The three-step strategy for retail banks to overcome the crisis and lead the way
The stagnant retail banking market
In the last few years, there have been substantial changes in the retail banking sector. Undoubtedly, the world has undergone a period of intense technological revolution. In addition to that, the 2008 financial and economic crisis, the disruptive regulations (e.g. PSD2) and the customers’ social and behavioral changes have had a significant impact on the shape of the financial services.
In detail, the regulator has opened up the market to a series of new fintech and non-bank players characterized by innovative business models, whose arrival increased competition in the banking industry, mainly thanks to predominant digital distinctiveness and lean and fast operative structures, giving the rise to open and beyond banking trends. To get an idea, Revolut customers grew from around 1.5M at the beginning of 2018 to over 10M in only two years. As a result, and given the increase in the share of the “digital population” — today’s Generation Z and Millennials will represent around 47% of italian population in 2030 — the demand side is evolving at a fast pace. A survey conducted by ZEB shows that an average traditional retail bank in 2019 does not fully meet customers’ expectations. The study has revealed that there is a clear gap in terms of digital functionalities and distribution model, which are expected to be respectively more extensive and widely accessible by customers.
Moreover, ZEB Digital Pulse Check shows that 50% of retail customers would imagine switching to a fully digital bank. This is aligned with the 20% decline in branch usage and the increase in popularity of new fintech services, such as instant payments whose market is expected to register a CAGR of around 30% over the next 5 years.
Accordingly, we observe two main phenomena:
- retail banking revenue pools are stagnant or shrinking in all major European markets and especially in Italy where players have mainly focused on organizational and operational restructuring;
- non-banking players are gaining market share and could represent a threat much more than an opportunity if the collaboration model is not effectively defined.
ZEB European Banking Study highlights how the return on capital of the top 50 European banks, albeit increasing up to 7.2% in the 2018, was not able to cover the average cost of capital, equal to 8%. Furthermore, over the past 10 years, in Italy, we observe a progressive contraction of total revenues, from EUR 92.5B in 2008 to EUR 82.8B in 2018. The prospects for the European and Italian financial markets characterized by low growth rates impose even more pressure on costs and make the creation of new revenues necessary.
So far, this ongoing condition has generated strong downward pressure on banks’ budgets and relevant focus on the optimization of infrastructural costs, shaping a global trend of re-designing operations. Financial institutions at all levels have seen their organizational structures evolving into more efficient and digital operating models, thanks to an articulated process of banks’ consolidation and branch network shut down.
Nevertheless, this does not seem to be enough to restore sustainable profitability levels. In fact, this objective can be achieved only through a profound change in the business model, which will play the game for new and sustainable revenue streams. Alongside the pursuit of efficiency, the prolonged low interest rates led banks to restructure their revenue model towards predominantly fee-generating products and services and pushed the most innovative players to create service ecosystems, enriched by offerings from third parties. The retail banking sector has made huge strides in digital development of platforms and processes, also thanks to new technologies (e.g. Open API, NFC, AI) which enable pioneering business models. However, there is still great room for improvement: the penetration of online banking in Italy reached 36% of individuals in 2019 and it will constantly increase over the next 3 years, when over 90% of Italian banks will have developed digital onboarding procedures. Though it looks like a great achievement, competition from fintechs, neo-banks and non-banks is racy. Firstly they are digital-native, so they reach the customer faster and better, reducing waiting times for product activation and providing 24/ 7 remote assistance; secondly, as far as operating expenses are concerned, they face lower overhead and infrastructure related costs. In a constantly evolving banking ecosystem, traditional retail banks’ challenge of increasing incomes can be overcome through customer-centric models.
The pandemic changed the rules of the game
The COVID-19 outbreak represents an unprecedented world-wide humanitarian challenge and the toughest exogenous shock in recent years. This pandemic is affecting the global economy as no other crisis has done before. Global and Eurozone GDP are expected to record a contraction of respectively 5.2% and 9.1%. In Italy, the estimated GDP fall ranges between 11.3% and 14%, depending on whether there will be a single or double-hit scenario. The outbreak affects also unemployment; according to the IMF’s World Economic Outlook, in Italy the rate is estimated to reach 12.7% for 2020.
How has this unprecedented global emergency impacted current retail banking trends?
