Patrick Burke, President and CEO of HSBC North America Holdings, discusses the impact of bank regulatory reform and the 2018 tax cuts on the U.S. economy, global regulatory harmonization, and the future for Real-Time Payments with Jim Aramanda, CEO of The Clearing House.
Jim Aramanda, TCH: It’s worth noting that you have had a long career at HSBC … 29 years, if I’m correct, holding positions in the U.S. and abroad. Can you reflect on your time at HSBC USA and discuss what has changed in the industry during those years?
Patrick Burke, HSBC USA: There have been many changes, so it’s helpful to discuss change through four different lenses. The first is consolidation which we’ve seen lead to a very significant level of scale and, from that scale, the adoption of new technologies. Initially, that technology was used internally, and then, more recently, newer technologies have been more customer-facing. Consolidation has created some very large and robust banks, although in the U.S. the banking system is still far and away more fragmented than in many other parts of the world.
The second lens is regulation and, particularly, post-financial crisis regulation. We’ve seen an intense level of regulatory scrutiny during the past few years associated with very steep consequences for any missteps. This has caused banks to inwardly focus on their own control environments. In just the last year, though, we’ve seen that pendulum move back to where there is a little more ease surrounding some overly burdensome regulations, and that’s a positive development for banks and our customers.
A third lens is changing customer expectations. Whether it is for retail or wholesale banking services, our customers have changed their perceptions of how they want to interact with their bank, when they want to, and even where they want to. That’s, of course, fostered by digital banking and mobile banking in both retail and wholesale banking.
Finally, the fourth lens of change is globalization. It’s much more prevalent in the corporate sector, where many of the clients we serve have become ever more global. Certainly, banks have too, but I think less so than the underlying corporate customers. At the same time, we’ve had an increasing number of nationalistic policies and regulations. So, banks have not moved at the same speed as some of our corporate clients.
Aramanda: You are referring to ring fencing, correct?
Burke: Yes. This discussion really gets back to the notion of the social and economic purpose of banks. My strong view is that you have to think about the banking system as integral to the underlying operation of our economies. This is true in both the corporate space as well the retail space. There is a view that taxpayers should not be exposed to future bailouts or recoveries that might stem from the next crisis, whatever the cause of that crisis is. Therein lies a tension: banks have not necessarily been able to do all of the things they would otherwise have done to keep up with the globalizing nature of business and their corporate clients, many of whom do not have the same regulations that banks have.
Aramanda: A few years ago, the CEO of one of our largest banks said that banks aren’t global because we want to be global; we’re global because our customers are global.
Burke: There is no question that’s true. I’ll give you a couple of statistics here. The amount of revenue that HSBC generates from the overseas operations of U.S.-based clients grew during 2017 by 15%.
The amount of business from non-U.S.-based clients – those clients that are headquartered in Asia or Europe or elsewhere – has increased in the United States in 2017 by 10%. These are levels of growth that are greater than underlying GDP by a factor. By the way, I see that continuing as we go into this year, next year, and the year after.
Many large banks will understand and recognize the globalization trend across their very largest customers. What’s unique about HSBC is we offer banking services in different markets around the world to the large corporate sector as well as to the middle market sector, and indeed down to the small business sector.
We’re seeing companies of all sizes do two things. They’re trying to sell into a different geography, and/or they’re working their supply chain across borders. The pace at which these two things are occurring is much faster than the overall rate of economic growth. I think that force has long-term momentum. Even when there is the potential for trade policy friction, it’s still going to accelerate, and it’s still going to run much faster than the overall pace of economic growth.
Aramanda: There has been more global regulatory harmonization since the crisis, but there still are some key differences between the regions. Is there anything that sticks out in your mind between the U.S. and the other regions that gives you concern, and where is there opportunity for future improvement in regulation?
Burke: This is another tension area, and regulators will have to seek the right balance. There are efforts to harmonize regulations, and we see that in capital, in liquidity, and even in places such as detecting and deterring financial crime.
The speed of the response [regulators] had in shoring up the capital positions of the banks in the United States led the world, and that just engendered a great deal of confidence in the U.S. banking system.
