How Can Banks Push Back Against Mounting Margin Pressure?
A new report from McKinsey highlights the growing importance of defending operating margins and offers advice on how to counter the combined impacts of falling rates, fickle consumers, activist regulators and surging fraud.
By David Evans, Chief Content Officer
The report: The State of Retail Banking: Navigating Profitability and Growth in the Digital Era
Source: McKinsey & Company
Why we picked this report: Margin protection is becoming of paramount importance to banks in an environment shaped by falling interest rates on one hand and pressure from regulators and consumers on fees and other sources of income on the other.
Executive Summary
Retail banks globally are at a pivotal juncture, emerging from a period of strength but facing significant headwinds. While returns on equity reached a post-2008 high of 12% in 2023, banks now confront challenges including cost inflation, escalating fraud, and interest rate uncertainty.
To thrive in this evolving landscape, banks must focus on two key imperatives: deepening primary customer relationships and protecting margins. Success will hinge on leveraging both traditional strategies and next-generation capabilities in digitization, AI and generative AI. As market conditions tighten, banks that can effectively balance customer-centric approaches with operational efficiency will be best positioned for growth and profitability.
Key Takeaways
- Global retail banking revenue surpassed $3 trillion in 2023, with an 8% annual growth rate in recent years.
- Mobile banking adoption has surged, with active users increasing by 18 percentage points to 57% between 2020 and 2023.
- Banks face margin pressures from regulatory headwinds on fees and anticipated interest rate reductions.
- Successful strategies will include mobile-first integrated distribution, relationship-based incentives, and hyper-personalization.
- Next-generation analytics, holistic fraud management, and proactive adoption of generative AI are crucial for protecting margins.
What we liked about this report: It’s delineation of the surging costs faced by banks (see chart below) is timely and sobering.
What we didn’t: The report’s global perspective contributes somewhat to over-generalization, and a smudging of regional differences.
A Period of Strength Faces New Challenges
Retail banks worldwide are emerging from a period of unprecedented strength. Bolstered by government stimulus during the COVID-19 pandemic and subsequent rising interest rates, the global banking sector achieved its highest returns on equity since the 2008 financial crisis, reaching approximately 12% in 2023. This performance significantly outpaced the 9% average experienced between 2013 and 2020.
However, the industry now faces a trifecta of challenges: cost inflation, a significant escalation in fraud sophistication and occurrence, and uncertainty surrounding interest rates. These forces are expected to limit asset growth, compress margins, and increase costs for banks. Additionally, rising consumer expectations and ongoing competition from the fintech sector add further pressure to the competitive landscape.
The Battle for Deposits and Customer Primacy
As the macroeconomic environment shifts, banks are recalibrating their strategies. The focus is now on nurturing primary customer relationships through deeper, more meaningful engagement. This approach aims to lower the cost of funds and improve liquidity profiles. Primary customers are more likely to generate high-ROE fee income, maintain lower-cost deposits with primary operating accounts, and foster longer-term relationships with their banks.
To develop and deepen these crucial relationships, banks are employing three key strategies:
Mobile-first integrated distribution: As digital channels mature and client preferences stabilize, mobile has become the preferred channel for most daily banking activities. Banks are adopting a mobile-first integrated channel distribution model, where mobile acts as the orchestrator, helping clients navigate to the right channel for their needs.
The shift towards mobile is striking: Globally, the share of consumers actively using mobile for banking climbed 18 percentage points between 2020 and 2023, reaching 57%. Mobile service touchpoints have proliferated, growing by 72% to reach 150 annual touchpoints per customer. This surpasses some leading e-commerce players, indicating customers’ preference for the ease and efficiency of mobile banking.
Tracking the Stats:
Mobile service touchpoints grew by 72% between 2020 and 2023, reaching 150 annual touchpoints per customer.
However, branches still play a crucial role, especially in new customer acquisition and complex transactions. In North America, branches still accounted for 72% of newly acquired current accounts in 2023, representing 92% of new current account balances. Banks must balance their distribution network, tailoring branch design and services to local market contexts while migrating daily banking activities to self-serve channels.
Innovation in relationship-based incentives: Banks are offering a range of benefits to reward customers with bundled product offerings. These include:
- Fee or price waivers: Discounts or free products based on the number of product relationships.
- Accelerated rewards: Enhanced proprietary rewards programs for customers with deeper relationships.
