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InsightsBanking in Bermuda Magazine Summer 2014

Discussions with the CEOs of Bermudas banksThe RoundtableKPMG in BermudaBANKING SURVEY2

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2 | KPMG 2014 Bermuda Banking Survey

INTRODUCTION

Welcome to our fourth editionof Insightswhere we discussthe continuation of signi-cant change in the banking

industry. Globally we have observed:

Unprecedented change to businessmodels including cost optimisation,and the reevaluation of product offer-ings and sources of revenue streams;

A continuing increase in regulationand the requirement for more informa-tion and more precision in informa-tion reported, and increased capitalrequirements;

A focus on customer centricity withcustomers looking to engage in newways with their banks. This includesthe desire for tailored banking services,and new channels to interact with theirbank (e.g. mobile applications);

Shareholders continuing to seekacceptable returns on equity, lessreputational risk, and the effectiveidentication and management of

signicant risks; and

An increased IT agenda includingthe increased harnessing of data tounderstand trends in client behavioursand needs, irregularities, to drive new

revenue opportunities. This is com-monly referred to as Data & Analytics.

In addition, low interest rates and chal-lenges within loan and mortgage portfolioscontinue to prevail in Bermuda.

We discussed these matters with repre-sentatives of the Bermuda banking sectorincluding the CEOs, the Chairmen of eachof the banks, and representatives of theBermuda Monetary Authority, to obtaintheir insight into these trends and how

they apply to the Bermuda marketplace.KPMG professionals have also providedinsights into these trends in the Bermudabanking sector.

We are once again thankful to the CEOs,Chairmen and the BMA for their willing-ness to take part in our annual survey.Specically, we would like to acknowledge

the involvement of Mr. Michael Collier and

Mr. Peter Horton (Bermuda CommercialBank), Mr. Brendan McDonagh (Buttereld

Bank), Mr. Zoran Fotak (Clarien Bank), Mr.Phil Buttereld and Mr. Richard Moseley

(HSBC) and Mrs. Marcia Woolridge-Allwood, Mr. Craig Swan and Mr. TomORourke (Bermuda Monetary Authority).

ByCraig Bridgewater

Head of Investments

& Banking


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KPMG 2014 Bermuda Banking Survey | 3

CONTENTS

4

The Roundtable:Discussions with the CEOsof Bermudas banks

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Data, Analytics andTechnology: Core strategicenablersBy Neil Patterson& Fred Obelhozer

12

Customer Centricity:Profitable growth throughcustomersBy James Berry& Valerie Robshaw

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Monetising Mobile: Mobile

banking and paymentsBy James Berry& David Harper

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Cyber Security: An evolvinglandscapeBy James Berry& Fred Oberholzer

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A Cost Optimised OperatingModelBy Craig Bridgewater& Alexandra McInnes

22

OECD Global standardfor automatic exchange ofinformationBy Charlie Thresh& David Harper

24

Basel III in BermudaBy Craig Bridgewater& Paull Davis

26

Effective Governance,Driving StrategyBy Neil Patterson& Alexandra McInnes

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2014 KPMG in BermudaBanking SurveyBy Craig Bridgewater& Richard Hobday

On the cover:Brendan McDonagh (Buttereld Executive Chairman and CEO), Peter Horton (BCB CEO),

Zoran Fotak (Clarien Co-CEO) and Richard Moseley (HSBC CEO)


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Top, from left:Charles Thresh (Managing Director, KPMGin Bermuda), Neil Patterson (Chairman, KPMG in Bermuda),Brendan McDonagh (Buttereld Executive Chairman and

CEO), Peter Horton (BCB CEO), Craig Bridgewater (Head ofInvestments & Banking, KPMG in Bermuda) and James Berry(Managing Director, KPMG in Bermuda). Bottom, from left:David Harper (Senior Manager, KPMG in Bermuda), ZoranFotak (Clarien Co-CEO), Richard Moseley (HSBC CEO) and

Valerie Robshaw (Manager, KPMG in Bermuda).

O

ur roundtable discus-sion focused on fu-ture opportunities forgrowth, new ways toaccess customers,

using data to understand cus-

tomers needs and behaviours,and the various challenges to thebanking sector that are currentlyon the minds of the CEOs in Ber-muda.

Key areas of discussion were:

1. How the banks were considering fu-ture business models and the growth

agenda;

2. Cost optimisation;

3. Operating models that have customercentricity at their heart;

4. How banks can use data to betterunderstand their customers;

5. Delivery channels and mobile banking;and

6. The increasing regulatory burden.

ByCraig Bridgewater

Head of Investments & Banking

Valerie RobshawManager, Banking


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CEO ROUNDTABLE

Future Business Modelsand the Growth AgendaOver the last few years since the nan-

cial crisis, there has been a redening of

business models in order to maintain or

increase prots and shareholder returns.

This has included cost optimisation or

reduction, the search for new revenue

streams and increased targets for cost

efciency ratios.

KPMG: Do you think the Bermuda

banking industry can maintain itshistorical levels of protability and return

on equity? If so, how might this be

achieved?

Fotak:Levels of protability and return on

equity post 2008 do not offer a compellingvalue proposition for risk capital or equityholders. Operating efciency improvements

alone will not be sufcient to enhance

returns to requisite levels; as such, growthareas need to be identied where Bermuda

has comparative advantages to other juris-dictions.

Horton:The dynamics of the banking sec-tor have changed over recent years and Isee there being two key factors impactingthe ability to sustain prots at historical

levels: Firstly, the increased capital costsand capital requirements post the globalnancial crisis. Secondly, the continued low

interest rate environment. The challengethen facing banks is to realign their busi-ness models and manage costs of capitaland alternative income lines much moreeffectively going forward.

McDonagh:A range of 15-20% return onequity in the banking sector performance

will be achievable with a reasonableimprovement in the economy. To achievea return on equity in excess of 20%, a com-bination of higher interest rates and a lowercost base is needed.

Moseley:The industry as a whole is facingincreased regulatory and nancial compli-ance costs, increased regulatory capitalcosts and demand headwinds. The industryis reforming itself by optimising cost struc-tures, using risk based pricing mechanismsas well as value based customer segmen-

tation. This means becoming selective

in customer acquisition and educatingstakeholders of the increased costs of do-ing business. Overall, this will enable theindustry to return to an acceptable levelof sustainable risk and reward balance;however, it is unlikely to lead to a return tohistorical levels.

KPMG: What initiatives are ongoing or

planned in relation to cost optimisation

and identifying new sources of revenues

other than interest income?

Fotak:Technological change is relentlessand is requiring continuous improvements

in work ows to achieve both cost efcien-cies as well as shortened lead times inbringing new products to market. Interestincome is the least compelling revenuestream in the current global environment ofgovernmental monetary easing.

Horton: BCB is undertaking signicant

work around its technology infrastructure,which will be a signicant driver in terms of

increasing productivity. We see technologyas a platform which will allow us to bringgreater access to existing banking ser-vices and products and, at the same time,

provide a broader range of services to ourclients.

McDonagh:We are going through a periodof continued process improvement tooptimise our cost base. In terms of newsources of revenue other than interestincome, we continue to expand our wealthmanagement franchise, particularly in thetrust division.

Moseley: Cost optimisation involvesstreamlining processes and reducing layersof bureaucracy in the organisation, includ-

AT THE TABLE:

PETER HORTONCEO, Bermuda Commercial Bank

BRENDAN MCDONAGHExecutive Chairman & CEO, Buttereld

Bank

ZORAN FOTAKCo-CEO, Clarien Bank

RICHARD MOSELEYCEO, HSBC Bank Bermuda Limited

NEIL PATTERSONChairman, KPMG in Bermuda

CRAIG BRIDGEWATERHead of Investments & Banking, KPMG inBermuda

JAMES BERRYManaging Director, KPMG in Bermuda

CHARLES THRESHManaging Director, KPMG in Bermuda

DAVID HARPERSenior Manager, KPMG in Bermuda

VALERIE ROBSHAWManager, KPMG in Bermuda


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ing looking at outsourcing non-value addedfunctions and reducing the footprint of

operations. These initiatives are ongoingand have become business-as-usual. Interms of new revenue sources, we look atchanging customer preferences; includingrapid expansion to alternative channels e.g.Mobile Banking.

KPMG: In what areas is cost not

considered as highly as other

factors involved in doing business

(e.g. compliance with regulation,

development of new products or

enhancing the quality of customer

service)?

