Industry Financial

Insight: Banking
COURSE TRANSCRIPT

2018
FINLISTICS SOLUTIONS
1. Module 1

Introduction:

Welcome to the Banking Industry Financial Insight course, click on the green button to get started with your learning
objectives.

Course Objectives:

There are three key learning objectives in this course.

First: understand important business and technology trends - selling to executives requires that you know the
important business and technology trends that are transforming their industry. This helps you better develop a
more executive perspective and to articulate the value of your solutions.

Second, each industry has a handful of financial metrics focused on by client executives; knowing these and how
your solutions impact them is a critical part of showing the value of your solutions.

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Finally, it’s important that you not only know the key financial metrics most relevant in the industry, but also the
factors influencing their performance. Understanding these helps you to develop a more holistic view of how your
solutions deliver business outcomes for your clients.

Course Contents:

It’s recommended that you take all modules of the course in the order shown here, but you can always return to
this page to navigate to different modules by clicking on the gray Contents button in the upper right corner from
anywhere in the course.

Also note that this course provides resources for you including industry data, financial metric definitions and
examples, and a transcript of the contents - you can access all of these course assets by clicking on the Resources
button in the upper right corner of the screen at any time. Click on the individual resource documents in the menu
to view and download.

Why Industry Insights?:

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Industry Financial Insights are designed to help you as a seller to better understand the industries you serve. You’ll
explore how an industry operates including how it’s organized, how it makes money, the drivers of growth and
profitability, and the trends and issues that each industry faces. Most importantly, you’ll develop an industry-centric
point of view that you can share with your clients to demonstrate that you understand them and their industry.
This builds personal credibility for you and helps you to have business led conversations with your executive buyers.

Financial Statements:

Let’s get started with a brief introduction to business & technology trends in Banking and the basics of financial
statements.

Business Trends:

How do current business trends affect a bank’s ability to grow and remain profitable? Click on the boxes at right to
explore each trend in more detail - you’ll also be provided with related lines of business and operational benefits for
the trend.

Enhance customer experience - In the face of stiff competition and heightened customer expectations, banks are
increasingly looking at fully embracing digitizing the end-to-end customer experience. While most banks now have

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an online and mobile banking presence, customers are increasingly looking for a seamless experience and real time
responsiveness through the entire cycle of their interaction with the banks. Digitizing only a part of the process, for
example, applying for loan online and not digitizing the subsequent processes, can lead to dissatisfied customers.
More banks are now moving towards digitizing the end-to-end customer journey, which means rethinking the
traditional processes across all functions and adopting more customer-centric design processes through the entire
lifecycle of any transaction.

Develop greater customer insights - Banks are focusing on adapting new technologies like big data and analytics
and finding innovative ways of delivering solutions to provide better customer experience. In the process of
delivering routine services, banks collect huge volumes of customer data, that, when combined with advanced
analytics can provide bankers with enormous intelligence to customize their offerings and also provide new services.
Banks are also leveraging these technologies to identify the most optimum channel of delivery for their solutions.
Other areas include improved fraud detection and enhanced compliance reporting.

Integrated Omni-channel service delivery - With the growth of multiple customer interaction touch points, banks
have had to transform their engagement with their customers, allowing customers to interact with the bank via
multiple channels be it online, mobile or at the physical branch. The primary focus being providing a seamless and
consistent experience across all channels. This not only involves a huge investment in technology, to integrate
backend systems and leverage advanced analytics, but also means rethinking all the traditional processes to move
from a product centric to a customer centric approach.

Branch transformation - With customers increasingly choosing to bank through digital channels, banks are looking
at leveraging technology to keep their branches relevant. As branches are closed to cut down on costs, the existing
ones are being transformed to improve efficiency and offer highly personalized service. This transformation
includes efforts towards simplifying the branch design, integrating new technologies and trying to introduce more
customers to alternative digital delivery channels, all with a focus to attract and retain the digital consumer.

Fintech Collaboration - A significant trend in the industry is that of financial institutions warming up to the concept
of collaboration with tech startups. Faced with the decision to buy or build with respect to digital transformation
initiatives, many banks have chosen to engage with Fintechs who have expertise and a head start in this space, for
example in the area of digital payments. This collaboration is evident in various forms like acquisitions,
partnerships and venture capital funding. For example, U.S bank, J.P Morgan Chase partners with Ondeck, an online
small business lender, to create a new Chase lending product that will provide online small-dollar loans to Chase
clients.

