Competition among banks and competitors grows fiercer than ever as the industry faces multiple challenges in acquiring new consumers, retaining existing ones, and ultimately achieving greater profitability. Banks are facing mounting pressure from various stressors — compressed margins, slower non-interest revenue growth, declining lending, and reduced overdraft fees among them — all putting pressure on banks to innovate and differentiate themselves from competition.
At the same time, the customer’s landscape is evolving, meaning banks must be nimble in how they communicate and transact with individuals across generations as expectations and preferences evolve.
However, there are strategic ways that banks can respond to these challenges, to improve profitability through any market condition.
Challenge 1: Compressed Margins and Slower Non-Interest Revenue Growth
Profitability, return on common equity and price-earnings multiples on stock prices have been down across the industry.
These trends can mainly be attributed to the continuing gap caused by heightened deposit costs and lower loan yields. To tackle these thinner margins, banks need better control over their funding management.
Solving this in part means having a better understanding of the pricing and value differences among different deposit pools — and figuring out how to make the most of them. As part of that imperative, banks should employ a granular, segment-based pricing strategy that is informed by as data that is as near-real time as possible.
Where warranted by segment and specific accounts within those segments — wealth management, for example — banks should carefully manage exception pricing. They must ensure it aligns closely to customer value and overall profitability.
Today, smaller institutions are more likely to be running a reactive playbook in the falling rate environment, driving higher costs as pricing teams manage to deposit objectives.
Modernizing pricing capabilities is the path forward in terms of dynamically managing price effectively in the future. But what’s to be done now? Smaller institutions can replicate, to some degree, this modern approach through scenario planning and product-level repricing plans for customers based on customer value and price elasticity.
Read more: How to Master Deposit Pricing with Data-Driven Personalization
Challenge 2: Falling Rate Cycles Don’t Automatically Lead to Funding Cost Relief
In the early phases of a falling rate environment there is often a disconnect between the expectations of bank investors and reality. That is because at the beginning of both a rising-rate and a declining-rate cycle, 100% betas don’t happen right away and deposit pricing takes time to catch up to the Federal Reserve’s actions.
Banks need to prioritize primary customer growth during this challenging period, as it is essential for retail profitability.
Effective analytics make it easier to sell the first product, leading to deeper customer relationships through tailored products and precision personalization. Growing primary relationships on the commercial side, in particular, requires a laser focus on cross-sell and targeted acquisition.
As rate becomes a less powerful lever in a falling rate environment, non-rate levers like the bank’s value proposition, products and marketing strategy become more important for attracting new customers.
One area that evolving rapidly is rewards. From small credit unions and fintech all the way up to the largest national banks, we’ve seen an emphasis on re-evaluating the way value is demonstrated to customers as rate becomes a less-effective driver of customer acquisition.
We’ve also seen a heightened focus on product strategy, in terms of how deposits and other everyday banking products are structured in order to incent greater depth of relationship, and ultimately bring the bank higher quality, stickier deposits.
Read more: What Makes for a ‘Sticky’ Credit Card Rewards Program?
Challenge 3: Subdued Lending in Most Segments is Driving Down Spreads
Rates are finally coming down, which means eventual relief for consumers and companies. However, major improvement to home-lending markets, commercial real estate and commercial lending, as examples, will not be felt immediately.
During times of economic uncertainty, borrowing costs remain elevated while consumer credit quality declines. Both macroeconomic cycles and encroaching competition from non-banks contribute to this sluggishness.
Because rapid growth is more difficult in this environment any revenue increases will need to be generated from optimization.
To offset the slowdown in lending, banks must improve their branch networks and customer engagement models for more effective growth. Our research has found that accounts opened face-to-face tend to have larger balances and last longer than those originated digitally or without human intervention.
Why this difference? Several factors play into the variance between physical and digital customer quality. For example, younger generations typically feel more comfortable engaging digitally — but they also tend to churn at a higher rate. (I’ll have more to say about the digital versus physical later in the article.)
However, churn does not explain all the variance.
We have also seen the number of average checking accounts per customer grow. The improvement of digital channels allows for more consumers to “try before I buy” — in this case, “buy” being transfer of their full relationship to the bank. In the meantime, however, their relationship becomes fragmented.
