Retail banking strategies for the technological revolution
Hardly a day passes without an alarmist article in the media about the future of banks, predicting their disappearance in the short or medium term. As well as articles that portray them as another steel industry, another Kodak, unable to deal with a technological revolution that has seen new practices and competition emerge.
Questioning the sustainability of the traditional banking model is nothing new. As Bill Gates said back in 1994, “banking is necessary, but banks are not.” Yet banks still exist.
The question of the future of traditional banks is clearly a legitimate one, because they are also subject to the major changes that are currently being experienced, in particular technological and demographic changes. Moreover, macro-financial conditions are currently exerting strong downward pressure on their profitability, because the interest rate structure has flattened towards zero.
Digital is a technological revolution, but also as a result, a revolution in customer behaviour, including in customers’ dealings with banks. Even though this revolution affects all customers, it has had a much bigger impact on households than on companies, which went paperless in their relations and communications with banks a long time ago. Relations between companies and banks, which are focused on the link between the account manager and the company manager and on the added value of advice, do not see great changes. We will therefore deliberately concentrate more on changes that particularly affect retail banking.
The number of customers at local branches has therefore fallen significantly, which could suggest branches and advisers are no longer needed. The only solution would therefore be a defensive retreat, a reduction in geographical coverage.
To consider the issue of the future of retail banks properly against this backdrop of major, rapid change, we must go back to key questions, questions that have no simple answers. The right formula is neither fatalism nor denying reality. Retail banks do have considerable strengths to showcase, with the potential to come out well from this technological revolution, but only through a more proactive strategy. They must not be backward-looking. Not changing and not responding to new practices would indeed be a losing strategy.
But to start with, we need to clearly differentiate between digital banking and the question of interest rates. We are seeing a convergence between these two phenomena that is affecting traditional banking activity, but they are in fact entirely separate issues. On the one hand, banks are facing an interest-rate curve that has become flat and near zero, which is weighing on the profitability of retail banks. On the other hand, digital banking has shaken up customer behaviour, experience and the organisation of work in banks.
This makes it particularly interesting to look at the innovative models brought about by the technological revolution: the potential move towards an almost unique model of online banking, the so-called ‘neobank’, the emergence of new players, particularly start-ups like fintech but also the arrival of GAFA in the banking sector, which may eventually compete with commercial banks in profitable segments of their value chain. These models are different, even if the responses of traditional banks may at times tend to converge. To avoid disintermediation, banks should take a proactive view of their business and always offer their customers greater added value, in a strengthened comprehensive relationship model. This will sometimes involve partnerships with these new players in the banking sector.
1) Is the technological revolution an opportunity or danger for traditional banks?
The technological revolution is a major environmental factor for banks. Drawing massively on technologies, new players in the banking sector – known as neobanks – are flourishing. France has recently seen the emergence of its 19th mobile bank, with La Poste launching its online bank.
There are various types of digital innovation that may be applied to the banking field: robotisation, digitalisation of processes, big data, artificial intelligence, payments and many others. Clearly, these innovations are leading to major changes in the behaviour of customers, who are becoming increasingly demanding on two levels. On the one hand, the need for practicality, ease of use and simplicity has grown considerably. On the other hand, customers have become increasing demanding about the level of added value in the advice they receive, and are much better informed as a result of the Internet. These major changes may be perceived as a danger for traditional banks, but in fact they primarily create a number of opportunities that banks should analyse and use to forge new banking strategies.
To analyse the strengths of and opportunities for traditional banks faced with the emergence of these new models and players, we need to return to the very essence of what a retail bank is, differentiating between constant and contextual factors, which change in step with current technology and customers’ use thereof.