Tech Trends:

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The primary focus of technology trends in Banking is to drive a better customer experience, which drives stronger
revenue growth. Added benefits of many of these technologies are better management of operating expenses
through an improved workforce experience and better operational efficiency. Click on each one of the tech trends
at right to learn how they’re impacting Banking today.

Open APIs - With increasing competition from Fintechs and the ongoing pressure to innovate, banks are gradually
opening up APIs - or Application Program Interface - to outside developers. Open APIs enable banks to integrate
their products and services with third-party applications. This enables them to bring in new revenue streams and
also monetize the vast amounts of customer data collected with fairly reasonable costs, as compared to developing
applications in house. For customers, it means they have access to innovative services from their existing banks at a
reasonable cost.

Cyber Security - With the increase in online and mobile applications in the banking industry, the threat of cyber
attacks has also increased. In addition, regulators now expect multiple layers of security from banks. Accordingly,
banks are increasing their investment in security systems and technologies such as biometric authentication to
ensure protection of systems and customer data.

Blockchain Technology - Banks are exploring distributed ledger technology applications such as blockchain
technologies to improve efficiencies especially in the mid and back office functions. The most common areas being
explored involve cross-border remittances, corporate payments and intra-bank cross-border transfers. The
distributed ledger technology offers benefits such as improved transparency, lower costs, quicker settlement, fewer
errors and enhanced security. Banks are exploring these technologies either by partnering with Fintechs or by
creating their own innovation labs.

Artificial Intelligence (AI) - Banks are exploring advanced technologies in artificial intelligence and cognitive
technologies especially in areas like customer relationship management to accomplish a range of banking tasks.
These technologies not only help to free up employee time and thereby save costs, but also help customers with
many routine tasks. One such example is the use of chatbots which assists customers with transactions like
monitoring accounts, paying bills, making transfers and deposits and providing status updates. Other areas where
AI is being explored include fraud detection, know your customer processes and profile based marketing offers.

Digital Payments - With the proliferation of fintechs in the digital payments space, banks are now pressured to
provide strong payments offerings to their customers. The consumer and retail payments sector has been the
fastest-moving in terms of innovation and adoption of new payment capabilities like mobile wallets, and P2P
payments. Banks are exploring this space either through venture capital investments in fintechs or by developing
these technologies in-house through innovation labs. Note that, with the revised Payment Services Directive
applicable to the payments industry in the European Union, banks now have to facilitate secure access of their
customer accounts to third party apps via API. This step towards open banking poses significant competition as
well as opportunities to explore new payment models.

Public Cloud - Many banks are making a major shift from wanting to own and house sensitive data and workloads
in their own data centers to public cloud services, which enables them to enhance their flexibility and business
agility. Combining big data and the computing power of the cloud allows banks to gain better insights, make faster
decisions, and reduce the time to market for new offerings as they cut down their own infrastructure costs.

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Income Statement:

The income statement of a bank provides invaluable insights into a bank’s ability to grow, manage expenses, and
provide earnings and returns to investors. Its structure starts at the top with interest income from which we
subtract interest expense to get what we call the net interest income. To that, we add non-interest income to arrive
at total income. From total income, we subtract non-interest expenses and the provision for credit losses to get
pretax profit. From there, we deduct income taxes to get to net income, or what’s also referred to as the bottom line.

Let’s look at a brief example of an income statement in Banking and what’s typically included in each line item. Also
provided are the financial metrics that are used to measure performance. After you get comfortable with the
income statement, Modules 2 and 3 will delve into specifics around growth and profitability metrics and what’s
driving them in banking today.

Click on the blue information button to learn more about what’s included in each item.

Interest Income

Interest income is income generated by earning assets such as loans, mortgages, and securities.

Interest Expense

Interest expense is interest that a bank or financial services company pays on liabilities such as interest-bearing
customer deposits, short-term borrowings, and long-term debt.