Fotak:Cost is always considered but,most importantly, the frame of reference iseconomic value add. Compliance and AMLcan be positioned as a key differentiator ifeffectively implemented.

Horton: Cost is always considered, regard-less of the area. The challenge is to ensurethat we are investing in the business in theright way, to achieve the balance betweenshareholder return and building a sustain-able business.

McDonagh:Cost is considered less inspecialist areas that are highly regulated,

including Trust and Fiduciary Services andAsset Management.

Moseley:The costs of compliance andregulation, including customer onboardingand due diligence, as well as risk manage-ment, have now become part of the costof doing business, just like most otherfunctional costs.

KPMG: How much emphasis is being

placed on technology or automation of

processes to reduce costs and generate

increases in revenue? What initiatives

are ongoing or planned in relation to

technology driven cost optimisation andrevenue streams? How successful have

these been?

Fotak: Technology implementation withoutthe corresponding updates to work ows

can lead to disappointment. New processescan be threatening to people, so consider-able time needs to be spent on appropriatetraining and development.

Horton:Signicant emphasis is being

placed on technology. A critical successfactor of any bank going forward will be theextent to which they successfully lever-

age technology. I see technology as one ofthe most exciting things happening in ourindustry and we are fully embracing the op-portunities this presents to us.

McDonagh:There is a signicant empha-sis being placed on technology, includingincreasing the functionality in direct bankingchannels, which makes it easier for custom-ers to access our products and services.The biggest challenge to this new wayof interacting with our customers is theirwillingness to participate in this manner; weneed to inuence our customers to change

their behaviours.

Moseley:Providing straight through pro-cessing through online channels and mobileapps for transaction banking remains a keycomponent of cost optimisation. Allowingour customers to interact in a secure man-ner for an increasing array of products andservices with the Bank on that basis hasbeen a key component of success in thisarea.

Customer Centricity

KPMG: Many customers are now asking

for tailored banking products and fortheir bank to be more responsive to their

individual needs (i.e. more customer

centric). What does customer centricity

mean to your organisation?

Fotak:We view banking products as fairlyhomogenous, therefore differentiation hap-pens when needs are identied and met

with seamless and consistent execution.

Horton: Customer centricity to me meansputting the customer right at the heart ofour business and aligning our business

around delivering a great customer proposi-tion. I see it as critically important to providea combination of easy access and a consist-ent quality service to our clients, if we areto be a truly customer centric business.

McDonagh: We have found that this trans-lates into better access to well functioningtechnology for our customers.

Moseley:It is becoming increasingly im-portant that we understand how customerinformation can benet both the customer

and the Bank by ensuring that the customereceives the appropriate products and ser-vices throughout the relationship lifecycle.Certain products will remain homogenousbut the improved understanding of ourcustomers will also assist in differentiat-ing the needs of customers and thereforeenable us to tailor products and servicesbetter, leveraging the strength of our globalcapabilities.

RegulationBanks continue to face an increasing

regulatory burden including an increase

in the amount and precision of report-

ing and an increase in capital require-

ments. Much of this has been enshrined

in regulation and statutory instruments

such as FATCA, enhanced KYC and AML

standards, and the advent of Basel III and

its related capital adequacy requirements

and liquidity coverage ratios.

KPMG: What is your state of readiness

for new regulations such as FATCA?For Basel III? What is your view on the

jurisdictions and the Bermuda banking

industrys response to FATCA? To Basel

III?

Fotak:We are prepared for the new FATCAregulations. Banks should be mindful ofways they can protect themselves whendealing with dual residents, including mak-ing updates to on boarding procedures. Ourgoal is to early adopt Basel III and we areon track.

A critical success factor of any bankgoing forward, will be the extent towhich they successfully leverage tech-nology. Peter Horton, BCB CEO

There is a significant emphasis beingplaced on technology, includingincreasing the functionality in directbanking channels, which makes iteasier for customers to access ourproducts and services. BrendanMcDonagh, Executive Chairman &CEO, Butterfield Bank


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CEO ROUNDTABLE

Horton: We are ready and I think the re-sponse has been an extremely positive one.I have been impressed by the high levels ofcollaboration within the industry and withthe Regulator.

McDonagh:We consider our organisationto be ready for FATCA. Bermuda and thenancial services industry here had no other

option than to be ready for FATCA, given itscompulsory nature and Bermudas location.

Moseley: The make-up of the Bermudaresident population include an exceptionallyhigh proportion of dual (or more) residents,which will require enhanced documentationand reporting requirements under the regu-lations. In terms of Basel III, all Bermudabanks have been involved in extensive con-sultation with the BMA around the potentialimpact of the new rules. This has been

extremely productive and we are condentthat we are ready for implementation.

KPMG: What areas of regulatory

compliance are currently the most

challenging in your business and why?

Horton: We have to accept continued regu-latory change as a fact of life, so I dont seethat as a challenge in itself. The challengeis essentially one of continually striving toachieve commercial success and to there-fore view regulatory change in a positive

rather than a negative way.

McDonagh:Financial Crime Compliance(including Anti-Money Laundering) is afocus for us. The criteria are principle andbroad based, meaning that we are requiredto have signicant and sufcient informa-tion on le for our customers.

Moseley:As compliance expectations ofBanks increase, the demands and costsfor sophisticated screening and reportingmechanism increase signicantly. In addi-tion, it is difcult to explain the process to

the customer, which could involve delayingand reporting payments for further investi-gation.

KPMG: Is the Bermuda banking industry

working together with the BMA to

ensure the regulatory requirements

are appropriate for the industry? Whatwould you like to see more of? What

would you like to see less of?

Fotak:We have found that the BMA hasbeen working on these issues very coop-eratively and constructively.

Horton:Yes, there is substantial consultationongoing between the banks and the BMA.

Moseley: Yes, the Bermuda Bankers As-sociation is actively working with the BMAto ensure appropriateness and relevance of

regulation. The consultation process around

Basel III is an excellent example of that andwe believe the results will be that Bermudabanks will be well positioned to retain andgrow following the implementation.

Customer ChannelsRecent trends have seen a disruption in

traditional customer channels such as

branches. Examples of new and emerg-

ing banking channels include mobile

banking and less card based transac-

tions, and digital banking experience

using the web, and mobile apps and

devices.

KPMG: What, if any, of the new

customer channels has your bank

adopted or are looking to adopt? Do

you think the rate of adoption of these

disruptive technologies is set to increase

in the Bermuda banking industry? What

barriers do you see to the adoption of

such channels?

Fotak: Disruptive technologies by denition

break down barriers to entry. So long assecurity issues can be addressed, this trendis unlikely to slow.

Horton: To me, this is about developingmobile banking channels to the fullest. Thebiggest barriers to adoption will be customeruptake and managing the cyber security is-sues. The security of these new and emerg-ing banking channels remains a key focus.

McDonagh:We have concentrated on themobile banking app to compliment our in-ternet banking offering. We have seen gooduptake in this channel, however we havefound that barriers are customers willing-

HSBC has adopted all new digital channels, including online, Mobile apps,smart ATMs and near field, which have been readily and rapidly adoptedby our customers as their preferred channels and we believe this trend willcontinue due to the relative sophistication of the market as well as the wideavailability of internet access in Bermuda. Richard Moseley, HSBC CEO


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ness to use our offering and their ability toaccess the new technology.

Moseley: HSBC has adopted all new digitalchannels, including online, Mobile apps,smart ATMs and near eld, which have

been readily and rapidly adopted by our cus-tomers as their preferred channels and webelieve this trend will continue due to therelative sophistication of the market as wellas the wide availability of internet access inBermuda.

KPMG: Bank branches have traditionally

been an important service feature of

the banking industry. In more recent

times, the trend has been moving away

from traditional branches and bankinghalls. Are there plans to change the way

your branches are used to service your

customers?

Fotak:Expansion of the ATM network andour electronic banking offering is the mostefcient way to deliver a signicant compo-nent of banking services. There will alwaysbe a need to have a physical presence forthe higher level banking services.

McDonagh:We currently have no plansto change the way in which branches areused to service customers, however we are

augmenting this service with other waysfor our customers to access our services.Bermuda is too small a market to warrantan extensive branch network.

Moseley:This is an area that continuouslydevelops as customer preferences change.We nd our customers now come to a face

to face meeting with a specic purpose,

such as opening an account, discussing amortgage or to seek nancial advice and will

no longer use our branches for transactionsor payroll services. We have changed ourbranch capabilities to match these prefer-

ences and also changed the working hoursof some of our staff to meet client needs.

