state of the financial service industry

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State o the FinancialServices Industry | 2009


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About this report

Oliver Wymans annual State o the Financial Services Industry report reviews the industrys perormance and providessenior stakeholders with key insights or success.

Our ndings are supported by Oliver Wymans deep nancial services expertise and a number o proprietaryanalyses, including:

An objective ranking o the worlds largest 400 quoted nancial services rms based upon our ShareholderPerormance IndexSM (SPI)

Projected industry value growth and top management priorities or the coming year rom our annual CEO Survey

Note: Many o the names in this report are current and previous Oliver Wyman clients. Any statements pertaining to suchclients have been derived rom publicly available inormation.


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Financialservices

2009

In the aftermath of the crisis, the industry is in a punctuated

equilibrium accompanied by selective extinction of many participants

and rapid evolution of the survivors in the new eco-system

State o the Financial Services Industry | Page 1

Executive Summary

2008 was an annus horribilis or nancial services. The crisis that started with the

credit downturn in late 2007 was amplied and spread via a dramatic reduction

o liquidity, causing a series o bank ailures and unprecedented government

intervention, particularly in the ourth quarter o the year. The outlook or 2009 issimilarly bleak, with industry protability and asset quality challenged by a global

macroeconomic slowdown and erosion o investor and consumer condence.

What happened in 2008 and the resulting changes to nancial services was akin

to a punctuated equilibrium, a rare evolutionary state caused by a catastrophic event

(e.g. a meteor, or in this case, concurrent crises in credit, liquidity and capital),

and accompanied by the selective extinction o many participants and the rapid

evolution o the survivors in a new eco-system. As it emerges in 2009, the new

nancial services eco-system will be governed both by new evolutionary orces set

in motion during the crisis, and by the more traditional macroeconomic cycle actors

that have aected it in the past.

Our 12th annual report attempts to provide broad cross-nancial services

perspectives as well as tactical and strategic insights or survivors.

Chronicling the crises

Oliver Wyman analysis reveals three successive and related blows to the

industry: the rst shock in August 2007 hit the assets side o the industry through

sub-prime credit losses; while the second and third shocks hit the liabilities

side in 2008, as continuous write-os eroded capital bases and increased risk o

insolvency reduced liquidity

The eect o these shocks has been catastrophic: The nancial services industry

lost 51% o its total market capitalization in 2008, eroding all shareholder value

created since 2003. And we believe the turmoil will continue over the long term:

Respondents to our annual Oliver Wyman CEO Survey indicate that on average

their expectations or the long-term steady-state annual growth rate in market

value has reduced by almost 40%, rom >12% to 7.5%, highlighting the longer-


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Page 2 | State o the Financial Services Industry

term need or individual rms to take share rom competitors to grow, rather

than growing with the market. Indeed, more than 75% o CEOs surveyed do not

expect a recovery in credit and equity markets until 2010, with hal not expecting

a recovery o macroeconomic conditions to pre-crisis levels beore 2011

Universal banking emerged as one o the most resilient business models, and

these institutions acquired ailed peers and solidied dominance during the rst

and second waves o the crisis. For example, the deposit share o the three largest

US universal banks (Bank o America, JP Morgan and Wells Fargo) increased rom

23% in 2007 to 33% in the immediate atermath o the crisis

The wealth management sector, including asset management and private

banking, struggled due to a new phenomenon we term structural substitution: a

sustained shit in investment preerences towards cash products (e.g. government

bonds and bank deposits) due to push rom banks eager to increase deposit

unding, and pull rom investors unable to re-allocate back to corporate securities

due to developed market demographics

Selective extinction

Funding mix prior to the crisis emerged as one o the most critical determinants

or survival: Banks with a solid unding base (dened as customer deposits,

long-term debt and equity capital) perormed better on average than those that

relied on short-term unding options. In our sample o selected global banks in

developed markets, 80% o banks with a Solid Funding Ratio before-crisis above

0.65 outperormed the industry average after-crisis, whereas all banks below 0.65

underperormed signicantly

Oliver Wyman analysis indicates that the surviving business models are evolving

rapidly, with consolidation o banks into larger universals, development o new

channels or deposits (direct and wealth-oriented platorms), and the prolieration

o multi-branded and segment-ocused models arising rom the spike in M&A

Continuing vulnerabilities and investor skepticism will motivate all survivors to

build resilience through uture-proong: including upgrading risk-capabilities;

right-risking; re-trenching to core businesses; and diversiying

Dont throw the baby out with the bath water: As they uture-proo, rms should

take care to distinguish between the ailure o specic business practices and the

ailure o individual rms that eatured those practices. Some worthy innovations

pulled down by poor unding models are worth saving, notably: the customer-centric distribution model o real-estate heavy banks; the originate-to-distribute

model o credit monolines; and the risk-taking principal nance model o bulge-

bracket independent investment banks in the US


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Preparing or rapid evolution

At least ve sources o rapid evolutionary stimuli will drive changes to the

industry going orward: accelerated M&A driving scale and increased requency

o multi-branded models; shrinkage o capital markets driving risk-sharing and

cascading sophistication; investor skepticism driving restructuring, deceleration

driving increased pursuit o wallet share; and the threat o re-regulation drivinginvestment into risk, nance, and systems

The scale and duration o this crisis has moved risk to center-stage and leading

institutions will intensiy eorts to build advanced risk capabilities and upgrade

the role o the chie risk ocer (CRO)

Our annual CEO Survey o short- and long-term priorities aected by the crisis

indicated that over 50% o respondents saw growth in risk management in the

short term as a shit in priority. Long term, CEOs see a nearly equal division

among risk management, strategic planning, and human capital

The atermath o the crisis will be accompanied by severe changes in centers ogravity across the dimensions o human capital, product/segment, channel, and

organization

The new eco-system

Industry structure will be very strongly infuenced by those governments who

have become major suppliers o capital to the industry

Our analysis o previous nationalization o banks reveals that temporary

nationalization can aid the sector, but does not necessarily result in a ull return

to private ownership

Our analysis indicates that even in the most optimistic scenario the industry will

continue to de-leverage through 2010, and the most pessimistic scenario indicates

de-leveraging lasting beyond 2012

By analyzing the most resilient business models we have identied critical success

DNA that exhibit what we call the 7Cs or success: cash/capital; conservatism;

closeness; convergence; consolidation; cost consciousness; and communication


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Ofcial sector developments

The ocus o the ocial sector 1 in 2009 will move rom re-ghting to re-prevention,

via re-regulation o the industry to reduce the likelihood o ailures, restore

condence and transparency to the nancial system and contain systemic risk in

global nancial markets. Institutionalization o industry support schemes will be

another priority to increase their sustainability and reduce drag on taxpayer unds

The biggest challenge or the ocial sector during 2009 will be to re-establish

global regulatory coordination, which has been threatened by increasing

prominence o national governments

Continued de-regulation during a period o unprecedented macroeconomic stability

has been among the many actors criticized or not preparing or evolving the

industry to prevent the recent crisis. Terrible though the cost o the current crisis

may be, we believe that a punctuated equilibrium unreezes much o our industryand presents a unique opportunity to the industry and ocial sector to re-shape the

landscape or both resilience and better long-term outcomes or all stakeholders.

Oliver Wyman SPI leaders

5-Year SPI Large Cap QBE Insurance Australia

5-Year SPI Mid Cap BEKB | BCBE Switzerland

Ater-Crisis SPI Large Cap Chubb US

Ater-Crisis SPI Mid Cap Capital Federal Financial US

1 Ocial sector includes entities with a regulatory/supervisory role in the unctioning o the nancial services industry,including governments, central banks, treasury departments, dedicated industry regulators, and other public agencieswith supervisory roles such as deposit insurance corporations


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Chronicling the crises

2008 was a disastrous year or the nancial

services industry globally, with extreme levels

o volatility across all markets and the largest

shareholder value loss observed or at least a

generation. The nancial services industry lost

51% o its total market capitalization, eroding all

shareholder value created since June 2003.

