Banking revolution: The change is here IF CORRESPONDENT

The US banking industry, real estate appeared to be unstoppable at the beginning of the 2000s, and a euphoric price run-up encouraged consumers, banks, and investors to take on more debt. Exotic financial products drew investors from all over the world but instead of diffusing the risks they exacerbated and concealed them. When US home values started to fall in 2007, there were cracks that eventually led to the failure of two sizable hedge funds that were heavily invested in subprime mortgage instruments. However, when 2008's summer came to an end, few people could have predicted that Lehman Brothers was going to fail, much less that it would trigger a global liquidity crisis. The damage ultimately sparked the first worldwide recession since World War II and laid the groundwork for the eurozone's sovereign debt crisis. Millions of households lost their jobs, their homes, and their savings.

Following the 2008 crisis, central banks, regulators, and decision-makers were compelled to adopt exceptional measures. As a result, banks are now more capitalized, and the global financial system is experiencing less money sloshing. But new threats have also developed, as well as some old ones. The article will draw on ten years of financial markets research to examine what has changed and what hasn't happened in the banking sector since the crisis.

Banks are safer but less profitable

Following the crisis, authorities and policymakers all around the world took action to fortify banks against potential shocks. For US and European banks, the average Tier1 capital ratio increased from less than 4% in 2007 to more than 15% in 2017. According to Jerome Powell, all banks now keep a minimum level of liquid assets. He stated that the largest systemically significant financial institutions must hold an additional capital buffer.

Scaled back risk and return

Most of the biggest international banks have scaled back their trading activity during the last ten years, including proprietary trading for their own accounts, which has decreased risk exposure. However, despite the extremely low-interest rates and new regulatory frameworks, many banks with headquarters in industrialized economies have been unable to develop new, viable business models. Since the crisis, the return on equity (ROE) for banks in advanced economies has decreased by more than half. For European banks, the pressure has been the strongest. They had an average ROE of 4.4% over the previous five years as opposed to US banks' 8%

Banks are only modestly valued above the book value of their assets by investors, who have a pessimistic view of growth prospects. The priceto-book ratio of banks in advanced nations was at or slightly below 2 % before the crisis, reflecting expectations of rapid development. However, most advanced economy banks have had average price-to-book ratios of less than one since 2008. (including 75 % of EU banks, 62 % of Japanese banks, and 86 % of UK banks). Nonperforming loans are a burden on the banking system in several emerging economies. More than 9 % of all loans in India are non-performing. The recent currency decline in Turkey may increase the number of defaults.

In the post-crisis era, the best-performing banks have been those that have drastically reduced operational expenses while also hiring more risk-management and compliance personnel. In general, US banks have reduced more drastically than their European counterparts. But unless the sector revives revenue growth, banking might turn into a lowmargin, commoditized enterprise. The industry's average annual global revenue growth from 2012 to 2017 was only 2.4 %, a sharp decline from the euphoric pre-crisis years of 12.3 %

Digital disruption

New digital players are posing a threat to established banks, just like they are to incumbents in every other industry. Platform firms like Alibaba, Amazon, Facebook, and Tencent threaten to snatch up some market share; this is already happening in the world of mobile and digital payments. According to predictions made by McKinsey's Banking Practice, the banking sector's ROE might reach 9.3% in 2025 as interest rates rise and other favorable factors come into play. However, if retail and business consumers transfer to digital providers at the same rate that people have in the past for new technologies, the industry's ROE may decline much lower.

However, technology threatens more than just banks. It might also provide them with the boost in productivity they require. For increased efficiency, several institutions have already begun to digitize their consumer-facing and back-office activities. They can also improve how they employ big data, analytics, and artificial intelligence in risk modelling and underwriting. By doing this, they may be able to avoid the kinds of bets that went wrong during the 2008 financial crisis and increase profitability.

Global banks retrench

Banks in the Eurozone have taken the lead in this decline in global activity by becoming more regional and less national. Since 2007, their total foreign debts and other claims have decreased by $6.1 trillion, or 38%. Reduced intraeurozone borrowing accounts for about half of the drop (and especially inter-bank lending). German banks, for example, had two-thirds of their assets located outside of Germany in 2007, but that number has since dropped to one-third.

The amount of business conducted abroad has decreased for some US, Swiss, and UK institutions. Since the financial crisis, banks have sold more than $2 trillion worth of assets worldwide. Global banks' cutbacks are a result of a number of factors, including a new assessment of country risk, the realization that doing business abroad is frequently less profitable than doing business at home, national lending policies that favor domestic lending, and new capital and liquidity regulations.