Net Interest Income

Net interest income is total interest income less the interest expense. Insights into how well net interest income is
managed are provided by measuring period-over-period growth, like for a fiscal year or a quarter. Executives also
reference Net Interest Margin when discussing the performance of their earning assets. Earning assets includes
loans, leases, securities and any other assets that earn interest. Net interest margin is net interest income
expressed as a percentage of earning assets. Net interest margin is influenced by the credit risk of the portfolio of
earning assets. The higher the risk of earning assets the higher tends to be the net interest margin. Other factors
that impact, include, the level of interest rates and a bank’s sources of funding.

Non-interest Income

Non-interest income includes income from service charges, credit card fees, investment and brokerage services,
mortgage and investment banking fees, trading account profits, clearing services and other income producing
activities that do not generate interest income. Like net interest income, measuring period-over-period growth
helps banks assess how well it’s managed.

Total Income

Total income is the sum of net interest income and non-interest income.

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Provision for credit losses

The provision for credit losses is the amount deducted from income that is equal to the amount a bank adjusts its
loan balances to reflect anticipated losses on the credit like loans and leases. The provision for credit losses is
added to the allowance for credit losses, which shows up on the balance sheet. Provision for credit losses is
expressed as a percentage of total income to analyze performance over time and compared to peers. Provision for
credit losses as a percentage of revenue varies by the level of credit risk. For example, banks with more consumer
loans tend to have a higher percentage provision than those with higher quality commercial loans

Non- interest expenses

Non-interest expenses are operating expenses that include salaries and related expenses for full and part-time
employees; benefit expenses like medical, insurance and retirement; Premises & Equipment expense like rent,
utilities, maintenance on buildings, depreciation, and equipment expense on hardware and Other Non-Interest
expense which includes, for example, external payments for marketing and advertising, professional fees,
compliance, telecommunications, brokerage, exchange and clearance fees, and fines. How well a company is
managing non-interest expense is measured by the Cost-to-Income Ratio, also known as the Efficiency Ratio, which
is non-interest expense expressed as a percentage of total income. A common goal is for the cost-to-income ratio to
be 60 percent or lower.

Pre-Tax Profit

Pretax profit is a measure of earnings before taxes; it subtracts the provision for credit losses and non-interest
expense from total income. Executives talk about pretax profits and also pretax profit margin, which is pretax
profits expressed as a percentage of total income

Income Taxes

Income taxes include those taxes paid to domestic and foreign taxing authorities.

Net Income
Net income measures profit remaining after all expenses and income taxes. It is used to in many return measures,
such as return on equity, return on assets, or earnings per share. It is also used to calculate a commonly referenced
measure of profitability, which is net profit margin. Net profit margin is net profit expressed as a percentage of
total income, which again is the sum of net- and non-interest income.

Bank Balance Sheet Assets:

The balance sheet shows a company’s financial position on a given day, for example, the end of the fiscal year or
quarter. It’s comprised of assets that are used to generate revenues and shows how those assets have been
financed through liabilities and equity. Combined with the income statement, the balance sheet provides insight
into a client's utilization of assets and potential areas to explore further. It is called the balance sheet because

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assets have to equal liabilities plus equity.

Now let’s explore the assets section of a bank’s balance sheet. We will examine some of the commonly reported
items on the balance sheet. Click on the blue information button next to each line item for more detail and example
of what’s included in each category.

Cash and due from banks are highly liquid assets that include items like cash on hand and receivables from - or
short-term loans to - other banks and financial institutions.

Interest bearing deposits with banks include time deposits that have a specified date of maturity held with other
banks including the Federal banks.

Securities are assets like government or corporate debt and mortgage-backed securities. They include Trading
securities, which are intended to be sold in the short term, Held-to-maturity securities, which are intended to be
held until the maturity and Available for sale securities, which are not classified as trading securities or held-to-
maturity. Securities play an important role in meeting a minimum level of liquidity required by regulators for banks.
This is called the Liquidity Coverage Ratio. The liquidity coverage ratio is high quality liquid assets like short-term
government debt expressed as a percentage of net cash outflow, like repayment of short-term borrowing less
expected cash inflows, such as, loan repayments. Current regulations require a ratio of at least 100 percent.

Loans and leases include assets such as commercial, industrial and consumer loans and leases, as well as, credit
cards. Executives discuss the composition and growth in loans and leases and also the loan-to-deposit ratio also
referenced as “LTD” ratio. The LTD ratio is used to assess a bank's liquidity and ability to convert deposits into
earning assets. LTD is a bank's total loans and leases expressed as a percentage of total deposits. If the ratio is too
high, it means that the bank may not have enough liquidity to cover any unforeseen fund requirements. If it is too
low, the bank may not be earning as much as it could be.

