“We went into this in very good condition.”
Michael Neff

Michael Neff: We’ve been doing this event for many years and it is very helpful to get a group of folks from different backgrounds to share perspectives on Bermuda. Also, as a member of the Finance Minister’s Economic Advisory Committee, there may very well be things that come out of this that are relevant to that committee.

For the banks of Bermuda, the good news is that the pandemic is very different from the financial crisis. The financial crisis impacted all banks here to varying degrees—in fact Butterfield actually had to be recapitalised. But all banks faced difficulties.

Coming into the pandemic we had learned lessons from the financial crisis, the banks were in the best financial shape collectively in terms of capital adequacy, credit exposure and the like. We went into this in very good condition—and that’s important because the pandemic did mean challenges.

The first issue for the banks was a compression in interest rates. When you go into a zero-interest rate environment, it compresses net interest margin spreads, and that compresses net income.

Consequently, the banks do not have the earnings power that they had, say, before the millennium, and we can expect to see a significant decline in interest income in the near future.

The second issue was their credit portfolio. In the last 10 years, the banks’ underwriting standards have been tightened significantly, so their credit portfolios are in much better shape than they were going into the financial crisis.

On top of these factors, Basel III capital requirements have increased since the financial crisis—and the Bermuda Monetary Authority (BMA) has added to this. But the banks are extremely well capitalised, and their balance sheets are quite liquid because the deposit base significantly exceeds the loan base.

What we’re expecting now is that there will be borrowers, both consumer and corporate, who are going to face challenges. We have all used various kinds of deferments to help clients through lockdown, but the Financial Accounting Standards Board only allows six months of that.

The good news is that we’ve seen consumer deposits and corporate deposits tick up significantly through the lockdown, which we think is a combination of people not spending a lot of money and not having to make loan payments. So that will help. That said, we are expecting our biggest credit challenges probably late fourth, early first and in the second quarter next year.

The banks will work with clients to help them structure their obligations as best we can and for the most part it’s a pretty good story, but the story hasn’t been completely told yet and we’re going to learn in the next couple of quarters just how significant the credit issues are.

“We can expect to see a significant decline in interest income in the near future.”
Michael Neff
“The banking sector was able to deal with the inevitable credit problems.”
Thomas O’Rourke

Thomas O’Rourke: That was a pretty good summary of how the banks have fared during this pandemic. I will highlight just two items. Operationally, the banks did a very good job coming together and working cohesively to keep services available during trying times in the lockdown. That’s testament to the strength of the banks and their ability to work together.

As regards resilience, capital earnings and liquidity, Basel III (which became a final rule in 2015) was very timely in that it ensured not only capital strength but diversification of balance sheets. As a result, the banking sector was able to deal with the inevitable credit problems that flowed from the COVID-19 situation.

Contrary to the V-shaped recovery many hoped for, the pandemic is likely to cause long-term damage to businesses, especially what I would call the ‘Front Street’ sector. We’ll have to wait and see how that’s going to be dealt with by government.

I agree that the banks are in a good position. We do expect tough times on the credit front, but everyone is prepared and fully aware that these are our customers, our clients and our neighbours. We have to work as best we can to make sure that everybody survives this.

The next challenge is going to be financial services digitisation, which is going to be even more accelerated as a means of delivering banking services.

As we work through this credit crisis, we have to keep in mind that digital transformation is on the horizon. There is no doubt that COVID-19 will act as a catalyst towards the greater use of technology in the banking sector. We can already see this in the way our workforces have become more remote, and a lot of that is going to carry over—even when things do get back to normal.

But that’s just one aspect of technology. The other is going to be the delivery of banking services. The government is already embracing different forms of digital currency, and there is also a consultation paper by the BMA outlining how a new class of banks can offer more digital services.

The landscape is changing, and COVID-19 probably accelerated it, and we will have the chance to determine how fast it has accelerated in about three to six months’ time.

Neff: COVID-19 has pushed a lot of businesses into the online world, and while banks provide online services for transactions, they are now also offering mobile services. It’s probably fair to say that not everything the banks do is state of the art. We need to improve the seamlessness with which people can transact and I have no doubt we’re going to pay greater attention to it because more and more of our customers are headed in that direction—and the trend is accelerating.

That will require investment in technology. At Butterfield, we are restructuring our core architecture so that we can move towards a cloud-based system with more plug-and-play architecture. This will allow us to keep up with the technology that the larger banks are providing.

“We are restructuring our core architecture.”
Michael Neff
“The situation is moving very quickly.”
Peter Hughes

Lynesha Lightbourne: Bermuda has done an amazing job with testing and resilience in response to this pandemic. We’ve managed the situation really well and we have been innovative which is very important. The pandemic has of course accelerated a number of trends. A huge piece of the banking landscape is now about banks elevating their existing platforms to target the next generation by embracing technology.