Financial services industry market valueExhibit 1:

0

2

4

6

8

10

12

2002 2003 2004 2005 2006 2007 2008

Market value US$TN

51% drop

in 2008

Source: Datastream and Oliver Wyman analysis

The crisis will have a lasting eect on the

industry beyond 2009: our annual CEO Survey1

indicates that CEOs expectations or the

long-term steady-state annual growth ratein market value have reduced by almost 40%,

rom >12% to 7.5%. More than three quarters

o CEOs do not expect a recovery in credit and

equity markets until 2010, with hal o them

not expecting a recovery o macroeconomic

conditions to pre-crisis levels beore 2011.

In last years report, we predicted a volatile

2008. In retrospect, the credit crisis o 2007 was

tantamount to a meteor crash. The ensuing dust

storm created two additional concurrent crises

in 2008, lack o capital and lack o liquidity,

triggering a re-assessment o the industrys

capability to absorb and intermediate risk.

1 Oliver Wymans annual CEO Survey gathered expectations or 2009 rom CEOs o 80 major nancial services institutions globally,representing nearly US$1 TN in combined market value

This dust storm spread globally through inter-

connected capital markets and undamentally

altered the industry eco-system, its centers o

gravity, and the ate o its participants.

Consistent with previous banking crises, the

meteor rst hit the assets side o the industrythrough sub-prime credit losses in 2007. In

2008, its impact spread to the liability side, as

continuous write-os eroded capital bases,

and increased risk o insolvency reduced

borrowing ability, even or shorter durations.

Subsequent actors exacerbated the impact

o the meteor, or example: increased pro-

cyclicality through second order eects o

regulation, such as mark-to-market accounting

and the reserving requirements o Sarbanes-

Oxley. The lack o transparency on balance

sheet structure and the resulting perception

o imminent counterparty deault created a

climate o indiscriminate ear that turned what

might have been a containable predicament

into a complete systemic liquidity crisis. As

the year wore on, the crisis hit the equity

markets, as nancial valuations collapsed,

and as the realization grew that there would

be a signicant knock-on impact on the real

economy. The crisis also prompted a currency

realignment, with economies that were most

exposed to nancial fows (UK, Iceland andothers) experiencing a currency fight, and

those reliant on commodities (particularly

Australia and South Arica) weakening in the

ace o the economic slowdown.

Many industry participants were unprepared

or the meteor crash, and could not avoid the

impact or its atermath. In hindsight, this was

largely due to ailures in risk management and

governance, and business models that were

anchored on the assumption that the conditionso the last 20 years would broadly hold.


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The crises exposed the shortcomings within industry control mechanisms, which were

implemented in response to previous crises. While these mechanisms largely responded asexpected, they were insucient to prevent or contain the impact:

Industry control mechanisms during the crisisExhibit 3:

Capital regulation Central bank borrowing

The primary purpose o capital adequacy regulationswas preventing lack o capital, not lack o liquidity.

Liquidity risk was poorly understood and massivelyunder-estimated both by internal risk managers andby regulators. Regulation o leverage was also madecomplicated by o-balance exposures used to obtainadditional leverage.

Moreover, the systemic linkages between creditrisk, reputational risk and liquidity risk were notully captured.

"Lender o last resort" liquidity was initiallyunavailable to non-bank institutions, and wasinsucient in the ace o increasingly large debt roll-over requirements o over-leveraged institutions.

Central bank borrowing also generated an adversemarket signal and contributed to a decrease inmarket liquidity.

Investor disclosure Deposit insurance

Extensive investor disclosure requirements(on banks risk proles) were ineective in anilliquid market and ailed to achieve the desiredmarket discipline. When aced with signicantpotential o-balance sheet liabilities and multipleconsecutive large write-downs, investors andcreditors assumed the worst o bank balance sheets.

Deposit insurance did not eliminate the liquiditycrisis, as the industrys reliance on deposit undinghad decreased signicantly during the previous years.Also, the main actors and casualties o the crisiswere the non-depositary institutions such as creditmonolines and investment banks, that depended onwholesale markets or unding.

Three concurrent crisesExhibit 2:

3Lack ofliquidity

1Creditlosses

2Lack ofcapitalAsset managers and banks exposed

to insolvent banks incur heavy losses

Banks incur heavy write-downs on their structuredcredit portfolios eroding their capital bases

Insufficientrisk

management

Failures at top-levelrisk governance

Over-reliance onexternal credit ratings

Over-reliance on models

Declining underwriting

standards

Pro-cyclicalregulation

Mark-to-market accounting

Pro-cyclical regulatory capitalcalculations

Increased democratization ofequity ownership

Regulatory gaps in shadow-

banking sector

Banks simultaneouslyattempting to unwind

their credit positions areunable to find buyers

Threats of impending

insolvency reduceswillingness to trade.Temporary freeze

in interbank markets

Illiquidity depresses exitprices for all mark-to-market instruments andfurther erodes capital

Source: Oliver Wyman analysis

Those banks most exposed to structured credit

products aced an increasingly illiquid market

in early 2008, and their attempts to reduce their

leverage by selling these impaired instruments

drove their prices to very low levels. These

prices observed in an arguably illiquid market

impacted the mark-to-market accounting

value o all similar instruments in other banks

balance sheets globally, setting up a vicious cycle

o urgent sales and declining prices.

Attempts to recapitalize and reduce leverageproved unsuccessul or the most leveraged

players. Consequently, many became insolvent

or were acquired by larger peers. The threat o

impending insolvency eroded investor condence

in nancial institutions drastically increasing

LIBOR spreads to unprecedented highs and

sending equity prices spiraling downwards.

From September onwards, the severe and rapid

withdrawal o liquidity rom even the short-term

unding markets, such as inter-bank borrowingand money markets, triggered another wave

o insolvencies among institutions dependent

on short-term unding. As a result, the ocial

sector increased its response to the crises to

restore stability. The nal months o 2008 have

seen unprecedented government intervention

across every sector o the industry globally.


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While the meteor aected the industry as a whole,

its point o impact was the banking sector. The

rst wave o casualties included consumer nance

companies, mortgage monolines and real estate

banks heavily dependant on wholesale markets

and securitizations or unding. Most o these rms

have since been acquired by universal banks, have

been nationalized or have entered bankruptcy.

The second wave o casualties included heavily

leveraged independent investment banks who

struggled to renance in the ace o declining asset

values and disappearing liquidity. They were also

orced into bankruptcy, sale or into becoming bank

holding companies.

Universal banking emerged as one o the most

resilient business models. These institutions, aided

by regulatory orbearance on competition laws,

acquired ailed peers at substantially reducedvaluations and solidied their dominance as the

rst and second wave o casualties hit.

The wealth management sector struggled, with

small and leveraged und managers, particularly

hedge unds, hardest hit due to severely decreased

borrowing ability and perormance-based revenue

models. All wealth management businesses are

under signicant pressure due to relatively xed

costs, revenue models that rely primarily on unds

under management, liquidity issues due to massive

redemptions and increased customer scrutiny ovalue-add.

In addition, the sector struggled and will continue

to be under pressure due to a new phenomenon

we term structural substitution. As well as the

typical cyclical move away rom corporate securities,

investment preerences have changed structurally

towards cash products (e.g. government bonds and

bank deposits) due to two additional actors. First,

banks have increased their reliance on deposit

unding in the ace o illiquid wholesale markets,

and are strategically pricing to attract deposits.Second, developed market demographics and the

bulge in the population nearing retirement are

shiting many asset holders toward more structurally

low risk asset allocations.

The insurance sector not withstanding the

experience o the worlds largest insurer at

the beginning o the year (AIG) emerged by

comparison with ar less damage than the banking

sector. In particular, P&C insurers investment

portolios particularly in Europe were more

diversied away rom equities ollowing the

2001-2002 dotcom bubble, and beneted rom

expectations o insurance prices hardening and a

reasonably benign natural catastrophe experience

in North America and Europe. Lie insurers,

given their greater exposure to both equities

and credit in their investment portolios, their

structural exposure to low interest rates, and their

dependence on savings fows or new business

(particularly or investment-linked and single-

premium business), have been more aected.