Allowance for Loans and Lease Losses, also referred to as “A” triple “L”, is a reserve that banks establish in
relation to the estimated credit risk within loans and leases. This credit risk represents the charge-offs that will most
likely be realized against a bank’s profits. Allowance for loans and lease losses is expressed as a percentage of loans
and leases to provide insights into a bank’s management of credit risk. The acceptable percentage varies by type of
credit. For example, a bank with a higher percentage of consumer credit card loans “A triple L” will be higher that a
bank with a higher percentage of lower risk commercial loans.

Loans and leases, net of ALLL are loans and leases less the allowance for loans and leases.

Premises and equipment is the value of physical assets with economic life beyond one year and can include
buildings, office equipment, furniture, information technology hardware, and capitalized leases. The amount shown
on the balance sheet will be net of any accumulated depreciation and amortization.

Goodwill is an intangible asset and is typically created when one company buys another and pays a premium on
top of the actual book value of the company. A bank’s balance sheet may also list intangible assets, examples of
these include the value of a trademark or patent; they’re not physical assets, but they do have value.

Other assets are typically other minor assets that don’t fall under any of the major item headers on the balance
sheet. They can include prepaid expenses, the scrap value of obsolete equipment, and restricted cash or
investments.

Total Assets is the sum of all assets. Insights into how well total assets are managed is provided by the metric
Return On Assets, also referenced as “R” “O” “A.” ROA is net income expressed as a percentage of total assets. A
common benchmark for ROA is 1 percent or higher but this varies by the underlying credit risk of earning assets.

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Bank Balance Sheet Liabilities:

Now let’s explore the liabilities and equity sections of a bank’s balance sheet. Click on the information button next
to each line item for more detail and example of what’s included in each category.

Non-interest bearing Deposits are accounts like checking accounts where no interest is paid. For many banks,
especially those focused on retail customer, these deposits are the largest source of funding. A measure of these
deposits’ performance is the period-over period percentage change.

Interest bearing Deposits are accounts like interest bearing checking, savings, time deposits, and money market
accounts.

Short-term borrowings are securities sold under repurchase agreements and other short-term borrowed funds
with original maturities of less than one year.

Long-term debt is the amount owed beyond one year and includes funding sources like fixed and floating rate
senior notes, as well as, subordinated notes.

Accounts payable and other liabilities are those expected to be paid within the next twelve months and include
items such as salaries payable, payments to vendors, deferred taxes, and payments to regulators.

Total Liabilities is the sum of total deposits, short-term borrowings, long-term debt, and accounts payable and
other liabilities. A measure of a an institution’s financial leverage is the debt to equity ratio which is total liabilities
divided by total shareholder equity. There are more sophisticated measures of a bank’s financial leverage or
capitalization like Tier 1 and Tier 2 capital ratios required by bank regulators.

Total shareholder equity include items such as common stock, retained earnings, and preferred stock. Return On
Equity is one of the most common measures of a bank’s performance. It is net income expressed as a percentage of
total shareholder equity.

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Key Financial Metrics:

Let’s review the financial drivers map for the Banking industry. There are many measures of overall financial
performance including cash flow, return on equity and earnings per share. But regardless of which overall measure
we’re using, performance is driven by the same individual financial metrics. For this course, we’ll focus on two of the
key financial metrics that most bankers are focused on improving, which are total income growth and profitability.

Click on a metric for a brief written description. Industry statistics for each financial metric are included in the
Supplemental Data download in Resources which you can access at the top right of this window.

2. Module 2

Total Income Growth:

Let’s start by reviewing total income growth in Banking.

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Knowledge Test:

Let’s start this module off with a quick knowledge check: A national bank reports declining net interest income but
earnings assets increased. Is this possible?

Correct! Net interest income is the volume of earning asset times the net interest margin. For example, one million
in earning assets times a 3 percent net interest margin results in thirty thousand in net interest income. If earning
assets grow to 1.1 million but net interest margin falls to 2.5%, then net interest income declines to $27,500.

