Advantage: Trends in Banking and Increasing Competition

Five Global Trends That Will Change Your Business Forever

Darren Peel | darren.peel@navigant.com | +44 (0)20 7015 8736

Many underestimate the changes that are occurring in Retail Banking. In a period when many banks are focussing on rebuilding their balance sheet or integrating acquisitions the world around us is evolving rapidly.

In this article we highlight five trends that will have a major impact on Retail Banking and consider the seismic shift in strategy required to remain successful in 10 years time.

1. Generation Y

The offspring of the baby boomers are commonly known as Generation Y. Born between 1975 and 1990 they are radically different to their parents. The way they interact with each other and the corporate world is leading a shift in behaviour in all generations. They are becoming increasingly wealthy with an average income of £23,500 in the UK and will contribute significantly to a bank’s P&L over the next decade or so. The Generation Ys are much more likely to purchase from the internet with 41% using online banking or mobile. Naturally liberal and interested in the green movement they will care about your brand and ethical values.

Is your strategy written by and for generation X or generation Y? If you answered in the former you may be missing out on the next wave of the most profitable customers.

2. Internet Mega Players

The giants of the Internet are coming and there is no hiding their ultimate strategy. Apple sits on cash reserve of $100bn and are under pressure to invest in new markets. Google, Pay Pal and many others are dipping their toe into the water with payment and mobile wallet solutions. Banks will see their transactional income reduce rapidly as Near Field Communication (NFC) and other peer-to-peer payment services become the norm. When these companies achieve critical mass in this space they will move to other areas either via acquisition or innovation.

What is your strategy to cope with these radically different competitors? Do you fight or partner?

3. Town Centres are Evolving

When walking down many traditional high streets it won’t have escaped your notice that they are primarily populated by coffee houses, charity shops and banks. Many of these high streets will continue to decline and will be replaced by fewer, larger entertainment destinations. These areas will be a mix of leisure, retailing and housing. The average footprint of the facilities will be significantly larger than their high street equivalents and customers will expect an experience rather than a transaction.

Is your branch location and composition strategy moving as quickly as the high street is changing?

4. Data, Data and More Data

Understanding your customer is key for future competitive advantage. Many of the challenger brands already have access to a much broader and deeper pool of customer data than just their financial interactions (e.g. Sainsbury Nectar and Tesco Clubcard). Properly integrated, these are powerful tools to better understand customers, generate sales, risk profile customers, and can inform the development of new products and solutions. To be successful, banks will need to move beyond their limited customer insight, to develop knowledge of their individual customers from channel interaction and social media.

What is your customer data strategy and how will you compete with institutions that have access to much broader data?

5. Commoditisation

Greater use of technology means financial services products are becoming increasingly transparent. This will support the increasing use of comparison websites and will impact the industry profoundly. It's worth considering the impact of commoditisation on the general insurance industry and translate that to other products. Clearly, commoditisation will not be applicable to all sales but a significant proportion of the market will be impacted. A bank’s strategy and commitment to the market will dictate their success.

Do you need a dual brand business model strategy? One low cost, low touch and one high service, high margin for traditional customers?

“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don't let yourself be lulled into inaction.” - Bill Gates

How Navigant Can Help

Navigant works at the heart of Retail Banking helping our clients respond to the challenges and capitalise on the opportunities that market change brings.

Call or email Darren Peel on +44 (0)20 7015 8736 or darren.peel@navigant.com for more information.

The Boom and Bust Cycle

Ewen Fleming | ewen.fleming@navigant.com | +44 (0)20 7015 8716

Are you guilty of “financial amnesia”? A recent report by the Chartered Financial Analyst (CFA) Society of the UK condemns “financial amnesia” among institutional investors, arguing that a failure to heed the lessons of past bubbles was a key factor behind the global financial crisis. It is now seeking to reform the CFA programme to include a practical history of financial markets, designed to remind us of the effects that liquidity, consumer psychology and regulatory failure can have. The CFA hopes – through publishing their report – that through improved education, the boom-bust cycle will be less severe or even removed altogether.

