Good afternoon and thank you for having me.
Unlike many of those you will hear from over the course of this conference, I'm not an expert on transaction services. I'm an equities trader who, somewhat against my will, got corralled into senior management.
But I oversee Citi's Global Transaction Services business and have since 2008. I understand how important this business is not just to my own company but to nearly every company in the global Fortune 500. And I understand how important this industry is to the entire world economy.
At Citi, we move more than $3 trillion in global transactions every day for multinational corporations, financial institutions and government agencies. We have built the industry's largest proprietary network, spanning nearly 100 counties with ten major regional processing centers worldwide.
Francesco Vanni d'Archirafi, CEO of Citi's GTS business—someone well known to all of you—has done a terrific job with this division and is one of our most talented and valued executives.
But because I'm not an expert on the business—on your field—I'm going to talk to you more broadly about the trends that I see shaping the financial sector as a whole and then tell you a little about what we at Citi are doing to respond to—and keep ahead of—those trends.
The global financial system is still emerging from the profound seismic shock of the 2007-2008 financial crises. And we had another, thankfully much smaller, shock just this past summer. As the wild market swings in much of August showed all too clearly, we haven't yet returned to anything like stability. And it's not clear when we will.
But I think it is clear that we will. And once the crisis and all its ancillary effects are fully behind us, the structure of global banking will likely look very different than it did before the crisis.
This change in structure is driven by three broad trends, which I will sketch first and then elaborate in turn.
First, the emerging and developed markets are gradually decoupling from one another. Emerging market growth no longer depends on growth in developed economies and sometimes even continues strongly when developed markets are in recession. Part of the reason is that, as emerging markets mature, they increasingly trade with one another and so are less dependent on linkages to the developed world.
Second, this industry is in the midst of a new wave of regulation, at both the national and international levels. Speaking very broadly, national or single-country regulation attempts to address consumer leverage and lending practices while international rules seek to shore up the overall safety of the financial system through higher capital requirements on banks and new rules for calculating what counts as capital—and to what extent. There is some overlap of course—for instance the so-called "resolution authority" provisions of Dodd-Frank. But by and large, this is what the two strains of regulation are intended to accomplish.
Third, changes in technology are revolutionizing consumer expectations and also forcing changes in bank business models. This may be the most revolutionary trend of all, and the hardest to track and predict.
These trends will create at least four major consequences.
First, there will be a shift in banking's global center of gravity from the Transatlantic region to Asia. We're already seeing this.
Second, regulation will have some unintended consequences, including a more difficult banking environment in the developed world, leading to more consolidation, and also a reduction in service to lower income consumers.
Third, we will see a shift in financial services economics out of banking and into a new "shadow banking system."
Finally, there will be a recalibration of banking economics forcing us all—or at least those of us who intend to survive—to change our business models.
Together I believe that these trends and their consequences are all converging in a way that will lead banks to adopt what we at Citi have termed the "universal banking model." I think I can safely say that Citi is the one international bank that is most out front in the development of this model but others are implementing it as well and the competition is fierce.
But to see all this more clearly it's necessary to go into more detail.
I don't need to tell you how bad the growth figures are right now for the developed world. Not long ago we all would have been extremely disappointed with 2% growth. Now we'd be delighted to see even that. The US economy grew less than half a percent in the first quarter and just above 1% in the second. The EU's numbers are even worse and the Japanese economy has actually shrunk for the past three quarters. Canada is one of the bright spots in the G7, growing at around 3% or above for the last year.
Emerging markets, meanwhile, are growing much faster. They suffered less from the Great Recession and recovered more quickly. China is back near 10% annually and India is close to 8%, for instance.
Such disparities would have been unthinkable only a few years ago. The developed markets drove world growth and the emerging markets hitched a ride. Not anymore. Now they speed off on their own.
We're all waiting for things to get better here in North America, in Europe, and in East Asia. But several factors complicate long-term recovery. The developed world is grappling with serious debt problems—both as a consequence of over-borrowing before the crash and long-term liabilities in popular pension, health care and other programs. Even when—and if—all of these problems are satisfactorily solved, demographic change such as aging populations in Western Europe and Japan ensure that developed nations will never again grow at anywhere near the clip that has become routine in the developing world. Research conducted by Citi has concluded that China and India will be the world's largest economies by around 2030—that's about two decades earlier than some other forecasts—recovering the role they had in the world two centuries ago.
So the decoupling of the two economic zones is not only largely complete already, it is likely to be permanent.
The biggest driver of this decoupling is the maturation of emerging markets and the consequent rise of intra-EM trade and capital flows. This is one of the most important economic trends of our time—maybe the most important.
Trade within the emerging markets—transactions that never cross an EU or G7 border—has risen sharply, from 6% of total world trade to 13% between 1995 and 2009. Emerging market trade with advanced economies is still bigger than intra-EM trade but the gap is closing. The advanced economies' share of global trade is now 65%, down from 79% in 1995.
