In order for any business to be successful there has to be a strong business model. Love them or hate them, banks — thus far — have clearly had a strong business model. But as laws and regulations change, it’s time for U.S. banks to take a second look at their foundations.

If customer dissatisfaction wasn’t enough for these banks to rethink their business model, three big factors weighing on the way they conduct business may be the catalyst needed for a change.

When you look at a company’s business model it’s important to see how the company operates from the outside in. How do they price products, compensate employee,s and ensure strong profits? One of the most important parts of running a business is keeping investors happy.

A prominent figure that everyone looks at is the average return on equity or ROE. With banks’ ROEs projected to fall 4% to 7% by 2015.

McKinsey Quarterly, a business journal focusing on the management in the private, public, and nonprofit sectors, recently released a story on the subject. According to the quarterly review, although Europe’s sovereign-debt crises has had a negative impact on our country, and the banking system in general, there are three additional factors that are worrying investors.

Basel III

The Basel III international-banking regulations are not as often spoken about as some of the more hard hitting regulations of 2010, but they are still important nonetheless.

As a quick overview, Basel III basically makes sure banks have stable capital requirements and introduces regulations on their liquidity and leverage. The reason this is a threat to investors is these regulations may cause the ROE of certain banks to decrease by five percentage points.

According to McKinsey Quarterly, “While the details are still being determined, we estimate that the U.S. banking system will need an additional $500 billion in retained earnings or new equity to meet the new capital adequacy standards (assuming the current asset level and mix).”

Prolonged Deleveraging of Consumers

Banks aren’t the only ones who have seen some tough times over the past few years, consumers have been struggling as well. In fact, consumers have of course been hit the hardest by the recession causing many to take out loans and go into debt in order to save their struggling businesses.

Many things lead to a recession, one of them being excessive borrowing by customers. History has shown that it often takes up to 8 years to repay these debts. Considering we are only three years out of the recession, there isn’t going to be relief anytime soon.

The problem with this is: banks are pulling in revenue on consumer credit at a higher percentage then their longer-term average — weakening their overall outlook.

Dodd-Frank Act

Ah, the good ol’ Dodd-Frank Act, created to tighten regulations on banks and instead leaving the customer to deal with the consequences. One of the biggest regulations coming out of the Dodd-Frank act was a cap on debit card swipe fees, cutting bank profits by a proposed $1.55 Billion in just the fourth quarter alone.

The banks chose to retaliate against consumers killing their free checking programs and even trying to charge a debit card usage fee. Either way, these new regulations have been causing bank profits to plummet and banks have chosen to take it out on their customers.

What to do?

Yes, banks are still doing absurdly well considering the struggle many businesses and consumers are currently facing. But, if banks want to continue to do well and maintain customer loyalty — something that is currently wavering — they need to make some big changes to their business model.

First, they have to completely rebuild their four core services:

  • retail branch banking – due to the shift towards online and mobile banking the cost of serving a customer in a branch is said to fall by one-third
  • payments –  going along with the capped fees on payments banks have been forced to look for other ways to make revenue
  • mortgages – the inability for banks to offer attractive rates is costing them potential customers
  • fixed-income over-the-counter trading – banks have had to move their over-the-counter trading to clearing houses making trading procedures more pricey and complicated

Changing a 100+ year old business model is no easy undertaking, but the shifting regulations and consumer relationship to banks is a clear indicator that something needs to be done. We’ve already told the banks where they need to focus, now they just have to go ahead and make the change.

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  • Anonymous

    Low rates are at an all time low. It’s not the rate that is the issue. People actually have to qualify for a loan and some banks have gone too far in the qualification process. It’s making it extremely difficult, even for qualified borrowers to get through the process easily.