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Rewriting the rules in retail banking

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  • Four important trends are changing the terms of success in retail banking. Banks need to act now to develop new skills.

Retail banks have long competed on distribution, realizing economies of scale through network effects and investments in brand and infrastructure. But even those scale economies had limits above a certain size. As a result, in most retail-banking markets, a few large institutions, operating at similar efficiency ratios, dominate market share. Changes to the retail-banking business model have mostly come in response to regulatory shifts, as opposed to a purposeful reimagining of what the winning bank of the future will look like.

Retail banks have also not kept pace with the improvements in customer experience seen in other consumer industries. Few banks stand out for innovation in customer interaction models or branch formats. Marketing investments have traditionally focused on brand building and increasing loyalty: a reputable brand stood for trust and security and became a moat, providing protection against new entrants to the sector.

Today, the moats that banks have built are more likely to restrict their own progress than protect them from attackers. Four shifts are reshaping the global retail-banking landscape to the point where banks need to fundamentally rethink what it takes to compete and win. This should be an urgent priority for banks. The pace of change will likely accelerate, with a select set of large-scale winners emerging in the next three to five years that will gain share in their core markets and begin to compete across borders, leaving many subscale institutions scrambling for relevance.

 

Four Shifts Reshaping Retail Banking

Over the next three to five years, it is expected that a few players will emerge from the competitive scrum to gain dominant share in their core markets and possibly beyond. These firms will have taken bold and decisive actions to capitalize on the following shifts that are reshaping the industry. In some cases, these winners will be incumbents that build on an already significant share; in others, they will be institutions newer to the banking industry, which use their agility, strategic aggressiveness, and sharp execution to attract customers.

 

The traditional distribution-led growth formula no longer applies

Until the financial crisis in 2007, a retail bank’s total share of deposits was tightly linked to the size of its branch network. Over the past decade, this relationship between deposit growth and branch density has weakened.

Retail-banking branch networks are contracting even across Europe, North America, and the United Kingdom, although the pace of change varies considerably between regions.

The rate of branch reduction is often tied to customer willingness to purchase banking products online or on mobile devices. While customer willingness to purchase products via digital channels varies, however, the common thread is that in all markets this readiness is far ahead of actual digital sales and will require banks to catch up to consumer needs and expectations. Within any specific market, of course, there are banks that have acted swiftly to adopt digital and remote as their main channel for interactions; these banks are pulling away from the pack and have taken decisive actions on several fronts:

  • Set a bold aspiration for sales/service channel mix. Banks must do more than react to shifts in consumer preferences—they need to set aspirational targets for sales and service across channels. Some customers will self-select into digital channels, but banks can do more to encourage less motivated customers to make the shift.
  • Use advanced analytics to reshape the physical footprint. Optimizing the branch network requires a deep understanding of consumer preferences in every micromarket, and of the economics of making changes at the branch level. Leading institutions are using combinatorial optimization algorithms to optimize the net present value (NPV) of the network based on granular customer data on characteristics such as digital propensity, willingness to travel, needs based on transaction patterns and branch usage, and the size and space/format of branches.
  • Develop cutting-edge digital sales capabilities. Achieving meaningfully higher levels of digital sales requires sophisticated digital marketing and an understanding of how to optimize each stage of the funnel. Most consumers already seek information on financial products on digital channels, but few institutions are highly effective at converting these inquiries into digital sales. Leading banks use first- and third-party data (for example, geospatial, browsing behavior), a robust marketing technology stack (such as 360-degree view of customer, omnichannel campaigns), and an agile operating model (for example, cross-functional marketing war rooms). With these elements in place, progress can be rapid.

 

Customer experience is beginning to generate meaningful separation in growth

Across all retail businesses—including banks—customers now expect interactions to be simple, intuitive, and seamlessly connected across physical and digital touchpoints. Banks are investing in meeting these expectations but have struggled to keep pace. Many are hampered by legacy IT infrastructures and siloed data. As a result, few banks are true leaders in terms of customer experience. Even for institutions ahead of the curve, typically only one-half to two-thirds of customers rate their experience as excellent.

The impact of this less-than-stellar performance is measurable. The few “experience leaders” emerging in retail banking are generating higher growth than their peers by attracting new customers and deepening relationships with their existing customer base. Highly satisfied customers are two and a half times more likely to open new accounts/products with their existing bank than those who are merely satisfied.

