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New Bank, Old Bank

In response to the financial crisis of 2008 many of the worst affected banks adopted a “Good Bank, Bad Bank” strategy. In this they hived off their most toxic assets into what was referred to as the Bad Bank, leaving the cream (most profitable?) of their business in an entity referred to as the Good Bank. With this the Bad Bank and the troubles related with it were essentially left to someone else to sort out, often a government and the taxpayers.

Why do I recap on this? Well, I think that we will soon see a variation that I call “New Bank, Old Bank”. The trigger for this is the difficulty many banks are having bringing their legacy systems, legacy products/activities, legacy data and indeed legacy clients up to the standards required to meet current and future regulations.

Legacy systems have long been cited as an issue for large and long established banks. They all operate complex sets of poorly understood systems, many of which are based on technologies dating back to the 1980’s (and before?) ie pre world-wide-web, pre mobile phones, etc. The effort to maintain and upgrade them has been enormous, but so is the effort required to consolidate and replace them. Now the new regulations are forcing many banks to make multiple changes to long neglected technology and not surprisingly it is often proving very difficult and sometimes nigh impossible.

Likewise new regulations are placing new obligations and operational standards on old products and activities. It is not uncommon to hear the complaint that “that was not the way this was made to work!” The additional cost related to compliance for these products will almost always have a detrimental impact on their profitability, making them far less attractive and in some cases unprofitable to maintain.

Data used to be the forgotten child of Banking operations with an attitude that “those that can do while those that can’t, do data management”. The trouble is that most of the new regulations strive for greater transparency and a degree of related reporting that is demanding data that has not been collected or stored before. Indeed many of the systems have inflexible data structures with poorly maintained data and significant inconsistencies between data stores. As a result few can have high confidence that what they are reporting or will report is completely accurate, something I expect regulators to pick up on.

Lastly, many banks are driven by market share and client base. They are hugely acquisitive of new business and very protective of old business. The problem is that many of the new regulations require extensive co-operation from those clients, old and new. Not all of those clients are inclined, intent or able let alone ready to do that. Large retail and globally diverse client groups prove the most demanding in this respect and it seems ironic that it is a truism that most client service/relationship teams I have worked with seem reluctant to actually talk to a client about anything and especially not the impact of these new regulations.

It is clearly not an easy task for a large established bank to make and keep itself fully compliant. In contrast new banks, like Metro Bank are starting from a clean base. Yes they are still rather small and may still make mistakes, but they have a better chance of success as they are not held back by the legacies I describe above.

So what? Well it seems logical to me that some of those banks will look to make the “New Bank, Old Bank” split. In this they will create a New Bank that utilises a lean set of well architected modern systems and technologies, undertakes only activities and provides products that fit with the new world and regulations and supports this with higher quality data on a smaller set of current clients that “get” the requirements of modern finance. This would then be their prime vehicle moving forward.

The rest will be left in an Old Bank, but what would become of this? Well it could be managed (and run down over time?) separately, maybe a bit like aspects of Lehman’s are still being managed. I suspect though that it is more likely to follow what happened in the insurance fund world, someone will see an opportunity and there will likely be consolidation of a number of Old Banks by a specialist service provider.

One of the benefits(?) is that it would reduce the size of some of the largest banks, reducing the “too big to fail” concerns, something many regulators and politicians would like to see, I have spoken about this with a number of people and few have rejected the idea, but it is not without its problems. One of the main ones is that the split will create an implicit admission that the Old Banks will be less compliant. This will not be an easy message for politicians, but may be the acceptable price. It may also prompt clients to review and update their own business models if they want to work with New Banks and benefit from the related protection.

There would also be huge issues in separating technology, controls, data and staff, but with the “Good Bank, Old Bank” splits we have seen that where there is a will there is a way.

Lastly, once the best and cleanest business is hived off into a New Bank, who will underwrite the risk of failure of the Old Bank? I am sure this is something the smart brains of the financial world can solve…..if they want to.

Though right now this split is optional, looking forward I suspect it will become a “must do” for many organisations if they are to survive without regulatory sanction.

I would be interested to hear the views of others?

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