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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 long competed on distribution, realising economies of scale through network effects, and investments in brand and infrastructure. But even those scale economies have limits above a certain size. Retail banks have also not kept pace with the improvements in customer experience seen in other consumer industries.
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 channel, 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 few years that will gain share in their core markets and begin to compete across borders, leaving many subscale institutions clambering for relevance. It is expected that a few players to 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 capitalise on the following shifts that are reshaping the industry.
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 across the globe, 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, some banks have acted swiftly to adopt digital and remote as their main channels for interactions; these banks are pulling away from the pack and have taken decisive actions on several fronts, i.e., set a bold aspiration for sales/service channel mix, use advanced analytics to reshape the physical footprint, develop cutting-edge digital sales capabilities. Achieving meaningfully higher levels of digital sales requires sophisticated digital marketing and an understanding of how to optimise 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, a robust marketing technology stack, and an agile operating model (for example, cross-functional marketing war rooms). With these elements in place, progress can be rapid.
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 banks know that the customer experience is not just about the front-end look and feel but that it requires discipline, focus, and investment in the following actions, i.e., Focus on the journeys and sub-journeys that matter, Change the way engage with customers. Translate data into personalised products and real-time offers.
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. Banks around the globe show 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 take out efficiencies or realise the benefits from scale. It is expected that the 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. 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 the scale and skills to leverage 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 towards digital channels, the productivity gap between large and small banks will widen. Of course, scale is not everything. Banks that succeed in this new wave of productivity will also have taken actions, i.e., Use cutting-edge technology to automate, Build and reinforce the brand.
Re-bundling of retail banking: The tight one-on-one retail-banking relationships of old are unbundling. Many households today hold a deposit account with more than one institution. 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 selectively, 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 trend towards unbundling in financial services is well underway, 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. 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, i.e., Retain superior access to data on transactions and financial behaviour, Leverage insights to develop innovative products and features, 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. 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 it is expected that 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 capitalise on current shifts in the market will emerge with a winning position in their core markets and begin to compete across borders.
The writer is Company Secretary, City Bank PLC
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