Mikael Krohn discusses the challenges for lenders facing uncertainty, as they try to balance risk management, scalability and profitability.

Over the past 18 months, the UK lending industry has seen extensive changes and the latest lending figures indicate that mortgage lending in particular decreased by almost 90 per cent since its peak in 2007, reported The Guardian. Following the upheavals of the recent past, banks' risk management processes have been pulled into the spotlight to an unprecedented degree.

Regulatory pressures draw attention to liquidity and risk management

Liquidity and risk management will continue to dominate banks' agendas in the coming months. The 'Basel III' proposals, for example, that were first put forward last December, are designed to build stronger buffers in the financial system, creating a less procyclical financial system in the wake of the economic crisis.

However, the French Banking Federation predicted that Basel III proposals would lead to a €360 billion core capital deficit for Eurozone banks, said Reuters, while Wells Fargo claims that lending would drop by US$3 trillion if US banks shrink their balance sheets to avoid having to raise the estimated US$250 billion-300 billion in new capital which the Basel Committee's proposals would require, according to Risk.

Despite the gloomy predictions, the Basel Committee chairman Nout Wellink, suggests that "a modest reduction in growth during upswings in the business cycle would be acceptable to regulators if the proposed capital and liquidity framework also produced greater financial stability. If the cumulative 0.5 percent to 1.0 percent reduction in growth estimated by Dutch central bank economists is the price for getting a really resilient banking system, that price is not too high."

As banks prepare to meet compliance challenges, they are simultaneously working towards improving customer service and rebuilding trust in the industry's ability to effectively manage risk. In addition, we can expect that existing regulations around data quality and processes will be more strictly enforced, and the UK's new coalition government's statement that the FSA should continue as a separate body under the Bank of England will remove the uncertainty around who will enforce these rules and how swiftly.

Introducing scalability and maintaining profitability

Many banks have undergone a period of cost cutting in an attempt to achieve greater levels of efficiency. However, financial institutions now have an opportunity to use this low activity period to invest in building scalability into their lending processes in advance of the anticipated economic recovery.

In order to achieve this, they need to ensure that their processes are both efficient and of high quality. Taking a holistic view on how to solve their challenges relating to risk management, efficiency and scalability should result in well-defined processes that, to a high degree, are supported by IT services.

Those financial institutions that do not ensure their businesses are scalable may find that the effect on the bottom line will be short-lived, whereas banks and building societies that are fully prepared for a new period of growth, will be best placed to gain significant competitive advantage.

Keeping it simple

There is a trend towards greater simplicity in banking to achieve greater efficiency, which banks can leverage as a competitive differentiator. This trend is also a result of the opportunity that derives from new technology and change in customer behaviour. Online banks that have been set up around Europe using very simple products and processes have already achieved a great deal of success, and more banks will also look to meet the competition through their own direct banking channels.

This concept also extends to a more transparent and simpler banking model. Vernon Hill, the founder of the new British Metro Bank, for example, believes in the success of a new business model based on a purely deposit-funded bank. Metro Bank plans to expand its deposit base faster than its mortgage book and expects to have a core tier one ratio that will "never drop below the high teens" said FT.com.

Those banks that encourage a culture of "simplicity" may be able to both improve efficiency and also strengthen relationships with customers. Whilst regulations will continue to affect banks' ability to manage risk, preparing for economic recovery and building efficiency into their processes will continue to dominate the banks' agenda in the coming year. Moreover, achieving a balance between risk management, scalability and profitability will be a greater challenge than ever for financial institutions, but one that cannot be avoided.