The Changing Picture of Retail Banking

What is Changing: The Customer

I and We

Retail banking, at a high level, largely operates on a one-to-one relationship between the bank and the customer. Today's customer is increasingly, is a blend of individual and community. The community aspect of this is changing the relationship implicitly from one to one, to one to many (bank:community that the customer belong to). This change affects all aspects of the value sought from financial services across solutions, selection and delivery. In essence, banks need to provide fulfillment across individual and community affiliations that have financial and/or access implications.

Need to save

Customers across all markets are under a range of stresses. Getting favourable rates on investment and/or funding has never been more important. This has provided sufficient impetus for customers to look around and leverage communities to capitalise on a good deal or offer.

Monologue to dialogue

In parallel with the need to save, the understanding of banking among customers has increased considerably over the past two decades and banks can no longer push whatever products they want. This has paved a way for banking that is built on a dialogue-based relationship.

What is Changing: the Bank

Custody of transactions versus custody of customer

Retail banking, at its core, is about managing two levers: customer (relationship) management and risk management. At some point during the past couple of decades, growth pressures have transformed banks into transaction-processing machines, with most customer-facing initiatives structured to either save costs, generate sales or a combination of both. While banks were busy processing transactions and paper, their non-bank competitors have taken a more customer-centric approach. Banks were always in a ‘two-sided market’¹ where banks matched two sides of a deal (savers and borrowers) and made net interest margins or transaction fees or both. Ironically, the same ‘marketplace’ approach has been reconceived and redefined by a few non-bank players who have focused on involving the customer. Increasingly, such players are creeping in as a layer between the bank and the customer across countries. In certain countries, banks are bidding to win deposits, clearly signaling that someone else is now the custodian of the customer.

The information and fulfillment paradigms

Banks typically had access to information (identity and credit) and a steady influx of customers. They leveraged this access and influx to structure products and linked processing units accordingly. Processing units were then centralised into shared service centres (SSCs) and/or outsourced. These processes have transcended their mere fulfillment purpose and are now considered to be an integral part of the banking value chain. This value chain is set to be redefined, as access to this information is increasingly not restricted to banks alone. A few players, including credit bureau, are leveraging this information and are providing services such as account opening and funding by bundling authentication, money transmission, processing and IT services capabilities. A change in the information-handling model has created downstream changes in the ‘what’ and ‘who’ aspects of the fulfillment dimensions within the boundaries of a bank. It now seems clear that, due to lack of viable alternate entities/organisations who could deliver similar services, there was an ‘institutional void’² that led to banks doing it themselves. Despite the residual risk of passing out’ the ownership of the customer, similar fulfillment and associated enablers now seem dispensable. The second wave implications of this paradigm for banking could be to enable sourcing on a requirement basis across information and fulfillment. This can be viewed as a financial services version of the just-in-time (JIT) inventory strategy used in manufacturing, and could have similar profound and far-reaching implications.

What is Changing: the Competition

Competitors galore

While there has been a lot written on this subject, a ‘balance-sheet’ point of view of who impacts what may provider a deeper insight.

• Fund business: The marketplace approach of peer-to-peer (P2P) service providers’ could snatch away ‘the custodian of customer’ function from banks. Most P2P service providers have ‘back-to-back’ arrangements with traditional banks for account handling, information presentment and transaction processing. Increasingly banks own transactions and not customers. This is a clear route to commoditisation and a lower share of the profit pool.
• Fee business: Adjacent players from mobile/telecom, authentication and money transmission businesses, when viewed together, can greatly impact two interconnected loops of transaction fees and information presentment.
• Information: Information-oriented players like credit bureaux, comparison and benchmarking service providers can propel further bank disintermediation. Alliances with P2P and adjacent players can potentially form formidable competition.

Clean(er) slate advantage of newer/smaller banks

The advantage for newer or smaller banks cannot be underestimated. Newer and smaller players have less baggage and can therefore find the transition to becoming a newer/leaner service provider much easier. In a sense, while the crisis has humbled giants in the banking world, it has also provided a chance for smaller banks to take a bigger shot at the market.

Transition from monologue to dialogue

A cursory review of leading non-bank service providers demonstrates ‘design principles’ adopted to engage customers in a more personal and relevant manner. Some of the key principles include:

• Speak the customer’s language: Some the key themes are: focus on keeping it simple, limit jargon in all communications, promote use of functions such as internet banking³ for bank staff and customers for easier interaction, etc.
• Focus on disintermediation: ‘Keeping the bank out’ is a persistent message with regard to the benefits of lower funding rates and transaction fees.
• Demand orientation: Examples include the transition from canned products (classic supply thinking) and standard documentation to product structuring and drafting documentation leading to a ‘co-creation’⁴ basis for customer interaction and engagement.
• Value chain engagement: Most P2P players also provide for lending to specified borrowers rather than the traditional ‘black-box’ approach of a bank doing the lending, thus lowering opacity to unprecedented levels. The corollary is lower bank/P2P staff effort, which translates to lower fulfillment costs, ultimately resulting in lower transaction costs for customers.

Are banks defenseless?