Closer inspection of banks’ liquidity ratios will also ensure a bank’s capital reserves will see them through future market crises. This means banks having to guard against future losses by increasing the size of their financial cushion; something that many have campaigned for over a decade for. The fact that capital adequacy has not been effectively legislated, demonstrates the complexity of the subject on an international scale. It also suggests a failure by government, central banks and regulators as well as the institutions themselves!

Clearly there were a multitude of reasons for the economic slump. However, many commentators have suggested that a key one was psychological: a long financial boom breeds an atmosphere of risk tolerance and complacency. That is why governments, organisations and individuals made excessively risky bets. They all thought they couldn't lose.

Consumers

Whilst needing to ensure that the mistakes of the past do not repeat themselves, it is important not to lose sight of the impact that economic hardship has on consumers. A notable indicator is the number of people recorded as having second jobs: up 1.9% in the last quarter to 1.13m, according to a study by the labour market study June 2012 by the Office for National Statistics. This total represents the highest recorded since 2002.

Undoubtedly many people are struggling to get by as their finances are squeezed by muted pay growth and high inflation. Additionally many face reduced hours in their primary employment or worse still redundancy.

Financial Services Industry

The financial services industry is already experiencing a peak in the numbers of customers making reduced payments to their mortgages, and implementation of an effective arrears management strategy is becoming much more difficult in the face of impairment provisioning and shareholder interest versus government and consumer group pressure. This is a real pressure point for the industry; with the current deflated property market making selling and/or downsizing an unviable option. The question then is: how long will banks accept reduced mortgage payments before foreclosing?

As a result many Financial Services institutions face knock-on challenges in the current environment. With a higher number of borrowers defaulting, the quality of banks and building societies lending books suffers. This in turn, can affect how the institution is viewed by the rating agencies. In October this year the credit ratings of some of Britain's biggest financial institutions were cut reflect reduced Government support. At the time Moody's stressed its review did not reflect deterioration in the financial strength of the banking system or the Government. Nevertheless it reduces confidence in the financial services industry and those institutions directly affected. Just as importantly, this also causes the cost of borrowing for the affected financial institutions to rise.

As a consequence financial institutions have two emerging, yet pressing needs:

1. To optimise their controllable costs, in order to be able to offer attractive rates to maintain their savings books and fund profitable lending. There is a temptation to cut costs quickly and ruthlessly, yet it is all too easy to cut lean muscle as well as fat. This can reduce the institution’s capability to generate sustainable future revenue.
2. More forward-thinking organisations will look at smarter ways to manage their non-performing lending books, and develop innovative strategies to deal with customers facing financial hardship.

How Navigant Can Help

At Navigant, we have experience across many financial institutions, with developing clear business strategies, cost management and business operating models.  We also have significant experience in financial services regulatory activities, and have helped many of your peers in interpreting regulations and manage risk through design and implementation of effective business policies, strategies and processes.

Call or email Ewen Fleming on +44 (0)20 7015 8716 or ewen.fleming@navigant.com for more information.

Independent Commission on Banking (ICB): Government White Paper — Transforming the Industry

Simon Rose | simon.rose@navigant.com | 07825 323 015 

The principles of the ICB's recommendations have been endorsed by the Government in its recent White Paper on Banking Reform. However, it is the details of the regulations which will determine whether they deliver stability and competition. Fundamental details such as corporate governance and permitted funding structures will determine the efficiency of the banking system in terms of the supply of credit and whether the measures remove systemic risk. The details will also determine whether the banking sector becomes even more concentrated or becomes more contested. There are few details of what the ICB had in mind by 'effective competition', but the dominance of existing banks, malpractices and misallocated credit suggest there is real scope for improvement. It is rare that our long term prosperity depends so much on the details of legislation.

The public debate

If there is a silver lining in the recent interbank scandal, it is that the public debate on reforming the banking sector is now centre stage. Commentators and editors are now casting a more critical eye on the ICB proposals and are asking if the remit was wide enough and whether or not the recommendations go far enough. Academics around the world are examining the relative merits of policies and as the economy continues to stagnate the case for deeper reform is likely to increase.

