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DUBAI/DAVOS: In a context of rising inflation, higher defaults, cost reductions including job cuts impacting consumers and businesses, 2023 seems to be pivotal for the banking industry.  

The rising geopolitical challenges and the role of China, Russia, Ukraine, and climate change considerations perfectly position the industry in the “eye of the storm”. 

The banking industry is faced with several risks including cyber security risks, private credit risks, and the risk of an economic slowdown. These risks are all connected, as witnessed by the pandemic and the war in Ukraine. 

A panel of bankers and regulators at the World Economic Forum in Davos on Wednesday highlighted some of the risks facing the sector today and the challenges brought by non-banks and the lack of regulation. 

However, “there is a feeling of optimism in Davos this year,” declared François Villeroy de Galhau, Governor of the Central Bank of France, with the level of activity in Europe being more resilient than expected, “we should avoid a recession this year. Inflation in Europe will peak during first half of 2023, but we will bring inflation towards two percent by 2024-2025,” an ECB commitment. 

Banks and insurance companies are regulated and are systemically safe. There were critics by banks of overreaction and over regulation to the financial crisis, nonetheless, “we were right, and if banks are on a better health today, and more solid in terms of capital solvency or liquidity, it is thanks to this type of regulation. We will not diminish the requirements,” added the governor.  

This year might witness more regulation as banks lean towards the final implementation of Basel III across jurisdictions.  

The panel stressed assets linked to non-banks as a rising challenge, with recent episodes of financial instability related to money market funds, LDI derivatives, and FTX among others. 

The challenges arise from the nature of the landscape that is constantly evolving. 2022 was marked by disruptions from FTX and crypto due to a lack of regulation. As such, it is crucial to have a consistent global framework for managing new forms of money and payment systems. 

Different regulation applies to different products, including unbacked assets, to mitigate money laundering and provide better investor protection. 

For Tharman Shanmugaratnam, Senior Minister of the Government of Singapore, “Anti-money laundering needs to be applied to all new innovations” however, regulation may seem as a “never ending game,” and as such, encourages better consumer education on risk taking. 

“Crypto is part of the equation, but it’s not the only factor,” Jane Fraser (CEO, Citi) added ffinancial inclusion and addressing inefficiencies in payment flows, as factors needed to build the right regulatory framework. 

Going forward, new asset classes will be created in one form or another and will require regulatory framework to respond to investors who choose to tap into them.

“We had to draw a line on what was suitable for our investors, what is our fiduciary duty and by the way what is of compliance responsibility,” said Colm Kelleher (Chairman, UBS AG).

There is consensus for a need for a global regulatory framework. The challenge is to keep up with a fast-evolving technology. A solution is to develop partnerships between regulators or public authorities and banks. “Banks should not be against any regulation because regulation can help stabilize the industry, while public authorities work on promoting innovation,” added François Villeroy de Galhau. 

CBDCs (Central Bank Digital Currency) are a good example of partnership driving innovation and efficiencies on a larger scale in the industry. The Fed and the ECP are currently working on a digital currency. CBDCs are not about disintermediating banks, rather help facilitate cross-border flows, financial inclusion, support the economy and the financial markets. “Digital currencies are part of the toolkit. They are not the toolkit,” added Jane Fraser. 

In addition to developing tools and digital currencies, regulators in the banking industry are working on providing the conditions that make cross-border deals more accessible to the industry.  

In Europe, it is called “banking union” and it serves to facilitate cross-border mergers. The banking industry will benefit from economies of scale arising from consolidation, “to have cross-border macroeconomic effects because it means that savings can circulate across Europe and this has a powerful stabilizing effect,” added the governor.