Module Objectives:

In this module, we’ll first review performance drivers - or the factors that commonly affect growth in Banking; we’ll
then compare & contrast the trends in total income growth for five sub-industries; that’s followed by the business
processes or lines of business that can impact & support growth in Banking; and finally, we’ll close out the module
with a quiz to test what you’ve learned.

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Growth Drivers:

Click each driver to learn more and understand how it impacts total income growth in banking - keep clicking until
you’ve reviewed them all.

Net interest income is directly affected by the volume of the earning assets which are loans and securities.
Typically loans grow during economic expansions and decrease during economic slow downs. For example, loans
for US banks declined approximately 8 percent in 2009 during the global financial crises. In more recent times, loan
growth has been more in the range of 4 to 8 percent.

The net interest margin is a crucial driver of net interest income. It’s net interest income expressed as a
percentage of average earning assets. Over the last few years net interest margin has averaged between
approximately 3.25 percent to 3.50 percent. Net interest margin is driven by economic growth, which in turn
impacts demand for loans and interest rates. Net interest margin also reflects the risk of a bank’s earning assets.
The higher the risk, the higher the net interest margin to compensate for the risk. For example, Bank of America’s
Consumer Banking segment earned a net interest margin of 3.54% in 2017, which was higher compared to it’s
Global Corporate and Commercial Banking segment, which earned a net interest margin of 2.93%.This reflects the
higher risk in consumer banking operations compared to commercial and corporate banking. It’s also important to
note that since the financial crisis in 2008, net interest margin has been low compared to historical standards. This
is due in part to central banks in the US and Europe engaging in monetary easing, which lowered interest rates. As
interest rates move up, as is the trend in the U.S, net interest margin too is expected to grow.

A bank’s revenue is tied directly to the business or the economic cycle which determines how much businesses are
spending and borrowing. In a recessionary environment, borrowers are not keen on investing in their businesses
and hence borrowing declines. Banks too become wary of the quality of loans, and limit lending to only high
performing loans

Fluctuations in exchange rates can have a direct impact on a banks net inflows. Banks which hold assets in
foreign currency or have operations in international markets are exposed directly to the risk of the foreign currency
fluctuating versus its domestic currency. Such risks are most often hedged by banks, to reduce its negative impact.

Regulatory requirements like Basel III require banks to keep more capital and liquidity. This directly impacts the
volume of credit lending by banks and has also restricted them from offering certain products and services.

One of the most important things when looking at differences in total income growth over time and across
companies is understanding the difference in their service mix. If a company has new and innovative services that
are drawing in new customers and growing their market share, these high-growth services will likely contribute to
higher total income levels.

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Growth Trends:

Let’s look at performance by sub-industry for total income growth, using the five-year growth trend for each of the
sub industries of Asia Pacific, Europe, North America, Middle East and Africa, and South America. Overall economic
activity is an important consideration. Note that Europe has the lowest income growth trend; many countries in this
region are still grappling with an unstable political and economic environment, which means that economic
recovery has been slow and challenging. The annual real GDP growth rate for the European Union for the last five
years has been less than 2%. This slow economic activity directly impacts bank lending as investment activity slows
down. Persistent low interest rates have also impacted banks net interest margin in this region. Banks in some of
the regions like Italy and France, are also still grappling with past-due and delinquent loans which makes it harder
for such banks to lend more money.

Looking at North America, we see an upward trending growth rate reflecting a lot of positive factors for the industry,
like the steady recovery in the economy which has fueled growth in lending volumes, improvement in the net
interest margin as a result of the recent hikes in the interest rates, stronger balance sheets and low loan loss rates.

Asia Pacific and the Middle East & Africa have experienced stronger economic activity, leading to higher growth
rates. GDP growth rates in many countries in these regions, though declining, are still at mid single digits.

Finally, South America’s rate of growth is the highest. Though lending activity has been impacted by recessionary
conditions in certain key countries, lending volumes are still positive in many others. Another key factor to be
considered in this region is inflation. As interest rates increase as a result of inflation, growth also increases, even
though it may not be backed by higher volume.

Industry growth trends for net interest income and non-interest income are included in the Supplemental Data
download in Resources which you can access at the top right of this window.

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Growth Business Processes:

Click on each box at right to explore how each business process or line of business supports and affects total
income growth in Banking.