This trend has been at work for a while. I don’t think that will stop. The tension comes in where you have regulators trying to protect their domestic banks and making some decisions that may not serve the interest of global finance in the same way. That is definitely a challenge for any bank that is international, especially one that is truly as global as HSBC. We like regulatory harmonization because it absolutely makes a lot of sense, and we’d like to see the domestic supervision become more international in its focus.
Aramanda: Let’s discuss innovation, but in particular you spoke earlier about regulations around financial crime. A recent article in the Financial Times reports that HSBC is starting to use artificial intelligence to help spot money laundering and terrorist financing. Can you comment on what AI can do in the AML/CFT space?
Burke: If you look back on our industry, a number of years ago we had businesses that we referred to as monolines. These businesses focused on credit cards or mortgages and so on. They became very expert at using technology and using data in that single line of business. Ultimately, the monolines found their way back inside the banks. The advantage of this has been the banks have learned a lot about using data and using these large-scale technology structures across other businesses.
We have to think the same way about innovation today, whether it’s FinTechs or financial crime. There are very advantageous applications and strategies that somebody may have come up with, and the more we can adopt these innovations, the faster and the more efficient these areas will become.
As for financial crime, it’s gaining in importance around the world, similar to the level of focus that it has had in the United States for a long period of time. Banks want to be able to partner with law enforcement agencies to be able to do everything possible to prevent bad actors from accessing the banking system – or, if they’re already in the banking system, to be able to detect them and kick them out.
Banks want to be able to partner with law enforcement agencies to be able to do everything possible to prevent bad actors who want to access the banking system.
Artificial intelligence and some of the machine-learning capabilities that exist today let us very effectively identify what kind of bad person is using the financial system and stop them quickly. And most importantly, the technology allows our strategies to adapt. Remember, the criminals are always going to try to find new ways into the system. These tools – artificial intelligence and others – learn quickly, and so as the bad guys adapt, the tools can adapt as well.
Also, banks want to generate information for law enforcement that is more useful. Currently, banks spend a lot of time, energy, and resources on financial crime compliance but are using largely manual processes that generate results with a significant share of false positives of minimal value. As banks adopt newer technologies, if the financial crime compliance regime was redesigned, we could better help law enforcement by providing information that is more accurate in surfacing bad actors.
Aramanda: That’s helpful. Thank you. I think you know at The Clearing House, we’ve been pushing for a while to help reduce what I would call the disconnect between the three groups involved: law enforcement, regulators, and the banks. None of us believe that law enforcement is getting what they need.
Let’s switch gears to the economy. HSBC is one of the largest banks in the world, the largest bank in Europe, and operates in over 65 countries. I think you have a unique perspective for this next question. We’ve started to see healthier economic growth, with the U.S. recovering more quickly than other regions. Why do you think the U.S. economy has been recovering faster than other economies?
Burke: There are a few different elements. One is the continuing flexibility of the U.S. system overall. The United States has been the fastest to react when shocks enter the system. We’ve done a pretty good job of agreeing on necessary changes to make the most efficient use of the capital that’s available.
I give credit to our regulators. The speed of the response they had in shoring up the capital positions of the banks in the United States led the world, and that engendered a great deal of confidence in the banking system and by extension in the underlying corporate environment in the United States. Similarly, I think that both monetary and fiscal policy responses were very clear, so that it was very obvious what was intended. All of that is testament to the ability of the United States to see what needs to be done, be able to gather the decision makers and the resources in the right way, and end up making the right decisions.
My strong view is that you have to think about the banking system as integral to the underlying operation of our economies.
There is also something to be said about Americans, whether they are employees, entrepreneurs, or anybody else driving a business. Some would argue that we have lost a little bit of our edge in that regard, but we’re still faster than just about anybody else in the world at adapting to change. All of those ingredients, if you bring them together, explains why we have had a faster recovery.
Aramanda: HSBC really has a unique perspective among all the banks. Let’s talk about the tax law change in 2018 and couple that with the lighter regulatory burden, or, at least, a perception that there’ll be a lighter regulatory burden. How has that changed any of your customers’ strategies, and how are you adjusting to it?
