Three things banks must do to thrive in 2021
Most people would agree that the coronavirus pandemic has further jolted a financial services industry that was already in the throes of disruption caused by competition and changing economics. Timescales to realise a digital future have been accelerated. The race is heating up, executives must act quickly.
Digital technology will be the primary driver of business success. It will enable banks to increase revenues and reduce costs. It will also help create the agility, resilience and scalability needed to succeed in the face of future uncertainty. In this white paper we explain how to plot a path to success.
Banks face a variety of external challenges
Banks were generally well-positioned to weather the storm of the pandemic from a liquidity and capital perspective, thanks to adequate reserves built up over the previous years. However, loan loss reserves grew, and write-offs are expected to increase into 2021 as government action is wound down.
The prolonged ultra-low interest rate environment is driving low NIM (Net Interest Margin) and low ROE (Return on Equity) is expected to continue, according to the Bloomberg Central Bank review. This is putting pressure on banks to scale their customer base, find alternative fee-based income streams and optimise costs.
On top of this, competition continues to grow from challenger banks, fintechs and larger tech companies who are looking to disrupt value chains by taking advantage of the agility, low cost-base and rapid delivery of customer-centric propositions enabled by digital technology. However, they too are facing their own challenges to be profitable.
Customer needs continue to evolve, and expectations continue to grow. The bar for digital experience continues to be raised by non-banking experiences and the propositions of digital challengers. Digital adoption has increased as banking customers have been forced to switch from branches to digital channels during the pandemic.
Customers expect compelling and personalised interactions that are seamless across digital and physical channels. There is also a growing demand for banks to be socially responsible and to contribute positively to the significant challenges society faces, such as climate change and social inequality.
The strength of these forces vary by region, but the trend is the same.
Banks also face internal challenges and constraints
Traditional banks have a much higher cost base than digital-native challengers, and technology costs alone can be up to ten times more on a per-customer basis.
Traditional banks also find it more difficult to adapt and scale to meet these external forces head-on. Legacy systems are both business critical and monolithic in nature. This means they are both risky and expensive to change. They are not architected in a way that enables the kind of rapid change that challenger banks can deliver.
Existing digital capabilities have been built on top of this legacy stack; there is generally not a front-to-back digital-first orientation from a technology or an organisational point of view. Gaps exist; the rapid increase in digital adoption has highlighted gaps in functionality and disjoints in customer experiences across different channels.
On a positive note, banks displayed an unprecedented ability to adapt to the challenge of COVID-19. They were able to keep operations running smoothly, rolled out new ways of working and customer service, and delivered new products and services to market in record time. Lessons from this period can be learned to embed this way of working in the future.
Coping with the challenges: priorities for banks
To survive and thrive, it is clear that banks need to focus on three strategic imperatives simultaneously:
- Increase and diversify revenues
- Optimise costs
- Increase the agility, resilience and scalability of the business.
The good news for banks is that there are also opportunities: digital adoption is accelerating, and this opens up new business models, revenue sources and the ability to bring down cost significantly. With digital adoption comes vast quantities of data that can be leveraged to better understand customer behaviours and needs.
The best news of all is that the answer is clear; digital technology, the source of much disruption, is also the power that will drive the strategic response. Banks have been on a digital transformation journey for a number for years, but now is the time to turn this into a competitive advantage. Technology is maturing, and there are many shining examples for banks to learn from.
The top five areas we think banks should be looking at to deliver impact across all three strategic priorities are:
- Cloud adoption
- Channel strategy
- Data & AI
- Intelligent automation
- Legacy modernisation.
It is our opinion that the banks who invest and execute well in their digital programmes in the coming years, will be best placed to weather the continued economic and competitive head winds and emerge as the leaders of the future.
One: increase and diversify revenues
Quite simply, revenues are driven by the customers you have, how well you can meet their needs across a range of products and services, and how resilient these revenues are to market pressures.
