Germany is a tough market. On the one hand, Germans consider themselves as innovative and technology driven. The internet and mobile phone technology is commonly used in the population.
On the other hand, internet banking and online transactions are primarily used by the younger generation and are not generally accepted across all generations. The percentage of internet banking users in Germany may be higher than some of their neighbors (e.g. Belgium and Poland), but compared to countries like the UK, the USA or South Korea the customer behavior is still pretty conservative.
This may change with the iPhone.
71% of the Germans who have internet access also possess a web-enabled mobile phone. This is an increase of 14% in comparison with last year. The main driver behind this development is the iPhone. Even though a standard for representing online information already existed for about 10 years it was considered slow, inflexible, not user friendly, and costly. The market launch of the iPhone in 2007 brought relief by introducing the first intuitive usable mobile browser. In addition, the other barriers were removed, i.e. the telephone companies increased the data throughput significantly and developed affordable call charge models.
The introduction of the iPhone came along with a variety of applications in the iTunes store to enhance the functionality. Other vendors, like Google and Nokia, followed lately with similar smart phone concepts, broadening the spectrum. According to an article I read recently every fifth sold mobile phone in Germany is already a smart phone.
Anyhow, so far the mobile banking business did not capitalize on this development. In 2009 – referring to results of a recent survey from Steria Mummert Consulting – only 11% of the mobile internet users handled their banking transactions via mobile phones. The demand, however, is much higher. One out of three would like to use this kind of service but only a few financial institutions can fulfill their needs.
That does not mean that the financial services organizations will not jump on the bandwagon. The survey (conducted with banking executives) “Branchenkompass Kreditinstitute 2009” from Steria Mummert indicates that 42% of all German banks plan to invest in mobile banking (M-Banking) in the near future. 15% of the banks already provide some sort of mobile application but those applications are still very simple. They provide customers with guidance to the nearest branch office or a dictionary of contact persons.
While these applications may be useful, they do not use the potential of mobile intelligence. Why should a bank point their customers to the next branch when instead they can manage their transactions online? There are many M-Banking applications economically reasonable which can simplify the life of customers but also give banks an ideal vehicle to interact with them.
· Monthly Financial Statement (for free). The customer can check the settlement of his accounts
· Portfolio Analysis (maybe for free or for a fee). Customers will get a daily/weekly view of their investment portfolios
· Multi-Banking (chargeable offering). Management of multiple accounts of the customer,
including those outside of his house bank. This functionality could be very attractive to customers with multiple accounts in different banks, especially with those that do not offer smart phone apps yet. The only requirement: each bank need to support the HBCI-protocol for online banking.
· Marketing Campaigns. The bank can include actual product information as part of new applications, as long as the customer does not suppress this feature. This will not only improve customer loyalty but can also serve as sales vehicle.
These applications are already available in the market. Other M-Banking features that customers could benefit from and are accustomed to using online banking, have not reached market maturity yet, e.g.
· Management of Standing Orders
· Portfolio Management
· Personalized Stock Information Services
· Live News Ticker
The disposability of these applications will enable customers to react quicker and to use otherwise unproductive time more efficiently. By offering these apps the bank will generate added value for their customer base and will benefit through increased customer satisfaction and retention.
The developments in the mobile phone industry will continue. While the various applications mentioned above can be realized with current technology, the next level of smart phone innovations is already in the making, mobile phones as means of cashless payment.
The next generation of smart phones will – according to industry observers – contain a Radio Frequency Identification chip, short: RFID-chip. This technology allows a wireless data transmission on short distances, thus making the mobile phone a functional currency.
By now this technology is only implemented in a few mobile phones and rarely used. In contrast, being part of an iPhone and using the hype around it could mean a breakthrough for the technology. The debut of the next iPhone generation is expected in summer 2010. If the prevalence rate of the next iPhone is similar to prior generations or the current run on the iPad, banks have to be quick, reacting to these new market conditions in order to keep their customer base.
Because one thing is clear, not only banks and credit card companies target this market. New players will arise with attractive product packages, trying to get a piece of the pie. It is therefore mandatory for the financial services industry to be prepared if they do not want to lose their customers or at least a capital drain.
The main counter-argument of those banks not planning to invest yet in M-Banking: it is a low margin business. The usage of internet banking has a higher net value added (due to the required development effort for M-Banking) and even that technology is not widely used by the customers – as mentioned earlier.
However, business intelligence software like MicroStrategy already incorporates mobile functionality. In addition, more and more effort will be spend on enhancing the smart phone capabilities and providing banks with the right toolset for their business. As a consequence the development costs for the banks can be limited and furthermore, banks will be able to sell these new offerings to their customers (smart phone users are used to pay for qualitative apps), hence reducing their investment and maybe even build new attractive revenue streams.