Risk Management and theManagement of Reputational RiskGiven the increasing pressure to use

and leverage technology in business

delivery models and to meet the needs

of signicant stakeholders, including

customers, shareholders and regulators,

cyber security and the resultant business

and reputational risk has made its way

onto the Board, Audit Committee and

C-level executive agendas. Regulators

are also concerned. Investment needs to

be focused in the right places in order to

protect reputations, systems and trust.

KPMG: Many boards have cyber security

high up on their agenda. How do you

assess the cyber security risk of your

organisation? Have cyber security

strategies been integrated into business

operations and your entitys risk

appetite?

Fotak:This is a hot topic in the industryand among regulators, directors, clientsand insurance carriers. Banks are becomingincreasingly prepared for cyber attacks fromoutside their organisations, but they should

also be mindful of attacks from inside theirorganisations. We consider this to be theprincipal overlooked risk in relation to cybersecurity.

Horton:This is a key reputational risk facedby banks globally. It is vital to maintain thetrust of customers, and banks need to dowhat they can to ensure this. Even smallbanks must be aware and be prepared forattacks that happen on a daily basis.

McDonagh:We consider it to be of criticalimportance and it has been integrated intoour operations and risk appetite. To mitigatethe risk, we have executives who are dedi-cated to ensuring we are ready for threatswe are inevitably going to experience. Wecontinue to upgrade our defenses in linewith industry best practices.

Moseley: These areas are high up on ouragenda, working closely with the resourcesin our Group. Each cyber risk is classied,

assessed and controls, monitoring and miti-gation strategies have an assigned owner.

KPMG: How prepared are you to act in

the event of a cyber attack or insider

threat? Considerations include having

robust defence capabilities, having theability to detect and respond to breaches

and having the ability to remediate

vulnerabilities?

Fotak: We are as prepared as we can be.The problem is that even a 1% penetrationincidence can have signicant negative

consequences and a 100% defense is justnot possible. As such, we also focus on theresponses to incidentsbecause they dooccur.

McDonagh:We consider ourselves as pre-pared as we can be, but there will always

be unforeseen attacks.Moseley:We use our global frameworksand capabilities and are as well prepared asthe rest of the HSBC global network.

Data Analytics andCompetitive AdvantageIn general, it was found that the Bermudabanking industry is at the infancy stage withregards to warehousing data on customerneeds and behaviours. However, the CEOsall acknowledged that this is a growingarea of focus in Bermuda which has been

historically underinvested in and, if appropri-ately harnessed, can provide a competitivestrategic advantage to each of the respec-tive organisations and to the industry as awhole.

In conclusion, the Bermuda banking

industry and its participants are well

aware of the signicant issues and op-

portunities available to the industry and

are very focused on taking advantage of

them. The industry works well with the

BMA in regards to the appropriateness

of regulation for the Bermuda market-

place and to ensure that the respectiveregulations are implemented, reported

on and monitored. There continues to

be an effective relationship between the

industry and the regulator.

The Bermuda banking industry will

continue to evolve the products offered

to customers and the channels by which

such products are delivered. We look for-

ward to the continued developments in

these areas over the next twelve months

until the time of our next publication.

Banks are becoming increasingly

prepared for cyber attacks fromoutside their organizations, but theyshould also be mindful of attacksfrom inside their organisations.Zoran Fotak, Clarien CEO


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T

he international banking sector is increasingly being charac-terised by rapid and transformational developments in data,information, and technology, and Bermuda is no exception.These developments present challenges and opportunities forBermudas banks. Managing and taking best advantage of this

new data environment requires new approaches to systems, processesand governance. Rapid and accurate data collection needs to be com-plemented by ensuring its accessibility in real time to relevant decision-makers. New tools for data and analytics and business information cannow radically simplify and streamline the task of extracting managementdata and creating timely and insightful reports.

The role of data and information

The role of data and information is nowintegral across the business, from

back-ofce to marketing and sales, and

from risk management to meeting stake-holder and regulators expectations. Banks

need to consider the strategic implicationsof their data management processes andview data and analytics in terms of:

Cost and efciency:Banks need tobecome leaner, simpler and more cost-ef-

fective in their operations. As a key enableof process and workow efciencies,

technology has a huge role to play here.

Exploiting data:Mastering the massiveincrease in data ow and extracting the

greatest value from it is fundamental toorganisational health and success. Theimplications extend across the businessoperating model. At the front end, banksface real challenges in managing and mak-ing sense of the vast array of informationwhich can now be made available about


DATA ANALYTICS

Data, Analyticsand Technology:Core strategicenablers


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Bermudas banks have a long andimportant history in the commu-nity and have played a key role inshaping the island as it is today.The small number of banks and

the size of the jurisdiction mean that the

relationship between customer and bank istypically much closer than in other environ-ments. Therefore, Bermudas banks havecustomer focus as a key priority and seekto give all their customers a positive experi-ence. If successful, this certainly benets

the customer but also the bankrelation-ships and customer loyalty will be strength-ened and customers become advocates.

However, in an environment of continuedlow interest rates, increasing costs, highercapital and other regulatory requirements,it is important that banks not only treat alltheir customers well but also analyse theircustomer base to identify opportunities forprotable growth.

This requires a focused strategy, anactionable plan and rigorous execution ofidentication of existing customers whose

relationship with the bank could be prot-ably developed further, and new custom-ers that the bank wants to attract.

What are the characteristics of a

customer centric bank?

There are four key attributes that institu-

tions with successful customer centricmodels have: Focus, Efciency, Agility and

Trust. While each attribute is applicableto todays conditions, organisations mayplace greater focus on one over another,depending on their particular circumstanc-

es and priorities. Some companies mayhave highly developed strategies relatingto individual attributes, but recognise theneed to fortify their other capabilities.

Focus:Best-in-class institutions articulatea clear strategy that reects their vision

and focus. Top rms have charted a pre-cise course focused on a long-term viewof their customers needs and how theserelate back to protable growth.

Efciency:Successful institutions em-brace a culture of continuous focus onefciency. They invest in scalable systems,

processes and delivery channels to resolvelegacy inefciencies.

Agility:Top institutions demonstrate theexibility to adapt swiftly to a changing

environment. An open mind-set character-ises their people from the boardroom tothe front line.

Trust:Top-performing institutions havebuilt condence and trust in the eyes of

their customers, regulators, investors andthe communities they serve.

Going beyond customer focusto customer centricity

Know your customer

The business model of a customer centricbank starts with better knowledge of itsclients that gives genuine insight into

the true voice of the customer. Thoseinstitutions that understand their custom-ers are better placed to offer products andservices that customers have a higher pro-pensity to buy, particularly if this is doneon an institution-wide basis rather than insilos. Customer centric banks often seekinsight from methods such as satisfactionsurveys, net promoter analysis, and socialmedia, frequently resourcing these effortsby positioning customer insight as a centreof excellence, thereby attracting talent,including from other sectors.

Know and use your dataBanks that are able to connect internal andexternal data are better positioned to cre-ate value and gain competitive advantage.To be able to do this, data must be acces-sible and easily analysed across products,brands, businesses and functions. Socialmedia and internet tools can supplementin-house data to predict customer behav-iour, with individual-specic or demograph-ic lifestyle data. Successful institutions usestatistics, modelling and data mining to


CUSTOMER CENTRICITY

Customer Centricity:Protable growth through customers


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extract information from data, to analysecurrent and historical facts, and to predicttrends and behaviour patterns of custom-ers. Such predictive analytics is a criticalpart of meeting customer needs, anddriving protable growth in competitive

markets.Propositions based on customer needs

As with any service organisation, a bankthat can develop unique buying reasonsas opposed to unique selling propositionswill be rewarded by customers throughgreater loyalty, referrals and retention. Astrategy built on an analysis of customerneeds can provide increased value fromproposition and product alignment anda better allocation of resources focusedon higher value segments. Insights intocustomer needs should drive propositionswhich are based on the key momentsof truth that wield the most inuence on

customer decision making. This focusesan institution on those incremental valueareas for price-sensitive customers whootherwise see banking as a commodity.

Optimise your distribution and

operations

The evolving preferences of the next gen-eration of customers will change the waybanks operate and distribute productsand constantly emerging technologies will

be key to that process. There is evidenceglobally that there is no one effective strat-egy for channel optimisationthe rightsolution depends on the geography, regu-latory environment and, most importantly,customer preferences. While Bermudas

banks are considering developments in dis-tribution channels, such as mobile banking,it may be that the size of the communityand customer relationship history meansretention of a strong face-to-face relation-ship is appropriate. Ultimately, banksneed to adopt a distribution strategy thatoptimises return on investment and alsomeets customers needsnot only froma convenience perspective but providingtransparency to customers regarding riskand return of products and services.