Improving marketing strategies also helps apply precision to target segments geographically while automating back-end processes through technology like AI, making operations more efficient.
A special note on physical acquisition: Many of the larger banking institutions are expanding branch networks in growth areas of the country. Examples include JPMorgan Chase, PNC, Bank of America, Huntington and more.
But what about institutions where such expansion isn’t a realistic strategic option? For them, there are two areas of focus.
The first focus must be on digital experience and the application and onboarding journey, where small funnel improvements can drive significant returns.
The second focus centers around product — specifically refining or innovating lending solutions to be more accessible and tailored to customer needs. This includes more self-service “customization” of existing products — giving customers the ability to tailor their own repayment schedules, for example. Another suggestion: Tie loan products design more directly to specific types of consumer financing needs.
Read more: Traditional Banks Can Adapt to a Digital-Only Model. Here’s Why They Should Consider It.
Challenge 4: Declining Overdraft and Nonsufficient Funds Fees Create a Gap to be Filled
Through a combination of regulation and market forces, revenues from overdraft and non-sufficient funds fees continue to decline. Even though other streams of noninterest revenue are seeing some growth, the decline requires further shoring up.
Direct replenishment of the lost revenues will be difficult. A critical step is defining key areas where consumers see value that they are willing to pay for.
One approach is fee-based membership or subscription models. It’s not a new idea, but one that makes more sense in an age of Amazon Prime and more. Consumers will pay for the right package of rewards and benefits.
Another strategy calls for a change in perspective. Instead of directly replacing the old fee revenues, many banks are re-focusing their efforts on “depth of relationship.” Increasingly, we see banks striving for more personalized treatments and experiences for existing customers to drive incremental balance and product ownership.
Banks are also re-thinking their product lineups to make them work better together to encourage people to consolidate their relationships over time. Here’s a simple example: A bank can provide greater value through a short-term liquidity product (e.g., granting a higher credit limit or reducing rates or fees) provided the customers maintain an active checking account with direct deposit.
Some institutions must also acknowledge that they must target customer segments outside of the mass market, which is becoming increasingly unsustainable without the overdraft and NSF fees. In a sense, they will have to be subsidized by mass affluent or wealthy consumers.
Read more: Capping Credit Card Rates and Fees Won’t Ease Consumer Debt Crunch
Challenge 5: Understanding and Responding to Shifts in Preferences and Behaviors
The last hurdle for improving bank profitability lies in banks’ struggle to fully understand and effectively respond to changes in how people deal with their finances.
Consumer preference for digital when opening accounts is growing unabated, now at seven out of ten accounts, as shown in the first section of the exhibit below. But cracking the code on the quality of digital originated balances is tough.
As shown in the middle section, accounts opened in a branch are over seven times larger than those opened digitally. Further, after six months, accounts generated at branches still exceed those opened digitally by a ratio of 2.5 times higher balances, meaning they attrite much slower.
On the commercial side, our research finds that migration from non-interest-bearing account to interest-bearing account continues accelerating, putting strain on overall portfolio costs.
Banks need to develop stronger digitally originated relationships by improving and optimizing the onboarding process and offering the best of personalized experiences — similar to improvements to mitigating fraud in recent years. There are some simple, obvious steps: They should be early with direct-deposit sign-ups and issue customers debit cards as soon as possible, for example.
Additionally, strategic investments into digital capabilities for business clients can help banks effectively compete with maturing fintech alternatives.
Personalization has continued to be an industry-wide challenge. While a growing number of banks have started down the path of AI-enabled personalization, many remain mired in foundational initiatives like the need for data modernization and a lack of a true owner within the bank in terms of the personalization agenda.
This is the right strategic path, but to drive results in the near-term, banks are designing and testing new offers and onboarding mechanisms to maximize quality for those coming in through digital channels — including driving a more hybrid approach to onboarding, leveraging digital and the branch network.
Ultimately, as competition mounts banks need to focus on five major themes; precise rate management, which is critical in a declining rate cycle, that primary customer growth is the foundation to profitable growth; future proofing the business model across branches, marketing, product, and sales; and accelerating a personalization agenda to grow portfolio value.