For Most Banks, the ‘Do It All’ Days Are Over: Here Are Their Options

In an era when national megabanks, digital banks, fintechs and big techs dominate consumer financial services, does it make sense to keep hustling just to be an also-ran in that race? Doubling down on fee-based activities, especially on the business side, may be a smarter use of time and energy. But Deloitte experts say digital transformation must still be pursued.

While most midsize banks did well over the course of the pandemic, these institutions now face an acceleration of the factors already facing them pre-Covid. To underscore the urgency for change on multiple fronts, a report from Deloitte projects that in 2021 midsize institutions will see their net interest margin, as a group, fall below 3%, compared with 3.9% as recently as 2019.

Twin Challenges:

Increasingly midsized banks must manage a dual set of changes, one operations oriented and the other strategic.

Success in the future will hinge on making a series of strategic and operational shifts on multiple fronts, according to the report. But in addition, many midsize banks will have to decide what kind of institution they can realistically succeed as. The time where midsized institutions could still be all things to all customers has just about ended, according to the firm.

Deloitte also suggests that the time of midsized banks trying to vie with national banks across the board is coming to a close.

“Midsized banks are highly dependent on interest income,” explains Val Srinivas, Research Leader, Banking & Capital Markets, in an interview with The Financial Brand. “It’s a disadvantage compared to their larger peers who have more diversified business models and more fee-based activities.” Srinivas says expanding non-interest income businesses needs to be a greater priority for most mid-sized players. At the same time, they must choose activities they can excel at, and concentrate on those, rather than trying to have a dog in every fight.

Developing and building on that expertise, according to Deloitte research, will depend not only on accentuating specialties that the institutions already have, but also picking good M&A partners as well as building strong relationships with fintech companies whose services need the customer bases that midsized banks can provide.

“The types of businesses that banks get into will at times mean extending the banking value chain, going both upstream and downstream from the services they currently provide,” says Richard Walker, Principal, Deloitte Consulting LLP, during the same interview. “Instead of just providing business credit, for example, they will need to provide advisory services on how to best deploy capital and treasury services to help manage use of credit and more.”

The consultants discussed strategies for midsize banks — which Deloitte delineates as between $10 billion and $100 billion in assets. However, smaller institutions can also consider similar strategies in many cases. Walker and Srinivas drew on two Deloitte resources, “The Future of Midsize Banks: A New Playbook for Supercharging Growth,” and “CIO Tech Spend Survey: Moving into the Digital Future” The latter is a joint project between the firm and the Mid-Size Bank Coalition of America (MBCA).

Many Midsize Institutions See the Need for Change

In some quarters midsize institutions have been criticized for not moving fast enough, or at all, to pick up their pace of evolution. Pundits fault them for not revamping their technology quickly enough, for not seeing the threat of digital competitors, even for having older consumer bases compared to national banks and other players.

Countering this viewpoint, Walker says too much has been made of this. While there are issues, there’s more dynamism among these institutions than some believe. He points out that about half of the leading Paycheck Protection Program lenders were regional banks. “They saw an opportunity to strengthen brand and community impact by participating,” says Walker.

“Arguably, if you were to create a brand new banking environment from scratch, it would look nothing like what we have today,” Walker notes. But history, not logic, brought about what we have today.

One factor working against many midsize banks, according to the research, is lack of tech talent and significant “tech debt” due to legacy systems. Replacing the latter cold turkey is costly and disruptive and is undermined by the fact that a major portion of the banks’ tech budgets go to running the existing systems.

Walker says the joint survey with MBCA demonstrates that the need for such changes is not lost on midsize institutions responding to the survey. For example:

  • Fintech partnerships: 90% are interested in developing them to fast-track new technologies.
  • Cloud computing: 64% of midsize institutions responding have committed to a strategy to help increase agility and cost effectiveness.
  • New IT staffing philosophy: 59% expect IT staff will be working remotely, which can both expand the pool for IT talent and fill gaps in current recruitment bases.
  • Digital platforms: 29% have adopted open application programming interfaces, both to improve access to existing tech and to enable access to new platforms.
  • Robotics: 17 bots have been deployed, on average, among the responding banks.

An Expensive Tech Arms Race:

Midsized banks’ pockets aren’t deep enough to keep up across the board. The total IT budget for all institutions belonging to the Mid-Size Bank Coalition of America equals the average IT budget for a large national bank.

Increasingly midsize institutions will need to re-think how they obtain IT services. 72% of the joint study sample own at least one data center, utilizing “home-grown” IT. This approach may not last for the long run.

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Recommendations for How Midsize Institutions Can Improve Their Tech Side

In the firm’s playbook report, Deloitte makes eight recommendations:

  • Digitize the institution front to back.
  • Ace the digital customer experience.
  • Encourage a digital-first culture.
  • Forge dynamic alliances.
  • Modernize core systems with modular solutions.
  • Expand fee-based business models.
  • Rationalize and redesign the brank footprint.
  • Use mergers and acquisitions to add more profit muscle.

M&A’s Role for Midsize Banking Sector

Partnering with fintechs may be the way to solve part of the tech challenge. In fact, mergers with fintechs could be part of the future picture. The deal Lending Club made, buying Radius Bank to become LendingClub Bank, is an example.

“The fintechs already bring the technology,” says Srinivas. “So they’re looking for distribution. They’re looking for license. Maybe they’re looking for brand name.”

That said, Walker suspects most midsize bank-fintech deals will consist of the bank buying the fintech, rather than vice-versa.

“If fintechs want a bank charter, a midsize bank target would involve too much complexity and too big a premium, just to get the charter. They’d go after smaller banks for that.”

While midsize banks will acquire some fintechs, Walker predicts that most of the M&A activity among the midsize banks will involve rollups, “banks buying other banks for complementary business lines, either with geographic expansion or within a consistent geographic footprint.” Walker adds that a key opportunity will be acquisitions that grow fee-based business lines. How this strategy will play out will depend, in part, on the Biden administration‘s evolving policy on bank mergers.

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Business Banking May be Midsize Banking’s Strongest Shot

Both consultants believe that for midsized banks there will be much more opportunity to grow and to innovate on the business side of banking. Walker points out that even under current conditions those midsized institutions that focus harder on commercial banking tend to have strong ROEs.

This emphasizes the need to pick and concentrate on specialties.

“The large national banks have one of everything,” says Walker. “They are universal in their model but they frequently differentiate very little.”

This makes them multiline operations. By contrast, midsize institutions that concentrate are more like monoline financial companies.

“For decades, monolines have consistently outperformed multiline financial service companies. So midsize banks could get the benefit of monoline performance with the option of adding selective businesses to the mix to produce outstanding returns.”

— Richard Walker, Deloitte

One such business is banking as a service, which has typically been the province of smaller institutions. The firm’s own report suggests this could be a two-way street for some midsize institutions, with intriguing possibilities

“Given their lower revenue growth, laggards could consider experimenting with this model to generate fee income from the partners accessing their BaaS platform,” the report states. “In addition to building revenue, this model could also allow them to offer greater personalization of their products and services and enable their partners to roll out new solutions that are both timely and more cost-effective.”

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