Create a positive end-to-end customer

experience

After the initial contact with the customerhas been made, turning their expectationsinto reality requires efcient and effective

operations organised around customersrather than products. The customersneeds and expectations must be metacross the organisation and not just insilos. In todays banking world, custom-ers are looking for consistent error- freeprocessing regardless of service channel,working online one day, using the phone

the next and increasingly using smartphones and tablets. However, while an ag-ile digital strategy can be a game changinginitiative to meeting customer needs andmaintaining cost control, just as impor-tant in the service experience is ensuring

that the banks people and processes arefocused on the customer rather than indi-vidual products.

Customer preferences change, as must

best-in-class banks

Moving from vision to action requires con-tinual ne-tuning. Technology is changing

at a fast pace, and customer demands areevolving. The traditional banking model isunder pressure from low interest rates andhigh legacy cost bases. Shadow bankingand niche products are also increasingtheir market share. Meanwhile, a carefullybuilt brand is under pressure from ad-verse opinions on social media, and fromadvances by new entrants. The end-to-endexecution of a clear customer strategy iscritical for banks to generate protable

growth in these changing times.


Dynamic banks are consist-

ently challenging the notion

that customer relationships

are owned by one particular

bank. Focusing on customer

centricity will help ensure

that existing customer rela-

tionships are retained and

that new ones are gained.

ByJames Berry

Managing Director

Valerie RobshawManager, Banking


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MOBILE BANKING

Monetising Mobile:Mobile banking andpaymentsThe era of mobile banking and payments

has arrived in Bermuda. Around the worldand across the banking value chain, banksare waking up to the huge potential of amarket that is rapidly changing the waythat customers interact with their nancial

institutions.


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Late in 2013 mobile bankingservices were introduced to the

Bermuda market by HSBC andButtereld Bank. But those intro-ductions are expected to be just

the start of a number of mobile bankingservices innovations.

Terminology: Mobile banking vs. Mobile

payments

Many consumers (and even a fair numberof bankers) make the mistake of usingthese two terms interchangeably.

But there is a difference: Mobile Bankingrefers to platforms that enable customersto access nancial services (such as trans-

fers, bill payments, balance informationand investment options).

Mobile Payments, on the other hand, isgenerally dened as the process of using

a hand-held device to pay for a product orservice, either remotely or at a point-of-sale.

Mobile payments gaining importance

Almost 85% of respondents to KPMGInternationals online survey of bank execu-tives say that mobile payments will havesignicant importance to their business

within the next one to four years.

Our survey shows that a select group ofbanks are quickly moving ahead of theirpeers to gain customer loyalty, reducecosts andultimatelysecure their placein the mobile payment value chain. Others,

however, are waiting for standards to beset and for customer demand to hit criticalmass.

But Bermuda banks may quickly nd that

the spectre of new, nimble and highlyeffective competitors taking control ofthe mobile payments market represents aclear and present danger. In fact, the tra-ditional hegemony of banks over the pay-

ment process is certainly not guaranteedand is more at risk today than ever before.

Challenges and opportunities of mobile

payments

And while there are, as yet, very fewcertainties in the mobile payment arena,our survey illustrates a number of keychallenges, considerations and opportuni-ties that are universally critical to banksas they develop their mobile banking andpayments strategies.

Monetising mobile: Innovator banks are

taking the lead

In both mobile banking and mobile pay-ments, a small number of banks aredriving ahead with developing mobile pay-ments to brandish their credentials as in-novators and gain competitive advantage.

Mobile banking pilot programmes

Some institutions are already running smallpilot programmes in local communities andwithin their own company facilities. Forthe innovators, these pilots are a criticalstep towards gaining a better understand-ing of customer preferences, trends and

challenges. They also build awareness ofthe emerging service within the banksemployee base.

But, according to our research, somebanks are still not convinced about thebenets of mobile payments. At the root

of the debate is whether customers willsee enough value in the new channel topush adoption rates to a level that offsetsthe investment costs. As one respondentinsightfully pointed out, Consumers dont

always act as logically as you think theywill in the marketplace.

In our opinion, if banks can roll out a safe,easy to use and ubiquitously acceptedsystem, consumers will very quickly adoptmobile payment solutions in much thesame way as they have adopted othermobile services.

Monetising mobile: The strategy for

retail banks

Building a sustainable and achievable

retail strategy in the face of a complex anduncertain technology environment is noteasy. It requires banking executives to bedecisive about the objectives they hope toachieve and the route by which they mighttravel to get there.

For example, organisations pursuingreputational benets may want to focus on

being rst-to-market with mobile solutions

in order to demonstrate their innovativenature and customer focus. Others mayprefer to set more quantitative objec-tives around revenue generation and maytherefore focus on developing high-valueservices that merit a premium fee. Andthose pursuing customer loyalty benets

will want to ensure they are focused onmeeting and exceeding their customerexpectations.

Central to any strategy for retail banksmust of course be the customer. Indeed,the ability to accurately assess customersegments, trends, demands and concernswill be critical to creating a strong and valuable mobile payment strategy.

ByJames Berry

Managing Director

David HarperSenior Manager, Banking Advisory

The introduction of Near Field

Communications, being short-range wireless technologies,will change the traditional valuechain for banks for low-valuepayments, bringing in newpartners to manage devicesand drive merchant adoption.James Berry, ManagingDirector, KPMG in Bermuda


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MOBILE BANKING

Monetising mobile: Scenario spectrum

The drive towards mobile banking and pay-

ments can take many forms and no twobanks will approach the eld in the same

way.

However, the development of mobile solu-tions tends to follow an evolutionary pat-tern that starts with basic mobile bankingand progresses towards mobile paymentsat the physical point-of-sale (POS).

The following scenarios examine some ofthe impacts, benets, challenges and cus-

tomer considerations facing banks at threedistinct points in this evolution.

Conclusion

The banking value chain is rapidly changingand so are the ways that customers inter-act with their nancial institutions. Mobile

banking is one of those rapidly changingservice areas that customers in Bermudawill seek and demand and is likely to represent a signicant focus of innovation in the

years ahead.

BASIC MOBILE BANKINGENHANCED MOBILE BANKING

& REMOTE MOBILE PAYMENTS

MOBILE PAYMENTS

AT THE PHYSICAL POS

OVERVIEW

The basic mobile banking marketconsists of nancial institutions that are

focused on developing and rening their

mobile banking platform

The enhanced mobile banking and

remote payments market consists of

players with mature mobile offerings,healthy adoption rates, and basic remotepayment services

The physical POS mobile payments mar-ketplace is composed of traditional andnon-traditional players vying for early mar-ket share of mobile payment revenues

KEY

FEATURES

Typically includes core service offeringssuch as account access, balance informa-tion and internal transfers and are usuallyon 1-2 technology platforms serviced bya vendor

Typically consists of market leadingmobile banking features such as mobiledeposit capture, mobile capture and billpay, enhanced enrollment features, andsome remote payment offerings such asperson to person (P2P) payments

Features and functionality allow mer-chants to use mobile devices as point-of-sale terminals and facilitate paymenttransactions

BENEFITS

Enhanced reputation and customerservice

Reduced cost to serve (and therefore

more exible capital)

Can be straightforward to deploy

Easily integrated into existing internetbanking services

Demonstrates innovation

Creates a base comfort level for con-sumers using mobile devices

Builds in-house experience and skills

Reduces cost to serve and increases

available capital

Streamlines processes and reducesmanual intervention

Builds in-house experience and skills

Capitalises on rst-to-market op-portunities

Provides new revenue streams

Protects existing payments revenues

Creates new revenue opportunities

Responds to customer demands

CUSTOMER

IMPACT

Unfettered access to banking informa-tion and basic transactions

Convenience and ease of use

Integrated view of banking informationand accounts

Higher customer loyalty and sticki-ness

Reduces branch and ATM visits

Delivers increased exibility to cus-tomers

Builds comfort and acceptance ofmobile payment solutions

Acts as a stepping stone to contact-less and proximity payments

Convenience and ease of use, particu-larly for low-value payments

Tighter security and privacy

Replaces traditional wallet or existing

stored value accounts and electronicpurse cards

KEY

CONSIDERA-

TIONS

What is our mobile channel strategy?

