Risk, operations, technology and talent are key banking priorities

28 March 2017 Consultancy.uk

The new regulatory landscape for banks is almost complete. Banks are now moving towards implementation of the new requirements, as well as compliance. In a new survey of the industry, banks are asked about their current efforts to implement rules in line with regulatory frameworks, as well as wider efforts to boost ROE, which has flagged in recent years.

The global financial crisis, and the resultant near complete collapse of the global financial system – saved by taxpayers – has seen new regulatory frameworks put in place to reduce risk to the financial system as a whole and shift some of the cost of risks to their shareholders, rather than taxpayers.

In a new report from EY, titled ‘Global Banking Outlook 2017: Uncertainty is no excuse for inaction’, the consultancy firm considers current trends within the wider banking industry, from the effect of new regulations to wider transformations of their operations.

Top recovery signs

2016 was a turbulent year, no less so for the financial services sector and their operations. The start of the year was shaped by falling commodity prices and concerns around slowing global growth, while the middle and later quarters saw disruption from geopolitical events, with EU referendum result in the UK and the US election outcome in the US.

Regulatory efforts too were being completed during 2016, and, while banks now know the wider implications of policies and frameworks, implementation and compliance remains a key factor for the near terms.

Over recent years, during which the banking system has been transforming, banks across most developed nations and Europe have tended to have returns on equity below the cost of equity. While in emerging nations ROE has fallen steadily, from almost 16% in 2012 to 12.5% last year. The US has operated slightly above the cost of equality, at around 11% ROE.

Top three reshape priorities - all banks

The challenging operating environment and new regulatory landscape mean that banks have mostly undergone strategic reviews to improve their operations in line with changing demands. The reviews have seen them make a range of sometimes difficult strategic decisions, from divesting out of non-core assets, to rationalising products and services.

To better understand the current trends shaping the strategic priorities of banks, the firm asked survey respondents to identify their top three priorities for reshaping their operations. The top listed is ‘simplifying/restructuring business operations or legal entities’, cited by 43% of respondents, followed by ‘developing partnerships with industry disruptors/Fintech companies’, noted by 39% of respondents (FinTech companies themselves too are keen to join forces), while ‘developing partnerships or joint ventures with other financial organisations’ comes in at 24% of respondents.

Differences are noted between strategically important banks and smaller players however. For systemically important banks (G-SIBs) developing partnerships with industry disruptors/FinTechs is more important than at non-G-IBs, at 68% and 40% respectively, while ‘simplifying/restructuring business operations or legal entities’ is considered a key priority for G-SIBs (64%) but generally not for non-G-SIBs (33%).

Top three protect priorities - all banks

While the key regulatory frameworks are now well defined, banks will need to be proactive in implementing processes and other internal procedures to meet the respective criteria, aside from more general questions of remaining in compliance with the new rules. Other issues, particularly cyber security, too create risk conditions for businesses.

EY also asked banks to indicate their top three priorities for protecting their wider operations from risks. According to the results G-SIBs are the most concerned about enhancing their cybersecurity/data security’ (86%), followed by ‘complying with consumer regulation issues and/or dealing with remediation’ (81%), finally,’ managing the threat of financial crime’ takes third spot as picked by 78% of respondents.

Non-G-SIBs however, are more concerned about ‘managing reputational risks, including conduct and culture risks’ (68%), followed by ‘meeting capital, liquidity and leverage ratio requirements’ at 61%.

Top three optimize priorities - all banks

The low ROE at many banks has seen them seek ways to optimise their operations across a range of functions. G-SIBs tend to be focusing on ‘optimising customer channels’ (74%), ‘rationalising their physical footprint’ (63%) and ‘strategic efficiency and cost reduction’ (62%). Non-G-SIBs are more focused on ‘strategic efficiency and cost reduction’ (62%), ‘optimising customer channels’ (60%) and ‘leveraging new technologies efficiently’ (56%).

Top three growth priorities - all banks

In terms of growth strategies, strategically significant banks are focused on ‘investing in customer-facing technology’ (62%), ‘recruiting and retaining key talent’ (59%) and ‘developing new products and services’ (35%). Non-G-SIBs are more focused on driving growth through the ‘recruitment and retaining of key talent’, 64%, ‘investing in new customer-facing technology’, 60%, and ‘developing new products’, 41%.

Karl Meekings, Lead Analyst at EY Global Banking & Capital Markets, remarks, “The key to success will be building a better ecosystem, not a bigger bank. Institutions must look for alternative ways to be organised and to operate; to have a much thinner spine than they have today.”

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The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.