These experience leaders are adopting tactics pioneered by digital-native companies in other sectors such as e-commerce, travel, and entertainment: setting a “North Star” based on proven markers of differentiated experience (for example, user-experience design, carrying context across channels), redesigning journeys that matter most for digital-first customers and not just digital-only customers, and establishing integrated real-time measurement that cuts across products, channels, and employees. These banks know that customer experience is not just about the front-end look and feel, but that it requires discipline, focus, and investment in the following actions:

  • Focus on the journeys and subjourneys that matter. The relative contribution of subjourneys (such as app downloading; activating account) in determining overall customer experience varies considerably. In fact, ten to 15 subjourneys have the biggest customer-satisfaction impact for most products and should thus be the first priority. For instance, when opening a new deposit account, the researching options subjourney has eight times the impact on customer satisfaction than other account-opening subjourneys, on average. For banks, the key is to prioritize these high-impact subjourneys and systematically redesign them from scratch—a process that can take about three to four months and result in at least a 15 to 20 percent lift in customer satisfaction.
  • Change the way you engage with customers. Experience leaders understand that digitization is not just about creating a cutting-edge online and mobile experience, and that satisfaction is shaped by customer experience across channels. The experience should be seamless, especially on journeys that are more likely to take place over multiple channels, such as new account opening, financial advice, or issue resolution. Banks need to deploy these tools broadly and empower their frontline staff to play a more consultative role that blends human and digital recommendations. They will also need to revisit how these employees are incentivized, shifting to a longer-term view of relationships and profitability rather than just product sales.
  • Translate data into personalized products and real-time offers. The amount of data available on individual customers or prospects has exploded in recent years. The challenge is to convert these data into actionable nudges and highly relevant offers for customers that are delivered at the right moment. Credit-card companies have long offered discounts on specific spending categories or with specific retailers. Today, they can improve loyalty and share of spending by providing location-specific offers right when a customer enters a coffee shop, movie theater, or car dealership.

 

Productivity gains and returns to scale are back

Larger retail banks have historically been more efficient than their smaller competitors, benefiting from distribution network effects and shared overhead for IT, infrastructure, and other shared services. Analysis of over 3,000 banks around the globe shows that while there is variation across countries, larger institutions tend to be more efficient both in terms of cost-to-asset and cost-to-income ratios. However, beyond a certain point, even larger institutions struggle to eke out efficiencies or realize benefits from scale.

We expect this paradigm to change over the next few years, as structural improvements in efficiency ratios and increasing returns to scale enable some large banks to become even more efficient. The reason is twofold: first, advances in technologies such as robotic-process automation, machine learning, and cognitive artificial intelligence—many of which are now mainstream and commercially viable—are unleashing a new wave of productivity improvements for financial institutions. Deployed effectively, these tools can reduce costs by as much as 30 to 40 percent in customer-facing, middle-, and back-office activities, and fundamentally change how work is done.

The second factor leading to a wave of productivity improvement in retail banking is the shift from physical to digital channels for customer acquisition. Banks with scale—and skills in leveraging that advantage—will achieve customer-acquisition costs of up to two to three times lower than their smaller peers. Their outsized volumes of customer data will lead to better targeting and funnel conversion. As investments shift toward digital channels, the productivity gap between large and small banks will widen.

This dynamic has played out in more digitally mature industries, with firms like Amazon and Priceline acquiring customers at a significantly lower cost than competitors. As in these industries, eventually a limited number of dominant firms will emerge, squeezing out undifferentiated midsize and smaller competitors. Banks that succeed in this new wave of productivity will also have taken the following actions:

  • Use cutting-edge technology to automate. Over the next few years, banks will increase their use of technologies such as natural language processing and artificial intelligence to automate customer-facing interactions and complex internal tasks.
  • Build and reinforce the brand. With rising digital sales consumers have more choice than ever in selecting a financial-services provider. However, research shows that across most categories, consumers actively consider only two to three products before deciding on a purchase. So it remains as important as ever for a bank to be part of the initial consideration set. Brands with superior awareness and recognition are not only more likely to be part of the initial consideration set but also achieve higher conversion rates than lesser-known brands when they are considered.

 

The unbundling and ‘rebundling’ of retail banking

The tight one-on-one retail-banking relationships of old are unbundling. It is common to have a mortgage with one bank, an unsecured loan with a different lender, and separate deposit and investment accounts. The banking relationship is fragmenting even faster in countries with higher digital adoption.

This decline of customer loyalty provides a perfect context for firms seeking to enter banking in a selective way—focusing on the most profitable segments. Some attackers have demonstrated that while they cannot compete with incumbent banks’ broad access to customer data, they can compete effectively on customer experience coupled with aggressive pricing.

New entrants in financial services typically begin by focusing on a niche—making either a product- or segment-focused play. Their ambition, however, is often to own the full banking relationship of this segment over time—providing cards, mortgage products, and broader banking services.