Burke: The customers that I’ve spoken to say that they’re still studying the tax law and trying to understand its implications. There has not been a dramatic shift in what anybody is doing so far on the business investment side. Clearly, there are things in the tax law that are favorable. Customers will obviously benefit from having a lower tax rate. Cash flows will be better. There are some business investment advantages that come with the tax law, and projects that companies are considering will have an easier time passing their economic hurdles. Everybody is factoring those elements into their decision-making. So, it may be too early to say precisely what the result of the tax law will be, but it is safe to say that everybody is trying to understand how this will change investment decisions.
Also, you have many companies holding very large cash positions offshore. Based on the recent changes to the tax law, you will see a lot of that money come back into the United States as it has already started to do. Some companies will use it to pay down debt, to buy back shares, and essentially, to address their capital structures.
There will be some impact from repatriation on business investment and then what companies do for their employees. We’ve already seen a number of companies make announcements about what they intend to do to benefit their employees.
Aramanda: The next question deals with populist and anti-globalization sentiments that have gained traction around the world over the past several years. I balance that with what we just talked about and the growth of globalization among all the corporations in this country. When we’re discussing tariffs and the prospect of a trade war, is this something that concerns you and HSBC in any significant way?
Burke: The primary concern of tariffs and the possibility of a trade war is that they sap the environment of certainty. Certainty is important for anybody trying to make longer-term decisions. The more certainty they have in what the future will look like, the more comfortable they are in making those long-term investments and sourcing or selling from certain markets.
The risk of trade frictions is that uncertain outcomes will cause more people to sit on their hands and wait to see the outcomes before they decide what to do. We’ve already seen this on tariffs on steel. We do have clients in different parts of the world, some here in the U.S., that are now looking to see whether they need to make changes in the way that they source steel.
Overall, so far, I don’t think that the impact of these proposed tariffs is going to have a material impact on overall global GDP growth. From my perspective in the U.S., we look very closely at trade that occurs between the United States and Asia, Europe, the Middle East and Latin America. We might see less trade between the United States and Asia, but that will be made up with interregional trade within Asia, for example. Overall, tariffs won’t have much impact on overall trade levels, but depending on the size of the tariffs and how many other trade barriers get erected, they may end up changing where the trade occurs.
Companies will adapt. From our point of view, we stand ready to help our clients adjust.
Aramanda: That’s a very interesting perspective and, again, I think HSBC is uniquely positioned to be able to adjust and pick up slack in one market when it moves from another.
Switching gears to interest rates, we’ve had historically low interest rates since even before the crisis. Now, they’re starting to inch higher, with a promise for more rate increases coming this year. What’s your perspective on how this has impacted both our industry and the economy?
Burke: I think it was a very good policy response to bring rates down as quickly and as deeply as the Federal Reserve did. Central banks around the world then responded in an appropriate way to also bring borrowing costs as low as practical. In Europe, to some extent, it even became negative. All of that was the right action to take, and it helped to stave off what could have been much deeper issues and potentially more devastating consequences.
We’re starting to see rates tick back up. On the one hand, this is good news for banks because we should start to see better spreads on lending. Typically, a steeper yield curve would be helpful to net interest margin. Interestingly enough, the current dilemma now is that even as the central banks start to tick up short-term rates, we’re not necessarily seeing the long-term rates go up with conviction. We’ll be watching this aspect of the interest rate cycle as we go through 2018. Is the economy generating inflation, and is there going to be an uptick in longer-term rates? If that doesn’t happen, then that doesn’t bode as well for net interest margin. That just reinforces the need for banks to do more fee-based transaction business such as trading and markets activities, as well as general liquidity and cash management on products and services.
Aramanda: Let’s switch to the banking bill that’s making its way through Congress. The Senate recently passed its version of the banking bill, which aims to adjust the post-crisis regulatory framework. The bill now sits in the House of Representatives. The banking bill follows a period where the banking industry went through the most sweeping set of changes to the regulatory architecture in history. What portions of the bill, as it now stands, make the most sense for an efficient banking system, while also maintaining the safety and soundness of the financial system? What portions of the bill need to be improved?