Mobile banking services will be one of the keys to success of financial institutions and their customer relations in the future. Addressing customer needs is therefore one of the main objectives of mobile banking applications. That is not to say that there is no use for internal apps as well, the typical audience is just smaller. Here are some examples of possible mobile apps in financial services:
· Executive Dashboards. All relevant KPIs for the management available at a glance.
· 360 Degree Customer View. All relevant information of a customer (including product suggestions) directly send to the mobile device of the customer service field representative
· Wealth Management Dashboards. Actual information to manage the portfolio of wealthy customers.
· Risk Dashboard. The most important risk indicators (for the C-level management) to run the business.
· Internal News Updates. Possibility to communicate company news to the workforce.
To sum up, I can say that mobile banking will become more and more important to the financial services organizations, externally to communicate and interact with their customers, internally as a reporting vehicle to their management and employees. Even though I used Germany as an example these deliberations can be applied to the financial services industry as a whole.
Wednesday, May 5, 2010
Monday, May 3, 2010
Government Bonds – The inherent risks in the balance sheets
European banks and insurance companies hold to a great extend consols (government bonds) from shaky candidates like Portugal, Ireland, Italy, Greece, and Spain. Since these five countries have a history of uncertainty, they are known in the financial market as “Piigs”.
The rate of these bonds as well as their solvency decreased significantly especially due to the downgrade of Greece (and later of Portugal and Spain) by the rating agencies and the following disturbances of the markets. According to the newspapers, a 10-years Greece bond of Greece which was noted in March 2010 with almost its denomination value, can at the end of April only find a purchaser with 82% of its repayment values.
Banks that were heavily involved in the government financing business own lots of these consols, like the now government owned Hypo Real Estate in Germany with 39 billion Euro. However, that does not mean that it has an immediate impact on the balance sheets of the banks (i.e. exposure of their equity ratio). It depends on a complex set of rules.
Is the bond part of the trading portfolio of the bank (those consols that are supposed to be traded on a short-term basis) then the volatility of the stock price will have an immediate effect on the profit and loss statement.
Financial services organizations also need to have a foundation of liquid assets. Since government bonds are usually considered to be sound investments – even from the PIIGS countries – they can often be found in the liquidity reserve to serve short-term payment obligations of the organization. The problem here is the same as with the trading portfolio, changes directly impact the P/L.
As a counter measure, to avoid the effect and to reduce the risk of negative impacts on the balance sheet, banks often moved these consols positions into different portfolios, as asset investments. With this trick the investments are labeled as long-term positions with the consequence that the bank can wait with adjustments of their financial statement till the government of the bond is unable to pay the interest or – as a measure of debt refunding – is reducing the repayment value of its debts (called haircut). But that scenario is not likely as the countries of the European Union are willing to help Greece with around 110 Billion Euro of instant loans.
The solvability and Basel II rules demand from financial institutions to hedge their security portfolio with equity in their balance sheet. If the securities rating are going from bad to worse, more and more equity is required as a safeguard. However, government bonds underlie special regulations. As long as the European banks follow the standard principles of capital adequacy, i.e. accessing only external ratings, they do not have to allocate any equity for consols coming from countries of the European Union!
While bonds issued by a company with the same rating as Greece at the moment would result in a requirement to reserve 8% equity on the balance sheet of the holding financial institution, none of this applies to the Greek bonds, under the premises of using standard external ratings. Larger banks, though, do not fully rely on external ratings; they consult in addition their own rating models and hence have to comply with different rules.
Some institutions have therefore most likely added more equity as a risk provisioning due to the lowering creditworthiness of Greece. Most others however, did not follow that path and appeal to the fact that companies that follow their own rating guidance in general can still assess parts of their portfolio according to external ratings. Allianz, the German insurance heavy-weight for example, has heavily invested in Piigs-bonds but still does not see a reason for depreciation, since none of them has defaulted yet.
What does that mean for the industry?
The European governments are trying to get voluntary support from the private banks to take on parts of the credit burden. The financial institutions have a lot of risk hidden in their balance sheets that is not hedged by equity reserves. That is why they may be willing to help the EU to some extent, but I doubt that they will accept taking on a large portion of the additional credit risk, they will leave that to the politicians.