What is our mobile commerce strat-egy?

What is our position on mobile pay-ments?

What are our current mobile bankingcapabilities?

Who is our mobile service vendor andare their capabilities sufcient?

What are leading practices in mobilecommerce?

What should our mobile paymentsproduct look like?

What should our revenue sharingmodel look like?

How should we plan for enhance-ments to our mobile platform?

How should we rollout our mobile pay-ments pilot?

What are the estimated costs of themobile payments initiative?

All mobile banking solutions must be created with the customer in

mind. Banks cannot lose sight of their targeted end user segmentsas they develop their strategy.


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Cyber Security:An evolving landscape

CYBER SECURITY ByJames Berry

Managing Director

Fred OberholzerSenior Manager, IT Advisory


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CYBER SECURITY

Cyber security is an importantconcern for every nancial insti-

tution, including those locatedin Bermuda. Cyber is one ofthe fastest-growing areas of

crime directed at banks. Cyber criminals,and indeed others such as hacktivists,are exploiting the speed, convenience, andanonymity that modern technologies offerto invade bank information technology (IT)systems. The nancial impact, coupled with

reputational damage could be devastating.

Focusing on technology alone to addresscyber security issues is not enough. Effec-tively managing cyber risk means puttingin place the right governance and support-ing control processes, along with appropri-ate enabling technology. It is essential thatexecutive leadership take control of allocat-ing resources to deal with cyber security,actively manage governance and decisionmaking, and build an informed and knowl-edgeable organisational culture.

Cyber security threats faced by the

banking industry

Whilst there is, rightly so, a lot of media at-tention focused on cyber security and thehigh prole breaches in recent years, the

media often sketches an alarmist picture

of cyber security, creating a culture of dis-proportionate fear. The reality is that cyberrisks can be managed, and good securitystarts with developing a robust cyberdefense capability and understanding thethreat landscape. Some of the most signi-cant threats include:

Account takeovers: Cyber criminalstarget personal computers of onlinebanking customers via phishing e-mails or text messages to gain accessto their accounts. Fraudulent moneytransfers and counterfeiting of storedvalue cards are the most commonexploits of account takeovers.

Third-party payment processor

breaches:Cyber criminals target com-puter networks of payment processorsto hack personal data of customers.

Securities and market trading

exploitation:Cyber criminals ac-cess brokerage accounts in a similarmanner as they access bank accountsto conduct market manipulation andunauthorised stock trading.

Mobile banking breaches: Cybercriminals gain access to a users

credentials and account informationby installing malware via a mobile ap-plication.

ATM skimming:Cyber criminals x

a skimmer inside or outside the ATMto steal card number and the relatedpersonal identication number (PIN).

They would then either sell the data orcreate fake cards to withdraw money.

Supply chain inltration: Cybercriminals attack suppliers of technol-ogy, software and hardware to thenancial sector. Thus, when a nancial

institution installs the equipment or

software impacted by a cyber crime itcompromises its own security.

The human factor:The human factoris and remains, for both IT profession-als and the end user, the weakest linkwith respect to security. Cyber crimi-nals target employees using socialengineering, a kind of con-game thatmanipulates employees into releas-ing valuable business information.Criminals may also use former bankemployees who supply telephone ac-cess information to contact bank em-ployees, who then unwittingly allowthe criminal into the banks internalcomputer portals.

Responding to cyber risks

Dealing with these threats is a complextask. The goal of being 100% protectedagainst cyber risk is neither feasible norrealistic, especially when we consider therate at which cyber attacks continue toevolve and diversify.

Banks can lower the risks to their businessby developing capabilities in three critical ar-

easprevention, detection, and response.

Prevention

Prevention begins with governance andorganisation. It is about installing funda-mental measures, allocating responsibilityfor dealing with cyber crime within theorganisation and developing awarenesstraining for key staff.

Although this is generally led by the IT de-partment, the knowledge and awarenessof the end user is critical. Cyber security

is often seen as the responsibility of adepartment of specialised professionals,however this mindset may result in a falsesense of security and lead to the widerorganisation not taking responsibility.

DetectionThrough monitoring of critical events andincidents, an organisation can strengthenits technological detection measures.Monitoring and data mining together forman excellent instrument to detect strangepatterns in data trafc, to nd the location

on which the attacks focus and to observesystem performance.

Response

Response refers to activating a well-

rehearsed plan as soon as evidence of apossible attack occurs. During an attack,

the organisation should be able to directlydeactivate all technology affected. Whendeveloping a response and recovery plan,an organisation should perceive cybersecurity as a continuous process and notas a one-off solution.

The emphasis must be on the detectionof and response to cyber crime morethan what has traditionally occurred. At arecent KPMG Audit Committee Institute(ACI) event, a board member from a largeregional US bank suggested, We dont

The media often sketches an alarmist picture of cyber

security, creating a culture of disproportionate fear. Thereality is that cyber risks can be managed, and goodsecurity starts with developing a robust cyber defensecapability and understanding the threat landscape.


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know what we dont know. It was notedat the event that in 65% of the bank cyber

attack cases handled by the FBI last year,the federal agency actually alerted the banksecurity teams because the bank did notknow its systems had been breached.

A good defense is based on understandingorganisational vulnerability, establishingmechanisms to detect an imminent oractual breach, and immediately confrontingintruders to minimise loss. Organisationsshould develop an enterprise-wide methodfor assessing, prioritising, and reportingcyber security risks to appropriate stake-holders.

Management needs to collaborativelyescalate efforts about threat awareness,timely discovery of incidents, risk assess-ments of vendors, and closer coordinationwith regulators about how cyber securityrisks are being identied and managed.

Only an organisation that understands criti-cal data and technology assets, externaldevelopments, and incident trends, anduses this insight to inform policy and strat-egy is likely to succeed in combating cybercrime in the long term.

Cyber security will become an evenbroader responsibility in the years aheadas banks, eager to expand their offeringsand boost efciency, partner with third-

party vendors and service providers whosenetworks are connected in turn to otherbanks, subcontractors, and third partiesall boosting the risk that an attack on onecould morph into an attack on many.

New technologies in mobile and cloudcomputing are also upping the ante. Bankswill need to respond to these spreadingthreats on multiple fronts, building soundand secure IT infrastructures and vettingand monitoring vendors and other service

providers for their own compliance withsecurity protocols.

Cyber risks can be managed. Cybercriminals are not invincible geniuses, andwhile they can cause real damage to yourbusiness, you can take steps to protectyourself against them. You may not be ableto achieve 100% security, but by treatingcyber security as business as usual andbalancing investment between risks andpotential impacts, your organisation will bewell prepared to combat cyber crime.


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COST OPTIMISATION


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A Cost Optimised Operating ModelChanges are required to the current bank operating model to prepare forthe challenges of the future as banks across the world must acclimatise tothe negative or low growth environment.

The past number of years hasbeen a time of unprecedentedpressure in the banking sector.Customers have become evermore demanding; regulators risk

management expectations are more oner-ous than ever before; investment in newtechnology has become a business-criticaldecision; and new players into the marketare providing more options for customers.

The consistent theme that underliesmany of the challenges facing the bankingmodel is the achievement of growth and/or maintenance of the return on equity, amajor component of which is cost optimi-zation. Many sources of cost optimisation

are being explored by the banking sector,including:

Greater efciency of processes and

data management through investmentin IT systems;

Closing branches and relying more oncentralised and increasingly auto-mated and industrialised front to backofce processes;

Focusing more on the overall prot-ability of products and services, andon where a bank has a competitiveadvantage, rather than justifying new

or incremental products and serviceson the basis of their marginal contribu-tions to net prot;

Simplifying products and services, andtaking a more risk-adjusted approachto costs and revenues;

Greater automation of some controlsfunctions, including compliance andinternal audit, based on a re-assess-ment of risk tolerance in these areas;

Simplifying legal entity and operatingstructures;

Reducing staff numbers; Reducing variable remuneration, in

response to weak economic condi-tions and regulatory constraints onremuneration; and

Off-shoring and near-shoring.

Changes are required to the current bankoperating model to prepare for the chal-lenges of the future as banks across theworld must acclimatise to the negativeor low growth environment. Banks arecompelled to cut costs, whilst at the sametime to upgrade their IT architecture to

accommodate their new operating modeland handle greater demands for data.