Government White Paper

The White Paper has no major surprises and is in line with expectations; broadly, ring-fencing will happen as per the original Vickers proposal. The White Paper contains a few small, but welcome, changes to the original ring-fencing proposals, such as permitting ring-fenced banks to provide ‘simple’ derivative products to their customers. However, careful definition of these products will be required and there will possibly be limits on customers – both personal and SME.

Clarification

The entire industry will be affected. Even if a firm is not within the ring-fence, their competitors will be changing their business models to reflect the developing competitive environment.

Whilst the devil is in the detail, there’s still a huge amount of clarification needed for the industry on the proposed regulations. It is the biggest change in the UK banking landscape sine the creation of limited liability banks one hundred and forty years ago and it will affect customer choice, staff incentives, investor behaviour and even the performance of the regulators.

When finalised, the regulations will inevitably require interpretation: the risk is that each firm will make different interpretations of the regulations – thus causing confusion and complication where the rules are not properly clarified –  such as restrictions on products and the exact nature of intra-group relationships. The biggest area of concern for banks is the significant expectations which the government has put forward around governance; these will require considerable thought to enable banks to operate efficiently while upholding the essence of the regulations.

Consultation

At publication, the government has offered out to consultation, fourteen questions to the Banking sector: these are examples of the areas out for consultation:

• SME Definition – setting quantitative limits to be used to determine whether a firm’s deposit base must be held by a ring-fenced bank.
• Definition of High Net Worth Individuals – suggesting free and investable assets to be between a range of £250,000 to £750,000.
• Restrictions on Types of Institution – seeking to restrict those to which ring-fenced banks have exposure and who engage in prohibited activities; facilitating payments and managing liquidity for other financial institutions will not be prohibited.
• Ancillary Activities – proposed secondary legislation for exemptions to prohibited activities. For example, to allow ring-fenced banks to package cash flows (securitisation) to fund itself.

The government in its review of the Vickers report, feels there’s a case for exemption from ring-fencing for certain firms—those with less than £25bn of mandated deposits may be appropriate (c.87 percent of the banking sector by deposits will be covered by the ring-fencing), leaving 3 building societies needing to ring-fence.

Through provision of a draft bill for pre-legislative scrutiny, the government offered questions for consultation by 6^th September. The final draft bill will arrive later in the autumn, making provisions for the measures outlined in the White Paper and taking in consideration the responses to the questions.

Switching

The immediate activity from the ICB proposals is for the switching of current accounts. The existing ToDDaSO system for changing payments and accounts will be rebuilt, and become known as the current account redirection service.

The current account redirection service is currently being developed by The Payments Council aims to go in to testing from January 2013 and be ready for deployment in September 2013. The government has fixed this timeline, and to date 97 percent of banks representing this market have committed to the launch date. It provides for a guaranteed seven-day switching period, is free to use, guarantees customers will suffer no financial loss, a thirteen-month transition period to auto-route any incoming/outgoing payments sent incorrectly, and it affects all users of the current payment services. This means the “agency” and “sponsor” bank relationship will become more important than ever.

The introduction of the ICB regulations will see a number of changes to the day-to-day operations of banks and building societies, wealth managers, private banks with the most immediate changes being an enforced competition requirement for consumer switching of current accounts.

Impacts

The legislative impact to consumers and the banking sector will be profound. Firms will see a reduction in profits, simplification of products, increased switching of current accounts, and more pertinently, major changes to corporate culture, staff knowledge, changes to the regulatory bodies, a need for new business operating models and management information, changes to board directors, as well as huge expense and reduced profits.

Some key questions to consider:

1. Have you begun to review your business model and how it will be separated?
2. How will this impact shareholders and society members?
3. Have you considered your funding arrangements and apportioned your capital and liquidity requirements yet?
4. Have you reviewed your suite of products?

