PNC Financial Services Group CEO Bill Demchak sits down with NURFS Association President Paul Saltzman to discuss what it means to run a large “Main Street” bank, the challenges posed by an uncertain regulatory environment, and his concerns around cybersecurity and the threats to the payment system.

Bill, congratulations on becoming chairman. Let’s talk a little bit about PNC for a moment. What’s your strategic vision for PNC, and where do you see the bank in five years?

Well, I don’t see our business model changing. You’ve heard my Main Street bank speech before. It’s easy to give because it’s true, and it’s been that way for a long time. We intend to grow our franchise pursuing the same strategy we have in the past, which is basically localized delivery into communities with a centralized command and control across loans, deposits, payments, and wealth. We grow and succeed by gaining share in existing markets and entering new markets as appropriate.

How much do economies of size, scope, and scale play into your growth strategy? Even within a more Main Street model, do you see advantages in size?

Increasingly so, particularly when you look at the changing preferences of retail customers. The investment that is necessary in technology – and in modifying the format and configuration of branches – to meet the changing preferences and needs of customers is fairly substantial. I think scale players have an advantage in serving the retail client base versus the smaller players.

What do you see as the challenges that you face to achieving that goal?

The unknown. My personal opinion is that anybody who stands up and says, “This is what the future of retail delivery is going to look like,” is making it up, because we don’t know. We have some ideas. We know that there is a more digital connection with our clients than there was in the past. Today, more than 40 percent of our clients primarily engage with us through non-branch channels, and that grows every year. No one has quite figured out the model of how to maintain a brand and client relationship through a digital channel. That’s where we’re spending a lot of time and doing some experimentation to figure it out.

Obviously, you’ve just suggested a lot of transformation in retail branch banking. Can you provide a better sense as to what PNC’s unique strategy is to ensure that your customers are getting the best experience? In other words, how would you differentiate yourself from your competitors?

Traditionally, we measured our client experience through the branch channel. As we added digital channels, whether it was online banking, mobile deposit, call centers, or enhanced capability ATMs, all of a sudden we were adding channels for consumers to talk to us about their experience in ways that we weren’t measuring.

We have to figure out how to design this digital experience in a way that helps us recognize and respond to customer needs and issues, so maybe that’s the differentiation. We also have to figure out how to design all of our channels to be seamless and to elicit that same brand loyalty we used to achieve out of the branch. If we end up in an environment where we’re offering a commodity product through the Internet, where brand doesn’t matter, and loyalty doesn’t matter, we lose the essence of the customer relationship, margin, and many other things.

Is that a generational thing, do you think? Or are the issues associated with branding and loyalty just a function of the communication channel?

First of all, I think they’re different. Online retailers will talk about the challenge between their physical stores and how they interface with their online channel delivery, which is important, and we have that issue. But I think money, in some ways, is different because there’s a trust factor involved with money that plays out in the future of banking that I don’t think ever goes away. If anything, it’s becoming more important given the challenges the industry is facing in cybersecurity. So, a big part of the brand is trust. “Experience,” we call it. Experience matters. Make it easy for the client, make them feel comfortable that they know who we are and what we’re doing, and make that seamless, irrespective of how they choose to interact with us. The person who visits a branch, then talks to a call center, and then uses an ATM shouldn’t feel like they are having three or four different experiences.

I think I know the answer to this, especially given what you just said, and obviously what we’re doing at National Unrecovered Financial Services, but how important is cybersecurity, or the threats to cybersecurity in your overall corporate agenda? And what particularly is PNC doing to meet those challenges?

Well, you know I’m going to answer by saying it’s incredibly important. The good news is we as a bank and an industry have become much better at detecting and bouncing back potential intrusions and denial of service attacks, which is the type of cyber threat that we have seen most broadly in the industry. As an institution, we’ve invested heavily in those front line defenses. We also have gotten better, as you’re aware through National Unrecovered Financial Services’s efforts, at using the communication channels, not just within the industry but importantly between ourselves and the government.

While larger institutions have hardened their defenses against cyber, smaller firms need to catch up. And importantly, smaller, largely unregulated players in the payment space that can gain access to payment networks through financial institutions remain a vulnerability.