To overcome inevitable loss of scale andcost issues, banks must devise innovativeoperating models. An imaginative ap-proach is needed to cut costs and controla disintegrated value chain. Innovation canbe encouraged by lateral thinking, basedaround preemptive rather than reactiveprocesses. Furthermore, banks mustintroduce cost-reduction measures whichare both long-term and sustainable. Thefollowing three strategies in particular

could have a high impact on cost optimisa-tion, while being versatile and scalable,and improving customer service.

Straight Through Processing (STP)

STP is about paring back to an absoluteminimum the human input required toprocess transactions. For example, if acustomer creates a standing order online,with STP the whole process is automatedfrom start to nish and little or no human

input is required. In preparing for the im-plementation of this strategy, banks should

identify their STP throughput rates and tryto dramatically increase them.

Self-service channel usageBy giving customers more power and re-sponsibility for carrying out their own bank-ing activities, there will be less need forhuman input from the bank, with obviouspositive cost and error rate implications.However, banks should remember thatmoving a process to a self-service channelwithout adequate planning introduces therisk of inadvertently increasing the cost. Inviting customers to bank online increasesthe number of transactions carried out andreduces the related cost per transaction. Ifrelated processes are not automated, you

will eventually need more people simply tohandle the volume of transactions.

First-time resolution (FTR)

With FTR, processes are resolved im-mediately at the rst point of contact with

the customer, whether it is a branch or acontact centre. For example, if a customerwants to open an account, they are ableto do it at once, without needing multiplecontacts with a bank employee or con-tact centre to complete the transaction.This contrasts with the current central-ised model, where the vast majority oftransactions end up in central operations.Again, FTR will only work effectively if

the underlying transactions abide to STPprinciples. Otherwise, the same strategymay increase costs.

By pursuing these three strategies or anycombination thereof, the need for sharedcentres will fall, middle and back-ofces

will handle only exceptions, fewer peoplewill be needed, customer service levelsand the customer experience will increase,and costs will drop dramatically.

ByCraig Bridgewater


Alexandra McInnesSenior Manager, Banking Advisory


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On 13 February, 2014 theOrganisation for EconomicCo-operation and Develop-ment (OECD), released theCommon Reporting Standard

(the CRS), which is intended to become

the new global standard for automaticexchange of nancial information (covering

bank accounts and other nancial assets

held offshore).

Following in the wake of FATCA, this newproposed standard is intended to facilitatesuch information exchange between par-ticipating countries.

Automatic exchange of information

(AEOI)

The legal basis for AEOI will either be theMultilateral Convention on Mutual Admin-istrative Assistance in tax matters, or alter-natively a bilateral treaty. In either case the

OECDs standard then envisages a bilateralCompetent Authority agreement provid-ing for automatic exchange of information.Given Bermudas numerous InternationalTax Agreements, the CRS is something

Bermuda business need to be following.

Information exchange is envisaged to bereciprocal, but the same framework couldin principle be used when there is nodesire for reciprocity. In addition to the en-visaged bilateral agreements implementingthe exchange of information between taxadministrations, the OECD document pro-vides common reporting and due diligencerules that will need to be implemented intodomestic law of participating countries.

The OECD document makes the point thatthis is intended to be a minimum stand-ardcountries can ask for more informa-tionand crucially, it is not intended to re-

strict other types of AEOI. This raises theprospect that nancial institutions might

be required to report under multiple AEOIregimes simultaneously, thus signicantly

increasing cost and complexity.

Like FATCA in some aspects

As with the U.S. FATCA regime, the scopewill be broad to reduce the risk of circum-vention. Thus, it will apply not just to banks,but also to certain brokers, investmentrms, and some insurance companies.

Many aspects of the OECD proposalsare consistent with the Model 1 IGA ap-proach under FATCA. However, there area number of areas where the standarddeviates from the Model 1 IGAsuch asthe removal of minimum threshold limitsand new account opening denitions. This

will considerably increase the amount ofwork required.


OECD

OECD Global standardfor automaticexchange of

information


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The CRS provides a common global ap-proach for jurisdictions to obtain nancial

information from their nancial institu-tions and to automatically exchange thatinformation with other jurisdictions on anannual basis. The CRS outlines the nan-cial account information to be exchanged,the nancial institutions that need to

report, the different types of accounts and

taxpayers covered, as well as commondue diligence procedures to be followed bynancial institutions.

The three key aspects of the CRS are:

Financial information to be reportedwith respect to reportable accountsthis includes all types of investmentincome (including interest, dividends,income from certain insurancecontracts and other similar types of in-come,) but also account balances andsales proceeds from nancial assets.

Financial institutions that are requiredto report under the CRS include not

only banks and custodians, but alsoother nancial institutions such as

brokers, certain collective invest-ment vehicles and certain insurancecompanies.

Reportable accounts include accounts

held by individuals and entities (whichincludes trusts and foundations). TheCRS includes the requirement to look

through passive entities to report onthe individuals that ultimately controlthese entities.

Its on its way so start preparing

These initiatives were endorsed by theG20 at their recent meeting of FinanceMinisters and Central Bank Governors inSydney on 22-23 February 2014. There isoverwhelming support for the CRS for the

automatic exchange of tax information ona reciprocal basis. The G20 announced thatit will work with all relevant parties, includ-ing their nancial institutions, to detail an

implementation plan at its meeting in Sep-tember 2014. In parallel, the G20 expect tobegin to exchange information automati-cally on tax matters among G20 membersby the end of 2015.

The G20 calls for the early adoption of thestandard by those jurisdictions that areable to do so. The G20 urges all jurisdic-tions that have not yet complied with theexisting standard for exchange of infor-mation on request to do so and sign theMultilateral Convention on Mutual Admin-istrative Assistance in Tax Matters withoutfurther delay.


ByCharlie Thresh

Managing Director, Advisory

David HarperSenior Manager, Banking Advisory


24/32

I

n the aftermath of the nan-cial crisis, the Basel Com-mittee on Banking Supervi-sion (BCBS) embarked on aprogramme to substantially

revise its existing capital ad-equacy and liquidity guidelines.The resulting framework isknown as Basel III. Basel III isthe third in the series of BaselAccords which deal with therisk management aspects of thebanking sector.

According to the BCBS, Basel III is acomprehensive set of reforms developedto strengthen the regulation, supervisionand risk management of the banking sec-tor. These measures aim to: Improve the

banking sectors ability to absorb shocksarising from nancial and economic stress,

whatever the source; Improve risk man-agement and governance; and strengthenbanks transparency and disclosures.

The BCBS established a rather extensivetimeline for the banks to adopt the neces-sary requirements of Basel III, so differ-ent components of the Accord have theirspecic deadlines and time frames for

implementation. Although the transitional

period appears long, the 2019 deadline tocomplete implementation should not dis-tract institutions from the need to demon-strate capital and liquidity resilience muchearlier and to meet interim deadlines along

the way. In the medium term, most rmswill be capital and liquidity constrained andso will need to focus on capital manage-ment, product and business pricing, capitainefciencies that remain from Basel II,

and the structure of their liabilities.

In November 2013, the Bermuda MonetaryAuthority (BMA) released a consulta-tion paper that makes proposals for theadoption of capital and liquidity regulatoryrequirements consistent with Basel 2.5


CAPITAL REQUIREMENTS

Basel III in Bermuda


25/32

and Basel III for Bermuda from 2015. TheBMA noted this should be viewed in thebroader context of its efforts to promotehigh standards of risk management andcorporate governance within Bermudasbanks. The consultation paper includedthe comments from Bermudas banksand other stakeholders in response to adiscussion paper that commenced theformal public consultation process on theadoption of the Basel III measures relatedto the quality, consistency and transpar-ency of capital, the leverage ratio, capitalbuffers, and prudential liquidity standards.The consultation paper included, amongstothers, the following key provisions:

Increased quality of capital: Basel III con-tains various measures aimed at improvingthe quality of capital, with the ultimate aimto obtain a higher loss-absorption capacity.

The BMA proposed adopting the muchstricter Basel III denition of capital where

common equity and retained earningswould be the predominant component oftier 1 capital instead of debt-like instru-ments. These adoptions would likelyrequire the raising of signicant additional

capital by Bermuda banks, along withincreased retention of prots (e.g. through

reduced dividends) and with the increasedfocus on loss absorbency criteria, less ex-ibility for the BMA to allow capital instru-ments to be included in tier 1 or 2 capital.