There are two main retail banking fields, although the model may vary between countries depending on their own habits and customs: transactional ‘everyday’ banking, and relationship or advisory banking, for ‘life projects’. These are two distinct types of banking demand, although they may naturally overlap and hinge on one another. Day-to-day banking involves current transactions: obtaining chequebooks, making transfers, depositing or withdrawing cash, etc. The development of the Internet, smartphones and machines means that a transactional bank almost no longer needs a network at all to carry out these day-to-day operations. There has been a marked fall in visits to local branches for these banking transactions, leading to a drastic fall in the need for ‘counter staff’. For its part, the relationship bank deals with life projects and advisory work, but also provides support in the difficult times experienced at some point by us all. It sees the deepest relationship between individuals and their bank, far beyond managing means of payment. This bank deals with customers over the long term. This long-term relationship is linked to the fact that it deals with their life projects, in terms of both preparation and progress. These projects may be major: funding a degree, a first job, buying a property, planning retirement, etc. They may also lead to smaller life projects, such as planning holidays or buying a car. A long and strong relationship of mutual trust forms between the customer and bank. The universe of needs that relationship banking meets is therefore long-lasting, just as the products it offers, such as loans, savings or insurance, are long-term products.
The fall in the use of retail ‘bank counters’ can thus be an opportunity for banks to better meet their customers’ new requirements.
People are therefore travelling less and less for day-to-day banking. But is their appetite for relationship banking any smaller? For about a decade, the methods used to interact with banking networks have changed: physical presence, telephone, email, video, web chats among others. However, this does not mean that advisers are no longer needed, because there has been no drop-off in banking demand for life projects – quite the opposite. The number of appointments has increased, whether in the form of telephone or physical meetings. But although bank advisers are still needed as much, if not more than ever, some thought needs to be given to their positioning. Customers want to see their adviser in person, at regular intervals, frequently or occasionally, either to talk about key issues or simply for reassurance. So having local branches has some merit. Given that local branches already exist, why take away this advantage? They also offer kilometres of advertising windows that are the envy of many online banks. Therefore, with relationship banking, the types of interaction are changing and complementing one another, rather than replacing each another. Ultimately, they are essentially based on the relationship with the customer adviser.
With the Internet, customers are also increasingly demanding about the quality of the advice, because they are skilled at surfing the web to find information, make comparisons and change if need be. They expect their adviser to be even better, and more skilled, responsive and proactive than before.
In reality, the fall in the use of ‘bank counters’ is an opportunity for banks, and this is no paradox. First, digital banking has replaced repetitive tasks at the ‘counter’, which are not charged for. More business time can therefore be allocated to customers, who are more demanding, by developing counter staff into customer advisers. And also by digitising the repetitive tasks carried out by sales staff. Advisers’ productive business time can therefore be increased, which boosts productivity. Banks’ GDP is therefore enhanced by their ability to serve and advise customers better, equip them better and meet their needs better. Digital banking also greatly improves the customer experience, because some transactions are easier to process without needing to travel or wait. Customer satisfaction is therefore increased as banking practicality increases. Finally, digital banking is also an opportunity because it helps improve the relationship model itself. Big data and artificial intelligence, which are gradually being integrated, allow customers and their needs to be better understood. This means the success rate of sales activity can be improved. And customers are much more satisfied, because they are only now called about issues that involve their real needs.
In addition, the digital revolution and changes in customer behaviour do not undermine their need for advice, therefore underlining the importance of the adviser. On the contrary, it boosts advisers’ credentials even further. The adviser is no longer there just to give basic explanations, but to add expertise that customers are unable to find for themselves online. This means understanding their plans, whether business or personal, and an ability to combine offers to propose intelligent and appropriate solutions that add value.
Increasing the ease of accessing banking services and the quality of advice are two fundamental keys to success, enabled by massive investment in digital and training. Therefore, if traditional banks manage to become ever more simple and user-friendly for customers and, at the same time, more proactive and able to add ever greater value, they will differentiate themselves from low-cost banks through high-quality advice. Because even though they may sometimes be completely legitimate, banks that are purely digital do not have advisers, or they would not be low cost. In reality, French customers require both: highly practical day-to-day banking and a qualified adviser who can add value. They will not therefore try to separate transactional and advisory banking, or even to get by with a single day-to-day low-cost bank – unless their usual bank does not excel in the two fields. The branch network therefore has a definite comparative advantage, but on subject to two conditions.
