Traditional banking model under threat from demographic time-bomb

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In the coming decades, commercial banks will face substantial challenges from the greying of societies around the world. These will range from a declining demand for credit in the economy and a shrinking stream of regular payroll deposits to tougher competition.

Populations are ageing rapidly as people live longer, healthier lives. This substantially reduces the proportion, and in some economies the number, of people of working age. This process will be exacerbated by low or falling birth rates – the impact of which has yet to filter through.

During the past 30 years, the average age of the typical man or woman in advanced economies has jumped from 32 to around 40 and will hit 46 by 2050. In economies such as China, ageing is occurring even more rapidly. The median age there stands at 35 but will have risen by 13 years to 48 by 2050.

What this means is that the ratio of people older than 65 to the economically productive portion of the population aged 15 to 64 is steadily rising. Japan and Germany will be among the hardest hit, with their working-age populations set to shrink by more than 30% by 2050.

Without raising productivity, low growth might also become the new normal. Fewer and fewer workers will have to bear an ever-increasing burden of pensions and healthcare for the elderly while a narrower tax base will pose serious challenges for government budgets.

For banks, a smaller working-age population, whether in absolute terms or as a proportion of total population, means lower demand for loans and a slower flow of regular wage deposits.

“An ageing population is clearly a challenge and one of the effects is that there will be less demand on the accumulation-type products such as mortgages, savings and loans, and more demand for pensions, annuities and fixed-income products that will draw down on those savings,” says Zil Bareisis, a senior analyst at Celent’s banking group.

“While the flow of direct payments such as salaries may come under pressure, there’s a question going forward of whether these payments will even be going to banks or would they go into some sort of alternative transactional account.

“The European Commission is going to be mandating that everyone in the EU should have access to a basic payment account, but that payment account doesn’t necessarily have to be provided by a bank. It could be in the form of a pre-paid card or some alternative vehicle and that would further fragment the types of deposits banks receive.”

Bareisis says new technologies will help banks to adapt and weather these future challenges through innovation and efficiency gains. At some point, the higher costs associated with servicing older customers – manned branches, call centres and hard-copy communications – will reverse as the connected-all-the-time Facebook generation advances into old age itself.

However, the current banking model in which banks compete for deposits to fund their lending might be fundamentally unsuited to a future in which an ever-expanding supply of capital from retirees outstrips demand for borrowing.

“The older people are, the more they need to store wealth, but if everybody is trying to store wealth and save it, on the other side of the balance sheet you need somebody who’s at an earlier stage in life who wants to buy a house or start a business today and pay for it over the long run,” says Simon Wolfe, professor of banking and finance at Southampton University’s school of management.

“They need an older person with surplus funds to lend them the money.

“But as society ages, you don’t have sufficient people at the bottom who want to borrow the funds from people who have it. So you end up with banks with too much on one side of the balance sheet, too much in the way of deposits, and nobody to lend it to.”

Wolfe adds: “You create an imbalance that means the banks themselves will have to shrink because they have no way to advance credit because there’s no demand. Therefore they won’t necessarily want the deposits.

“That will mean lower interest rates. People who have money will then debate about how they’re going to store it as wealth – whether to invest it in the stock market or somewhere else.”

An even bigger threat might be the question of where the drivers of future economic growth are going to come from in a society with fewer economically productive members. Lower growth will mean banks will not only have fewer places to invest retirees’ wealth – too much money chasing too few investment opportunities – but less banking business.

Wolfe says the double whammy from this demographic time-bomb will likely see banks forced to downsize in line with their reduced individual slices of the pie.

However, Lombard Street Research’s senior economist Jamie Dannhauser argues that while advanced economies will see a lot more asset and fund management, pensions and insurance and far less banking, the future for the industry is not nearly so bleak elsewhere.

“Major banks can lend to the emerging world which will still have a very considerable demand for credit for years to come,” he says. “Or they can move into a different part of the business managing fairly stable pots of money, providing safe assets and wealth preservation.

“But the whole demographic time-bomb story assumes that people don’t work longer and that’s going to be entirely disproved. We’ve already in the last five years, both in the US and Britain, seen a far more rapid pick-up in labour market participation for people over 65 than anyone was projecting five years ago.”

“I don’t see that ending at all soon anywhere in the advanced world. I also think the assumption that current pension arrangements are going to remain unchanged and countries won’t renege on their pension deals is incorrect.”

Dannhauser concludes: “I see the world over the next few decades as one in which people work substantially longer and that countries that are willing to make real efforts to encourage that will reap substantial economic benefits.”