- Non-banking benefits: Lifestyle perks like exclusive event access or entertainment passes.
These strategies have proven effective. For instance, there was a more than 60% likelihood of a customer signing on to a bundle combining a credit card, savings account, and checking account when the bank waived monthly checking account fees.
However, banks must tailor these offerings to different segments; for example, only 28% of U.S. baby boomers indicated they would sign up for certain bundles, compared to 58% of millennials.
Hyper-personalization: Leveraging their vast customer data, banks are working to meet rising consumer expectations for personalized experiences. This involves:
- Identifying and prioritizing use cases based on value.
- Rapidly activating and optimizing personalization at scale across channels.
- Deploying marketing technology (MarTech) and data enablement.
- Developing an agile operating model for personalization.
- Building capabilities in digital acumen, agility, and analytics.
The impact can be significant. One Western European bank deployed over 100 personalized campaigns powered by AI, resulting in a three to five-fold increase in conversion rates and reducing campaign durations from several months to less than four weeks.
The application of generative AI tools promises to further boost personalization capabilities, enabling banks to deploy end-to-end engines that use bespoke imagery, subject lines, and language to personalize customer touchpoints at scale.
Protecting Margins in a Challenging Environment
As retail banks face headwinds from various cost pressures, protecting margins becomes paramount. Three key areas of focus are emerging:
1. Next-Generation Analytics for Deposits and Lending
For deposits, banks need a toolkit for pricing with precision and building deeper visibility into their customer base. This includes:
- Dynamic and personalized pricing strategies
- Enhanced customer balance sheet visibility
- Advanced deposit modeling
- Unified operating models across the organization
- Rapid decision support capabilities
On the lending side, banks need to move beyond tactical pricing adjustments based on competition. Leading banks are leveraging AI capabilities for cost-of-risk adjustments and customer elasticity assessments. By analyzing a wide range of parameters from transaction history, channel data, and credit bureau information, banks can accurately assess price elasticity for loans and use it to guide pricing at an individual level.
2. Holistic Approaches to Fraud Management
Given the significant growth in fraud — U.S. consumer fraud losses have grown at a 44% CAGR since 2019 — banks need a comprehensive, end-to-end approach across prevention, detection, and resolution. Key elements of this approach include:
- Looking beyond fraud losses: Enhancing mitigation is no longer synonymous with tightening controls. Banks that tailor their fraud prevention systems to limit false positives can enjoy significant revenue impact.
- Setting an acceptable risk appetite: This enables accurate and consistent measurement of fraud, supporting active target setting and monitoring.
- Taking an end-to-end approach aligned with product strategy: Banks should calibrate fraud enhancement strategies with their broader business objectives.
- Streamlining fraud operations: Banks can improve their fraud approach by calibrating resources with their overall portfolio risk profile.
One regional bank overhauled its fraud management capability by identifying operational improvements across alert review, investigation, and resolution. As a result, process efficiency increased by 35%, and fraud losses declined by roughly 45% overall.
3. Proactive Adoption of Generative AI
Generative AI is reshaping productivity in financial services. Four key application areas are emerging:
- Contact centers: Gen AI can improve the quality of customer interactions and boost efficiency, potentially driving down human interaction costs by 10-25%.
- Operations and technology: Gen AI can reduce costs for a wide range of back-end processes, using automation to replace manual labor and accelerate time to completion.
- Legal, risk, and fraud: Gen AI can have a significant productivity impact on activities requiring document interpretation and text generation, potentially reducing document generation costs by 35-40%.
- Talent management: Banks can utilize gen AI to create efficiencies in hiring, onboarding, and workforce training and development, with a 20-35% productivity potential.
As market conditions become more challenging and the competitive environment shifts, retail banks must revamp their strategies and execute with precision. Success will hinge on a dual focus: deepening customer relationships and achieving superior operating efficiency. This approach should be enabled by strong investments in digitization and the strategic use of AI and generative AI.
Banks that can effectively balance these priorities — leveraging both traditional strengths and cutting-edge technologies — will be best positioned to turn the page on a bright future in retail banking. The moment for decisive action is now, as the industry stands at the threshold of a new era defined by digital innovation, customer-centricity, and operational excellence.
Editor’s note: This article was prepared with AI language software and edited for clarity and accuracy by The Financial Brand editorial team.
