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OBSERVATIONS FROM THE FINTECH SNARK TANK
Two big consulting firms recently published advice on what banks need to do in the near-term as an economic downturn looms, and over the next five years.
(Not So) Bold Late-Cycle Moves
In a report titled The last pit stop? Time for bold late-cycle moves, McKinsey asserts that “the breadth and depth of the slowdown signal that we have entered the final stages of the economic cycle.”
The consulting firm identifies a number of issues facing banks in the late-cycle:
- Slowing asset growth. According to the report, “Growth in bank assets is no longer keeping up with growth in nominal GDP, and this, historically, has been a turning point for banks as the cycle begins to wind down.”
- Faster margin compression. Average margins before risk in developed markets declined from 234 bps in 2013 to 225 bps in 2018 in developed markets, despite rising interest rates.
- Declining productivity gains. McKinsey reports, “Annual gains in productivity have been more modest since 2016, with the average ratio of cost to assets (C/A) as of 2018 reaching 144 bps in developed markets.
Spot on. McKinsey recommends that banks:
1) Improve risk management with powerful analytical tools. The consulting firm encourages banks to better evaluate liquidity risks, and cautions that these risks “are further amplified by the potential of social media to spread negative reports, true or otherwise.”
My take: This is hardly a “bold move.” US banks have been investing heavily in risk management for the past decade. Cornerstone Advisors’ annual What’s Going On in Banking study found that roughly half of all banks invested in risk management system improvements or replacements in each of the past three years,
2) Increase productivity using modular utilities to materially change cost structures. McKinsey points to the auto industry which moved from a “common chassis strategy” in 1990 to a “modular strategy” in 2010. The consulting firm goes on to claim that by outsourcing non-differentiating activities (e.g., application development/maintenance, risk) to modular industry utilities, banks could improve return on equity by 60 to 100 basis points.
My take: If it takes 20 years to achieve modularization (like it did the car makers), how does this help banks prepare for a coming downturn?
And a move to outsource activities like application development/maintenance and risk would require a lengthy vendor selection and deployment effort that wouldn’t be completed before a downturn hit.
Again, hardly a bold move. Banks have entered into outsourcing arrangements for the past 30+ years. Many find that: 1) Costs don’t go down as much as they thought they would, and 2) Speed to implement change is hampered.
3) Grow revenue through an improved customer experience, bringing a larger customer base and/or share of wallet. McKinsey follows this recommendation by saying:
“Customers will switch if they’ve had a very poor experience, but they will not necessarily buy more even if they are highly satisfied. Simply trying to move customers from ‘unhappy’ to ‘okay’ to ‘great’ usually fails to lift revenues, due to diminishing returns.”
My take: What am I missing here? Sounds to me like improving the customer experience won’t help to bring in a larger customer base and/or increase wallet share.
And even if it did, this would still not qualify as a “bold move for the late-cycle.” Banks have been getting lectures about improving the customer experience for the past decade.
4) Market to micro-segments. McKinsey advises banks to “Prioritize rapid implementation of micro-segmentation cases to avoid competitors gaining market share.”
My take: Why do consultants think ‘micro-segmentation” is an easy thing to do?
Firms that successfully serve narrow niches (or micro-segments) identify the unique needs of those segments and develop targeted products and services for those niches.
Easier said than done.
First, this is nearly cost-prohibitive for a large bank to do–no way they’re going to develop this capability by the time a downturn occurs.
Second, how would they be able to do it if they outsource application development and maintenance as McKinsey suggests they do?
Up Close and Personal Banking
Not to be outdone by McKinsey, the Boston Consulting Group weighed in with their prescriptions for banks in Retail Banking Distribution 2025: Up Close and Personal. BCG defines five levers banks can pull to increase profitability by up to 25%:
- Implementing the intelligent routing of customer requests between digital and assisted channels, yielding a profitability increase of 5% to 15%.
- Shifting from contact centers to customer care platforms, 2% to 8%.
- Embedding distribution on partner platform services via APIs, 2% to 8%.
- For most banks and in most markets, reducing branch networks while, at the same time, taking steps to optimize the remaining branches, 2% to 8%.
- Harnessing the creativity and passion of front-line colleagues to meet customers’ needs, providing support for the four other levers.
My take: These profitability improvement estimates are unrealistic and conflicting.
Why do customer requests get routed to “assisted” channels today? Because: 1) Customers want to use those channels, and/or 2) Digital channels are unable to support those requests today.
“Intelligently” routing customer requests is unlikely to improve profitability by 5% to 15% because banks will need to make substantial investments in digital capabilities to enable that (which, by the way, they’re already making).
If banks eliminate customer requests through better product and service design, there’s a possibility of seeing some significant profitability gains.
But where will those gains come from? From eliminating customer support headcount. If that happens, however, how will banks “harness the creativity and passion of front-line colleagues?”
In addition, it’s not clear how a “customer care platform” (which BCG never defines) will improve profitability by 2% to 8%.
Truly Bold Moves
With two exceptions (embedding distribution on partner platforms and materially changing the cost structure with modular activities), the consultants’ advice falls far short of being the “bold moves” or “future predictions” they’re advertised to be.
In fact, banks are already: 1) Enhancing risk management capabilities, 2) Improving productivity (particularly through agile IT approaches); 3) Taking steps to integrate customer care channels; and 4) Streamlining branch networks.
Dangling projections of huge profitability gains is as bad as the click bait title of this article.