The changes that may redefine ‘who is a banker?’ and ‘what can and should a bank do?’ is increasingly clear. However, the changes indicated above are ‘lead indicators’ and ‘first wave effects’ of technology and information-driven possibilities. While there are many starts, critical mass has not yet shifted away from banks. Also, a few P2P players have had to face up to some regulatory issues. Nevertheless, profound changes have been triggered. Regulatory bodies have vowed more regulation and licensing will be easier going forward. Banks are not defenceless. The most potent defence for banks comes from their capital strength, intelligence learnt from handling growth/complexity, and the availability of technology and licenses (leading to network/reach) to operate. In fact, banks that understand the current market changes and adopt a suitable mix of solutions will be able to ride out change.

Strategies for a Brighter Banking Future

The following are some of the strategic solution paths that could aid banks in adapting to the evolving landscape of retail banking:

Gateway/network and not destination

Banks are denominators of financial activity and have developed a sense of destination/finality into their existence and growth. This has translated into a custody of transactions mindset. With competition for the customer rising, a ‘gateway/network’ approach will help regain lost ground. A gateway helps users realise more value than if they are acting on their own. Banks will need to deliver value propositions that ease customers’ pain points directly or indirectly. Initiatives such as e-vaults (identity assurance for City administration) is a preliminary initiative in this direction. Value propositions can be ‘adjacent’ as well, but should be beyond traditional forward integration approaches. One approach would be to align demographics to communities when attempting to revise market definition/segmentation.

Transition to core-competence

Availability of ‘first wave’ technology over the past couple of decades has provided the impetus for handling growth and differentiation, and banks promptly utilised the possibilities. Technology capabilities were differentiators and banks strengthened technology investments and organisations.

As profit pools move and institutional voids evaporate, investments in first wave technology can now be viewed as ‘backward integration’, with all its limitations to absorb investment while providing limited continued differentiation. While technology will remain a differentiator, banks still need to move to next level of backward integration from ‘transaction technology’ to ‘customer engagement technology’, subject to evolving regulation. This transition is evident in an adjacent service industry. A global chain of hotels⁵ now only possesses less than 1% of hotels under its direct management and the remainder are run and managed under the franchise model. The chain has only retained the branding and reservations processes for itself, which are the key differentiating competencies or customer engagement technology. While it is too early to fully replicate this model in a banking context, banks are pursuing three main paths that have service as a common denominator:

1. Managed services (business operations & IT).
2. Service oriented architecture (IT).
3. Software-as-a-service (SaaS) (IT).

These three services, considered together, have a dramatic impact on the operating and delivery model of banks. They make the transition to the first level of backward integration possible.

Innovation programs to aid transition

Banks are implementing various change and transformation programmes under the umbrella of ‘innovation’. Two models are mainly being attempted; internal and external. Internal programmes, as the name suggests, are aimed at transformation of as-is technology, processes and people to deliver the desired levels of service. Also, this model typically is aimed at serving as-is customer groups. The external model aims to address people, which may include customers at an interest level based on communities e.g. social cause, sports etc. While following either of this models will result in an ‘old bank / new bank’ dichotomy, a blended approach appears to provide the best option to aid transition.

Re-thinking ‘standard’ practices

Most practices, including those related to the business model, are taken as given. Cross subsidies and pay-off models in pricing are considered standard. Canned services are standard in product definitions and offerings. Instances of re-thinking are evident in different but related finance models. In micro-finance, a model of charging depositors for safekeeping of money known as ‘Pay to save’⁶ is radically different from the typical practice of paying interest to depositors. Of course, revenue and profit models will depend on adopting the ‘two-sided’ business model and compliance to pricing regulatory directives.

Transpose from supply to demand

A universal approach can sometimes be summarised as ‘one size fits all’. When the solutions suggested above are attempted in an integrated manner, the business and operating models would translate into a new definition of universal banking - ‘all sizes fit one’. It is a transition from a supply mindset to a demand mindset. Figuratively, the universal bank could look like a ‘T’: the horizontal line referring to value proposition bundles and the vertical line referring to the delivery mechanism, with limited levels of backward integration.

People

Employee handling, to enable core competence and demand thinking, will be the single most important factor after the strategy itself. Employee engagement beyond traditional job descriptions and short-term targets will be imperative. The challenge for banks is to move decision-making abilities that are currently concentrated at defined centres to the customer-facing areas of the business. A key issue in this alignment process, among other things, is to have the best staff in customer-facing roles, not hidden away in the back-office.

Integrated approach versus piecemeal approach

The scale of transition required to realise the new ‘to-be’ banking strategy will need an integrated approach across initiatives and people handling. A common framework that guides, measures and ties the stakeholders together can help lower the risks in realisation of target state.

Conclusion

The common thread across the solutions suggested in this article is that there is a need to pursue ‘direction before details’. The need to chart a new course is evident. While the picture for retail banks in the short- to medium-term is looking good, the changes on the horizon are far too significant to ensure continued comfort. A customised mix of suggested paths may help banks prepare for the evolution of the industry.

Article by Venugopal, Tata consultancy services. The article was earlier published in one of the reputed website