The requirement for banks to share data and provide access to consumer and small-business accounts through a common framework of application programming interfaces is likely to fuel a wave of innovation and level the playing field for fintechs and technology providers seeking entry through payments or consumer financing.

The trend toward unbundling in financial services is well under way, but where it will lead is still an open question. In industries such as music, television, e-commerce, and transportation, digital distribution led to unbundling that destroyed value for incumbents in the short term; over time, consumers tend to converge on a single provider—often an attacker. In this context, firms that effectively orchestrate platform or ecosystem environments tend to eventually emerge as winners.

The history of the music industry over the last 20 years provides a possible model for how things will go in banking. Until the 1990s, music distribution was dominated by stores selling tracks that record companies “bundled” onto albums. In the early 2000s, digital distribution, especially via iTunes, radically reduced distribution costs. Consumers could now “unbundle” albums by purchasing individual tracks online; not surprisingly, many record stores went out of business.

If we apply this scenario to banking, winning firms will be those that leverage superior access to customer data to provide truly differentiated and cutting-edge experiences—potentially extending beyond financial products and services. To do this effectively, banks will need to retain privileged access to information about consumers’ sources and use of funds, especially through payments and transaction activity. Banks that rebundle effectively will use this data to deliver compelling and integrated experiences that provide seamless funding, investment, payments, and money-movement capabilities. The bottom line is that in order to reverse the unbundling of financial services, banks need to make it worthwhile for consumers to have a relationship with one institution; they need to deliver not only simplicity and convenience, but also superior value. Only a few banks in each market are likely to be able to succeed with this strategy.

Already, large technology firms such as Amazon are extending into parts of the financial-services value chain, starting with areas where they have a data advantage such as payments, short-term financing for purchases, and working-capital loans for merchants on their platform. To counter the unbundling of their most profitable products, banks need to develop capabilities that few currently possess, and follow the lead of successful technology platforms:

  • Retain superior access to data on transactions and financial behavior. As vast amounts of data are captured by tech firms on consumers’ behavior and preferences, one of the last bastions of valuable information is data on transactions and financial behavior. To retain unparalleled access to this data, banks will need to continue to own the transaction layer, giving them a full view of inbound and outbound activity, to form a complete picture of consumer balance sheets. Historically, this required a bank to be a customer’s primary checking-account provider; over time, we expect that institutions could do this without necessarily owning the checking-account relationship. In some cases, payments or transaction providers could see a significant share of customers’ spend volume. Financial aggregators may also be in a position to capture a broad spectrum of customer activity and use it to build an analytics advantage.
  • Leverage insights to develop innovative products and features. The traditional suite of products that financial institutions offer has remained largely unchanged over the past few decades and is often structurally hard to change given how banks are organized. More nimble firms will be able to leverage insights to create unique offerings.
  • Extend beyond purely financial services and products over time. There are a couple of clear benefits that financial institutions are likely to have relative to ecosystems being created by large tech firms. Superior access to financial information enables them to create faster and more precise offers for big-ticket products that have financing needs associated with them (such as homes or cars). For these types of products, banks could be well positioned to own the full customer journey, including the browsing experience and the transaction.

 

Retail banking is at an inflection point, and we expect the pace of change to accelerate significantly over the next three to five years. Success will require clarity in direction, and speed and agility in execution. Retail banks that capitalize on current shifts in the market will emerge with a winning position in their core markets and begin to compete across borders.

 

  • By Vaibhav Gujral, et al

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Finance

Building a Sustainable Competitive Advantage in the Financial Market

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The prime differentiator among firms, and the heart of wholesale banking, is talent. A small subset of talent creates the majority of value in the industry, making it critical to identify, attract, develop, and retain the right people. This task has become more challenging, however, as financial services has lost some of its allure as a destination for many top new graduates.

Here is the challenge: banks must envision the future value chain for products, customers, and technologies in their sector and then pinpoint what talent they will need to bring this value chain to life. They must assess what sorts of talent their business lines need, recruit and identify the individuals best suited for those roles, align talent to the value those functions produce for the organization and maximize their productivity, and broaden their organizations’ reach to create more diverse and inclusive teams of talent.

Best-practice talent management can deliver highly cost-effective incremental value. At capital-markets firms, for instance, full ‘electronification’ combined with the astute talent management required to attract and retain the talent that remains could shrink the front office by 20 to 30 percent in the long term, while increasing the productivity, value, and rewards to the remaining team. For the largest capital markets and investment-banking firms, this combination of a smaller, more highly rewarded team could cut compensation costs by about 10 to 20 percent, realizing savings of $300 million to $600 million annually off of the average $9 billion in capital markets and investment-banking costs (3 to 7 percent).

