Financial Institutions Must Rethink Digital Delivery in the Next Decade

Should a financial institution attempt to transform their current organization into a more agile, responsive institution with a completely new digital foundation, or should banks and credit unions consider building an entirely new entity outside the parent company? Either option will require a new perspective on the role of digital delivery within your existing branch-based model.

The ability to compete in the future will require new systems, new processes and a new culture. Banks and credit unions may determine that transforming the entire existing organization to ‘become digital’ is the way to proceed. Another option is to build a separate organization that would be a network of only a few branches or a completely branch-less offering … separate from the legacy organization.

Even if a bank or credit union decides to stay the course, the future will require differentiation defined by customer experience and innovative offerings similar to what are being provided by fintech and big tech organizations. The focus can’t be on cost savings alone, since digital options have focused on improving the consumer experience and delivering solutions proactively and in real time.

A new successor bank structure should make it far more efficient to acquire new customers, leveraging new consumer insights and modern digital technologies. This will result in an improvement in return on marketing investment, with stronger loyalty based on experience and improved digital delivery post-sale.

According to Novantas, “A successor-bank transformation is necessary regardless of the economic environment. When the economy is good, banks have more time to make the transition. The current landscape of falling rates, the threat of recession and customer adoption of digital banking, are forcing banks to address the issue now.”

To get a perspective on the need to disrupt current distribution paradigms and the options available to institutions regarding whether to build a separate digital banking entity or not, I interviewed Kevin Travis, EVP of Novantas’ financial services consultancy for the Banking Transformed podcast. Kevin discusses distribution alternatives for the financial services industry and the cost of inaction by the industry.

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What economic issues are prompting a review of current distribution models in banking?

Travis: If you look at our research going back almost 15 years, we’ve seen a couple of inflection points. One was when the majority of customers coming into the bank were digitally enabled, which was around 2006 and 2007. We’re now at another inflection point in terms of consumers, where the network scale and network density, which used to be a competitive advantage for most banks, is becoming a bit of an albatross.

The challenge is that no one is going to let financial institutions make big losses to fund transformation, but they are competing against private equity funded Neobanks and other fintech players who actually don’t have to make money in the short run. This is pushing financial institutions to make some pretty radical decisions about how they think about their highest cost infrastructure … which is their distribution networks.

Haven’t consumer expectations around delivery also changed?

Travis: Absolutely. If you think about branch convenience or what makes banks convenient to consumers, branches used to be the leading driver and now they’re one of the smallest drivers of convenience in banking. And consumers now have more information about their options. They have more transparency about pricing and they get more advice from social networks and other places.

Consumers also understand the trade-off between the fees they pay and the services they get. A lot of younger consumers in particular, but even older consumers in many segments as well, are saying, ‘I don’t quite understand what I’m paying for. If I can get the same basic services in a cheaper model that’s more convenient and more efficient through a digital-only player, I’m now willing to consider that.’ I think that shift in the willingness to consider digital options as an alternative is something that’s a big, big change in the last two to three years.

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Is a banking transformation around distribution required?

Travis: Structural transformation is going to be needed whether margins improve or whether margins decline. We’re dealing with essentially a secular change in the industry where the relevance of the core of the bank depends entirely on your ability to get customers to want to do business with you. And I think that no matter what happens, the way in which consumers are going to make decisions and how they’re going to choose their banks is changing dramatically.

What is a ‘successor bank’ strategy?

Travis: I see two ways a ‘successor bank’ strategy could play out. I think one model is building a totally separate entity, with separate technology stack, staff, call center and delivery strategy. The other model is a group of folks who are siphoned off from the regular day-to-day operations, but are still fundamentally operating inside the existing franchise.

There are different trade offs for either one. I think the benefit of the separate organization is you get to, in a way, build a challenger bank the same way as if you were running a startup. You start with a clean sheet of paper and ask yourself questions about what the business should look like if it were built today versus at the early part of the 20th century.

