands, traditional banks should be best positioned to dominate the industry in the future,” he said.
“Nevertheless, their complex structure means they must allocate huge amounts of capital to IT legacy systems and maintenance, often limiting available budget for innovation.
“In fact, partly due to their legacy-free IT, financial technology companies can now offer services up to 50 per cent cheaper than banks.”
The Jupiter manager referred to research by Morgan Stanley to emphasise banks technology spending and willingness to innovate differs across geographies.
“JP Morgan, for example, has grown its tech budget from $9.5bn in 2017 to $10.8bn in 2018, and $5bn of this year’s budget will be spent on new technological developments,” added de Blonay.
“In part, US banks have been supported by US regulation, with regulators generally treating fintech companies in the same way as established financial institutions, thereby enabling banks to compete on an equal playing field and therefore potentially keep up with the pace of the sector’s digital transformation.”
While Asian banks have some of the lowest overall IT spending globally, de Blonay noted Asia (excluding Japan) is now spending the most on innovative technology as a proportion of the overall IT spend.
“Over the longer run, this investment in innovation could have a significant impact: according to the Monetary Authority of Singapore, banks could cut their costs by as much as 30 per cent if they leverage fintech in areas such as automation of banking functions and artificial intelligence, representing 10 per cent to 20 per cent of Asian banks’ operating income,” he said.
According to de Blonay, innovation in the financial sector has opened new opportunities for investors.
These, he said, broadly fall into two camps: the technology ‘adopters’ among the sector’s established banks and financial firms, and fintech firms or ‘enablers’ of financial innovation, which provide a wide range of services and solutions across the financial technology spectrum.
Performance of fund vs benchmark since launch
Source: FE Analytics
Since launch in 2014, the four FE Crown-rated Jupiter Global Financials fund – soon to be renamed as Jupiter Financial Innovation – has delivered a 114.21 per cent total return, doubling the MSCI ACWI Financials index gains of 57.17 per cent.
The fund has an ongoing charges figure (OCF) of 1.01 per cent.
the four FE Crown-rated Jupiter Global Financials fund