Some banks are already reaping the benefits of investment in these kinds of improvements: in corporate banking, new skills and technology have produced significant revenue gains from a smaller staff of relationship managers (RMs), and shown gains in productivity on the order of 20 percent.

The impact of banking’s electronic transformation on talent

Automation and analytics are transforming the basic processes and economics of commercial and investment banking.

In capital markets, electronic venues will continue to supersede voice trading, shifting the source of value from traditional traders to trading platforms and, importantly, to the engineers who develop them.

Trading operations will continue to evolve from the factory floors of the past, with large, expensive teams of traders and salespeople showing little differentiation in performance, to select technology-focused staff. Automation is well underway, and will continue to reduce staffing needs for trading desks.

Off the trading floor, the automation and modernization of traditionally labor-intensive, as well as pre- and post-trade analysis and processing, will deliver significant cost savings.

In corporate banking, predictive analytics can anticipate customers’ credit needs, converting RMs’ traditional brute-force selling efforts into more targeted and timely offerings. And as customers increasingly rely on digital channels for day-to-day business, RMs will be freed from many administrative tasks and gain as much as 30 percent in time to develop client relationships.

Traditional approaches to networking and business development need to be updated to leverage the latest technology and analytics, raising the success rates and productivity of RMs, and with their returns on firms’ assets. The shift creates greater opportunity for each RM by enabling more targeted and strategic conversations, but also raises the bar to assemble the skills to leverage these new technologies.

Technology is central to the task, but as mentioned earlier, value in banking is centred on talent—as well as the firm’s balance sheet. Experience has shown that the top 10 percent of a capital-markets bank’s team creates as much as 50 percent of value, and that in corporate banking, RM production is similarly concentrated.

Research shows that current technologies could automate the work of more than 40 percent of positions across financial institutions. The reinvention of banks’ organizational mechanics is inevitable. Staffs will be smaller and more productive, and possess different talents and personal profiles.

To emerge with greater productivity, banks of all types will have to adapt their talent to the new structure, in their attitudes toward recruiting, training, succession management, and the work environment.

The gaps in banking talent

And yet, while many banks have come to realize the importance of these shifts in technology and environment to their talent management across all business segments, few have made the needed changes. Digital talent that is well versed in capital markets and commercial banking has always been scarce—and even greater challenge in the current competitive labour market.

Complicating the challenge, finance is no longer the preferred career destination for much of the talent banks so crucially need. Among tech-skilled candidates, large tech companies and start-ups are typically viewed as offering engineers more interesting and innovative problems to solve, as well as more collaborative cultures, than the command-and-control financial world. Moreover, potential tech recruits perceive a limited career path at financial institutions.

In recruiting more generally, the damage to the industry’s reputation from the financial crisis has dissuaded many students from pursuing financial careers.

Last, having stripped so many people from the cost base over the past several years, as well as reduced investment in training, many banks lack a strong internal bench of talent to develop. Thus, their organizational pyramids have become misaligned and show gaps at critical levels.

Talent management in three directions

To succeed in the technology evolution in banking, banks will need to retrain, restaff, and reorganize. They need to start by determining what skills they need, then identify individuals with those skills, and finally develop succession programs to ensure they have the right talent in the future.

Banks have many talent levers at their disposal, in the following three categories:

  • identifying talent and aligning talent to value
  • improving the productivity of talent
  • building more diverse, inclusive, and agile talent teams

Identifying talent

Banks tend to fill leadership positions with their biggest individual producers. But big producers do not necessarily make the best managers. In addition, the current generation of top producers may not possess the digital skills and experience needed to identify and act on future value-creation opportunities. Banks need a more expansive approach to hiring that recognizes the importance of digital skills.

Banks should also reconsider the practice of drawing senior producers from their industry competitors with lucrative pay packages. While proven production certainly has value, past successes may not be as relevant or lasting in a digital environment.

In recruiting, financial firms also tend to “hire in their own image”—for example, favouring candidates from a small circle of select business schools. Research has shown that graduates from a range of universities can perform as well as, and sometimes better than, those hired only from the elite schools, depending on the specific needs and requirements of function. These graduates also frequently stay at their firms longer, reducing the burden of having to replace talent in the future.

Conventional thinking about aligning talent to value holds that a business unit’s front office creates the most value. In a digital environment, however, a firm’s essential trading algorithms and platforms—and the software engineers that design them—may dominate the value equation and generate even more than its RMs, salespeople, and traders.