However, they were generally protected rom

the worst o liquidity diculties by the lack o a

run on the insurer phenomenon. Moreover, in

many countries, lie insurers are now also seeing

increased demand or protection products drivenby post-crisis risk-aversion. Whilst the weak

economic outlook or 2009 will put pressure on the

sector, there are as many opportunities as threats.

Consequently, the insurance sector is also open to

selective consolidation, driven by a combination

o highly-varied valuations, o-loading o

insurance assets by struggling bancassurers, active

participation rom private equity and recognition o

scale benets.

Governments have been orced to provide

immediate assistance to prevent a systemiccatastrophe. The extent o government actions

ranged rom emergency short-term liquidity

to nationalization o an entire banking sector

(Iceland). In general, news o capital injection rom

governments has been ollowed by large rallies

in equity indices in major markets. Worldwide,

governments announced borrowing guarantees

o more than US$6 TN and the total value o

assistance to the industry exceeded US$1.9 TN1. As

the macroeconomic eects o the crisis worsened,

many governments saw declining revenues and the

need to stimulate their economies with aggressivemonetary easing and large scal stimulus packages.

Regulatory institutions were orced to employ

specic short-term actions, such as restrictions on

short-selling. They were also orced to re-evaluate

existing regulation, particularly on components

that have proven critical in the ace o the crisis,

such as management o liquidity.

1 Global Financial Crisis Bailout Announcements, Grail Research, as o 1 December 2008


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Selective extinction

Just as the crash o the Chicxulub asteroid

65 million years ago regressed sea levels and

may have ultimately caused extinction o the

dinosaurs and other species, the severe reduction

o liquidity in global capital markets threatened

many nancial services business models. We

believe our industry has similarly entered a state

o punctuated equilibrium, where selective

extinction and rapid evolution occur in a very

compressed time rame.

Selective extinction has already occurred in a

number o business models, including: non-

depositary lenders and consumer nance

companies, monoline nancial guaranty

companies, real estate banks, independentinvestment banks, smaller hedge unds and

asset managers. For those large banks that have

survived, their unding mix prior to the crisis

emerged as one o the most critical determinants

o success during the crisis. Banks which had

a solid unding base (dened as customer

deposits, long-term debt and equity capital)

have perormed signicantly better on average

compared to banks relying on shorter-term

unding options. In our sample o selected global

banks in developed markets, three-quarters

o banks with a Solid Funding Ratio1 Beore-

Crisis above 0.65 outperormed the industry

Ater-Crisis, whereas all banks below 0.65

underperormed signicantly.

Solid unding ratio Beore-CrisisExhibit 5:contributes to shareholder value creation Ater-Crisis

Selected global banks in developed markets

0

-1200

-1000

-800

-600

-400

-200

200

400

0.25 0.50 0.75 1.00Average Solid Funding Ratio Before-Crisis (Jan 04-Jul 07)

fter-Crisis SPI (Aug 07-Dec 08)

Industry average

0.65

Source: Bloomberg, Datastream and Oliver Wyman analysis

Similarly, the surviving business models are

evolving rapidly, with consolidation o banks

into larger universals, development o new

channels or deposits (direct and wealth-oriented

platorms) and the prolieration o multi-branded

and segment-ocused models arising rom the

spike in M&A.

1 Solid Funding Ratio illustrates the ratio o a rms customer deposits, long-term debt and equity capital to its liabilities

Share o sub-industry in fnancial services industry market valueExhibit 6:

Market value share

Threatened

Expandingdominance

0%2000 2001 2002 2003 2004 2005 2006 2007 2008

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Banks

Diversifieds/bancassurers

Asset management and life insurance

Capital markets

P&C and mixed insurance

Reinsurance

Service providers

Consumer finance/monolines

Source: Datastream, Oliver Wyman analysis


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The abrupt changes in relative share o market

value best illustrate those business models that

have expanded their dominance and those that

have been threatened (see Exhibit 6).

During a punctuated equilibrium, the tactical

and strategic priorities o survivors need to adapt

quickly to the new eco-system. The ollowing

table compares key priorities and required skill

sets pre- and post-crisis:

Pre- and post-crisis prioritiesExhibit 7:

BC (Before-Crisis) AC (After-Crisis)

Short-term tacticalpriority:Rene core valueproposition and respondto competitor initiatives.

Long-term strategicpriority:Continually improvecompetitive positioningin a stable and ast-growing dynamicequilibrium.

Required skill set:Exceptional execution

Gearing to controlledgrowth

Short-term tacticalpriority:Exploit discontinuitiesand uture-proobusiness model.

Long-term strategicpriority:Continually evolvebusiness model to arapidly changing eco-system.

Required skill set:Cost and riskmanagement,merger and customerintegration

Agility andadaptiveness

Simultaneous

strategies to hedgean uncertainenvironment

Exploiting discontinuities

The immediate priority or survivors is to exploit

the many discontinuities created by the crisis,

in particular rom the fight-to-quality and rom

the depressed and polarized valuations across

the sector.

Consecutive bank ailures and the uncertain

uture o many industry participants haveincreased risk aversion and triggered a

substantial fight-to-quality. Strong and agile

institutions are best poised to exploit the

opportunity to capture the best customers

and sta rom their weaker competitors

and signicantly grow market share. The

extent o the fight-to-quality is apparent in

several sectors. It is particularly remarkable

in consumer deposits, where the existence o

explicit and implicit deposit insurance schemes

may have been expected to sustain more

condence. For example, during the crisis, Bank

o America grew its deposits six times aster

than the US industry average.

Quarterly growth in deposits (3Q 08)Exhibit 8:

0%

2%

4%

6%

Bank of America Wells Fargo US banking sector

8%

10%

12%

Quarterly growth

Source: Oliver Wyman research, Company reports

This fight-to-quality acutely demonstrates

overcapacity, and the likely bi-polarization o the

industry into winners and losers. Outperorming

rms will recognize this more correctly as a

ght or quality and may already be investing

in eorts to skew their acquisition and retention

eorts to ocus on capturing a disproportionate

share o value as well as o volume.

The crisis, through changes in relative P/Es and

orbearance on competition regulations has

created a rare opportunity or bargain hunting

with the valuation o many institutions being

severely depressed, some at all-time lows, and

with some struggling institutions exploring the

sale o their viable business units in order to

raise cash.

While there are many surviving institutions with

the requisite strong capital base and unding tobenet rom these acquisition opportunities, they

will need to demonstrate two urther key qualities

in order to eectively capitalize on them:

Local market knowledge, experience and

capabilities, to complete these transactions

with accurate diligence (particularly on

balance sheet quality) and avorable pricing


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Market-recognized operational PMI

capabilities, to integrate the new level o scale

and complexity and o-set investor concerns

around diminished capital

Exploitation o these discontinuities leads to a

second order opportunity which is pricing. Withsecond tier players eliminated or weakened

and customers more willing than ever to pay

a premium or perceived saety, survivors are

particularly well placed to capture a larger share

o value.

Future-proofng

While the crisis has orced the extinction o

several business models, it has also revealed

vulnerabilities in surviving business models.

These vulnerabilities and the resulting investor

skepticism will motivate all survivors to build

resilience in their business models and uture-proo them against urther adverse developments

in the economic, regulatory and industry

environment.

