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Returns reboot

4 January 2016 By Antony Currie

Technology can help America’s banks do a hard reset on costs. Lenders have little to look forward to in 2016, and face pressure from a variety of startups. But the revolution the new players threaten could actually revitalize traditional institutions.

Most big banks fail to earn a return on equity above the 10 percent usually seen as their cost of capital. Only JPMorgan, Wells Fargo and U.S. Bancorp do so regularly – and even then not spectacularly. Nor is there much room to grow. Interest rates rising slightly will help profitability, but only a bit. And rising credit costs could increase bad loans.

So returns will not budge, unless banks begin to co-opt the best of financial technology. That could mean buying fintech outfits, building homegrown equivalents on their own or with other lenders or simply purchasing their services.

There are plenty of inspiring examples. Alternative lenders use sophisticated algorithms to better assess would-be borrowers. And companies like Bill.com and Viewpost are rationalizing large chunks of processes such as small-company invoicing and cash management. Viewpost, which partners with banks, claims its technology can strip out enough costs to cut current fees by more than 90 percent.

Elsewhere, technology could allow banks to provide a more personal phone service yet cut costs by as much as two-thirds, according to digital communications firm Xura. It could also help combine support functions, like so-called know-your-client data gathering, which could shave up to a tenth off back-office costs, according to the Boston Consulting Group.

All told, the results could be dramatic. U.S. Bancorp, with $400 billion of assets, is the most efficient big bank, spending around $54 of each $100 of revenue on expenses. But suppose it could eventually cut 15 percent of its bills. That would boost its ROE to 17 percent from the recent 14 percent level, Breakingviews calculations show.

Similar cutbacks would add around 3 percentage points of ROE to both JPMorgan’s and Citigroup’s returns, boosting them to 13.7 percent and 10.7 percent respectively. Higher earnings would also let Citi use its $48 billion of crisis-era tax losses faster, reducing its capital and further bolstering returns.

Granted, banks will have to spend heavily on kit and on redundancies, so any gains would take time. But fintech can help a stagnant sector reboot itself.


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