Sales and Marketing - Every financial institution needs to generate a steady stream of new customers, but one of
the most common approach to acquire new business and related revenue for a bank is to reach out to current
customers for additional business. This is commonly referred to as cross-selling and up-selling. Banks are
continuously evaluating opportunities to improve cross-selling by leveraging online and offline channels, rewarding
customer loyalty, empowering customer facing employees and promoting referral programs.

Customer Service - The quality and consistency of a Bank’s customer service function across the entire customer
journey can have an impact on revenue, especially in an age when feedback from customers is real-time and shared
across multiple platforms. A bad customer service experience can go viral in an instant and hurt revenue growth; at
the same time, good customer experiences that are shared can have a positive impact and boost revenues.

Credit Extension is the primary function of banking. There are multiple types of credit offered by banks ranging
from banks loans, overdraft, credit cards, vehicle finance, and home loans. Whom to lend and how much to lend is
often determined by the risk appetite of the bank and the economic environment in which the bank operates
among other factors.

Product development would include upgrading of existing products and introducing new products for the customer.
In the new world of banking, product development has become the engine for revenue growth. Significant focus is
on exploring new technologies to digitize the customer experience. Speed in product development is critical and it
allows banks to take advantage of new revenue opportunities.

Regulatory Compliance - Banks in the last few years have been significantly affected by the regulatory environment.
These regulations have become expensive in terms of compliance, but at the same time it has also limited growth
by increasing capital ratio requirements and limiting certain products or activities. Also, banks are now more risk
averse and prefer to limit growth than venture into risky activities to increase revenues.

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3. Module 3

Profitability:

Let’s explore profitability metrics in Banking.

(True/False, 10 points, 1 attempt permitted)

Knowledge Test:

Let start this module off with a quick knowledge check: Typically, an increase in compliance cost increases the cost
to income ratio, all else remaining the same - true or false?

Select your answer below and click on the Submit button to see if you’re right.

True: Correct! Compliance costs are a part of the non-interest expense of a Bank. Increase in the compliance costs,
with total income staying stable, will increase the cost to income ratio, also called the efficiency ratio.

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Module Objectives:

In this module, we’ll first review performance drivers - or the factors that commonly affect profitability in Banking;
we’ll then compare & contrast the trends in profitability for the five sub-industries; that’s followed by the business
processes or lines of business that can impact and support profitability in Banking; and finally, we’ll close out the
module with a quiz to test what you’ve learned.

Profitability Drivers:

Click each driver to learn more and understand how it impacts profitability in banking - keep clicking until you’ve
reviewed them all.

Service mix is a key driver of profitability. Different products and services require different types and amounts of
resources. For example, the consumer and business banking division of a bank usually has a much higher cost to
income ratio compared to say, the commercial banking division of a bank. For example, for a large UK bank, the
pre-tax profit margin for retail banking and wealth management is in the mid-twenties, commercial banking in the
mid-forties; and private banking in the mid-teens.

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Credit risk can have a direct impact on profitability. The higher the credit risk, the higher the provision for credit
losses which by itself lowers profitability. However, the higher credit risk ideally is compensated for by a higher net
interest margin.

Regulatory compliance costs have increased significantly for many banks after the 2007 - 2008 financial crisis.
There has been increase in various regulatory fees, as well as, administering stress tests to prove the bank’s
financial viability. The impact of tighter regulations on profitability depends on the bank’s ability to pass the higher
costs along to its customers.

The pricing strategy can be a key factor impacting profitability. A “low price, go for volume” strategy, for example,
may increase the cost to income ratio and in turn, decrease pretax profitability. Lower prices tend to lower
profitability, but it may not impair overall financial performance if it is made up in volume. It may also lower other
non-interest expense as a percentage of revenue by leveraging fixed costs on higher volume.

A bank’s business model can have a significant impact on profitability. Bank’s with an extensive branch network
tend to have higher costs than those pursuing a more virtual banking model.

Profitability Trends:

Let’s look at performance by sub‐industry for pre-tax profit margin over the last five years for each of the
sub‐industries. We see clear upward trends for Europe and also North America. Middle East and Africa profit
margins have been the highest in the industry, Asia Pacific and South America trends have been fairly consistent
over the years.

