Date: October 26, 2023

Executive Overview:

The global banking industry finds itself at a significant inflection point, navigating a landscape shaped by potent macroeconomic forces and deep-seated structural shifts. A pivotal development has been the normalization of interest rate policies, which has provided a welcome, albeit potentially transient, uplift to sector profitability, primarily through enhanced Net Interest Income. This improved near-term financial health presents a crucial window of opportunity. Simultaneously, the unrelenting pace of digital transformation, evolving customer expectations, and a dynamic regulatory environment demand sustained strategic focus and investment. Leading institutions, exemplified by Spanish banks such as Santander and BBVA, are strategically maneuvering to capitalize on current tailwinds while rigorously pursuing long-term transformation agendas. Successfully balancing these immediate financial opportunities with the imperatives of future-proofing the business model is the defining challenge for banking leadership in the current era.

The Reshaped Macro-Financial Environment

The recent era in banking has been fundamentally reshaped by the decisive move away from prolonged ultra-low interest rates. This policy normalization has had immediate and tangible effects on bank performance. Most notably, the widening spread between asset yields and funding costs, as central banks increased benchmark rates, has fueled significant Net Interest Income expansion. Banks were able to reprice loans upwards relatively swiftly, while the adjustment in deposit rates, although now accelerating, initially lagged, creating a favorable margin dynamic. Institutions possessing large, stable deposit franchises, including prominent players like Santander and BBVA, were particularly well-positioned to benefit from this initial phase.

However, this improved profitability landscape is not without its complexities and emerging considerations. The same higher interest rates that boost NII inevitably exert pressure on borrowers, necessitating a prudent approach to managing potential increases in credit risk across both retail and corporate loan books. Consequently, banks are proactively adjusting loan loss provisions. Furthermore, the competitive landscape for deposits is intensifying, which is expected to gradually increase funding costs and potentially compress margins from their recent highs. Compounding these factors is the potential for slower economic growth, itself influenced by tighter monetary policy, which could dampen loan demand and moderate income from fees and commissions. Effectively managing this intricate balance between capitalizing on NII opportunities and mitigating evolving risks is therefore a critical focus for bank management.

The Enduring Imperative of Digital and Technological Advancement

Flowing beneath these macroeconomic currents is the powerful, ongoing transformation driven by technology, which continues to fundamentally alter banking operating models and competitive dynamics. Recognizing that legacy systems can hinder agility and innovation, leading banks are making substantial investments in modernizing their core banking platforms. Increasingly, this involves migrating critical workloads and data infrastructure to cloud environments, seeking the inherent benefits of scalability, enhanced cost efficiency, accelerated product development cycles, and superior data accessibility.

Parallel to infrastructure modernization is the diffusion of Artificial Intelligence and advanced analytics across the banking value chain. These technologies are rapidly moving beyond niche applications to become deeply embedded in core functions. Use cases are diverse and impactful, ranging from more sophisticated risk modeling and fraud detection capabilities to the delivery of hyper-personalized customer engagement and product recommendations. AI is also driving significant efficiencies through the intelligent automation of complex processes within middle and back-office operations and enhancing regulatory compliance monitoring. Institutions that successfully integrate and leverage data and AI are poised to achieve significant competitive advantages in both operational efficiency and the quality of their customer value proposition. The engagement model with the fintech ecosystem also continues to mature, moving towards strategic partnerships, API integration through Open Banking frameworks, and the adoption of Banking-as-a-Service models, allowing incumbents to leverage external innovation effectively.

Strategic Positioning of Industry Leaders

The strategic responses of major international banks like Santander and BBVA offer valuable insights into how established players are navigating this complex environment. Their significant scale and geographic diversification provide crucial advantages. Operating across diverse economic cycles and interest rate environments, particularly through substantial presence in regions like Latin America alongside their European home markets, enhances earnings resilience and presents varied growth opportunities. This scale also enables them to undertake ambitious investments in technology and develop global platforms, such as Santander’s PagoNxt payments initiative, achieving synergies across their network.