Even though most financial services and insurance companies used the accounting standards to their advantage, avoiding additional equity reserves as risk mitigation for the unsafe consols, they are aware of the risk involved. This leads to additional reporting needs:
· Companies always differentiate between external and internal reporting to cater to the various stakeholders’ needs. The authorities are interested in a public view of the business according to the accounting standards, while the internal view gives the management a different overview based on other criteria.
· The principles for external reporting follow tax law and other regulations, like Basel II compliance. External reporting is therefore strict and formalized. The accounting tricks mentioned above are reflected in the external reporting.
· Internal reporting on the other hand is more flexible. Here the management can use the reporting for strategic purposes, for different views of the business (e.g. using an organizational structure to-be) and is not limited in the usage by regulations. The added risk of government bonds is taken into account and separately shown in the balance sheet. In addition, it is very likely that the executives want to see specific dashboards qualifying the impact of government bonds in terms of value at risk.
The rate of these bonds as well as their solvency decreased significantly especially due to the downgrade of Greece (and later of Portugal and Spain) by the rating agencies and the following disturbances of the markets. According to the newspapers, a 10-years Greece bond of Greece which was noted in March 2010 with almost its denomination value, can at the end of April only find a purchaser with 82% of its repayment values.
Banks that were heavily involved in the government financing business own lots of these consols, like the now government owned Hypo Real Estate in Germany with 39 billion Euro. However, that does not mean that it has an immediate impact on the balance sheets of the banks (i.e. exposure of their equity ratio). It depends on a complex set of rules.
Is the bond part of the trading portfolio of the bank (those consols that are supposed to be traded on a short-term basis) then the volatility of the stock price will have an immediate effect on the profit and loss statement.
Financial services organizations also need to have a foundation of liquid assets. Since government bonds are usually considered to be sound investments – even from the PIIGS countries – they can often be found in the liquidity reserve to serve short-term payment obligations of the organization. The problem here is the same as with the trading portfolio, changes directly impact the P/L.
As a counter measure, to avoid the effect and to reduce the risk of negative impacts on the balance sheet, banks often moved these consols positions into different portfolios, as asset investments. With this trick the investments are labeled as long-term positions with the consequence that the bank can wait with adjustments of their financial statement till the government of the bond is unable to pay the interest or – as a measure of debt refunding – is reducing the repayment value of its debts (called haircut). But that scenario is not likely as the countries of the European Union are willing to help Greece with around 110 Billion Euro of instant loans.
The solvability and Basel II rules demand from financial institutions to hedge their security portfolio with equity in their balance sheet. If the securities rating are going from bad to worse, more and more equity is required as a safeguard. However, government bonds underlie special regulations. As long as the European banks follow the standard principles of capital adequacy, i.e. accessing only external ratings, they do not have to allocate any equity for consols coming from countries of the European Union!
While bonds issued by a company with the same rating as Greece at the moment would result in a requirement to reserve 8% equity on the balance sheet of the holding financial institution, none of this applies to the Greek bonds, under the premises of using standard external ratings. Larger banks, though, do not fully rely on external ratings; they consult in addition their own rating models and hence have to comply with different rules.
Some institutions have therefore most likely added more equity as a risk provisioning due to the lowering creditworthiness of Greece. Most others however, did not follow that path and appeal to the fact that companies that follow their own rating guidance in general can still assess parts of their portfolio according to external ratings. Allianz, the German insurance heavy-weight for example, has heavily invested in Piigs-bonds but still does not see a reason for depreciation, since none of them has defaulted yet.
What does that mean for the industry?
The European governments are trying to get voluntary support from the private banks to take on parts of the credit burden. The financial institutions have a lot of risk hidden in their balance sheets that is not hedged by equity reserves. That is why they may be willing to help the EU to some extent, but I doubt that they will accept taking on a large portion of the additional credit risk, they will leave that to the politicians.
Even though most financial services and insurance companies used the accounting standards to their advantage, avoiding additional equity reserves as risk mitigation for the unsafe consols, they are aware of the risk involved. This leads to additional reporting needs:
· Companies always differentiate between external and internal reporting to cater to the various stakeholders’ needs. The authorities are interested in a public view of the business according to the accounting standards, while the internal view gives the management a different overview based on other criteria.
· The principles for external reporting follow tax law and other regulations, like Basel II compliance. External reporting is therefore strict and formalized. The accounting tricks mentioned above are reflected in the external reporting.
· Internal reporting on the other hand is more flexible. Here the management can use the reporting for strategic purposes, for different views of the business (e.g. using an organizational structure to-be) and is not limited in the usage by regulations. The added risk of government bonds is taken into account and separately shown in the balance sheet. In addition, it is very likely that the executives want to see specific dashboards qualifying the impact of government bonds in terms of value at risk.
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