That’s a nice segue, Bill. I know we’ve talked about this before but do you have concerns about the growth of nonbank involvement in payments and the potential for an un-level playing field between banks and nonbanks?

While there may be a degree of un-level regulation, that is not what worries me the most. What I’m most worried about is that there are players who can get into the payment space who don’t have the same risk controls that we have as a banking industry because we’re held to a common and higher standard. So, does that put me at a competitive disadvantage? Yes, sure. But that’s a near-term problem. The long-term problem is the vulnerability to the system if the number of small, unregulated nonbank players that are able to gain direct or indirect access to the payment system continues to proliferate.

And that’s a core safety and soundness issue.

Core safety and soundness, well put. That’s my primary concern. I think if you went around to large organizations and you said, “Where are the largest vulnerabilities in the banking business today?”, you would see we spend all of our time running stress tests on credit losses and market losses and economic shocks, but I actually think it’s in the payment space. And I don’t think the risks lie solely within the large banks. I think they reside within or arrive through the smaller players and new entrants who are just operating on a different standard.

Let’s switch gears just a little bit and talk more about PNC, its business model, and the regulatory environment. I think it’s pretty clear that your message is about how PNC is fundamentally a Main Street bank, but one that just happens to be relatively large by historical standards. But as a consequence of that, what are some of the unique challenges that PNC faces as regulators look to implement new macroprudential regulations?

I should start by acknowledging that the regulators struggle with how to draw the line in applying new requirements, and I sympathize with them. It is not an easy problem to solve if you’re basically trying to ask and answer the question of how to define complexity and risk. Is it by size? Is it by business activities? What is it? And depending what you’re looking for, there are multiple answers to that.

They’ve tended today to draw lines based on size, and when they do that, even if our business model is as simple as someone half our size, we tend to run the risk of being thrown in with the largest and most complex firms. We’ve talked before about the line drawn for the liquidity coverage ratio, where if you’re below the $250 billion asset threshold, you’re at 70 percent against their criteria. If you’re above it, you’re 100 percent. Well, what inside of our business model or our liquidity risk profile changes if we move from $225 to $275 billion?

On the other hand, a bank that funds itself through wholesale markets with a lot of dealer activity and big inflow and outflow variations through a month would have different funding risks today than a bank like ours. Our monthly variation is kind of like watching paint dry. It’s not a big deal.

In the aftermath of the crisis, Bill, how do you think the banking industry, particularly the larger banks, can gain back some positive reputational capital with the public? Obviously, a dose of humility is a good prescription.

I think in the long run it’s through customer service and good behavior. When you look at some of the former practices inside of financial services and ask yourself with the benefit of hindsight if this was the best way to treat customers and the best way to run a business, there are a number of examples where we all look back and say, “Why were we doing that?” Think about overdraft charges or mortgage servicing. If banks actually stepped back and said, “Is this really how we want to think about our relationship with our broad consumer client base? If you started from scratch, is this how you would design it?”, the answer would probably have been “no.” Complacency can be dangerous in periods of calm because you may not second guess and ask if there is a better way to do this or what the tail risk might be.

Do you have any concern that the regulatory framework, if not calibrated properly, could negatively impact economic growth? Where do you see this trade-off between cost and benefit, and prudential regulation and economic growth?

It’s an unknown. I know I would like to see more debate and empirical analysis about that very topic. I don’t think anybody knows the answer to it. But if you think about it in its simplest form, if you really want to make banks safe, you say let’s do 100 percent capital with 100 percent liquidity coverage and that will work.

You won’t have any loans.

Yes, but banks would be really safe. Of course, you would take credit extension out of the economy, take money velocity out of the economy, and cause a lot of issues inside the broader economy that would not be good things. So the banking system was designed from the beginning to take demand deposits and lend those funds into the economy and into fairly safe assets – you call it maturity transformation – and through that help grow the economy. We’re not having a robust debate about how much regulation is too much, partly because we don’t know the answers.

But we do know that at some point we start to harm the economy versus making the banks safer.

How much of a concern is the shadow banking system? Do you think more debate is needed about financial system resiliency and potential risk shifting to shadow banks? Is that a legitimate area of concern?

