Evolution Or Extinction: Where Are Banks Headed?

The banking industry represents an interesting and important case study of how changes in technology and regulation influence business strategy and organizational design. A narrow focus on traditional bank products and performance measures would lead one to conclude that banking is a declining industry. Such a focus, however, would miss most of the innovations in banking–most notably, the move to “off‐balance‐sheet” activities–that have been taking place in recent years. A broader perspective shows banks evolving in ways that are enabling them to provide the same basic functions as before, but in new, more efficient ways. In the past, most banks thought of themselves as delivering a set of specific, largely unrelated products to different sets of customers. Today many banks are pursuing strategies that aim to strengthen their ability to perform various functions–for example, financial planning for retail clients, or raising capital for middle market companies–that tend to cut across the old product boundaries. As a result, and in contrast to most industrial firms, many banks are offering a more diversified range of products and services than ever before with the aim of exploiting potential synergies among those products. Such major changes in banks' strategies are in turn leading to fundamental changes in their “organizational architecture.” Some banking activities that were once controlled by a rigid management hierarchy are now being decentralized, whereas other functions that were largely decentralized are being subjected to more central coordination to help realize potential economies of scale and scope. Along with these changes in decision‐making authority, banks are also being forced to rethink their internal performance evaluation and incentive compensation systems. As an ever larger portion of their activities continues to move off balance sheet, more and more banks are deciding that conventional accounting measures of bank operating performance such as ROA and ROE are inadequate, and that economic measures of performance like RAROC and EVA are needed to reflect the new reality of where banks are putting their capital at risk, and whether the rates of return they are earning on their different activities are high enough to reward their shareholders.