Moreover, it should be noted that online banking is not profitable. To acquire new customers, it has to incur major customer acquisition costs, due to the need to do much more marketing than other banks, given that it has no branches or windows. Similarly, online banks have to offer more welcome gifts and free offers. Additionally, by nature, low-cost online banking must essentially focus on transactional banking. Monetising this type of model and capitalising on customers therefore becomes relatively difficult, unless you expand the offer and appoint advisers, which we are starting to see. But where that happens, the offer is no longer low cost because, by definition, low-cost offers are unable to provide customers with access to a qualified adviser. Some online banks may offer access to advisers, but customers are charged specifically for this. Similarly, if a customer has personal difficulties to manage, their status often changes and they are no longer able to benefit from a low-cost offer.
While automation of day-to-day banking services may help free up business time and enable a greater focus on customer advisory work, this raises the question of whether the advice itself can be digitised. In fact, you might well think that with big data and artificial intelligence and the automation of ‘push’ SMS and emails to customers, human advisers would become redundant. The customer might even receive proposals that are more relevant than those of an adviser.
Although we cannot predict the situation in ten or twenty years with any degree of certainty, it is hard to imagine advice being provided without human intervention. Machines can certainly beat humans in many fields, but so far the combination of machines and humans are better than machines alone. The first point to consider is that trust is key to banking relationships, and for one simple reason: customers are entrusting banks with their money and the shared realisation of their life projects, which brings banks into a highly personal sphere involving the security of people and their families. Having a relationship with a person as opposed to a robot, even an ‘intelligent’ one, currently helps create much more trust. Even young people, who are very used to digital banking, want to have access to qualified advisers, even if they visit local branches to a lesser extent.
Moreover, cognitive sciences now show that decision-making ability is based on the ability to conceptualise and analyse, but also on emotional and intuitive intelligence. To make a decision, you need to be able to anticipate the consequences of the decision. And it is the combination of the ability to conceptualise and intuitive intelligence that enables this. However, artificial intelligence has neither the ability to conceptualise nor intuition. Artificial intelligence involves a series of algorithms and regressions that lead to correlations between billions of items of data. Of course, this will help human beings, whose brains cannot replicate the results of the algorithms, to make better decisions by providing useful correlations. But this cannot replace human beings because, in some ways, you need to go into the intimate sphere of things and people, with empathy, to really understand them, anticipate future movements and reactions and thereby take the right decisions. Studies show cases of injured people who have lost the use of part of the brain dedicated to emotional intelligence. These people are totally incapable of making decisions, even though their ability for reasoning and analysis of positive and negative aspects of every possible decision remains intact. Human relationships can therefore be a powerful factor supporting decision-making. And even more so in delicate areas such as the very personal ones regarding money, and therefore your own and your family’s financial security. In the same way, econometric studies show that it is more effective to study ‘in person’ with a teacher than via a MOOC (Massive Open Online Course: an online training course open to all). Although MOOCs are a great way of spreading knowledge and have the ability to reach many more students, teachers physically present in a classroom still have a future.
2) The technological revolution has created many new players in the banking market, such as fintech or the GAFA companies. Can they compete with commercial banks in profitable segments of their business?
Another issue is the potential loss of profitable market segments for banks, due to the arrival of external players such as fintech or the GAFA companies. In fact, Fintech companies are developing more and more services involving certification, authentication, biometrics, budget management, electronic safes, aggregators, payments, blockchain, etc. The question is therefore: are banks running the risk of being disintermediated in profitable sections of their value chain?
On this topic, it is important to differentiate between two activities that are not governed by the same regulations and operating models: payments, for which the regulatory operating framework has been opened up, allowing an explosion in the number of players in recent years, and other banking activities (loans, savings, insurance), which are subject to different regulations. Indeed, in the first case, regulations introduced a new payment institution status, governed by the second Payment Services Directive (DSP2) in force across the European Union since the start of 2018, and also new rules on access to customers’ payment data. This directive aims to support innovation and competition by requiring banks to make their customers’ account data available to payment service providers, and to give these providers the ability to initiate payments. This represents a major upheaval for banks.
The model of external aggregators who are now able to access data, offer transfers and therefore initiate payments is a legitimate worry for traditional banks. For example, these aggregators have the ability to offer budget management services. It is then natural to wonder what would stop them tomorrow from analysing customer data to offer customers the best banking products and services. Such players could in particular develop consumer lending by using brokers and offering the cheapest – but not necessarily the most appropriate – which may not be the customer’s traditional bank.