Future-proofngExhibit 9:

Upgrading risk capabilities Right-risking

Institutions with demonstrated ailings in riskmanagement will seek to upgrade their capabilitieson measuring, assessing and governing their risks

Following unexpected losses rom exposures in non-coremarkets (e.g. US sub-prime), institutions will aggressivelyreview their rm-wide risk appetite, to ensure it capturesall relevant risks, and to better align their risk taking andthe resulting earnings volatility, to investor expectations

Improved stress testing and scenario analysis,capturing all potential sources o risk, e.g.contingent and reputational

Investment into risk inrastructure to meetregulator expectations on real-time risk/liquiditymonitoring as well as to support increasingvolume o new products

Super CROs with elevated stature and on ExecutiveBoard, hard-wired into the businesses, and able

and willing to show red card to business headswhen necessary

Resetting o incentives to curb volatility-inducingbehavior

The spectrum o risk taking will all between theollowing two extreme examples:

Those who retreat to only what they know is notrisky: ocusing on core business while exiting riskybusiness lines (e.g. prime brokerage). Allocatingcapital only to those areas where they see asustainable ranchise, and improving simplicity andtransparency o unding and investing strategies

Those who accept selective higher risk/return areas

where they are comortable with their demonstratedcapabilities to manage this risk

Re-trenching to core businesses Diversifying funding and earnings sources

Faced with the most adverse macroeconomicenvironment in a generation, surviving institutionswill drastically cut expansion ambitions, and ocus onmaking the most rom their core businesses, throughseveral levers:

The crisis underscored the importance o diversicationto withstand emerging contingencies and improveresilience during a crisis. Firms will seek to achievediversication across dierent dimensions:

Strategic cost management : via right-sizingin challenged markets and cost managementdisciplines

Optimal pricing : Re-pricing prized balance sheetor SME and MM customers, rening blunt pricingtools or deposits, using sophisticated quantitativetools or segmentation

Capturing wallet-share : Building bridges acrosssilo businesses, upgrading cross-selling toolsvia exploiting cross-elasticities and bundlingopportunities

Funding sources:

Higher reliance on solid unding sources reliable

during contingencies, most importantly a diversesource o deposits

Leveraging both market and non-marketinstitutions or capital raising

Earnings sources:

Increased ocus on low capital intensity/annuitybusinesses (cashless payments, processing, in-sourcing, advice)

Seeking businesses which have an inherentdemand foor, e.g. mandatory insurance/long-term care


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Post-crisis management tool-kit

Many management teams have already responded

to the imperative to dust o and start upgrading

their post-crisis tool-kits. While individual tool-

kits will need to be customized, we recognize a

number o the most commonly critical capabilitiesand the most recent best practice techniques used

to optimize their deployment.

Collections and recoveries optimization

An exceptionally long and benign credit cycle

in developed economies has led most banks to

under-invest in their collection and recoveries

capabilities. Leading players are up-scaling

and up-skilling their processes in several

important ways:Using advanced propensity models and

skilled out bound teams to connect with

customers pre-deault, and restructure,

renance, oer payment holidays or alter

payment terms

Cross-pollinating skills rom their credit

card team, typically the home o the most

advanced capabilities

Employing value as well as volumetrics to

gauge the eectiveness o recovery eorts

Reaching out to alumni skilled in

collections practices

Risk appetite review

A risk appetite statement is the top-down

articulation o an institutions risk tolerance.

They are increasingly common and are

ormulated by taking into account the

sometimes competing priorities o various

stakeholders, such as regulators, depositors,bond holders and equity investors. They

provide transparency around acceptable and

non-acceptable risks or the rm, to ensure

that the resulting earnings volatility is closely

aligned with stakeholder expectations i.e.

no surprises especially during crises.

As this crisis has done much to expose either

the absence o a risk appetite statement, an

inaccurate statement, or a business model

poorly aligned to the risk appetite statement,

we anticipate many Board Risk Committees

and CEOs will build or upgrade this tool.

Leading players are already upgrading theirstatements to include coverage o less

visible risk types such as reputational risk,

adding quantitative measures, and ensuring

reerential integrity between business units

and institutional statements. The second

area o ocus will involve a holistic review

o a rms aggregate risk taking on each risk

type, ocusing on a bottom-up analysis o

risk drivers across business units, rather

than just metric aggregation. A nal area o

ocus is Board Risk Committee instigation o

external independent reviews o risk appetite

adherence and optimization.

Deposit optimization

Scarce and unreliable unding rom capital

markets has elevated the position o deposits

in the new unding hierarchy. Faced with

increasing competition, advanced banks

are aggressively upgrading their deposits

capabilities through our main levers:

Pricing1. : Ensuring an holistic view o

unding costs to ensure optimal pricing

and migrating away rom blunt high-yield

pricing to more sophisticated value vs.

volume optimization

Incentives2. : Migrating away rom

volumetrics and simple accrual accounting

based incentive schemes

Customer management3. : Continuing to

upgrade customer management and

retention models to ensure economic

impact as well as satisaction outcomes

Channel management4. : Adding direct and

wealth platorm distribution channels to

tap demand


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Elevation o the risk role

The role o risk in this crisis has urther

elevated the role o the chie risk ocer (CRO).

We observe the strengthening o eorts to

build advanced risk capabilities in the leading

institutions and observe the rapid upgrading

o the CRO role. While or many nancial

institutions the CRO is already recognized as a

true C-Suite peer, the role and responsibilities

are even urther elevated:

More independence and nal responsibility

on all rm-wide risk taking decisions

Executive Board position

Report to the Board Risk Committee on

the rms aggregate risk prole and its

alignment to the rms stated risk appetiteHard-wired into major business units via

immediate direct reports

Incentivation directly tied to risk management

goals with deerred components, rather than

business targets

At the same time, the typical CRO prole is

changing and is increasingly an executive

with a background in both business and risk

Strategic cost management

Rapid deceleration in demand and migration

to lower margin wealth and savings products

means many businesses have to quickly

rebase their costs. We observe that many

cost reduction programs do not produce

sustainable benets and oten jeopardize

revenue. Outperorming rms are already

cost conscious and are upgrading their cost

management tool-kits to include:

A customer-centric approach which aligns

cost/value trade-os by customer segment

to rame the opportunity

Reduction in compensation complexity

to incentivize the right trade-os and

sustainability

A ocus o ownership on what executives

are good at

Optimization within the market context

(e.g. collections and preparation or

increased regulatory complexity and

scrutiny)

Ongoing institutional commitment to cost

management


16/50


Dont throw the baby out with the bath water

Future-proong teams will learn many valuable

lessons rom the casualties o the crises.

Firms should be careul though to distinguish

between ailure o specic business practices

and ailure o individual rms that eatured

these practices. For example, a number o

worthy innovations were pulled down by the

weight o poor unding models so surviving

rms should avoid throwing the baby out with

the bath water:

Real-estate heavy retail banks are experiencing

severe diculties in the wake o the sub-prime

credit crisis, however, their customer-centric

distribution model deserves saving. Innovation

in segment ocused solutions and applicationo retailing techniques will continue to

be an important success actor in targeting

consumer and small-business segments

Credit monolines are threatened with

extinction, but the originate-to-distribute

unding model can potentially still be

repaired to enable some measure o risk

transer to the capital markets, and a unding

model that is not so prohibitively expensive

as to overwhelm the advantages that come

rom monoline operational ocus. However,any uture originate-to-distribute model will

need to eature; substantial risk participation

to erase moral hazard; increased transparency

and standardization, as well as robust risk-

aware pricing, while condemning structures

with the sole purpose o regulatory or rating

arbitrage into obsolescence

Bulge-bracket independent investment banks

in the US are all extinct but the risk-taking

principal nance model will evolve. Demand

or alternative investments de-coupledrom securities markets will acilitate the

merging o principal nancing activities

with wealth capabilities. Limits on the

size and complexity o aggregate gross

positions, and increased transparency around

counterparties and OTC exposures will

urther reduce systemic risk and improve

sustainability o the model

Preparing or rapid evolution

In this punctuated equilibrium, selective

extinction in the industry will be ollowed by

a period o rapid evolution o the surviving

business models. This rapid evolution

will continue against the backdrop o ve

evolutionary stimuli, as well as changes in

centers o gravity:

Evolutionary stimuli

Accelerated M&A driving scale and1.

increased requency o multi-branded

models

Shrinkage o capital markets driving risk2.

sharing and cascading sophistication

Investor skepticism driving continued3.restructuring

Deceleration driving increased pursuit o4.

wallet share

Threat o re-regulation driving investment5.

in risk, nance and systems

Changes in centers o gravity shaping

business model emphasis

Human capital

Product/segment

Channel

Evolutionary stimuli

We identiy at least ve sources o rapid

evolutionary stimuli:

1. Accelerated M&A driving scale and increased

requency o multi-branded models

The spike in M&A will turn attentionby participants to realization o scale

opportunities and by non-participants to scale-

seeking through outsourcing and industry

partnerships. Successul acquirers o viable

brands will be very sensitive to post-M&A

customer attrition and will look into the

development o sustainable multi-branded

models, where additional brands are recognized

as providing segment-ocused solutions.