There is a battle for the customer due to the competitive dynamics described above. Banks are challenged to offer innovative products and services that not only attract customers but also retain them by providing a compelling experience.
Banks are also looking to offset low interest revenues and gain more wallet share with fee-based services. This requires a deep understanding of the customer and the ability to innovate to deliver offerings that meet a broader range of their needs. For example, banks are looking at areas such as financial advice, spending analytics, insurance products, point-of-sale financing and subscription models to both improve customer retention and grow fee-based revenue.
Customers are attracted to personalised and predictive experiences, delivered seamlessly across all channels from digital mobile apps to branches. They want their banks to know them intimately, predict their needs and customise products.
How can digital technology enable this?
- Cloud adoption: Cloud brings a wealth of native out-of-the-box services and capabilities in advanced analytics and AI, along with fast provisioning of environments and time to market on new capabilities. Cloud-based bank-as-a-service (BaaS) offerings also enable banks to leverage external services for parts of the value chain, while focusing internally on the key business differentiators.
- Channel strategy: Customers want a seamless omnichannel experience, but different segments have different needs and use the combination of channels in different ways. Banks should conduct analysis to refresh their customer needs, personas and journey maps. A core digital platform backbone will enable orchestration of activity and the sharing of context across all channels and services. Digital technology can be used to interact more frequently with customers and bring channels together. For example – digital identification, reinvention of branches with digital and self-service capabilities for customers and the digital-enablement of staff.
- Data & AI: By leveraging data and AI, banks can build a holistic 360-degree view of a customer and use this to understand and predict their needs, as well as for data-driven product and service development customised to the individual. Better and faster decision making also follows from combining the right data sets with AI algorithms (e.g. improved credit decisions).
- Intelligent automation (IA): Intelligent automation and AI technologies can be deployed to improve customer experience through providing highly responsive, accurate and information-rich conversational interfaces. This enables staff to provide better customer service by focusing on personal service and higher value / more complex needs.
- Legacy modernisation: Modernising systems and selectively unlocking valuable data and functionality is key to creating the holistic customer view. It also enables the development of reusable assets and the progression of an API strategy to integrate with partners and ecosystems. Modernisation of the change function to a customer-centric agile model is a broad enabler for all revenue-generating activity.
Two: optimise costs
- Banks must prioritise bringing down their fixed cost base and reducing the cost per customer to maintain and grow profitability. Cost optimisation should be institutionalised as a continuous improvement mindset rather than a one-off exercise.
- Some of this is already happening as banks look at their biggest operating cost – the branch network. An integrated omnichannel strategy will have a role for branches. Still, the pandemic has shown that low-complexity transactional requests (e.g. money transfers, account applications) can be managed fully through a digital channel, and largely automated through AI-driven chatbots.
- Now is the time to look further at digital and intelligent automation opportunities to improve efficiency across the front, middle and back-office and reduce cost per customer.
- IT costs are significant, and traditional banks can often spend up to 80% of their IT budgets on maintaining legacy systems. There are a multitude of things banks can look at such as modernising/decommissioning legacy systems, cloud migration, improving IT efficiency through modern engineering practices, outsourcing non-differentiating solutions etc.
- The combination of measures that can be taken put the business in a much more competitive position by reducing cost per customer, and also improving the ability to scale in a cost-effective way.
How can digital technology enable this?
- Cloud adoption: Cloud adoption is a must to provide the cost-effective on-demand and as-needed compute and storage for big data and analytics use cases. Banks should be assessing the suitability of apps for migration and pushing ahead to reduce the costs of maintaining data centre capacity and infrastructure support and maintenance teams.
- Channel strategy: Expanding digital channel functionality to give customers self-service over a broader range of tasks will further reduce costs. Banks should move quickly to capitalise on the digital adoption seen during the pandemic to roll out more functionality past the basics such as balance checking and transfers.
