Retail banking: Platforms are the future

How is retail banking changing?

After a period of modest expansion in 2018, the outlook on retail banks’ margins and profits dampened in 2019 due to a reversal in the interest rate cycle in the United States and even lower/more negative rates in Europe and Japan.

Despite the pressure from macro forces, US retail banking market indicators are positive: Average NIM as of Q2 2019 reached 3.39 percent; deposits grew at 5 percent year over year; mortgage originations were up; consumer debt reached a record level of US$4 trillion (primarily driven, however, by a sharp and worrying rise in student loans); and the efficiency ratio and asset quality remained generally good. But the number of banks and branches continued to shrink. Despite the competition from fintechs, US bank consumers’ trust in and satisfaction with their banks as custodians of their money and financial data remained generally high.

In Europe, the persistent reality of negative rates – expected to last for several more years – has pushed down NIMs, with lending margins in Germany, for instance, declining since late 2009. The ECB’s September rate decrease has only intensified the pressure. Lending volume, however, has seen steady growth.

Banks in many parts of Asia, on the other hand, have increased their margins, with NIMs reaching 2 percent. China, in particular, has continued to see strong consumer lending growth. However, in Japan, despite near-zero/negative rates, loan growth has been tepid, and margins have been suppressed.

Regardless of business fundamentals, banking consumers around the world want the same thing: superior and consistent customer experience in branches, online, or via a mobile app. But delivering on this expectation is still challenging for many banks, despite their recent digitisation efforts.

Digital channels are increasingly driving growth in deposits and consumer lending, as evidenced by Goldman Sachs’ Marcus retail banking arm or N26, a German mobile bank. Unsurprisingly, digital lending is also where nonbanks are stealing share from incumbents. In the US mortgage and personal loan markets, nonbank players have captured a large market share already. For instance, Quicken Loans is now the largest mortgage originator in the United States.

Meanwhile, fintechs in Asia are becoming dominant players in retail banking. In Europe, fintechs are also making strides.

Some of these fintechs are aiming to expand globally. However, the business models of the new digital banks may be challenged in a low interest rate environment because of lack of scale and high rates for deposits.

And open banking, the sharing of customer data between banks and other external parties upon a customer’s request, has taken root. While still in the early stages of its evolution, it is most evident in Australia, the United Kingdom, and other countries in the European Union. Australia has even applied an expansive set of rules on consumer data rights and data-sharing to other industries as well. To date, there are no signs of new open banking regulations being developed in the United States, but banks are starting to craft their own guidelines voluntarily.

What will retail banking look like in the next decade?

By decade’s end, fewer retail banks might exist, although the degree of shrinkage could vary by region/country and will likely depend on the current level of banking capacity, competition, and market demand. As a result, the nature and degree of competition will likely change; the surviving fintechs should become mainstream players and traditional incumbents will recalibrate their strategies. Nevertheless, scale and efficiencies will be dominant factors. Also, in the next few years, banks could partner with others in the ecosystem to become de facto platforms, offering countless services that will extend beyond banking. Banks should still be best positioned to own the customer relationship, which would enable them to rethink their value proposition and serve client needs holistically, supported by data and analytics. Product innovations are expected to focus on clients’ financial well-being and closely connect lending, payments, and wealth management services. And, of course, maintaining superior customer experience and seamless connectivity to an ecosystem of other apps/application program interfaces (APIs) could be the norm. Offering advice should be a differentiating factor for banks as it becomes contextual and real time. Banks should rethink and innovate pricing models accordingly. In an open data environment, privacy concerns will also be a factor.

What can we expect in 2020?

The increasing pressure from a low-yield environment and the potential for an economic slowdown could negatively impact earnings, especially for smaller, less diversified, and consumer lending-focused banks. Banks should continue to increase their fee-based income, as well as focus on cost management, but should not lose focus on their digitisation efforts and regulatory obligations.

To enable insights-driven offerings to clients, attain a leaner cost structure, and ultimately unlock future success, core modernisation is key. Banks should digitise and transform across the entire value chain for all products. For instance, while almost every bank in the United States offers a digital mortgage application, only 7 percent manage end-to-end digital loan disbursement. This is material since traditional lenders have operating expenses that are three times those of digital lending players for their services.

Smaller banks, in particular, tied to a single core vendor in most cases, could find achieving their digital ambitions out of reach, so prioritising modernisation efforts could be key for them as well. To drive revenue growth, retail banks should focus on loan and payments products over deposit accounts. And, improving the customer experience for all products should be an overarching goal of core modernisation.

Open banking should take hold in 2020 in many regions. Open banking can amplify and accelerate banks’ digital transformation efforts and the emergence of new business models. While the potential upside is vast, the stakes are high. In the United States, given the lack of a regulatory mandate, there are still some uncertainties about the scale and pace of adoption of open banking. As such, banks should be selective in how they implement open banking practices.