17/50


2. Shrinkage o capital markets driving risk

sharing and cascading sophistication

The crisis has accompanied a massive re-

assessment o capital markets willingness

to take credit risk. In the new eco-system,

secondary credit market participants will only

be willing to take a partner role in explicitrisk sharing, rather than ull risk-transer

agreements, ensuring that every link in a credit

origination chain bears losses when appropriate.

Capital markets businesses within universals are

shrinking and de-risking. In this environment,

many will seek new sources o revenue by

building stronger bridges with private bank

and high net worth businesses, and cascading

more sophisticated solutions to middle-market

and SME segments. This will be reinorced by

selective hiring o talent rom ailed capital

market specialists.

3. Investor skepticism driving continued

restructuring

During the crisis, the immediate motivation or

restructuring was the sale o ancillary assets, in

order to raise cash and support capital ratios.

However, it has been oset by the ormation o

several super-universals as wholesale-unded

entities have ound shelter within broader, more

diversied groups.

Post-crisis, investors will be increasingly

skeptical o the revenue synergies claimed

rom convergence plays and will need

signicant proo to compensate or diversion

o management attention away rom core

businesses. In particular, blatantly incompatible

risk proles will be penalized: or example,

earnings volatility/reputational risks inherent

to certain investment banking activities make

investors skeptical about combining it withannuity businesses, such as private banking

and wealth management, where brand name

and reputation is o critical signicance. The

universal banking sector as a result is likely to

see urther restructuring as these actors play

out over the coming year.

4. Deceleration driving increased pursuit o

wallet share

Rapidly slowing revenue pools and increased

industry concentration will ocus attention

towards maximization o existing customer

value. Surviving banks will seek low-risk

distribution rents rom an increasingly widerange o complementary products, including

distributing P&C and protection-oriented lie

insurance, health insurance and wealth advice.

Leading players will auction their shel space

or large up-ront payments and co-distribution

expertise rom increasingly global platorm

owners. Increased demand or customized

comprehensive retirement solutions will

urther stimulate combining health care, wealth

management and banking oerings.

5. Threat o re-regulation driving investment

into risk, fnance and systems

In the immediate atermath o the crisis,

CEO priorities will be heavily skewed towards

improving risk management and IT inrastructure.

However, as survivors move into a more stable

post-crisis environment, CEOs will continue to

maintain ocus on risk management, though will

give much more attention towards areas that are

recognized as long-term success actors, such as

human capital and strategy planning.

CEO priorities during the short andExhibit 10:long term

Long-termsuccess factors

Short-termbusiness changes

0%

20%

40%

60%

80%

100%

Percentage of respondents

Grow significantly

Grow moderately

Reduce moderately

Reduce significantly

Maintain

Riskmanagement

IT Finance Operations Riskmanagement

27%

Strategyplanning

28%

Complianceand audit

3%

Humancapital30%

Finance5%

Marketing3%

Operationsand

technology4%

Source: CEO Survey, Oliver Wyman analysis


18/50


Changes in centers o gravity-shaping businessmodel emphasis

The atermath o the crisis will be accompanied

by severe changes o gravity across dimensions

o human capital, product/segment, channel and

organization. Some o these changes have been

introduced anew during the crisis, while othershave been accelerated.

Human capital

In their response to the crisis many rms have

announced sta reductions, particularly in

Western Europe and North America. This large

group o rictionally unemployed proessionals

creates ormidable potential or creative

disruption in the industry. They will have

multiple options to employ their skills:

Many will explore creative business1.

opportunities closer to home. We expect

evolution akin to the prolieration omortgage broking businesses in the

atermath o massive branch closures.

Our preliminary ideas or this evolution

include boutique M&A and corporate nance

advisory rms, integration o nancial

services and social networking, specialist

risk-taking businesses or principal

Risk is still the relatively newkid on the unctional block

I we use a simple proxy o the number o

publications, we can observe that the discipline

o risk management appeared rom the mid 70s,

signicantly behind other unctions such as

strategy planning and nance.

Functional evolution o risk managementExhibit 11:Based on number o yearly publications in Libraryo Congress

1950 1960 1990 20001970 1980 2008

Enron and

9/11

Risk management started relatively recently andexperienced growth during the 1980s and 90s,peaking at the turn of the century

Source: Oliver Wyman research and analysis, Journal o Congress

The scale and duration o this crisis argues orthe aggressive acceleration o the risk unctions

evolution. This will necessitate an elevation o its

role both in governance and strategy. We observe

the strengthening o eorts to build advanced

risk capabilities in the leading institutions and

rapid upgrading o the risk governance unctions:

Elevated role and increased independence

Elevated role o CROs as Executive Directors

Increased stature o Board Risk Committees

More independence rom, and nal

responsibility on, all rm-wide risk taking

decisions

Integration with other unctions

Seamless integration into major business

units via immediate direct reports

Change in CRO prole into an executive with

a background in both business and risk

Tailored compensation

Incentivation directly tied to risk

management goals with deerred

components, rather than business targets

Emergence o sub-specialties

Migration rom modeling and calculations

towards heuristic scenario analysis andstress tests leveraging qualitative as well as

quantitative inputs


19/50


investing, ranchised health and retirement

solutions and more traditional contractor

and alternative career models

The relative resilience o Asian and Middle2.

Eastern institutions accentuates the potential

osmosis o human capital rom established

western hubs through mechanisms such asintra-company sta re-allocations, the so-

called Shanghai, Mumbai, Dubai or goodbye

option, voluntary migration and the return o

expatriates to their home countries

Other likely changes to human capital

management within organizations include

a re-orientation back to the development o

traditional stewardship skills and a return to

horizontal business and unctional management

rotation models.

Product/segment

Risk appetite or retail lending has already

contracted signicantly in most major markets.

Lower-prime and high loan-to-value lending

products will continue to evaporate. Unsecured

and underutilized limits will be systematically

reduced/charged or to improve regulatory

capital eciency.

Balance sheet lenders will skew their eortsto the middle market that provide the best

balance o relationship longevity and risk-

adjusted return. Large corporations will be

serviced but only through a sophisticated

lter o relationship value analytics. SMEs,

i not providing sector diversication, could

be underserved, creating opportunities or

segment-ocused specialists and potentially

driving ocial sector encouragement.

Wealth management product oerings will

signicantly migrate towards advice, asshocked investors contemplate their utures

in depressed macroeconomic circumstances.

Players will respond to structural substitution

adding guaranteed deposit products to wealth

platorms and encouraging investors back into

equity markets to partially restore portolio

allocations. As cash yields decline, investment

product ocus will turn to simple, transparent,

unleveraged and inexpensive equity access via

exchange-traded unds, downside-protected

structured oerings, and simple yet illiquid

yield products de-coupled rom securities

markets, such as inrastructure bonds.

Insurers will increasingly capitalize onheightened risk sensitivities. As well as

traditional lie protection products, they will

continue to innovate solutions which combine

traditional nancial longevity products with

decumulation oerings. They will also be

sought-ater by asset managers who are eager

to bundle their core oerings with capital

protection capabilities.

Capital markets players income will all, but

will continue to be buttressed by volatile rates,

FX and commodities markets. Resilience intransactional advice will also compensate

or reduced securities trading and declining

demand rom hedge unds.

Channel

Both cost management pressure and

intensiying competition, especially or deposits,

will stimulate investment in direct channels,

especially online. More creative solutions will

be explored to reduce cost in the tail o branch

networks, including aggressive perormancemanagement, co-location, ood/travel/phone

partnerships, ranchising, and micro-ootprints.

Additionally, all players will exploit the crisis to

re-engage with their valuable customers through

their proprietary channels, urther reducing

reliance on intermediaries.


20/50


The new eco-system

The size o the new eco-system will be dened

by the macroeconomic environment and its

structure will be dened by the extent o ocial

sector intervention.

