By Steven Chai

Beginning in 2012, a specific and impermanent economic crisis in Europe as well as a permanent global new normal will set the tone on how the banking industry and competitive landscape shift takes place.

Despite some differences across business lines, there are common certainties around increased regulations, event-driven volatility and decreasing profitability which will prompt players to rethink their business models, competitive position and the meaning of risk costs.
For the medium term, the year 2012 will likely trigger the beginning of a new landscape formation where old champions fall, new contenders form and new cultures emerge all the while new regional and global plays get dominated by players from the East.

From the global tier one ratio capital requirements, from 4 percent to 9 percent, related to Basel II+ and Basel III will stem a flood of regulations, Dodd-Frank requirements and Volker rule — limitation on prop trading — in the U.S., EBA’s capital requirements for the EU and “ring-fencing” the traditional banking business from risky activities in the U.K. being just few examples.

European Banks will be hit the hardest given its current 200 billion euros plus in capital shortage and the current intermediated market structure — companies go to banks rather than capital markets for financing.

The U.S. banks, despite being better capitalized and therefore in a better position to weather the change, are looking at a decrease in eligible capital by over 35 percent. U.S. banks’ higher levels of activity in investment banking and global market will lead to more exposure to market risks thus higher risk costs.

Banks in Asia Pacific, with the exception of Japan, stand to be least negatively affected. Asia Pacific banks have less exposure to complex high risk activities; they have high levels of deposits and are well capitalized in general.

In the new environment, retail banking will reclaim its role as a foundational element in banking. Having a strong retail platform will be key given the increased value of deposits as stable funding source.

However, this advantage platform will need to be managed well; the regulations will also increase the cost of many retail products, over extended consumer debt in many parts of the world will further increase risk costs and the intensifying competition for retail business will drive margins down.

Corporate banking will lose much of its attractiveness. Business lending will be hit hard by the new capital and liquidity requirements, making it either too expensive for its customers or unprofitable for the banks. Trade finance activities risk-return profile will also be negatively affected. Disintermediation will increase leading to a reduction of traditional commercial banking activities.

The traditional Investment banking — equity capital market, debt capital market, M&A advisory, structured lending — will be less directly affected by Basel III. Increased disintermediation in corporate banking and M&A activity prompted by the volatile economic environment is likely to drive the business volume up on debt capital market and M&A advisory.

On the global market business front — fixed income, commodity, equity trading, the impact of regulations will be the strongest. Higher capital charge on bond trading, higher funding costs on cash equity trading and other cost hikes due to increased risk costs will be the new reality.

All in all, we are looking at an industry which sits at a crossroad. The overall industry growth will slow, the profitability will get squeezed and many event driven crises will have to be managed and endured.

The blurry picture will be skewed toward European banks while banks in Asia Pacific may see room for new growth. Over the next couple of years, banks will need to rethink their business model.

The winners will be banks who are able to go beyond regulation compliance. More than ever, the ability to interpret the business implications of the new regulations and the ability to aspire beyond a rather pessimistic environment will be key differentiating traits of the future champions.

Steven Chai is the managing director of Boston Consulting Group and the co-head of BCG’s Seoul Office.