The current crisis is reshaping the dynamics of our society as well as those of the retail banking sector. During these times, Italian banks experience various challenges. First of all, they are suffering the sudden worsening of P&L and financials. On the one hand, revenues are shrinking due to the reduction of transactional volumes and fees, the contraction of loans and the halt in mortgage payments; on the other hand, branches fixed costs overcame physical network productivity. The increase of NPAs then led some rating agencies to stand a negative outlook for the major Italian banks. Secondly, anti-Corona measures of protracted smart working slowed down the main corporate and organizational development projects, which involve large teams and undoubtedly benefit from in-person work-mode (differently, lean and digital-native business environments such as fintechs’ are not as impacted in this respect). Last but not least, banks’ relationships with customers are weakening since consolidating loyalty and improving customer retention is becoming harder and harder. Indeed, a growing segment of the population mainly relies on digital means to communicate and carry out financial activities, given the prolonged exposition to and use of these tools and platforms during the lockdown period. In addition, clients are less likely to enter a branch in this time and banks are not prepared to handle the entire customer portfolio remotely, as cost-to-serve would skyrocket.
Do these critical conditions represent a decisive push for incumbents to evolve?
It is crystal clear that some of these transitions are not temporary, rather they will endure and characterize the upcoming future. The COVID-19 crisis has accelerated the rate at which older generations — but not only — are embracing technology and digital solutions. These represent mainly customers of traditional banks who had been used to going to branches for everyday banking operations before the pandemic. In order to maintain a solid relationship with these customers, traditional retail banks are called to provide the right service offering through innovative distribution channels.
To sum up, incumbents must now press on the accelerator to speed up the business model evolution they sought over the past decade. They need to return profitable and build a trusted and seamless relationships with clients based on specialized advisory and enlarged offering.
The way forward to become a champion retail bank
All that said, moving on inertially is not an option for retail banks to remain successful, rather it is imperative to redefine priorities on the strategic agenda and evolve the business model to become customer-centric, consolidating and in some cases winning back clients’ loyalty. While drawing the new route for future success, banks should take the following guidelines into account:
- consolidate the “core” business to restore pre-crisis profitability levels by increasing volumes and pursuing efficiency thanks to digitalization and industrialized processes;
- renovate the relationship model for individual and business customer segments to enhance customer-centricity and build the ground for new opportunities;
- evolve the traditional business model to achieve a sustainable revenue growth thanks to a stronger competitive positioning and an enlarged value proposition.
Accordingly, a three-step strategic pathway can be outlined for a medium-term evolution (three to five years).
1. Empower the credit value chain
Retail banks’ first thought must be to enhance the lending machine. While ensuring a high collection and deposit activities, it is necessary to work on simplifying lending processes and investing in credit management automation. In particular, banks will be called to:
- “standardize” innovative solutions by developing instant lending and digital financing products, also through partnerships with large retailers or e-commerce, aimed at increasing target market organically and acquiring new customers;
- digitalize credit processes by developing an automated approval and lending system and simplifying credit policies, in order to ensure a fast-credit journey and reduce “time-to-yes” and “time-to-money”, which translate into a better customer experience;
- streamline NPA (non-performing assets) management through a set of measures which ranges from internal handling to partnerships with transaction platforms to direct sale.
From a strategic point of view, such measures are aimed at industrializing the core business, thus unlocking potential to increase volumes, reduce costs and create managerial space to focus on growth beyond the core business. According to ZEB analysis, banks which manage to increase earnings by 20% and reduce operating costs by 30% will be able to close the profit gap generated by COVID-19 induced LLP climb. Evidence that banks are approaching this path can be found in the partnership between Credimi and Illimity and the collaboration between Qonto and BorsadelCredito.it. The former makes Credimi’s digital factoring solutions available to Illimity customers and their supply chains, thanks to the technology and modular interfaces developed in Credimi. The latter responds to a synergy needs by offering an online account and a fast, innovative and efficient lending channel dedicated to Italian SMEs.
2. Develop an omni-channel distribution model
Banks must be capable of designing and implementing a model which is not built on customers’ relationship with a single branch, rather it is driven by their need of products and services. Therefore, banks will be called to:
- evolve distribution platforms by developing an end-to-end digital onboarding process and enabling an omni-channel interaction with clients, in order firstly to decrease drop-off rate and secondly to provide an easy access to the banks’ offering and a seamless customer journey;
- provide advanced and specialized advisory (products and industry knowledge) from central offices for either remote or in-person support and implementing a need-based client management rather than a segment-based one, in order to improve the quality of the response to customers while decreasing the cost-to-serve;
- optimize the agency structure by closing low-productivity branches to reduce physical network costs, and develop smart branches concepts as local point of reference.