Macroeconomic environment

At the commencement o 2009, the biggest

determinant o the new eco-system will be the

macroeconomic environment. A signicant

slowdown is inevitable, as the crisis continues

to spread to other industries globally, and will

naturally constrain nancial services growth

through reduced demand or credit, reduced

personal wealth and tightened underwriting

standards. Beyond these cyclical eects, the

growth o industry assets will continue to be

limited, due to reduced tolerance or leverage,

investors wariness to provide substantial

capital, more permanent structural adjustments

to recovery levels and regulatory intervention.

Ofcial sector intervention

Industry structure will be severely infuenced by

governments who have become major suppliers

o capital to the industry. 2009 will be hallmarked

by governments coming to grips with this new

responsibility and publicly determining their

management agenda and operating principles.

These decisions will signicantly impact

on remaining private sector participants in

these markets. We will see increasing levels

o government ownership as additional banks

ail, and the fight-to-quality re-directs capital

rom the private sector to government-backed

entities. In 2009, the governments will respond

with additional regulation, and over time, will

seek to determine the optimal combination o

re-regulation and partial government ownership.Past re-privatizations have typically taken a our

to ve year period, with governments even at

the end o that process maintaining ownership

stakes o the order o ~20%. In markets where

government ownership in the nancial services

industry has had a long history, the length o the

process and the size o the ultimate government

stake have been even greater.

Government intervention will increasingly

determine size and scope o activity or many

industry participants. For example, universal

banks will be allowed to retain scale only under

heavy utility-like regulation. The ocial sector

will also create and support protected species,

especially a mid-tier banking system comprisingo size-constrained regionals and cooperative

players, to provide competitive pressure and

a serious alternative to global behemoths,

particularly or underserved segments. Risk-

taking entities working with complex, illiquid

products will be subject to strict size, leverage

and connectivity constraints.

As the ocial sector accelerates its eorts

to re-regulate the industry, many major

participants would do well to consider proactive

development o sel-regulation and regulatorysubmissions to help shape a more sustainable

regulatory ramework. Already occurring

examples include senior management in major

institutions voluntarily orgoing bonuses and

severance packages.

Using the US and the UK as test cases, we

analyzed the potential time rames or

industry-wide de-leveraging, based on likely

macroeconomic scenarios (expressed in credit

related write-downs) as well as ocial sectorintervention (expressed in restrictive absolute

and risk-based capital ratios). Our analysis

indicates that even in the most optimistic

scenario, the industry in these countries will

continue to de-leverage until 2010, and the most

pessimistic scenario indicates de-leveraging

lasting beyond 2012.

De-leveraging time rameExhibit 12:

1. Absoluteleverage

2. Tier 1ratio

When will de-leveraging stop?Analysis o 17 major US and UK banks

8% 10% Q2 2011 Q1 2012 Ater 2012

6% 9% Q4 2010 Q2 2011 Q2 2012

4.5%(currentmedian)

8.6%(currentmedian)

Q3 2010 Q1 2011 Q1 2012

3. Increase in write-downs1 x2 x2.5 x3

Source: Bloomberg and Oliver Wyman analysis1 We estimate an increase in write-downs or 2009 only, with gradualreductions over 2010. Industry-wide capital raising via externalsources and prot retention are expected to ollow a similar path


21/50


Bank nationalization: Lessons rom the past

Banks have been nationalized in past nancial crises. This section

provides a brie history and tries to identiy lessons that can be

drawn rom these experiences.

These examples reveal that temporary nationalization o banks can

aid the sector, provided the banks are managed well and largely

returned to private ownership within our to ve years. They also

indicate the critical role played by rapid ormation o crisis resolution

agencies, and the potential or tapered integration to provide

governments with ongoing transparency and infuence.

However, nationalization o banks can have less desirable outcomes

Crdit Lyonnais provides an example. Between 1988 and 1993, public-

run Crdit Lyonnais engaged in aggressive lending growth, with the

bank providing loans and entering new businesses, some with non-

commercial motivations. These activities led to substantial credit

related losses or Crdit Lyonnais during the recession in the early

90s pointing to potential ailures o governance.

The Crdit Lyonnais example provides key lessons or investors and

regulators:

Prudent oversight and governance o nancial institutions, both

nationally and across borders, is crucial to ensure desirable results

or shareholders

Nationalized banks should continue to operate on a commercialarms length basis, with minimal political intererence

(particularly challenging when governments seek additional scal

stimulus in a capital-constrained environment)

It is clear that the current wave o nationalization is less driven by

political motivations and more by commercial necessity. The ocial

sector recognizes the importance o a well-unctioning private sector,

and will likely move to re-privatize aster than previous examples.


22/50


Bank nationalizations in major mature marketsExhibit 13:

Country Sweden and Finland (1991-1993) Japan (1998-2003)

Trigger Bursting o real-estate bubble threatenedsolvency o major banks

Bursting o real-estate bubble threatenedsolvency o many banks

Scope andprocess

Majority o the banking system across bothcountries required government assistance

Five o the seven biggest Swedish banksrequired government support and twowere completely taken over

Signicant assistance provided to threemajor Finnish banks with the largestacquired by Central Bank o Finland

Banks obligations were guaranteed inboth countries and assistance was providedsubject to strict requirements

Strict criteria o risk reduction andeciency improvement enorced on

banksBanks had to pledge equity to thegovernment and incur large write-downs

Process resulted in signicant industryconsolidation with the number o bankshalving in Finland

US$440 BN injected in the orm osubordinated debt and preerred shares

Weakest banks were nationalized

Stronger banks received capital injections,troubled asset relie and loans

Depositors protected via a blanketguarantee

Denationali-zationprocess

Banks returned to protability within ouryears and were then made public, however,government maintained minority stakes insome banks (e.g. 19.9% in Nordea)

Estimated cost reported at ~5.3% o GDP(Finland) and ~0.2% o GDP (Sweden)

Process started within ve years asbanks returned to protability, howevergovernment maintained stakes in somebanks (e.g. ~27% in Shinsei Bank1)

Estimated cost to government ~6% o GDPto date

Key lessons Success in deploying crisis resolution

agenciesAdministrative separation rom centralbank and other potential politicalinfuences

Consolidation provided industry-wideeciency gains

Non-perorming assets dealt with

Government maintains an interest

Regulators needed to act aster to prevent

the banking sectors troubles rom hurtingthe real economy

Crisis management agency to deal withnon-perorming assets

Government maintains an interest

1 27% share is the sum o shares owned by Treasury shares and the Deposit Insurance Corporation o Japan and its subsidiaries

Source: Oliver Wyman analysis, The 1990s Financial Crises in Nordic Countries Bank o Finland, Factiva, The Economist, The Finish Banking Crisisand its Handling, Bank o Finland Discussion Paper


23/50


Thriving in the new eco-system

The meteoric impact o the global nancial

crisis and the resulting punctuated equilibrium

has aected business models dierently,

strengthening some, eliminating others and

orcing yet others to evolve rapidly. Putting some

o the more resilient business models under themicroscope helps to decode critical success

DNA or the new eco-system.

Universal banks

Large global and regional universal banks

survived the crisis and emerged rom the rapid

wave o consolidation with considerably larger

scale. Universals best demonstrate the notion o

polarization, i.e. the strong getting stronger. They

exhibit a number o critical success DNA strands

which we believe will be crucial to ongoing

survival and evolution o business models:

Cash and capital through diversied unding

Convergence across multiple business lines

to diversiy earnings

Consolidation to reduce costs and urther

strengthen balance sheets

Communication o saety to customers,

acilitating fight-to-quality

To illustrate, the deposit share o the three

largest US universal banks (Bank o America,

JP Morgan and Wells Fargo) increased rom 23%

in 2007 to 33% in the immediate atermath o

the crisis. Another surviving universal, BNP

Paribas, is positioned to become the largest

deposit gatherer in Eurozone ollowing its

potential acquisition o Fortis.

Closed-loop unding models

Closed-loop unding models entail market-basedunding or, mostly illiquid, assets in a closed-

loop with matched assets and liabilities, ree

rom leverage and unding gaps. The resulting

investment product is simple, transparent and

has lower production/management costs due to

the elimination o ees to intermediaries, such

as merchant bankers. Furthermore, by directly

passing through, and not transorming the risk

between the borrower (provider o asset) and

the investor (provider o liability), closed-loop

remains very resilient towards crises and external

shocks that typically call or a step change in the

risk absorption capacity o investor base.

