Is Banking Losing the Battle for the Consumer?

Never before has the battle to hold on to consumer banking relationships been as heated. McKinsey estimates that in five primary retail banking businesses, from 20 to 60 percent of profits could be at risk as business shifts and margin compression occurs.

By Jim Marous, Co-Publisher of The Financial Brand and Publisher of the Digital Banking Report

Despite a significant financial recovery from the global banking crisis, the banking industry faces decreasing margins and increasing competitive threats as fintech start-ups are positioned to steal lucrative retail and business customers, according to a report by McKinsey & Company. The report, The Fight for the Customer: McKinsey Global Banking Annual Review 2015, states that, “As digitization accelerates, banks will be in a battle for the customer that will define the industry for the next 10 years.”

McKinsey expects stable returns, with margins declining as interest rates remain low, competition intensifies and new fintech firms start to undermine banking’s economics. The ongoing digital revolution and growing regulation will have a significant impact on banking economics and business models. According to McKinsey, “Driven by technology, non-banks, including start-ups known as fintechs, other more established tech companies and shadow banks, are disrupting banks’ relationships with their customers and posing a significant threat to revenues.”

The Battle for the Digital Consumer

The digital revolution is impacting all industries, including banking. It is impacting the way consumers access their products, how products and services are delivered and purchased, and the underpinnings of the entire financial marketplace.

McKinsey research has found that consumers are willing to try fully digital product propositions for deposit and credit cards, with more than half saying they would switch banks if a fully digital provider made an attractive offer. While actual switching may not reach that level (due to massive friction and consumer lethargy), the interest is definitely there for ‘digital natives’.

The chart from McKinsey below illustrates the economics of the basic banking business model. Fifty-nine percent of profits come from origination, sales and distribution of services with a 22% ROE.

McKinsey believes most new entrants are targeting the origination and sales components of banking, and estimate that in five major retail banking businesses – consumer finance, mortgages, lending to small and medium-sized enterprises (SME), retail payments and wealth management – from 10% to 40% of bank revenues will be at risk by 2025. Consequently, between 20% and 60% of profits from these businesses will be at risk, with consumer finance expected to be the most vulnerable line of business.

As shown below, the infiltration of fintech firms in different product categories is significant, especially in payments. The incentive for both start-ups and established technology companies is enormous, as capturing even a tiny fraction of the $1-trillion profit pool can mean a fortune to owners and investors.

While most (if not all) of these firms don’t want to become banks – with the associated compliance burden, they do want to gain scale by leveraging the customer relationship and related value. For traditional banking, the new competition has an upper hand since most are usually providing a better contextual customer experience, lower costs … or both.

The impact on banks’ economics will be widespread. Some tactical repricing may be possible, but over the long term, business models must change radically to reach a much lower CIR than banks have today.

Fintech Weaknesses

While it may look like the digital version of the wild, wild west for fintech firms, there are several challenges that could stand in the way of growth. The most important of these could be in the area of compliance and regulation. For the time being, most regulators have accepted the moderate amount of risk that has been associated with the new entrants. That could change as scalability increases and the industry is further disrupted.

Read more about how banking can respond to these challenges here ...