Furthermore, both institutions have demonstrated a sustained commitment to digital transformation over many years. BBVA is often highlighted for its early adoption of mobile-first strategies, agile working methodologies, and deep integration of data analytics. Santander consistently invests in enhancing its digital channels, automating processes, and developing open banking capabilities across its global footprint. These ongoing investments are essential for improving customer experience and driving operational efficiency. Complementing these digital efforts is an intensified focus on operational excellence. Despite recent revenue tailwinds, rigorous cost management remains a core strategic pillar, with initiatives aimed at optimizing distribution networks, streamlining workflows, and improving cost-to-income ratios. This discipline is vital not only for preserving profitability as funding costs rise but also for generating the capacity needed for continued strategic investment.

Navigating Evolving Regulatory Landscapes and Societal Expectations

The operating context for banks is further shaped by an evolving regulatory framework and shifting societal expectations. Regulators maintain a strong focus on ensuring financial stability, reinforcing capital adequacy through measures like the finalization of Basel III/IV, and enhancing operational resilience, with particular attention to cybersecurity and the risks associated with third-party providers, including cloud services. Concurrently, new regulatory regimes are emerging for areas like digital assets.

Beyond traditional financial regulation, Environmental, Social, and Governance (ESG) factors have moved decisively into the strategic mainstream. Banks face mounting pressure from regulators, investors, employees, and customers to play an active role in financing the transition to a sustainable economy. This involves not only developing green finance products but also integrating climate-related financial risks into their core risk management frameworks and demonstrating strong performance on social and governance metrics. Effectively embedding ESG considerations requires robust data infrastructure, transparent reporting, and the strategic alignment of lending and investment activities – areas where both Santander and BBVA are actively seeking leadership positions.

Meeting Heightened Customer Expectations

Ultimately, sustained success in this transformed landscape hinges on meeting the increasingly sophisticated expectations of customers. There is a clear demand for seamless, intuitive, and consistent experiences across all interaction channels – whether digital platforms or physical branches. The optimal approach blends the convenience and efficiency of digital self-service for routine tasks with the availability of expert human advice for more complex financial needs, creating a truly integrated “phygital” model.

Moreover, customers increasingly expect personalization that goes beyond superficial gestures. Leveraging data analytics and AI to genuinely understand individual circumstances and proactively offer relevant solutions, tailored advice, and timely insights is becoming a powerful differentiator. Underpinning all interactions is the foundational element of trust. In an environment of heightened awareness regarding data privacy and cybersecurity threats, maintaining robust security measures, practicing transparent data stewardship, and upholding ethical standards are absolutely critical for preserving customer loyalty and reinforcing the inherent advantages of established, trusted institutions.

Strategic Imperatives for the Path Forward

For banking leaders charting a course through this dynamic environment, several strategic imperatives stand out. It is crucial to capitalize judiciously on the current NII uplift, channeling enhanced profitability towards funding essential strategic priorities like technology modernization, while simultaneously managing the associated credit and funding risks with prudence. The acceleration of digital and core transformation agendas remains paramount, involving continued investment in migrating away from legacy systems, embracing cloud architectures, and deeply embedding data and AI capabilities to drive efficiency and customer value.

Optimizing operating models through a continued, rigorous focus on cost discipline and process automation is necessary to improve efficiency ratios and support ongoing investment needs. Simultaneously, ESG considerations must be fully integrated into strategic planning, risk management, product development, and reporting frameworks. Elevating customer engagement requires sustained investment in creating seamless, personalized, data-driven omnichannel experiences built upon a bedrock of security and trust. Finally, cultivating future-ready talent – attracting, developing, and retaining individuals skilled in technology, data science, ESG, and agile ways of working – is fundamental to successfully driving the necessary transformation.

Conclusion:

The banking sector is currently navigating a period marked by improved near-term financial performance, largely driven by shifts in the macroeconomic environment. However, this favorable phase coincides with deep, ongoing structural changes propelled by technology, regulation, and customer expectations. Leading institutions like Santander and BBVA exemplify the critical need to strategically balance the management of immediate opportunities and risks with the execution of long-term transformation agendas. Those organizations that demonstrate strategic clarity, maintain operational discipline, foster innovation, and adapt with agility to this complex and evolving landscape will be best positioned to achieve sustainable value creation and secure their leadership in the future of banking.

Carlos Marten