These models exhibit two critical successactor DNA:

Closeness to the business model and customer

(through simplicity and transparency)

Cost consciousness through a simple

business model and the absence o

intermediaries

Regarded as one o the more crisis-proo

residential mortgage unding models, Danish

mortgage bonds (Realkreditobligationer) provide

a amiliar example or closed-loop unding.

The Danish mortgage credit institutions

hold very simple and transparent balance

sheets, matching the mortgage assets with

mortgage bond liabilities they issue in the

market. They manage credit risk and mortgage

servicing and charge a ee o approximately

50bps as compensation. Callable bonds

ensure re-nancing fexibility to borrowers

by transerring the pre-payment and interest

rate risks to investors, mostly consisting oinstitutional investors such as banks, insurers

and pension unds, who seek exposure to long-

term simple and sae assets.

The specialized structure o Danish mortgage

bonds involve dedicated, bankruptcy-remote

institutions, which have a history o hundreds

o years in Denmark. However, we anticipate

the wide application o this model and

retailization o these structures or a wide

range o inrastructure and public-private

partnership initiatives needed to kick-startslowing economies. Universal banks with strong

ranchises can exploit linkages between their

principal risk taking and wealth management

activities by oering closed-loop investment

products to high net worth individuals and

institutional investors, who are looking or

opportunities to increase their yield as central

bank rates plummet.


24/50


Cooperative banks

Cooperative banks have escaped the crisis

relatively unscathed due to three critical

success DNA:

Capital through low levels o leverage

Conservatism in lending practices and

avoidance o complex nancial instruments

in general

Closeness to their customers or members

This operating model is derived rom an

ownership structure avoring long-term stability

or members over short-term prots. This enabled

them to stay afoat during the crisis and increase

their deposit base by exploiting the fight-to-

quality/saety. We anticipate that many in thecooperative sector will be strengthened by the

crisis through their back to basics proposition,

the elimination o many second tier competitors,

and sympathetic governments and regulators.

Islamic Finance

Islamic Finance institutions have proved

resilient during the crisis. This is to a large

extent driven by solid economic growth and

relatively abundant capital and liquidity in the

Middle Eastern geographies, at least until 2Q 08.However, a critical success DNA o conservatism

also played a major role, as illustrated in two

undamentals o Islamic Finance:

Risk sharing is a core principle o Islamic1.

Finance, whereby, instead o charging

customers interest, nancial institutions

retain an equity stake in the asset and

charge the customers a specic rent. Risk

o fuctuations in underlying asset prices is

shared between the borrower and lender,

reducing abrupt shocks to repayment abilitydue to asset price declines, and reinorcing

sustainable underwriting standards

Islamic Finance orbids excessive use o2.

leverage, as compliant banks are orbidden to

deal with any party that has more than a third

o its balance sheet nanced by debt, as well as

speculative trading, i.e. trading with securities

that are not owned by those involved

Some o these principles may also oer urther

insights to the regulators, as they seek to improve

the resiliency o global nancial services. For

example, continuous-workout mortgages,

proposed by economist Robert Shiller in the

wake o the US sub-prime mortgage crisis eature

similar characteristics o risk sharing. Thesemortgages index the repayments based on the

general level o house prices. It increases the

upront cost o the mortgage, but improves its

resiliency by sharing the impact o asset price

shocks between banks and borrowers.

In the new eco-system, Islamic Finance will

attract increasing attention as a segment-ocused

business model in developed countries with

signicant Muslim populations, such as Europe.

Insurers

Insurers lead the industry over the last ve years

in terms o risk-adjusted shareholder value

creation, as evidenced by their superior SPI

perormance. We identiy the ollowing critical

success DNA in their business model:

Conservatism through the elevated status o

CROs and actuarial unctions

Insurance CROs are in many cases treated

as an equal partner in senior management.This acilitates conservatism in investment

strategies, which have exhibited low

exposures to sub-prime related securities and

reduced exposures to equities over the past 10

years. Moreover, the statutory independence

o actuarial sign-os and independent

proessional ethic o the actuarial proession

has provided greater checks and balances on

executive management

Capital availability through strengthening o

balance sheet in good times

Insurers, in particular P&C insurers, typically

build up excess reserves in good times to

meet unexpected claims in bad times. The

proposed changes in capital regulation are

already moving towards a similar counter-

cyclical approach


25/50


Closeness through the development o long-term relationships with their reinsurance

counterparts

This has enabled reinsurers to better understand the risks in the portolios that they are taking

on, and which has also provided ceding insurers with greater stability and diversity in their

sources o risk-bearing capacity

Thriving species in this new eco-system will carry several or all o these critical success DNA, whichwe classiy into a helix o risk management, strategy and execution.

Ocial sector developments

Not since the Great Depression have we seen the need or the ocial sector to intervene so heavily

and decisively to correct or market ailure. Without this intervention, the industry in many

geographies could have collapsed. The level o nationalization in some countries has increased to

all-time highs, with more than 40% o the UK banking sector assets under government ownership.

The change in purview and depth o infuence will prooundly impact the structure and operation

o our industry in 2009 and beyond. We thereore dedicate a new section to the state o the ocial

sector to outline its major activities during the crisis, as well as its priorities or 2009.

7Cs or success in the new eco-systemExhibit 14:

Riskmanagement

Strategy

Execution

Convergence

Cross-selling Broad solution

components

Consolidation

Seeking scale Exploiting scale

Communication

Brand promise for customers

Consistency for investors

Collaboration for staff

Cost consciousness

Re-alignment topost-crisis revenues

Simplification

Systems automation

Cash/capital Liquidity and solvency

Compliant to regulatorand investor concerns

Conservatism Robust asset quality

Aware of reduced rewardfor risk

Prudent risk governance

Closeness

Customer-centricity Control of business

components

Core competencies


26/50

HDFC Bank

Leveraged strong brand and branch network

to attract low-cost deposit base and reduce

unding costs

Benetted rom stable growth in demand or

retail credit, particularly home loans, while

maintaining underwriting standards

RBC Financial Group

Leveraged large distribution ootprint to expand

FUM business and strategic acquisitions to

upgrade capital market capabilities and diversiy

geographically, with improved perormance in

the US

Exploited sae reputation and solid balance

sheet to win capital markets and international

business rom struggling competitors

Wave riders

Success factors

Well-capitalized balance sheets and prudent risk

management

Sae reputation attracting fight to quality

Strategic acquisitions to upgrade capabilities and

expand geographic ootprint

Skew to value as well as volume

What drives sustainable

performance?

The crisis dramatically alteredrelative perormance and the

success actors in the industry.

Some rms outperorming beore

the crisis have experienced

signicantly lower perormance

ater the crisis, while other under-

perormers have become relative

outperormers ollowing the crisis

However, some outperorming

institutions demonstrated resilience

during the crisis, maintaining theirsuperior relative perormance ater

the crisis. This analysis seeks to

identiy some o the drivers o their

resilience, and discern common

success actors leading to sustained

perormance during a crisis

High1

BeforeCrisis(BC)

(January2004-July2

007)

Low1

Low1

1

1 Companies in the High quadrant are in the top 33%. Companies in the Low quadrant are in the bottom 33% o SPI perormance

Sources: Oliver Wyman press research, Company reports

BNP Paribas

Chicago MercantileExchange

China Merchants Bank

Credit Suisse

Danske Bank

ING Group

KBC Group

National Bank o Greece

Ping An Insurance

Prudential Financial

Sberbank

Socit Gnrale

Unibanco

After C

(August 2007

Perormance through the crisis


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amsung Fire & Marine

Successully targeted mid-age and senior

afuent segments with strong brand positioning

and customer service reputation

De-risked investment strategy into low- and

medium-risk assets and adopted strict reserving

regime

Scotiabank

Robust liquidity and capital position allowed

diversication through strategic acquisitions

across geographies, business lines and products

Followed conservative underwriting practices

and de-risked urther by withdrawing rom the

US and UK wholesale markets

Standard Bank

Leveraged strategic partnerships in emerging

markets to diversiy revenue base and ocus onhigh growth segments

Well capitalized balance sheet and healthy

liquidity prole have acilitated growth during

the crisis

Westpac

Rapid growth in business banking and unds

management businesses through targeting o

high value customer segments and high cross-sell

Prudent risk management with a strong balance

sheet have acilitated strong organic and

inorganic growth

Zurich Financial Services

Derisked asset portolio by signicantly reducing

equity exposure and re-ocused strategy on prot

margins and cash fow over growth

Well-capitalized balance sheet with adequate

liquidity and risk averse investment strategy

have helped withstand the crisis

AC)

ober 2008)