Increased quantity of capital:BaselIII contains various measures aimed atincreasing the level of capital held bybanks, as well as providing counter cycli-cal measures. The BMA noted that theminimum common equity tier 1 capital willbe increased from 2% to at least 4.5% oftotal risk weighted assets (RWA) plus a

capital conservation buffer of 2.5% bring-ing the total common equity requirementsto 7.0% of RWA. The minimum total capital

will increase from 8.0% to 10.5% of RWA,

including the conservation buffer. There-fore banks will face a signicant additional

capital requirement and the bulk of thisshortfall will need to be raised as commonequity or otherwise by retaining earnings.These capital changes will gradually bephased in from 2015 to 2019.

Reduced leverage through introductionof a leverage ratio which acts as a non risksensitive backstop measure to reduce therisk of buildup of excessive leverage in theinstitution and in the nancial system as a

whole. The leverage ratio will be calculatedas tier 1 capital divided by total assets. TheBMA noted that banks in Bermuda will berequired to maintain a minimum leverageratio limit of 6% in 2015 rising to 7% in2016. The introduction of the leverage ratio

could lead to reduced lending and is a clearincentive for banks to strengthen theircapital position.

Increased short-term liquidity cover-

age:The BCBS has further strengthenedits liquidity framework by developing twominimum standards for funding liquidity.

First, the 30 day liquidity coverage ratio(LCR) aims at ensuring banks have

enough funding resources available overthe next 30 days thereby requiring banks

to have sufcient liquid assets to cover

30 days of expected net liquidity out-ows. The LCR is intended to promoteshort-term resilience to potential liquiditydisruptions and will help ensure that bankshave sufcient high-quality liquid assets

to withstand a stressed funding scenariospecied by supervisors. However, as the

LCR requires banks to hold signicantly

more liquid, low yielding assets, this couldhave a negative impact on protability and

restrict investment activity and the useof cash. The BMA noted that this will bephased in gradually from 2015 to 2019.

Secondly, the Net Stable Funding Ratio

(NSFR) aims to ensure that banks haveenough funding resources over the next 12months to provide for the expected fund-ing needs over the same period. The BMAhas decided to delay the formal reportingof the NSFR in Bermuda.

Basel IV:Even before Basel III is fullyimplemented, Basel IV may be emerging.Developments in recent months lay thegroundwork as some countries are alreadybeginning to impose requirements thatgo beyond Basel III; the US and Europeare requiring banks to meet minimum

capital ratios even after the impact ofsevere stress; Switzerland, the US and theUK have set a minimum leverage ratio atabove 3 percent; others (Australia and UK)are insisting that Pillar 2 capital add-onsare met through higher quality capital;and nally, countries such as the US and

the UK are pushing for tougher liquiditystandards.

Please note that at the time of publication, the

Bermuda Basel III provisions continue to be

developed.


The adoption of these new

standards is important to protect

the interests of depositors,

the Bermuda financial

system, and the reputation of

Bermudas banking market and

its participants. Bermuda

Monetary Authority

ByCraig Bridgewater


Paull DavisManager, Advisory


26/32


GOVERNANCE & STRATEGY

Effective Governance,Driving StrategyBanks must take a more strategic and forward-looking

approach, shifting to a more customer-centric approach and

taking a more outcomes-driven view of customer satisfaction.


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One of the key lessons learned from the nancial crisiswas that the governance of many banks was ineffec-tive, resulting in poor quality decision-making and riskoversight by bank boards. This led to the conclusionthat fundamental change is required across all aspects

of risk governance. Regulators have begun to dene what goodrisk governance looks like, while banks have begun to move to-wards higher governance standards.

Management, working with the board ofdirectors, needs to redene their busi-ness strategy and set the risk appetiteand risk culture. They will need radicallydifferent management information tomonitor progress against strategy and tomanage the risks, which only signicant

investments in core and critical systems,as well as emerging analytic technolo-gies, will provide.

Regulators are requiring banks to report

an increasing amount and granularity ofdata. Every new regulation brings withit additional reporting requirements, asdoes the increase in supervisory intensityand coverage, and the growing empha-

sis on stress and scenario testing. Thisplaces considerable costs on banks interms of the people, systems and qualityassurance processes necessary to sup-port this reporting.

In addition there is increased focus onindividual responsibility for reported data,on banks internal assurance processes(including the role of internal audit), andon governance (including how a banksnon-executive directors gain assuranceabout the quality of reported data),thereby resulting in signicant pres-sure on management and the board tounderstand the drivers behind the resultsreported and to make sound decisions asa result of that understanding.

Banks therefore need to be able toproduce and use high quality manage-ment information both routinely and inresponse to emerging risks as an input tohigh quality decision making.

Banks should be reviewing:

The quality and harmonisation of therisk data they collect;

Their ability to aggregate risk dataeffectively;

The use of IT to streamline datamanagement and to make it moreefcientit will be too expensive to

rely on manual processes and work-arounds; and

The internal reporting of aggregatedrisk data, to both senior managementand the Board, and the use of thisinformation for decision-making.

Banks need to do more in the area of riskand governance. New risk managementand risk reporting procedures are beingintroduced, but roles and responsibilities

have not always been fully determinedand documented. Most banks have notyet reached a stage where managementand the risk management function to-gether are strategic and forward-looking.

Strategy

In todays business environment, banksmust take a more strategic and forward-looking approach, shifting to a morecustomer-centric approach and taking amore outcomes-driven view of customersatisfaction.

Banks face multiple pressures to recon-

sider their strategies, business modelsand operating structures. These rangefrom structural separation requirementsto bail-in liabilities, and from capitalrequirements to liquidity. For customersof banks the impact of these changes isstark banking products and services arebecoming more expensive, and in somecases the availability of products andservices has been constrained.

Banks need to create a viable businessmodel with a nancial model that can

support the costs of the new capital and

liquidity requirements; and an operatingmodel that delivers both efciency and

the exibility to respond to the changing

needs of customers and advancementsin technology. Consideration should begiven to those business activities that cansucceed in the new nancial and regula-tory environment, and to which activitiesare non-core or marginal as a result.

The risk of not focusing on improvementand evolving is signicant. The competi-tion is assuredly moving ahead. Withouta dened and well implemented strategy,

a bank is likely to be left behind - in termsof efciency, reputation and nancial suc-cess.

The strategy must be in line with thecompanys vision. The vision is the aspira-tion. It should inspire all stakeholders andcreate a shared sense of purpose. Thevision should dene what the bank stands

for and why it exists. It should also dene

what the bank aspires to become, toachieve and to create. A vision should beconcise, direct and memorable so that allstakeholders are clear on the companysdirection and aims.

The vision should then be supportedby core values or guiding principles.These are deeply held beliefs that do notchange. They outline what is sacred tothe company and what must not change.Companies that enjoy enduring successhave a strong vision and core values thatremain xed while their underlying strat-egy endlessly adapts to a changing world.

The strategy is then dened to describe

how you will achieve your vision, in ac-cordance with your guiding principles. Forexample, a strategy denes how the bank

is going to be different from the competi-tion; how the bank will deliver a uniquemix of value to your customers; and howthe bank will attract customers and how itwill serve their needs. All decisions madeby the company from this point must con-sider the strategy in order for alignmentto be achieved. This will require manage-ment to make trade-offs and agree onwhat the bank will do, as well as what itwill not do.

ByNeil Patterson

Chairman

Alexandra McInnesSenior Manager, Banking Advisory


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2014 KPMG IN BERMUDA BANKING SURVEY

KPMG in Bermuda

BANKING SURVEY2014

BACKGROUNDThe Bermuda banking sector is madeup of four banks of different sizes anddifferent levels and types of services, theparticipants being: HSBC Bank Bermuda(HSBC); The Bank of N.T. Buttereld &

Son (Buttereld); Clarien Bank (Clar-

ien) formerly Capital G Bank; and Ber-muda Commercial Bank (BCB).

These differences make direct compari-sons difcult. This survey is intended to

highlight and discuss trends in the sectorand discuss some of the common chal-lenges market participants face in theshort term. The source of all the nancial

information is the audited nancial state-ments of each entity or calculations using

such information.

The reporting periods for the banks andtheir focuses are not consistent, and assuch it is important to consider the infor-mation below when making comparisons:

HSBC is part of a large global bank-ing network. HSBC has a December31 year end and prepares its nancial

statements in accordance with Inter-national Financial Reporting Standards

(IFRS).

Buttereldis listed on the BermudaStock Exchange and has a December31 year end. Buttereld prepares its

nancial statements in accordance

with accounting principles generallyaccepted in the U.S..

Clarienhas largely had a residentiallending focus to date and has a De-cember 31 year end. Clarien prepares

its nancial statements in accordancewith IFRS.