The partial disintermediation of banks is entirely possible, but the associated dangers are reduced by a number of factors. The first involves the potential to access the rest of the customer data, which is crucial to developing these new services in a relevant way. However, these payment service providers will not have access to customer data beyond just the payment data that banks must now make available via APIs, that is, current account data. Second, fintech without customer files will therefore struggle to acquire market share in some segments currently run by banks. There are then two options for these fintech companies: partnerships with specific banks, through the former buying the latter or a more or less exclusive partnership, or the creation of collaborative platforms with a number of other banks in order to offer services that may be shared. In this scenario, the fintech companies break into and integrate into the banks’ value chain, but without disrupting their model. When cooperation between these two models goes well, despite the difficulties of reconciling two very different worlds, they enable banks to extend their services to add depth to their relationship with their customers. Therefore, either the banks have the required IT investment capability and can enrich their services themselves, or they try to subcontract through these fintech companies. The response is often a mix of these two options. Whereas to date banks were used to doing things themselves in an integrated manner, banking will, in the future, very probably also involve assembly work. There is nothing wrong with assembly, if this enables banks to expand their relationship base and their income.
The second scenario, which can obviously cause problems for banks, is where these new players are able to access customer databases. This is the case for the GAFA companies which, unlike fintech, can draw on immensely rich data and a very large base of customers that are extremely dependent on using their services. In this scenario, a differentiating point for banks will be the trust their customers place in them – which will need to be maintained. There is now growing awareness among customers and citizens of the dangers of letting their data be used in an uncontrolled manner. The trend is accelerating, and particularly noticeable among young people. This increased awareness acts as a brake on intrusion. Furthermore, the EU General Data Protection Regulation (GDPR), in force since May 2018, emphasises that data belongs to customers and any use by a third party must be approved by them. These regulations apply not only to banks, but also to all other users of data such as the GAFA companies. Banks must remain this trusted third party that handles people’s highly personal data. As the trust customers place in their bank is obviously also based on confidentiality, it is crucial that traditional banks do not resell the data they obtain from their customers to commercial companies who use that data to send targeted advertising to these customers. Particularly as they are already saturated with all sorts of sales requests that, to varying degrees, are intrusive. In fact, every day, people are pressured by unknown people or organisations in the form of ‘push’ emails or text messages. Banks must keep this advantage over the GAFA companies, whose model, in contrast, involves letting commercial companies target their users for a fee, thanks to intensive analysis of user data.
To develop a banking business, the GAFA companies would also need to adhere to a growing number of regulations. Ever stricter, these aim to ensure banking institutions’ financial solidity, but also to combat fraud, money laundering and terrorist financing. Banks must therefore comply with very high own funds requirements, with capital adequacy ratios higher than ever. In the same way, the regulatory burden for compliance and reporting is significant and banks have to make extremely large investments to meet the requirements. These points may seem the opposite of the apparently free of charge, unconstrained universe in which the GAFA companies generally operate. If a fintech or GAFA company wanted to open a sight or savings account, as well as obtaining a bank licence, it would need to be able to verify the source of funds for each transaction. The investment needed to comply with regulatory requirements would therefore not fit with the free service model, and customers, used to everything being free and immediate, could be even more reluctant to leave their bank for relationship banking transactions with these entities. This is in addition to the trust issues discussed above. For this reason, the experience of creating Libra, Facebook’s global electronic currency, and the reaction of central banks to the currency will be particularly interesting to analyse.
There again, banks’ ability to save the very essence of their role – while changing, expanding and improving their comprehensive relationship model centred on local branches and trust – will be key.
3) Will digital technology affect the role of the distribution sector?
Some believe that retail distributors are doomed to disappear or at least are in great danger with the advent of digital technology, because consumers can buy directly from the producer and/or because a significant share of value could be lost to comparison platforms. Banks could also be threatened, because they partly distribute products, products that they may or may not produce. As outlined above, if banks do not change radically, this will happen. But if they manage to change and challenge themselves, distributors will emerge strengthened compared with producers.