High1

yancy vests

Ameritrade Holding

Corporation

AON

Bank o New York Mellon

Berkshire Hathaway

HSBC

Marsh & McLennan

Mashreq Bank

Munich Re

Northern Trust

Progressive

The TravelersCompanies Inc

US Bancorp

Wells Fargo

mpic swimmers

ank Central Asia

rupo Financiero Inbursa

DFC Bank

ublic Bank

BE

BC Financial Group

Sampo

Samsung Fire & Marine

Scotiabank

Standard Bank

Westpac

Zurich FinanicialServices


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Response during the crisis

Governments responded to the crisis primarily

to ensure the ongoing stability o the nancial

system; however, the magnitude o the crisis

prompted a signicant broadening o the

response menu as well as unprecedented levels

o coordination across geographies or example,

simultaneous rate cuts by all major central banks

and scal stimuli by the governments o most

major economies. Other response measures

originated in only a ew countries and then

permeated across borders when perceived to

be eective or example, the US ollowing

the UK in injecting capital directly into banks,

rather than purchasing troubled assets. Yet other

measures were implemented with signicant

dierentiation across national borders, such asthe introduction o or changes in the coverage o

deposit insurance schemes.

National regulators and supervisory institutions

also responded with immediate measures to

prevent a deepening o the crisis.

Some o these measures were more amiliar, and

ound relatively global acceptance:

Temporary loosening o competition laws and

processes in the ace o rapid consolidation

(e.g. Lloyds TSB acquisition o HBOS)

Demanding additional capital buers

(e.g. Australia)

Relaxing mark-to-market requirements that

accentuated the eect o asset write-os

(e.g. Europe)

Tightening restrictions on practices that

regulators believed contributed to capital

market volatility, such as short selling(e.g. UK and US)

Some other measures were pioneered by one or

two countries and are yet to be adopted more

widely, such as:

Extension o government-sponsored credit

insurance schemes or bank borrowing to

borrowings by rms in the non-nancial

sector (France and Japan)

Supplementing risk-based capital ratios with

a 3% gross capital ratio (4% or the parent,

recently proposed in Switzerland, already

applicable in the US)

Increased unding or regulatory agencies

to help them improve their supervisory

capabilities (Australia)

Both the introduction as well as implementation

o these measures were heavily dependenton local characteristics such as crisis severity

and policy preerences. Exhibit 15 provides an

indicative summary o responses across major

regions globally.


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Summary comparison o ofcial sector response to the crisis during 2008Exhibit 15:

US WE Can Jap China Aust CEE MEA IndiaOtherAsia Lat Am

Monetary Rate reduction

Reserverequirement

changesFiscalstimulus

Targeted tax cuts

Targeted spendingboost

Liquiditysupport

Short-term lendingagainst illiquidassets

Purchase o illiquidassets

Guaranteeingborrowing

Guaranteeingdeposits/increasingdeposit limits

Capitalinjection

Debt capitalinjection

Preerred equitypurchase

Voting equitypurchase

Regulatorychanges

Relaxingcompetitionregulations

Relaxingownership

regulations

Short sellingrestrictions

Relaxingaccountingguidelines

Formalized ratingagency regulation

Source: Oliver Wyman press research


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Post-crisis priorities

For 2009, the ocus o the ocial sector will

move rom re-ghting to re-prevention.

We articulate and explore three priorities:

Re-regulation1.

Institutionalization o industry support2.

schemes

Permanent global coordination o regulation3.

and crisis response

1. Re-regulation

Many international regulatory and industry

bodies have already initiated major reviews o

regulations related to saety and soundness o

nancial institutions, and transparency and

integrity o global capital markets. Due to the

nature o the consultative process, and the

priority o immediate tactical response, the

details o many initiatives were not nalized

during 2008, and are expected to be a major

agenda item or the ocial sector during 2009. We

expect regulators to ocus on three key objectives:

Reducing the likelihood o ailures

Restoring condence and transparency to the

nancial system

Containing systemic risk in global nancial

markets

Reducing the likelihood o ailures

The crisis illustrated signicant shortcomings

in management oliquidity and solvency.

Given the lethal impact o a lack oliquidity,

revising regulatory requirements or liquidity

management will be a key priority. Bothinternational (e.g. BIS) as well as national (e.g.

FSA) regulators will continue to implement

revised requirements:

Statutory minimum liquidity/unding ratios

and increased liquidity requirements

Quantitative and qualitative driven stress

scenario analyses

Increased monitoring, projection and

reporting capabilities

Explicit consideration o availability o cross-

border and cross-institution sources

Explicit consideration o contingent liquidity

constraints in dening risk-weighting otradable assets

Revisions on solvency regulation will seek to

increase both the level o capital as well as

its risk coverage. The race to de-leverage has

already resulted in a de-acto increase o the

acceptable minimum capital level, with banks

seeking to bolster their Tier 1 capital ratio to

8%, with some investors setting the threshold

or being well-capitalized at 10%. This already

marks a signicant increase rom the existing4% Pillar 1 minimum regulatory requirement

and a 6-7% pre-crisis threshold or being

well-capitalized. In addition, the observed

discrepancy between actual assets and risk-

weighted assets uelled consideration o risk-

insensitive measures to complement risk-based

capital ratios and limit maximum leverage.

The crisis also highlighted the need or explicit

coverage o some risks in capital adequacy

rameworks that have hitherto not been covered.

For example, rms will need to speciy capital

implications o reputational risk considerations,

particularly with respect to o-balance sheet

vehicles and other structures.

Restoring confdence to the fnancial system

Regulators will continue to strive to restore

condence in the nancial systems ability

to accurately measure risk and report the

air value o nancial assets traded in global

capital markets.

Investor protection:

Just as the burst o the dotcom equity bubble

in 2001 led to increased scrutiny and regulation

o equity analysts, the burst o the sub-prime

credit bubble led to increased scrutiny on the

credit rating agencies (CRA). Both industry

bodies such as IOSCO, as well as supra-national


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Containing systemic risk in the global fnancial

markets

The crisis illustrated clearly how systemic risk is

rapidly amplied and spread due to connections

between industry participants globally. Post-

crisis, regulators will seek to establish circuit

breakers into this global network o risk andcapital transer, to prevent any institution rom

orming a signicant threat to system stability.

Regulators will employ dierent levers or

establishing these circuit breakers.

Circuit breakers to contain systemic riskExhibit 17:

Size constraints Activity constraints Transparency

Firms engaged inrisky activities andexposed to highearnings volatilityare subjected to sizeand connectivityconstraints

Maximum assetsize restrictions orhedge unds

Maximum lendingconstraintsor smallerconcentratedbanks

Major universalbanks will operateunder signicantconstraints

Strict individual

and aggregateexposure limits torisky entities

Elimination ovolatility inducingpractices such asproprietary trading

Increasedtransparency orhigh-leveraged riskyproducts

Centralized

clearinghouse oOTC derivativetrades, andeventualmigration toexchanges

Increaseddisclosurerequirements ormargin-lendingand short-selling

2. Institutionalization o industry supportschemes

An immediate priority or the ocial sector

will be to increase the sustainability o theindustry support schemes instituted so ar.

This requires commercially viable pricing to

eliminate moral hazard and reducing drag on

taxpayer unds to insulate the schemes rom

budgetary constraints.

Deposit guarantee schemes

During the crisis, many countries substantially

increased the scope o their e

state of the financial service industry

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