- Data & AI: Data & AI technologies can be used to analyse operations and identify efficiency improvements. For example, branch rationalisation can be informed by data and analytics enabling banks to run models to optimise their entire footprint, including branch closure, branch reinvention and digital augmentation, intelligent ATMs, retail partnerships etc.
- Intelligent automation (IA): Banks have started to use RPA to automate simple manual processes. There is still low hanging fruit to go after here. For example, call centre volumes spiked during the pandemic, but with the use of AI-driven bots, the majority of customer enquiries can be handled automatically with a human-like conversational interaction. The real power, however, lies in leveraging IA to deliver both process automation but also the ability to adapt and learn through continuous process improvement in real-time.
- Legacy modernisation: Legacy platform maintenance and support is an enormous drain on IT budgets. A programme of gradual modernisation and/or replacement, or even outsourcing, has the potential to realise significant cost savings. Transforming the change organisation and way of working to a fully agile model can help to improve productivity and eliminate waste. Banks should adopt agile governance and delivery models, along with best-practice engineering principles and automation. This enables rapid experimentation cycles for new ideas, and the flexibility to stop or pivot quickly based on data, rather than locking into longer-term project costs with uncertain end benefits.
Three: increase the agility, resilience and scalability of the business
By definition, the industry’s disruption means we don’t know how it will settle; we don’t know the business models that will prevail, the ecosystems that will thrive, how customer expectations and needs will continue to evolve and which digital technologies will truly fulfil their promise.
It is therefore critical that banks evolve to become more agile, resilient and scalable. These characteristics are key to enable banks to reinvent themselves quickly and cost-effectively in the face of external challenges and opportunities. Agile companies are three times faster at going from ideation to implementation and two times more likely to take bold risks to transform the customer experience. Companies typically achieve these results without compromising their existing corporate governance structures.
To innovate at speed, banks need an agile business change function and a composable set of technology services that can be leveraged in combination to deliver business change quickly. Existing legacy systems are typically not designed this way, so a careful modernisation programme must be undertaken.
Another consideration will be to widen the thinking beyond traditional bank system boundaries – the future will be one of fintech collaboration and ecosystem cooperation.
How can digital technology enable this?
- Cloud adoption: Cloud platforms deliver many of the elements of microservice-based architecture and orchestration capabilities as standard. They also provide the ability to scale compute and storage at will and provide operational resilience. Various hybrid and multi-cloud models can be considered based on needs.
- Channel strategy: Achieving consistency across channels involves harmonising the back-end services, data and workflow management to remove duplication and reduce complexity. This, in turn, provides inherent agility as new functionality can be made in one place and be made available across all channels. Cybersecurity is also a key priority across all channels.
- Data & AI: Leveraging cloud-based elasticity for storage and compute brings scalability and resilience. Data & AI are also key technologies to enable banks to monitor their environment and be alerted to opportunities or threats early, for example, changing customer behaviour. AI-based decision-support tools also speed up and improve the accuracy of decisions.
- Intelligent automation: Intelligent automation technologies not only produce revenue and cost benefits as described above, but they also reduce operational errors and can adapt automatically to changing circumstances, enabling the business to scale quickly and cost-effectively.
- Legacy modernisation: Legacy platform modernisation and making functionality available via APIs, builds common assets and reduces complexity, which leads to reduced technical debt and increased agility. Adopting a client-centric and agile change organisation is also key. Areas such as governance, best in class engineering principles, joint business and IT teams, joint accountability, agile and high levels of automation enable more rapid and responsive business change.
As banks move into 2021, there is a unique opportunity to take stock of how the 2020 pandemic has influenced key industry challenges and refresh the strategy for the years ahead. Key to this will be to balance the priorities of revenues, costs and migrating to a business architecture that is more adaptable and resilient to change. Digital technologies hold the promise to deliver on all three priorities. We believe it is the banks who invest now and execute effectively, that will come out on top.