Historically, after the end of the Second World War, the producer designed products, granted selected distributors the right to distribute these products, and the consumer had no other choice but to buy what the distributor offered for sale. This chain went, in terms of power, from the producer to the consumer via the distributor. This has remained true overall, even with the development of marketing that segments the client base more and differentiates between the goods offered.
The Internet has reversed this hierarchy. Consumers are gradually gaining power because they can continually compare and analyse the quality of what they are sold. A simple click enables you to see what competitors are offering, compare products, find information and change, if need be. There are the equivalent of rating agencies too, such as TripAdvisor for example, where customers rate products and services using a star system. This also explains the current development of comparison tools for loans, insurance, etc., as mentioned above, which add value by facilitating price comparisons.
The hierarchical chain has therefore changed. Consumers have gained power, exercising much greater control over their own consumption. The term consomm’acteur (consumer-player) shows this reversal of the power dynamics.
Unless distributors do their jobs even better, by challenging themselves, they could disappear. This is what happened or almost happened to Virgin, Darty, FNAC, Conforama and many others worldwide. Some distributors, including hypermarkets, are really struggling today.
So what ability do banks have in their role as distributors to stay alive, and even to capture value to meet consumers’ needs? Here again, it is the value added by advisory work that will enable banks to avoid disintermediation. They need to rethink their distribution models and not just offer a product because it is the only one they are familiar with or have to sell, but find solutions tailored to customers’ issues. The distributor’s strength lies not just in having the product at the right time. With the Internet, we all have much better access to products at the right time. It lies in offering advice that shows their ability to offer customers intelligent solutions that are tailored to their needs, by comparing products with them and helping them choose the best. Traditional banks must therefore raise their game in service, the added value they bring as a distributor, to survive and avoid disappearing partly or completely.
This approach that aims to find the best products and solutions adapted to each customer’s needs helps the customer save significant time and effort, and therefore makes the bank indispensable through its deep understanding of its customers and their specific needs. Yet it is distributors as well as commercial banks that hold very rich data on their customers and can use this data to the maximum benefit of every customer. And, as we have seen, this represents a considerable advantage over producers or brokers. This also reinforces the importance referred to above of digital investment and training to strengthen the value added by advisory work and offers made to customers, according to their needs. Finally, this further underlines the essential role of the comprehensive local relationship model developed by banks.
The decisive factor in traditional banks withstanding the emergence of new models and players in the banking market will therefore be their ability to sustain and improve their overall relationship model with their customers, by improving the customer experience, freeing up business time for their advisers and increasing added value, such as by offering and including new services in line with the range of needs they are dealing with.
If banks invest generously in training and digital technology, and make vital structural changes in parallel, there is no reason to think that the network banking model will disappear. Like all enduring models, it does not need to be chemically pure, but rather needs to closely combine human and digital aspects. Today, in all fields of distribution, pure digital models are struggling and pure physical distribution models are dying. The future is therefore a good mix of the physical and digital models, and the best answers lie in understanding the real essence of banking demand and the key economic role of these banks. In the banking field, as elsewhere, the technological revolution has provided great competitive stimulus, which is essential in a highly regulated sector that is not conducive to rapid change. In addition to this stimulus effect, which improves the banking relationship model to the benefit of customers, the technological revolution could also trigger a fall in profitability due to new entrants exerting pressure on prices. To counter this threat and boost revenue, other fields in coherent areas of need could be developed in parallel to the recurring business of commercial banks.
It is also worth reiterating that only banks can respond to the need to transform short-term savings horizons to long-term credit horizons by taking on credit, interest rate and liquidity risk so that the economic actors, whether borrowers or lenders, do not have to bear them. This transformation function is the basis of banks’ economic and social role. Neither the financial markets nor fintech of any kind can replace them in this.
By taking all these elements into account, it may be possible for banks to come out of this well, provided that the necessary changes are accurately assessed and a deliberately proactive strategy is adopted.
The very adverse structure of interest rates is significantly damaging or will significantly damage the profitability of banks. Yet it does not change the need and demand for the type of banking described above, or the unwavering nature of their economic and social role.
Equally, the action that needs to be taken as a result of this unprecedented macrofinancial situation should not lead to the banking offer being curtailed, but should accelerate the changes explained in this article.