The suggested measures aim at reinforcing the commercial power of retail banks in facing harsh and innovative competition by leveraging on differentiating assets. Designing a strategy along the three above-mentioned initiatives will allow banks to improve cost-to-serve and cross-selling potential, achieving a reduction in cost-income ratio up to 15 p.p., with a revenue impact of up to 10%. Banks have indeed invested in this respect, but there is still work to do: a study conducted by ZEB reveals that 76% of the European retail banks have defined an online/ digital strategy, but approximately half (51%) of those observed has a specific omni-channel strategy in place, effectively combining digital and human channels (some northern European banks have declared to conduct 40% of advisory meetings through remote channels).
3. Build a partnership ecosystem
Over the next years banks will have to exploit their assets and expertise to expand beyond their traditional business model. In detail, retail banks will be called to:
- prepare the field for collaborations by building open architectures and platforms (e.g. open API network) and spreading culture and know-how on open banking inside the organization, with the aim of increasing attractiveness for thirds parties and facilitating the “go-live”;
- enrich the value proposition by developing partnerships with both financial players (on vertical services) and non-banks to strengthen customer retention and satisfaction and create a one-stop shop selling experience;
- enlarge the customer base through distribution and product partnerships, aimed at reinventing the revenue model and generating new business opportunities, also leveraging on data monetization (e.g. customers’ financial profiles, spending habits).
Positioning themselves between customers’ needs and the market supply will allow banks to unlock new revenue streams. ZEB estimates that such approach would have a 25% P&L impact. There are various examples of such collaborations. By partnering with Telepass, BNL BNP Paribas managed to enrich its value proposition and enlarge the customer base, while offering a seamless mobility and payment experience to clients. Another case study is Switcho, an Italian fintech that helps clients to save money in few clicks through a platform for the end-to-end management of recurring expenses. Switcho aims at partnering with retail banks to access larger pools of customers and provide them with innovative and specialized services, either integrated into the home banking or the personal finance system, entirely complementary with the banking value proposition, therefore contributing to generate new revenue streams for the banks.
To conclude, do-nothing is certainly not an option. Banks cannot risk to lose competitiveness and keep stagnating with low profit margins. The pandemic has hampered banks’ industrial plans further weakening their relationship with clients. The recipe for a sustainable growth is simple and ambitious at the same time: consolidate, renovate, evolve. The way forward includes indeed three strategic pillars, namely adapting the core business to current competitive and technological trends, reconnecting to customers and building a coopetition model driving revenue growth.
Authors
Arianna Sossi — Analysts at Bocconi Students Fintech Society
https://www.linkedin.com/in/arianna-sossi-26a992191/
Valeria Vitiello — Analysts at Bocconi Students Fintech Society
https://www.linkedin.com/in/valeria-vitiello-94711317a/
Andrea Novati — Analysts at Bocconi Students Fintech Society
https://www.linkedin.com/in/andrea-novati-172730176/
Antonio Macaluso— Analysts at Bocconi Students Fintech Society
https://www.linkedin.com/in/antonio-macaluso-53b102161/
Sources
International Monetary Fund, World Economic Outlook, Chapter 1, The Great Lockdown (April 2020)World Bank, Global Outlook, Pandemic Recession: The Global Economy in Crisis (June 2020)
OECD Interim economic assessment, Coronavirus: the world economy at risk (March 2, 2020)
Bank of Italy, annual report 2019 (May 2020)
Bank of Italy, report «Banche e istituzioni finanziarie» (May 2020)
Medici, Neobanks a global deep dive (August, 2019)
Rizzi W., Taraporevala Z., The Balancing Act: Omnichannel excellence in retail banking (January, 2019)
Gnauer W., Mueller N., Omnichannel banking and its implications for bank management (March, 2020)
ZEB European Banking Study 2020, A Black Swan event and its impact (2020 edition)
ZEB European Retail Banking Study 2019, Back-to-the-future retail banking — three pathways to profitability (2019 edition)