BCBs year end is September 30 andits nancial statements are prepared

in accordance with IFRS. BCB does

not have a signicant investment in

loan assets.

All amounts disclosed are in thou-sands (000s) of Bermuda dollars.

2013 AT A GLANCEBermudas banks were all protable in 2013 for a third consecutiveyear despite a continuing economic recession in Bermuda, and a

global low interest rate environment continuing to impact the abilityto earn revenue.


29/32


BALANCE SHEETThe balance sheets of the banks remainedfairly consistent in size and composition,with the exception of HSBCs balance

sheet, which grew by approximately $1billion, or 7% since the end of 2012. Thecomposition of HSBCs assets also shifted

slightly. Loans and advances to custom-ers reduced due to repayment of termloans during the year. These funds werere-invested in nancial investments, along

with the growth in deposits.Clarien remained the most highly invested(77%) in loans to customers.

PROFITABILITYProtability of banks globally is under

pressure due to the low interest rateenvironment, as well as a trend towards

more liquid, lower risk, lower yield invest-ments in the wake of the nancial crisis,

and in order to react to regulatory capital

0

3000000

6000000

9000000

12000000

15000000

BCBClarienButterfieldHSBC

2007

2008

2009

2010

2011

2012

2013

2007

2008

2009

2010

2011

2012

2013

2007

2008

2009

2010

2011

2012

2013

2007

2008

2009

2010

2011

2012

2013

$10,6

93,9

64

$10,2

62,9

54

$10,7

57,4

00

$11,8

46,8

31 $

14,8

80,6

64

$13,2

49,1

30

$14,1

72,3

85

$11,9

10,9

20

$10,9

11,8

44

$9,5

94,6

02

$9,6

23,0

60

$8,8

24,1

09

$8,8

33,0

09

$8,8

70,8

15

$621,5

46

$486,8

3

7

$423,3

5

4

$409,6

5

6

$531,9

83

$572,0

09

$591,6

74

$1,0

3

1,8

78

$1,0

3

5,8

84

$1,0

4

9,1

52

$1,1

8

5,9

99

$1,3

08,8

79

$1,3

03,7

46

$1,3

31,9

94

2013

2012

Loans to

other banks$4,405,978

Financial

Investments

$6,303,029

Financial

Investments

$4,638,894

Loans to

customers

$3,088,064

Loans to

customers

$3,666,811

Other

$381,361

Other

$375,314

Loans to

other banks

$4,562,064

2013

2012

Loans to

other banks

$1,730,472

Loans to

other banks

$1,542,526

Financial

Investments

$2,613,643

Financial

Investments

$2,881,704

Loans to

customers

$4,088,225

Loans to

customers

$3,955,960

Other

$452,819

Other

$438,475

Figure 2: Composition of Total Assets

HSBC Bermuda Buttereld

2013

2012

Loans to

other banks

$48,013

Financial

Investments

$265,264

Financial

Investments

$208,918

Loans to

customers

$942,624

Loans to

customers

$970,940

Other

$123,888

Other

$76,093

Clarien

2013

2012

Loans to

other banks

$192,615

Loans to

other banks

$226,914

Financial

Investments

$252,613

Financial

Investments

$256,763

Loans to

customers

$78,049

Loans to customers

$34,159

Other

$54,173

Other

$68,397

BCB

Figure 1: Total Assets

ByCraig Bridgewater


Richard HobdaySenior Manager, Banking


30/32


2014 KPMG IN BERMUDA BANKING SURVEY

pressures. The severe impact of the lowinterest rates is clearly evident in Figure 4,looking back to the sharp decline since thestart of the nancial crisis.

Bermudas banks have been under addi-tional pressure due to Bermudas eco-nomic recession and the related impact onimpaired loans and impairment charges.This is evidenced in the sharp increase inthe percentage of impaired loans of thosebanks actively engaged in lending illus-trated in Figure 5.

Despite this, all four of Bermudas bankshave managed to maintain protability

over the last three years.

With no real indication that interest ratesare on the increase, or that the economictides in Bermuda are changing, prot-ability will likely remain under pressurein the foreseeable future. The additionalcompliance costs associated with regula-tory changes such as FATCA, Anti-MoneyLaundering, enhanced Know-Your-Custom-er regulations and Basel III, will also havean impact on protability going forward.

To combat the lower net interest marginbeing earned, many of the banks havesought other sources of revenue, primarily

-60

-50

-40

-30

-20

-10

0

10

20


2009

2010

2011

2012

2013

$10,

693,9

64

2009

2010

2011

2012

2013

2009

2010

2011

2012

2013

2009

2010

2011

2012

2013

11% 13%9%

1%4%

-60% -26%

5%3%

10%

2%

15%

7% 8%

0%3% 3% 3%

1%4%

0.0

0.5

1.0

1.5

2.0

2.5

3.0


2009

2010

2011

2012

2013

1

.58

2008

2007

2009

2010

2011

2012

2013

2008

2007

2009

2010

2011

2012

2013

2008

2007

2009

2010

2011

2012

2013

2008

2007

1.4

5

1.

11

1.

06

1.

09

1.

06

1.

04

2.6

3

2.

11

1.4

5

1.

33

1.

21

1.

16

1.

13

2.

30

2.

22

1.

33

1.

10

1.

20

1.

24

1.

23

2.

31

1.

93

1.

58

1.4

3

1.

35

1.

32

1.

29

0

5

10

15

20

25

ClarienButterfieldHSBC

2009

2010

2011

2012

2013

2009

2010

2011

2012

2013

2009

2010

2011

2012

2013

2.0

%4.4

%4.9

%

13.5

%

20.7

%

5.4

%

3.9

%

2.8

%3.5

%

2.8

%

0.2

%

0.4

% 1.8

%4.4

%5.2

%

Figure 5: Impaired Loans as a Percentage of Gross Loans

Figure 4: Total Interest Income as a Percentage of Net Interest Before Credit Losses

Figure 3: Net Prot as a Percentage of Equity


31/32


fee income. In January 2014, Buttereld

announced their purchase of a Guernsey-

based trust and duciary services com-pany. While BCB, did not make any directacquisitions in 2013, its parent company,Somers Group did. This follows on fromBCBs amalgamation with Paragon TrustServices Limited, and Charter CorporateServices Limited in 2012. These transac-tions are expected to have a positiveimpact on fee revenues.

Clarien was subject to a change of owner-ship early in 2014. The new owners havemade it clear that they are focused onexpansion into new lines of business andmarkets.

CAPITAL ADEQUACYDespite the difcult times the capital ratios

of the Banks remain strong, exceedinginternational industry standards. It shouldbe noted, as it has been in prior years, thatthe BMA does require Bermuda basedbanks to maintain a premium above theinternational standards in order to compen-sate for the concentration risk associatedwith lending in the Bermuda market andthe absence of a central bank.

Banks are required to disclose informa-tion about their capital, risk exposures,risk assessment processes, and capitaladequacy. These disclosures, known as

the Capital and Risk Management Pillar III

disclosures, allow informed market partici-

pant to gauge the capital adequacy of thebanks, and are available on the websites ofeach of the four banks in Bermuda.

Capital adequacy and risk managementwill continue to be closely monitored byregulators worldwide in the lead up tothe implementation of Basel III, which isexpected to increase bank capital require-ments.

0

5

10

15

20


2009

2010

2011

2012

2013

17%

2009

2010

2011

2012

2013

2008

2007

2009

2010

2011

2012

2013

2008

2007

2009

2010

2011

2012

2013

2008

2007

16%

11% 1

2%

8%

4%

8%

9%

10%

9%

19%

18%

16%

18%

18%

8%

8%

7%7%

8%

Figure 7: Equity as Percentage of Total Assets

Bank 2010 2011 2012 2013

HSBC Bermuda 31% 33% 28% 21%

Buttereld 16% 18% 19% 20%

Clarien 17% 14% 13% 13%

BCB 27% 32% 26% 22%

Figure 6: Basel II Tier 1 Capital Ratio


32/32

Offering a strong local presenceand a Global reach of over

16,000 industry professionals,and counting.

KPMG in Bermuda know numbers; yet were more than that.We develop relationships with our clients that deliver real value.

Key Contacts:

Neil Patterson

Chairman+1 441 294 2605

[email protected]

Craig Bridgewater

Head of Investments & Banking+1 441 294 2647

[email protected]

KPMG Crown House | 4 Par-la-Ville Road

kpmg 2014 final web

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