The benefit of using an in-house team is that you get some of the economies of scale around the brand, around some of the existing technology, etc. There’s a trade-off with either model, but I see more people thinking about doing it as a separate entity these days.

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What’s the difference between a build, buy, rent or share strategy?

Travis: The ‘build’ option means you build it in house using your own technology resources. You spend money and capital to build the infrastructure internally. ‘Buy’ means you go to an outsource provider and you buy the new infrastructure straight off the shelf. When we discuss the ‘rent’ option, an organization essentially uses somebody else’s infrastructure, and they white label it for you. And finally, the ‘share’ option is where organizations pool their infrastructure into a new operating entity, building a scalable technology stack. In this case, each organization shares a back office but has their own front end.

The upside of building it yourself is that you can actually put proprietary features and functions into it. One of the big challenges is that the digital environment is continuously changing. If you create a killer app, it’s great for six months and then it gets superseded. By building the infrastructure yourself, you have to stay ahead of that curve.

I think buying the infrastructure is going to be more and more of the model for the largest regional banks in the U.S. and for the largest banks. I think when you buy the infrastructure, you have a fairly similar experience from the core, but it allows you not worry about the nuts and bolts of operating the back office as much. This is a great management benefit since you can concentrate on the customer franchise.

I think renting it and sharing is something that smaller banks are going to have to think about. And it may be the outsource organizations themselves that help put some of these coalitions together. I almost think of it as the ‘airline alliance’ model of operations. The benefit of this last option would be that costs are shared, and the pooling resources in a cooperative way may make sense for a lot of the smaller banks in the country.

What are the challenges of building a successor bank?

Travis: The first challenge is always going to be cultural. Banks operate the way they have operated for decades and most have succeeded because of their culture. Some banks have also failed because of their culture. But most banks have a fairly successful and deeply embedded culture, so change of this magnitude can be a bit challenging.

If 80% of your staff work in the core bank, and you begin to message that the core bank is the legacy (old) platform, how are you going to retain the best staff to run the legacy organization? Another challenge is sustaining the momentum for investment. If you announce a $100 million or $200 million a year investment plan targeting new technology, can you maintain that focus on the challenger, or does the challenger become a little bit of a hobby?

Do the largest banks have an advantage with digital distribution?

Travis: First of all, we need to realize that the very largest banks have a fundamentally different role in the banking system than many of the super regionals and the regionals. The biggest banks can afford to run three, four or five different value propositions around distribution, whereas most banks can barely afford to run one or two. The largest banks can afford to spend $1 billion on branch transformation in a year, which far outstrips any budget that anybody else can afford. In other words, big national banks have a lot of built-in advantages.

Sometimes organizations will say, “Chase is doing X, so I should be doing X.” I say to them, the reason Chase does what Chase does is because they get value out of their decisions and they have a huge ubiquitous brand awareness. You’re not going to be able to build enough technology. You’re not going to be able to build enough branches. You’re not going to be able to spend enough on marketing.

The reason building an alternative distribution strategy matters is because you need a plan B that does not require you to compete scale for scale with the biggest national players. We need to think about what non-traditional, out-of-footprint challenger models are doing and find elements that we can adopt that will help us compete nationally … and not cost us $1 billion a year.

What do most financial institutions need to focus on in 2020 and beyond?

Travis: The most important thing of all of them is the need to know who it is you are trying to bank. The biggest shift for most banks is that the utility play of banking is dying. The model of being ‘all things to all people’, where you build a branch and whoever happens to live in the area will bank with them no longer works. As things become digital, knowing who you want to serve, and then determining what the right way to serve them is the right answer for your bank.

There are different models if you want to make a challenger bank play because you want to serve young, affluent customers who don’t care about branches anymore versus if you’re a community bank with a really strong local franchise. If you want to stay local, maybe spending all your money on digital is a bad idea … because your most important customers are all near you in your local community footprint and you need to focus on them.

Banks and credit unions need to know who their customers are and what are they trying to do for those customers. Then, based on that, they can then make a whole series of decisions around what sort of strategy makes the most sense to them.

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