The challenges presented by a multichannel environment strike at the core of the traditional model of banking. In the era of big data, when customers want to perform more transactions online or through their phones, banks have to look hard at how they deliver services. Future Banking speaks to partner Lee Kyriacou and managing director Rick Spitler at consultancy firm Novantas about how banks can drag themselves into the present and prepare for a different future.
From big data to omnichannel strategies, banks have to deal with more than the terminology of a new paradigm for the financial services industry. Traditional banking services will soon not be enough to sustain profitability in a market that is no longer shaped by the supply side, but instead driven by the demands of customers.
Banks must face difficult decisions about how to manage their branch networks, and must develop strategies that not only incorporate digital channels for customer interaction, but also make those channels increasingly profitable in the face of increasingly intense competition.
"Part of what banks do is classic intermediation, which includes the meat-and-potatoes activities of collecting deposits and making loans," says Lee Kyriacou, partner at Novantas. "It also means ancillary business like investment banking, brokerage and wealth management. Profitability for these activities is falling, so if this is all a bank does, then it will face problems.
"Banks need to recognise the core banking challenges that come from the macroeconomic environment, regulation and shifts in customer preferences, which are leading to a sea change in how banks operate," adds Novantas managing director Rick Spitler. "In the US, banking has been paper-oriented for a long time and customers have used the branch network, but they are now shifting to online channels. What is happening is a virtualisation of the industry."
Novantas and 'customer science'
Novantas provides consulting, solutions and research services to the financial services industry, focusing largely on issues of revenue strategy, which it refers to as 'customer science'. Within this definition fall the disciplines of defining, building, managing and measuring revenue-generating capabilities such as branding, market mix management, segmentation, product design, pricing, distribution management, sales execution effectiveness and customer experience.
From this perspective, Novantas sees banks facing difficult choices about their branch networks. Those who fail to embrace virtualisation could, in Spitler's vision of the future, end up suffering the same fate as the Blockbuster video rental business in the age of Netflix. Blockbuster went bankrupt in 2012, because it remained stuck in a business model that relied on stores when online streaming was taking over.
"Banks will suffer a decrease in profits if they sustain big branch networks. As the industry virtualises and moves services online or to mobile phones, it must move from a product-centric model to a customer-centric model. The problem is that banks' systems are still product-centric or, at best, designed around customer segments. What the industry needs is a fundamental shift from a product sales environment to a customer-centric environment," Spitler says.
Bullish about mobile banking
There are many practical challenges that come with virtualisation. Embracing mobile banking, which in many ways exemplifies the confluence of customer expectations, highlights the need to move away from the typical intermediation activities of loans and deposits, for which the cost structure is rapidly changing. Banks must act quickly, but this can be difficult because of the fundamental nature of the change the industry is undergoing.
"There is growing interest in customer-centric core banking systems and in mobile banking applications," says Spitler. "Most banking services are about cash management for customers, and the mobile channel provides a real-time link in the customer interaction chain. We are bullish about mobile because of the integration it requires across a bank's products and services, and because of the real-time element of cash management that it introduces. But banks often struggle with their mobile offering, so there is an opening for a vendor-supplied solution, though it is hard for banks to find one at the moment.
"At the same time, US banks are struggling with how to manage their branch networks. You can't just shut down the old factory, as you can't take the write-down on fixed assets because of the implications for capital and risk. They need to invest in the digital space to become customer-centric and product-agnostic as customers flee the physical branch network, but affording it is hard because banks need to keep earning reasonable returns."
The pressure to adapt is becoming more intense; new entrants that are not hamstrung by the inertia of legacy systems start to build service capability in the financial services space.
"There is a lot of room for disruption in the industry, although regulators are nervous about this," notes Spitler. "The industry is too much a part of the fabric of the economy, so regulators won't allow too much disruption. Also, incumbents will be able to copy the new entrants."
"The ones to really worry about are the big names like Capital One and American Express that don't have the branch networks but have successful brands that they can transfer to the online space," adds Kyriacou. "They can mimic the new entrants more easily, so they will galvanise the industry. If they start to move quickly and pull customers to them, then banks will alter their cost structure and we will see more rapid rationalisation of branch networks. The question is whether they will have the cash to redo their core systems."
Banks need to move quickly
The pressure for banks to start acting quickly is not the same the world over. It is greater, for instance, in the US, where there is more inertia.
"US banks are five years behind the developed markets in Europe, and about two years behind emerging markets, where banks are unburdened by legacy systems," says Spitler. "So, there is a bigger challenge for US banks to become customer-centric. They face a five-year journey while still supporting a branch network and taking write-downs on assets."
"It is too hard for US banks to change their legacy systems," notes Kyriacou. "Some banks are moving to a payments hub approach, not organised around payment type or network but around who is paid and when. It is a way of integrating electronic payment methods without adjusting core systems."
As far as Novantas is concerned, banks need to clarify their strategies quickly and start making changes as soon as they have a clear understanding of the specific challenges that transformation will involve.
"Banks cannot sit back and wait," says Spitler. "Before, big changes in the industry were technology-led. There was a supply-side push with the move to ATMs, for example, but now change is customer led. Customers don't want to go to branches for traditional banking services. They have become more aware of the possibilities of self-service thanks to other industries such as air travel, and the ability to inform themselves online before making retail purchases. Banks have to quickly figure out what customers want."
"Those banks that are making money because they do more than classic intermediation can make the necessary investment and will move first," adds Kyriacou. "They will have an advantage."
The big data issue
The key target is to start generating revenue from virtual channels and building loyalty, making technology-led cost reductions where possible. There is a need to adapt core systems in line with this policy, either through costly rip-and-replace initiatives, or by adding a layer around core systems that allows them to operate as part of a customer-centric model. At the same time, banks need to start making better use of their data.
There is a lot of talk in the industry about big data and the invaluable insight it can give into customer behaviour. However, before tackling the big data issue, banks need to look at the data that exists within their own walls.
"Most banks can't make use of the data they already have because it is so rich," says Spitler. "They have to walk before they can run. The data is useful for customer segmentation, but they haven't caught up with their internal data, let along big data. You need to know how to use it first, which means having the right analytics in place."
Big changes are certainly coming in the industry and banks need to move fast, but the clear message is that, to reach the goal of customer-centric operation, they have to start at the beginning. This means finding out what customers want before making any investment in constructing a business model that meets their needs.