Top Factors Defining Future Success in Retail Banking

The existing business model for most retail banks is negatively impacting both profitability and valuations. To become future-ready, banks and credit unions must rethink their distribution strategy, reinvent their business model and double down on ways to achieve operational efficiencies.
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Recent trends in banking confirm that traditional banks can still dominate, despite significant competition from fintech firms and big tech players. But to do that they must be open to changing their physical distribution structure, legacy business models, inefficient back-office operations and limited value propositions.

According to research by McKinsey, while geography and business models continue to play a role defining the winners in retail banking, operational excellence has emerged as an increasingly important factor determining which financial institutions are best positioned for the future.

Keys to Performance Excellence:

While geography and business models continue play a role in separating leaders from followers in banking, operational excellence has emerged as an increasingly important factor. - McKinsey

In other words, the cost of delivering services, and the perceived value of these services to the marketplace, will drive market share and organic growth. This will require retail banks to operate from an advanced platform, leveraging new technologies and data capabilities that support the delivery of contextual digital products and services … in real time.

Legacy Banking Faces Profitability Headwinds

At a time when financial institutions of all sizes are trying to transform most of what made legacy banking successful in the past, there is an underlying threat as the performance gap between the world’s most profitable banks, and the least, is widening.

While variations in profitability between financial institutions have always existed for an assortment of reasons, many of today’s variations are being caused by operational inefficiencies, outdated business models, the inability to embrace change and product lines supported, i.e. the differences between core product profitability and deeper product engagements (embedded banking, mortgages, business banking, etc.)

In developed countries, existing cost structures are no longer sustainable. Organizations in the U.S., Europe and developed Asia must use modern technology to lower costs of distribution, manage data and analytics, create innovation at scale and speed, automate back-office functions, and create personalized customer engagement. Unfortunately, incumbent banks are often dragging their collective feet to compete effectively on the digital battlefield.

In emerging markets, such as Africa, Latin America and the Middle East, financial institutions must leverage profits from core banking services, such as checking/current accounts, credit cards, unsecured loans and basic savings plans to support new product expansion and cross-selling.

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Keys to Improved Banking Performance

According to McKinsey, the best performing financial institutions are able to digitally support what it calls the “search-shop-manage” value chain for core banking services seamlessly and without human or physical structure involvement. This digital initiation of the customer relationship can both increase sales and reduce costs.

To ensure that new distribution models satisfy existing and future customer needs effectively and efficiently, organizations must implement support functionality such as data, analytics, and modern technology.

Through advanced digital transformation, financial institutions can also enhance the value proposition to existing customers, building contextual digital engagement across the entire customer journey, increasing the number of log-ins and the opportunity for expanded relationships. This would provide a much-needed boost in profitability for traditional financial institutions.

In addition, as digital relationship initiation and engagement increases, cost to serve improvements will be possible, including the optimization of branch networks and the automation of customer acquisition/onboarding, credit underwriting, servicing, and more.

Finally, the support of new product and service business models will create the foundation for banks and credit unions to potentially abandon some legacy revenue sources (net interest margins, transaction fees, commissions and penalty fees). New business models will include opportunities from open banking, embedded banking, and banking as a service solutions

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Act Now to Become Future-Ready

Despite an uncertain economic environment, banks and credit unions must take action immediately to digitally transform their organizations in a way that will reduce operating expenses, increase customer engagement, build new digital solutions, and generate new sources of revenue. This will require a much greater commitment to leveraging data and analytics, creating a new technology platform, and rethinking existing back-office operating models.

The good news is that, compared to fintech firms and even big tech competitors, legacy financial institutions still know more about their customers than alternative providers. More importantly, there is an existing trust and reluctance to change primary providers by existing customers. Unfortunately, we are already seeing a shift in loyalty, where existing customers are ‘testing the waters’ of fintech and big tech providers.

According to McKinsey, “More than ever, banks and credit unions must leverage a comprehensive data infrastructure that will support data collection, storage, and advanced analytics, as well as a digital marketing engine to translate analytical insights into personalized messages that anticipate individual customer needs and intentions.” Since most legacy financial institutions do not have this data and analytics capability today, this is where third-party solution providers should be used to deploy these solutions at speed and scale.

Data Drives Value:

Banks will need to rethink their value proposition, simultaneously simplifying and upgrading the customer experience while creating value and engagement through data. - McKinsey

Similar to the requirement for a strong data and analytic infrastructure, financial institutions must also have an IT infrastructure that is capable of a much faster processing capacity and for supporting faster, iterative innovation cycles. Again, few banks or credit unions are in the position to build this capability internally, so outsourcing should be considered to reduce the cost while providing flexibility.

Finally, traditional banks and credit unions must completely rethink existing operations and back-office processes to support the speed and agility required of a digital-first financial institution. Institutions must provide the support and culture needed for collaborative development of new ways of doing business, including the retraining and hiring of the talent required for a future-ready digital bank.

The legacy way of supporting the financial needs of consumers is no longer financially viable in a world that rewards banks and credit unions that build new digital functionalities quickly and at scale. Winners will be those institutions that can support all transactions and sales digitally, use data and analytics to personalize engagement in real-time, and rethink back-office operations for enhanced efficiency and effectiveness.

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