We all know how the younger generations connect and how they use their phones. They are looking to transfer money to each other very swiftly. A lot of them are turning to non-institutional banking systems that allow them to transfer money via such as PayPal with no fees.

The banking sector in Bermuda has to meet the changing needs of consumers that are entering the market. I think it is very positive that the banks have used the pandemic to understand how they need to elevate their service offerings and how Bermuda can benefit from the transformation of technology, and what it can bring for all sectors and consumers

Peter Hughes: Around the world, I see disrupter retail banks such as Starling and Revolute in the UK, which along with others are transforming how banking can be done. The point is that the banks are taking those same steps themselves—and the situation is moving very quickly.

If banks are to remain competitive and provide solutions to both the retail and institutional sectors, then investment is going to be key.

O’Rourke: I would also agree that mobile apps are a tremendous convenience. But we need to bear in mind that new banks also have to make money and don’t have traditional lending or investment portfolios, so they make their money on transaction fees. As we move down the road towards adopting new mobile apps, we have to educate the public about the fees that could add up over time based on usage patterns.

There’s no free lunch even though there is convenience. But the technology is coming, whether it’s coming through our four banks here or through digital cash movers.

Louis Millar: We have spoken about the squeeze on the net interest margins and it seems likely that rates will continue to be much lower for longer given the current trajectory and outlook.

If we’re potentially looking at three to five years of interest rates anchored at these levels, coupled with the double whammy of a health-led crisis and its knock-on effect across the financial world, what are the main concerns for banks over the next three to five years, and what will be some of the keys to them navigating this environment successfully?

“What are the main concerns for banks over the next three to five years?”
Louis Millar
“We have limited options compared to some other jurisdictions.”
Lynesha Lightbourne

Neff: We are definitely back into the world of zero for longer, which means that banking won’t be as profitable. There are two big challenges that the banks have to address. First, an upgrade of their technology platforms so they can continue to be relevant to all sorts of customers. And second, managing costs, because the revenue base is not coming back to where it once was.

These are issues that all the banks are looking at. What is the new normal and what are we going to have to do to adjust the configuration of the business to be successful in that environment? Of course, that investigation also involves an expense control component.

Lightbourne: We already have four established banks in Bermuda but it has been mentioned that we have limited options compared to some other jurisdictions, particularly when it comes to new ways of doing finance or disrupter banks as were mentioned earlier, for example.

Neff: Several finance ministers have worked hard to attract additional financial institutions to Bermuda. Obviously, a vibrant financial sector helps the economy, and banks are like its central circulatory system—you want more, not less. But there are many challenges, including barriers to entry driven by onshore regulators, as well as the economics of making money and carving out a niche.

You also need the BMA to sign you up, which means that you need infrastructure, capital, and regulatory approval—and you’re going to need to move money around from one place to another

It is also very challenging to keep all of your correspondent banks because of the issue of offshore banking. You need correspondent banks to facilitate payments and those banks are looking very closely at what, and why, they are doing offshore. So you have a bit of a struggle.

If you arrive here as, say, a crypto bank dealing in cryptocurrency, you will likely never get a correspondent bank because they won’t sign you up. We don’t engage in cryptocurrency and we don’t engage in the cannabis business because our correspondents would cut our access to the international payments system. We are constrained, but any new entrant would be further constrained.

Sarah Demerling: Another thorny question is the world of compliance and the business of opening bank accounts. Ideally this could be digitised, leveraging a central depository that can accept a base form of ID from anyone who comes to do business on the Island. Are we any further forward? Is there any appetite for this? Do we think we are going to find a way to move that needle?

O’Rourke: The focus is now on making our customer due diligence more timely, more responsive, more risk-focused. We had an external review earlier this year and the Island came out favourably.

In the wake of that, we have to look at ways of making the anti-money laundering (AML) compliance process more technology-oriented, using tools that will keep the risk low but will reduce the burden on the customer when they go to open an account. We know how it’s done digitally, and we are on a journey to get there.

Neff: I agree with the point about a centralised database—it’s a conversation that continues not only in Bermuda, but also in Cayman. This may be a place where blockchain technology could be useful. We could use it as a central registry that each of the banks could then rely on to do their checks. That would work well for existing customers, while newcomers to the Island could be taken through the same set of processes that the regulators demand.

The onshore jurisdictions have demanded greater transparency and that creates a challenging operating environment for banks. We need to make the regulators happy, and then start thinking about the customers. We are working hard to improve all of that while at the same time keeping the regulators on side.

Demerling: Essentially, we need to gather and use the range of technology that is out there more efficiently, embrace it in accordance with international standards and ensure that the regulator is happy. That’s what we’re all aiming for.

Video on previous page courtesy of Adobe Stock / logoboom Image courtesy of Shutterstock / lzf

“We need to gather and use the range of technology.”
Sarah Demerling