Introduction

The last two years in retail banking have been turbulent times to say the least, particularly in the United States and Europe. Banks have been taken over by governments, government "rescue" loans or had to raise money from the markets to stay afloat. Some have even gone out of business. After enjoying unprecedented growth from 2001 to 2007, led by the booming mortgage market, growth in mortgage revenue came to an abrupt halt in 2008 as high-risk borrowers in the sub-prime market defaulted on their mortgages. The excellent 2009 World Retail Banking survey of 203 retail banks in 26 countries1 provides insight into what is happening in the retail banking industry. The survey looks at two main areas: mortgage profitability and bank charges (prices) for day-to-day banking services –two key sources of revenue in retail banking.

The Mortgage Crisis

In the area of mortgages, banks switched from lending out of their own deposits, to a credit model of operating whereby mortgage lending uses funds borrowed from the capital markets. Having access to these markets meant banks had much more capital available to lend than if they were dependent just on deposits alone. It is not surprising that fierce competition broke out among retail banks all pursuing aggressive mortgage revenue growth by marketing heavily to a wider prospect base while continuing to drop mortgage interest rates. The result was less and less mortgage unit profitability compensated by growth in volume of mortgages sold. Lowering interest rates made the cost of borrowing more affordable and attracted more borrowers. However more aggressive marketing - coupled with many retail banks having only product-level risk management systems, as opposed to a single view of customer level risk - meant that it was inevitable that higher risk customer acquisition occurred. In addition mortgages were bought on the markets, thereby expanding the global customer base. The moment the sub-prime mortgage market crashed, any bank operating a mortgage book based on a credit model found themselves facing rocketing cost of funds in the markets. This left some banks short of operating capital and with an increasingly less profitable mortgage book. In addition the threat of higher risk continued to rise. Many have even resorted to borrowing directly from the public by offering bonds at a lower rate than the markets in order to reduce cost of funds.

The World Retail Banking survey found that, despite reducing costs and generating revenue through other initiatives, retail banks could still not compensate for the reduction net banking income caused by mortgage interest rates being lowered to compete more aggressively in the market.