The biggest international banks have also reduced their correspondent links with local banks abroad, particularly in emerging nations. Banks can conduct different types of business in nations where they do not have their own branch operations because of these connections. These services have been crucial for remittances, trade financing, and providing underdeveloped nations with access to valuable currencies. However, due in large part to a new evaluation of risks and regulatory complexity, global banks have begun adopting a tougher cost-benefit analysis of these connections.

Ten years after the credit crunch

• £115bn total fines global banking group has paid out in the US

• £200bn unsecured household debt of June 2017

• £137bn bail out cost for the UK banking industry in 2008/09

• Increase in tier 1 capital held by UK banks now (compared to 2006): 244%

• The rise in London house prices (compared to March 2007): 78%

A few banks, most notably those from China, Japan, and Canada, are diversifying their international operations. Due to the saturation of their domestic market, Canadian banks have expanded into the United States and other markets in the Americas. Japanese banks are expanding their footprint in Southeast Asia and increasing syndicated lending to US corporations, albeit as modest investors. Banks in China are increasing their loans internationally. They used to have almost no overseas assets, but today they have more than $1 trillion. The majority of China's loans go toward supporting Chinese companies' outbound foreign direct investment (FDI).

FDI is now a larger share of capital

From a peak of $3.2 trillion in 2007 to $1.6 trillion in 2017, global FDI has decreased, but this decline is less dramatic than the decline in cross-border financing. In addition to reflecting a substantial fall in cross-border investment in the eurozone, it also represents a decline in the number of firms using low-tax financial hubs. However, FDI accounts for 50% of crossborder capital flows in the postcrisis period, up from the average quarter before the crisis. Contrary to short-term funding, FDI shows enterprises adopting long-term business expansion initiatives. It is unquestionably the least erratic form of money movement.

According to Ben Bernanke, the "global savings glut" produced by China and other nations with sizable current account surpluses is what is causing interest rates to drop and the real estate bubble to expand. Interest rates were pushed lower because a large portion of this capital surplus was invested in US Treasuries and other government bonds. The result was a reallocation of portfolios and ultimately a credit bubble. This pressure has now decreased, along with the danger that unexpected withdrawals of foreign cash will plunge nations into crisis.

The reductions in China's current account surplus and the US deficit are the most notable improvements. China's surplus peaked in 2007 at 9.9% of GDP but has since dropped to just 1.45 of GDP. The US deficit peaked at 5.9% of GDP in 2006, but by 2017, it had dropped to 2.4%. Large deficits have similarly decreased in Spain and the UK. There are still some imbalances. The previous ten years have seen Germany maintain a sizable surplus, while certain emerging nations, such as Argentina and Turkey, have deficits that put them at risk.

Corporate debt danger

There is a risk associated with the increase of corporate debt in developing nations, especially if interest rates rise and the debt is issued in foreign currencies. Companies may become trapped in a vicious cycle that makes it impossible to repay or refinance their debt if the local currency depreciates. At the time of writing, a sharp depreciation in the Turkish currency is causing market tremors that expose international and EU banks.

Credit quality has decreased as the market for corporate bonds has expanded. Non-Investment grade "junk" bonds have seen significant growth. Even investment-grade quality is no longer acceptable. 40% of the country's outstanding corporate bonds have BBB ratings, which are one step above trash status. We estimate that 25% of corporate issuers in emerging markets are already at risk of default; if interest rates increase by 200 basis points, that percentage may increase to 40%

A record number of corporate bonds will mature globally during the following five years, and there will be a $1.6 trillion to $2.1 trillion yearly requirement for refinancing. It is reasonable to anticipate more defaults in the years to come given that interest rates are rising and some borrowers already have precarious financial situations. The significant increase in collateralized loan commitments is another issue that merits close attention. These instruments, which are related to the collateralized debt obligations that were popular before the crisis, use loans to businesses with poor credit ratings as collateral.

Mortgage risk

One of the lessons from 2008 is how challenging it is to spot a bubble as it inflates. Real estate prices have increased dramatically since the financial crisis in highdemand real estate areas including San Francisco, Shanghai, and Sydney. Contrary to 2007, these run-ups are typically confined, and crashes are less likely to result in widespread collateral damage. But sky-high urban housing costs are also a factor in other problems, such as a lack of affordable housing options, financial strain on families, restricted mobility, and rising wealth disparity. editor@ifinancemag.com