A talent-to-value approach assesses the value creation and protection potential of key technologies and positions, and then identifies the roles that enable the creation of that value. Further, it looks at the skills required to capture value and examines the fit of the incumbent team to those responsibilities. The last steps lead to a plan for managing talent succession with the existing team and for building and refreshing the skills of the team.

Banks that confine their value analyses to the top tiers of their organization can overlook 90 percent of critical roles. After a rigorous analysis, firms may find that in a digital world just 10 percent of their managers create 50 percent or more of the value, and yet none of them sit with the senior team. On the other hand, as many as 20 percent of firms’ managers may create little value.

Accordingly, firms must rigorously analyse value across the firm, both for business units as a whole and for their individual employees. To define value analysis at the individual level, firms can develop a detailed understanding of each role to distinguish the value expected from being present on a team (the “beta” of value from the average seat on the desk) from the incremental value attributable to unique talent (the “alpha” of the individual producer).

Taking a more expansive view of talent to value can produce impressive results: organizations that frequently reallocate high performers to their most critical strategic priorities are 2.2 times more likely to outperform their competitors on total returns to shareholders.

Improving productivity

Talent is both the scarcest resource and the greatest differentiator for banks, so they need to protect that resource and enhance productivity. We see three key ways to do so: through technology that leads to smarter decisions and more intelligent client coverage, through active coaching, and through training to supplement the skill base. Consumer banks have historically offered the following strong coaching and training programs for talent development, but such efforts tend to lag for most capital-markets firms and commercial banks:

  • Decision technology. Capital-markets firms closely track talent performance indicators that emphasize outputs such as profits and losses and sales credits. They often fall short, however, in quantifying inputs that can heavily influence overall results—such as collaboration between groups to foster cross-selling—based on firm priorities and culture.

Within ten years, digital technologies will be able to relieve corporate banking RMs of many non-client-facing tasks, giving them more time to devote to production. To maximize the opportunity to relieve their front-office staff of manual tasks, banks should invest in advanced analytics systems, such as for client relationship management, which can automatically suggest the “next product to buy” for their clients, for automation of credit decisions, and for automatic distribution of market colour and axes in capital markets.

  • Coaching. In day-to-day management, banks should implement real-time, fact-based coaching and feedback with team members, guided by clearly defined matrixes of expected capabilities for development. Managers in commercial and investment banking are at a particular disadvantage in coaching, as many have been promoted on their production prowess rather managerial mettle, and lack a coaching awareness.

In order to maximize their productivity, capital-markets banks must invest in concrete training that incorporates situations that confront managers and their reports.

Banks should also deeply assess the strengths of their top performers and use the resulting insights to develop management training. Individuals can learn where they lead or lag peers and learn practices to enhance their capabilities. Through such programs, companies across industries achieve repeatable gains in revenues of from 5 to 20 percent, driven by more effective management.

  • Training. Banks must develop a metrics-based approach to identify the attributes that generate productivity, then quantify and sharpen those skills. Leading banks are developing training and rotational programs tailored to building skills—in one case a week-long technology boot camp for all managers, in another a three-day executive training program to build collaboration.

Corporate banking RMs will need to handle a broader range of products, and in some cases assume a more strategic advisory role for clients, sometimes with CFOs and CEOs. They will need training in the products, of course, but might also require some psychology training to prepare them for the more empathetic role they may need to bring to these relationships.

Last, meetings are an ongoing pain point for most institutions and a drag on productivity. Banks can reduce the pain with a coherent set of meeting practices: for example, 45-minute time limits for standard meetings; mandatory advance agendas; discouraging attendance by multiple, similar senior managers (for example the CEO and COO of a business); and inviting only necessary attendees. Meetings need not be so frequent. Digital communications can readily supplant many face-to-face meetings, freeing the business to spend more time with clients.

Building more diverse, inclusive, and agile teams

Financial firms generally underperform in promoting women and people of colour to senior positions, in spite of strong evidence in its favour: across industries, firms in the top quartile for gender diversity are 27 percent more likely to create value, and those in the top quartile for diversity in both gender and ethnicity were 33 percent more likely to rank high in profitability.

Banks should expand their programs for diversity, and make those efforts known in recruiting programs. They should also act—leveraging data and analysis—to remove bias from promotions both in policies and practice.

Banks will also benefit from diversity through better integrating the talent in nearshore and offshore centres that are frequently ignored and untapped. Last, the foundation of agile banking operations is empowered, multifunctional teams. Increasing interactions among geographic business centres—head offices and technology and data hubs—will maximize the value of agile processes but requires careful planning and more integration among units.

  • By Matthieu Lemerle, et al

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