Brazil, South Korea and China help to illustrate the trend. Brazil's trade with Asia represented just 6% of its total in 1995. In 2009 it was 18%—a tripling in less than 15 years. In 1995, South Korea's trade with China was 9% of that country's total. By 2009 it had more than doubled to 20%.
This trend shows few signs of slowing. Just this past December, the Indian and Chinese governments agreed to double trade between the two powerhouses to $100 billion by 2015. This despite significant political differences and even occasional military tensions between the two countries. FedEx also announced the establishment of direct service between India to China.
In addition, the growing emerging market consumer base has the power to drive global GDP. Around the globe, millions of people rise above poverty and enter the middle class every year—by one estimate, some 70 million in 2009 alone. According to another estimate, by 2020, three-quarters of incremental consumer spending will come from emerging markets. If that estimate is correct, then by that year consumer spending in Asia will overtake North America to become the world's largest consumer bloc.
What does that mean for our clients? For companies especially? To me the answer is clear. The companies that succeed in this new environment will be the ones that understand how to tap these different trade flows and serve the emerging markets. Western companies especially can no longer take for granted that they alone have the necessary expertise to serve emerging markets, and especially their complex needs. Home grown firms in the emerging markets are becoming more sophisticated by the day and offer real competition.
So what does it mean for us as a bank? Successful banks will be the ones that help their clients navigate this new reality. Banks need to understand the emerging markets, understand their unique needs and challenges, and be able to help their clients navigate this new world.
The second major trend is the new wave of regulation. It's actually not so new anymore, in that much of it was enacted months or even years ago. But rules are still being written and calibration still being finalized.
There are, broadly speaking, three goals for this regulation. The first is to protect the safety and soundness of financial system. In particular, one goal is to create greater transparency by moving over the counter derivatives to exchanges and thereby remove one of the single greatest risks to the financial system. Also, of course, Basel III will raise capital and liquidity standards and change the definitions of what does and does not count as capital.
At the national level, regulation—for instance, Dodd-Frank in the U.S.—also creates a "resolution authority" for large banks and non-banks. The idea is to allow the government to step in and wind down a failing institution, thus avoiding the chaos of sudden collapse on the one hand and the drawn out inefficiencies of "too big to fail" on the other.
Finally, regulation in the US especially seeks to enhance consumer protection by limiting the fees that banks and card issuers can charge and other measures.
The third major trend reshaping our industry is digitization. You might also call this a demographic shift in that—to borrow a distinction coined by Marc Prensky—"digital natives" are increasingly outnumbering "digital immigrants." That is, people who have never known a world without the Internet, cell phones and other information technologies—in other words, the young—are replacing people like me, who had to get used to them, at a rapid rate.
This population of digital natives is not just comfortable talking to their friends online or downloading music. They are happy—even eager—to live a significant portion of their lives online. And that definitely includes making all kinds of payments and other transactions.
New technologies such as smartphones and other mobile devices can act as "digital wallets" and are gradually displacing physical cash as a primary mechanism of value exchange—potentially leading to a greater shift in the way people pay for goods and services than the introduction of the credit card a half century ago.
And the emergence of digital communities such as Facebook, Twitter, and other social networking sites are changing the ways that all companies must interact with their customers and protect their reputations.
So far, banks have a mixed record of adapting to this new era. By and large, we have done a decent job of digitizing our back offices and some customer facing functions—for instance, the total ubiquity today of the ATM, which Citi helped to pioneer. We're currently focused on making faster progress in the use of social media and introducing innovative new payment methods.
So what do these trends mean for the financial sector? As I said earlier, I see at least four major implications.
First, we're already witnessing a shift in banking's global banking center of gravity eastward, away from the transatlantic orientation that defined the post World War II era and toward Asia. This fact is not merely a geographical issue. It also greatly affects capital flows. The coming years will see huge needs for capital in Africa, Asia and Latin America. A report from the McKinsey Global Institute compares this looming global investment boom to the Industrial Revolution and the reconstruction of Europe and Japan after the Second World War.
The global investment rate has been rising over the last decade, from a low of 20.8% of GDP in 2002 to a pre-recession high of 23.7% in 2008—fueled by demand for factories, roads, bridges, ports, hospitals, offices, housing, rail lines, water and power systems, shopping malls and other projects. That level could rise to 25% of global GDP by 2030, if projected growth levels hold true. And even if the global economy grows more slowly than expected, that will only soften, not eliminate, the world's rising need for capital.
Financial institutions will play a large role in raising capital, especially given the low levels of capital stock in many emerging economies, particularly India and China. Our role will be to supply capital both through direct loans and through underwriting fixed income securities. The latter will play an increasingly prominent role in the capital markets if, as many believe, interest rates start to rise in the coming years after three decades of a generally downward trend.