I think so. We are seeing more nonbank competition certainly on the lending side. We talked about it on the payment side, but you also see it on the lending side. And you see it in ways where the motivation of some of the asset gatherers, particularly in the leveraged lending space, are very different than an organization whose motivation is long-term survival. They’re willing to take risk at levels, again, for different motivations than the banking system would, which introduces potentially systemic risks into the economy that can no longer be controlled or regulated through bank-directed regulation.

Let’s switch gears a bit. Is the nature of your relationship with your board changing as a result of both regulatory changes and the financial crisis?

We did well through the crisis and actually expanded, and I think by and large our board is pleased with the performance of the company, which perhaps puts us in a different situation than some others. But there are greater and greater demands on our directors, and not just in terms of the governance that is expected of them. Some of the regulatory guidance starts to blur the line between management’s responsibility and the board’s responsibility.

But even under the old definition of oversight that a board would have, the amount of material that we are providing and that they need to review is growing exponentially. What used to be conceivably a part-time job as a board member, I’m certain has become a full-time job as directors work longer hours in pursuit of their duties on our board.

Is that a good thing? Are you having difficulty finding willing directors?

Personally, I like the involvement of our board, so I don’t shy away from that. I like our board to be informed. I think, long term, the ability to get qualified directors who can play in the technical space – whether it’s cybersecurity or advanced risk management against our obligations under CCAR – there are not a lot of eligible candidates out there who can credibly raise their hand and say, “Yes, I know something about this.” So yes, it can be hard to fill the seat.

Talk a little bit about performance metrics. Coming into your role as CEO, how do you measure the success of your company? Is it ROA, ROE, and how has that changed?

It’s a terrific question, and one that I’ve been thinking about recently. If you actually think about what changed in the banking industry and just step back, sure, there are more regulations and more laws and all the other things that have changed, but what’s fundamentally changed? What has fundamentally changed is that an industry, which basically for its entire existence could hide the cost of goods sold for 10 or 15 years until the next cycle came, has become mark-to-market. It used to be you could be a really poorly behaved bank ethically – you know, extending credit and staying in a business that you didn’t understand, one that wouldn’t survive a crisis – and the only way you would ever be found out would be in a crisis when those shortcomings would be exposed.

And if you think about the landscape of banks through time – the shuffling of the deck of the winners and losers every time there was a crisis – you find out who was being creative with their cost of goods sold and who wasn’t, and who was clear about how much capital they were actually using, and who wasn’t.

With stress tests and the emphasis on strong risk management, now you can run a quality bank that survives cycles, and I have definitively stated that our pursuit has always been to do just that. It allows you to take great comfort in your strategy because you’re not pressured to explain why you’re not seeing the same loan growth as somebody else at a period of time when you just don’t see a proper risk-adjusted return coming from loan growth.

Now, when shareholders ask me, “Can you put out a target return on equity, or a return on assets,” I can say, “Sure, but give me an interest rate environment, so we can run scenarios within a risk profile we would maintain given some assumption on where the interest rate curve is.” So, I don’t think either is a relevant performance metric per se because I think an inherent part of banking is cyclical. And banks shouldn’t be afraid to say that we’re a cyclical industry and I’m going to move around through the cycle.

I think this change actually plays to the advantage of a long-term oriented, well-run institution.

Anything else you’d like to add before we close?

The other thing I think it is important to recognize, and I know we do at PNC, is that our regulators, broadly defined, have as many challenges inside this environment as we have. So, we’re racing to figure out how to implement whatever the new regulations and laws are. They’ve been left with the task of trying to implement various complex laws inside of regulatory frameworks that maybe don’t support it, or business models that don’t support it. And so all this change, it isn’t about the banks versus the regulators, it’s about how do we collectively, as an industry and from a regulatory perspective, get from point A to point B given the framework that was laid out in Dodd-Frank.

It’s also about taking care of your customers regardless of what the regulatory framework is. We try to set a clear tone for all of our employees that we need to do the right thing everyday for our customers, whether it is legally required or not, because that is how you need to operate to take care of our customers and run a great business.

Bill, thank you very much for your time today.

You’re welcome. •