Europe and North America have had the most significant improvement to the pretax profit margin, from five years
ago, this change has been primarily driven by improvement to the provision for credit losses as pressures from the
financial crisis have eased and levels of the credit loss provisions are returning to more historical norms. An
improvement in cost to income ratio has also contributed in these two regions, but to a lesser extent. North
American banks especially, do not have the big legal bills that they incurred just after the recession.

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Provision for loan loss trends:

Let’s look at performance by region for provision for credit losses over the last five years.

Let’s look at the regions with the highest and lowest provision rates. The provisions are the lowest for North
America averaging about 3.2% and the highest for South America, averaging about 15%. Most banks in North
America have strengthened their balance sheets since the financial crisis. Also, regulations have tended to limit
banks’ risk taking appetite. The slight increase in the last two years can be attributed to an increase in the volume of
lending in most banks.

In the case of South America, the continuing sluggish economic environment has weakened the quality of the banks
assets reflecting the deteriorating trend.

The other region with a significant trend to note, is Europe. We see that it’s improved over the last three years and
this is line with many banks that have strengthened their balance sheets as economies are recovering from the
recession in most countries.

CII Trends:

Let’s look at performance by region for the cost-to-income ratio, also called the efficiency ratio. The largest
component of total operating costs for a bank is usually the salaries and incentive compensation paid to executives
and employees. We see that North America has the highest efficiency ratio compared to other regions. This can be
explained by the relatively higher salaries and incentive compensation paid to bank executives. Middle East and

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Africa on the other hand, has lower employee compensation expense, which is reflected in their low efficiency ratio.
Immediately below North America is Europe, which again has relatively higher salaries and compensation.

It’s interesting to note here, that though North America has the highest cost to income ratio, it’s reflecting a
generally downward trend. This can be explained by the fact that most banks are rightsizing their businesses,
optimizing their branch networks, and using technologies to replace manual processes. Also, North American banks
have moved on from the high legal bills that they had incurred post recession. One reason why these cost reduction
activities have not fully benefited the efficiency ratio, is because it has been offset in part by higher compliance
costs burden faced by these banks post the financial crisis.

Profitability Business Processes:

Click on each box at right to explore how each business process or line of business supports and affects profitability
in Banking.

Enterprise Risk Management as a function gained immense importance after the financial crisis, and banks have
invested heavily into the function to meet with the regulatory needs and also to be able to scale down on risk
associated with their operations. An effective risk management function can ensure that banks keep their
provisions for credit losses and other kinds of risks low, to avoid huge charges on profitability.

Credit Extension - though a credit risk is generated as soon as a loan is extended, bankers use multiple credit
monitoring tools to keep provisions low. Bad lending decisions or risky lending decisions can raise the provision for
loan losses.

Branch management which is a crucial function in banking has gone through tremendous transformation in the
recent years primarily to cater to the digital expectations of their customers. Operating branches in itself is a huge
fixed cost for banks, and many banks have optimized their branch network to reduce these fixed costs as they
migrate customers to digital channels. For existing branches, focus is on lighter and simpler formats with an eye to
both reducing costs and improving the customer experience.

Information Technology has become a key function in the banking industry in the wave of the digital revolution.
Banks are keen on digitizing the end to end customer journey to win more customers and improve retention. The
IT’s role within this industry has transformed from one that supports operations to one that is leading the change
into the new world of digital banking. As banks have become more conscious of their profitability, and are cutting
down non-interest expenses, IT cost is something banks are willing to bear and even increase, as banks cannot
afford to ignore this function in the wake of intense competition from other banks and Fintechs.

Increasing regulations on the financial sector has a direct impact on profitability, from more resources allocated to

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dealing with regulatory matters to costs attached with penalties, fines and legal fees for non-compliance. Regulatory
compliance has become a key function after the financial crisis, and banks continue to invest in this function to be
able to keep pace with the dynamic regulatory environment.
Customer Service - has become a crucial function in providing customers a seamless banking experience. Banks are
investing heavily in this function to provide service via multiple touch points, be it mobile, phone, email or a
traditional branch visit. An effective customer service function can play a direct role in improving customer
retention.

Mid-Back Office - While banks have been quick at transforming their customer facing functions, many activities
within the mid and back office functions still continue to rely on people and paper. This causes inefficiencies and
impacts costs. Banks which have automated their mid and back office functions have lowered their operating
expenses and are better equipped to respond to the changing market dynamics.

Thank you

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