And we will play a large role in developing the tools through which new capital, in the form of accumulated savings in the developing world, can be productively allocated to needed investment. Right now the financial markets in many of these countries lack sufficient depth. Financial institutions can help provide that depth, through bank accounts, equity and bond markets, and other instruments. While per capita savings rates may well decline in these countries—something that tends to happen as nations get richer—the aggregate amount of capital available for investment will rise given the explosive growth in these economies and the expansion of the global middle class. Financial institutions will also need to help developing economies build out their financial infrastructures—for instance, by establishing fast and reliable clearing and payments systems, which are critical to growth in a global economy.
Talent, too, will migrate to where the opportunities are—adding another layer of complexity to managing banks that currently know more about Paris, London and New York than about Shanghai and Mumbai.
Second, regulation will carry some unintended consequences. Higher capital requirements, plus rules that limit proprietary trading, derivatives, and interchange and overdraft fees, will change banking. On the institutional side, proprietary trading-based profits will be impacted. On the retail side, margins will tighten, requiring banks to reevaluate the feasibility of extensive branch networks, think hard about who they serve, and devise new fee and cost structures.
One unintended impact could be an increase in people in North America who lack access to financial services. Available credit is likely to decline further. $1.5 trillion in credit card lines were cut even before key provisions of the CARD Act took effect in the U.S. last year, and more are being cut every day. And prices are rising for certain basic financial services.
Another consequence of regulation could be that, as the operating environment for smaller banks becomes more competitive, we could see a new wave of consolidation.
Third, we will see financial services more and more be provided by non-bank institutions. Some of this will look familiar, such as retailers acting as lenders to finance purchases of the products they sell. But some will be new. Telecom companies are becoming more and more active in the payments space, using technologies and models similar to banks' own digital payments services. Consumers don't differentiate between—and don't care—what type of company they use to pay for things. Convenience and price are what matter to them. And there are regions where significantly more people have mobile phones than bank accounts. Mobile payments have the potential to bring these consumers into the formal banking economy. Social networking sites remain the wild card. But we are already seeing companies such as Facebook experiment with virtual currency. What form that will take down the road is anyone's guess.
Fourth, and finally, banks will need to develop new business models to overcome these challenges. Higher capital requirements, lower leverage, and higher funding expenses will combine to diminish banks' operating margins. The industry will have to fundamentally restructure in order to recapture much of that lost revenue.
There are many ways this can be accomplished: by shrinking the physical distribution footprint; by imposing fee-based pricing for previously free services; by utilizing capital more efficiently; through reengineering and better expense management; and through the divestiture of non-core businesses.
Successful banks will respond to this trend by adopting a "universal banking model," which we at Citi are already pursuing. The focus of this model is wholly on banking—this is not the "financial supermarket" of years past. The universal bank provides products and services that allow it to serve all of its clients' banking needs in ways that making banking more efficient for clients and that increase revenues and reduce volatility for the bank.
The universal banking model has four interconnected elements:
First, the combination of corporate and retail banking ensures funding stability and access while allowing banks to add greater value for their clients and shareholders.
Second, the combination of capital markets and lending protects earnings while solidifying relationships with clients and at the same time reduces earnings volatility since corporate banking and trading have counter-cyclical attributes.
Third, services businesses provide stable revenues and are less capital intensive than traditional banking businesses.
Fourth and finally, global geographical diversification further protects a truly international bank against volatility.
I believe that Citi is the bank that, at present, most represents the universal banking model. It's a model that will increasingly define the industry as a whole. We may have a head start, but the competition is fierce.
Citi is a completely different company than it was before the crisis. It's smaller, leaner, and more focused on its core strength: being a bank and serving clients. We've been profitable now for six consecutive quarters, our capital strength is among the highest in the industry, and our global network and position in the emerging markets are unmatched by any other large bank.
Citi is a major player in global flows and transactions. We are also an active player in the development of the global economy with leadership roles in key organizations tackling industry issues. In fact, one of our senior executives, Yawar Shah, is Chairman of SWIFT.
We also engage with regulators globally to shape the future regulatory environment. We are working with governments across the globe in emerging markets to assist them in building out their financial infrastructure such as local clearing systems.
SWIFT should similarly focus on supporting growth in emerging markets. SWIFT has successfully focused on dramatically reducing its costs to us and has actively listened to us on its strategic direction. Now we need you to be much more focused on emerging markets, to look at the emerging flows of commerce and address their gaps in other parts of the world.
The industry represented by the audience here should not expect SWIFT to bridge the gaps in emerging market commerce flows on their own. As local banks, we all need to work with local market infrastructure representatives, some of whom are probably in this audience also, to convince them that an open, global, standardized financial ecosystem is in the best interests of their economies.
The new realities affect us all and we all need to adjust.
The financial system of the future will be different—not worse. In many respects it will better—stronger, more stable, and better able to meet the needs of a changing global landscape.
Like all transitions, this one will not be easy or free of pain. But it will be salutary—for the system, and for those it serves.