Burke: The main thing is that most of the change is going to occur for the regional and smaller community banks. There is less in it for the larger $250 billion and larger banks, and HSBC falls into that category.
The banking industry supports and fully understands the idea that we don’t want an unnecessary amount of risk-taking occurring in our markets businesses. At the same time, I do want to have the ability to make markets for our clients and to provide liquidity in all of the asset classes. It would be helpful to have some reform that actually clarifies for banks what we are allowed to do to service clients and customers.
Again, it’s important to understand the role that banking plays in the economy. Banking is integral to corporate life, and banks need to be able to offer as much value to customers as we can. There’s a presumption from the regulators under the Volcker Rule that you need to stamp out any and all risks inside our books. Actually, you have to think about this more from a point of view of what’s actually helpful and useful for the corporate environment.
Aramanda: Let’s talk about the resiliency of the U.S. banking system. Earlier, you were very complimentary of the regulators, noting how they were quick to act and provide assurance and needed stability during the crisis. Other than what you’ve already commented on, what else sets the U.S. banking system apart from other regions and countries?
Burke: In addition to my earlier comments, one more point, which is that the U.S. banking market is more fragmented. There are many large banks, regional banks, community banks, and, of course, credit unions and specialty companies – whether they are credit cards, mortgage lenders, wealth management, asset management, or insurance. That specialization, coupled with the deepest, most sophisticated capital markets anywhere in the world, is one thing that sets the United States apart and is especially important when things go awry in the macro economy. From specialization and segmentation, you get faster decisions and movement of capital from activities that don’t provide enough reward for the risk taken to activities that do. That is what is more unique in the United States.
Aramanda: We spoke earlier of HSBC’s unique structure with mostly individually chartered banks in different countries. When the financial crisis hit, how do you think your compartmentalized structure benefited or may have hindered your bank?
Burke: I’m happy to say that when the financial crisis struck, HSBC was unique in that we didn’t take any bailout money anywhere in the world.
HSBC is also unique in that it has always operated, in almost every country that we operate in, as its own bank and its own legal entity that is self-capitalized, self-funded, and operates as a local bank. In the United States, we have not had to go through the structural changes that some of the other international banks are currently undergoing because we have always been structured as an intermediate holding company. That’s been very helpful to us because all of the risk decisions – the positions and the client activity – are undertaken within a risk appetite set locally.
In other words, we don’t have to rely on our parent to provide help. And even if we did the parent is in a position to be able to provide it. In a way, it’s the best of both of worlds. HSBC USA gets parental support if absolutely needed but operates independently on its own under normal circumstance. That’s positioned us well organizationally to be able to deal with crises when and if they come.
Aramanda: Thank you. Let’s switch gears to payments and innovation. The Clearing House and its banks are rolling out a real-time payment system. It’s not the first in the world. As you know, the U.K. and Singapore are ahead of us, but for the U.S., it’s pretty significant. What have you learned from the U.K.’s, Faster Payments initiative? Did Faster Payments change any of the businesses? And do you expect to see similar changes here in the U.S.?
Burke: It very definitely has, and you are right. The U.K. moved faster than the United States when it came to trying to generate a real-time payment capability. Initially, it was consumer adoption that took place and consumers quickly came to understand the advantages to the faster payment processing. It then moved into the business side, and wholesale clients started to use it.
In the United States, we’re at the point where we’re rolling out HSBC’s Real-Time Payments capability. We’ve focused very carefully and done a good job of generating ubiquity to try to give as much access to everybody as we possibly can.
There are numerous business cases for adoption, and I won’t predict which customer segment will take off first. But based on our U.K. experience, once adoption starts to take off, banks that don’t have the new capabilities will be at risk of losing customers to competitors. Real-Time Payments will be seen as a positive thing by the customers, and you’ll have to have the capability available in order to keep pace.
Aramanda: I agree that there will be a period of adoption but then, as you mentioned, I think it will start to take off really quickly.
Burke: Yes, I do. Once it starts rolling, I don’t think it will ever stop.