How Navigant Can Help

Navigant and the National Institute for Economic Research (NIESR) are leading an industry-wide research project on ICB and its impact on the future of UK banking. The project is co-funded by the Economic and Social Research Council (ESRC) and the private sector. The NIESR have letters of endorsement from HM Treasury and the Bank of England who are keen to get an independent assessment of the role and needs of smaller banks in creating an effective banking system.

Navigant will be establishing a consultation forum to enable banks have an opportunity to participate to:

• Influence areas of research and participate in the early review of findings
• Attend and participate in industry round tables with peer organisations to discuss their views on changing banking and regulatory environment including unintended consequences
• Contribute to policy responses and engage with policy makers
• Be positioned prominently in published reports and media coverage

If your firm is interested in hearing more about the research study please contact ray.nulty@navigant.com and we will be happy to arrange a meeting.

Will You Be Ready?

Navigant can help you address all of the areas covered throughout the ICB proposals. We have deep industry expertise across Banking, Investment Management and Risk and Regulation. We have led the way on ICB, have strong relationships across government and are renowned for our knowledge of the Banking markets.

For more information, contact Simon Rose on 07825 323 015 or simon.rose@navigant.com.

Increasing Competition in Financial Services?

Ewen Fleming | ewen.fleming@navigant.com | +44 (0)20 7015 8716

Recent retail banking research by Datamonitor showed that 80 percent of all current accounts in the UK are held by the top six banks. In the wake of the Vickers report/Independent Commission on Banking (ICB), these bigger players may lose some of their scale advantages as they will be required to split out elements of their shared services model. So, is the market really changing or indeed going to change?

Challenger Banks

Despite a difficult backdrop, Navigant believes that the prize for a challenger is still very much there to be had. However it will take a lot to shake and break the hold that the current Top 6 have on retail banking. In many respects, the break-up of RBS and Lloyds Banking Group (through their respective Rainbow and Verde programmes) may achieve very little in terms of competition and in the process inconvenience their customers.

Below the current Top 6 it looks as if Nationwide, Tesco Bank and Virgin Money are the ones most likely to be able to have sufficient scale to compete with the ‘big boys’.

For a new entrant to financial services, it appears too expensive and time consuming to go down a purely organic route. Without a back-book generating revenue to support competitive (and loss inducing) acquisition rates, a new entrant isn’t going to generate sufficient profits to break even in a reasonable time period. There are few attractive acquisition targets left outside the mutual sector. We therefore expect further encroachment into financial services from retailers who can leverage their own loyal customer base. Any future moves by retailers are likely to be focused on distribution/white label deals. This approach trades thinner ongoing margins, for materially reduced upfront costs and reduced time to launch.

Sustainable Customer Choice

Ultimately success and failure in financial services comes back to customer purchasing behaviours and their decisions based on their perceived options. Arguably the most valuable (and attractive) customers to the banks are least likely to want to consolidate their financial needs with one or even two providers. More importantly, the manner in which banks price to attract business, penalising loyalty through stealth pricing of their back book, only encourages promiscuity amongst those very customers.

Many retailers such as Tesco, Sainsbury, Marks & Spencer and Co-operative already have a significant range of financial services on offer: Marks & Spencer intend to increase theirs further with their recently announced intention to launch new current account and mortgage products, through their parent HSBC. However, so far only the Co-operative and Harrods have a current account available. This may be significant, given current accounts have traditionally been the ‘hub’ around which multiple financial products then hang off.

Who has the courage and the brand, to convince customers that a fair (not best) price to acquire their business will continue after the initial ‘honeymoon period’, eliminating the need for customers to shop around?

Breaking the Paradigm

Whether retailers, or other firms like a mobile phone provider, can leverage their customer base, and convince consumers they are a credible and compelling choice to move their main banking relationship to, remains to be seen. Navigant believes that the financial services sector is wide open to a provider that can demonstrate and maintain a reputation for value, fairness and trust. Many retailers already score highly in these areas and therefore can they – as opposed to a totally new entrant – grab profitable and sustainable market share and break the current paradigm?

How Navigant Can Help

Navigant have significant market experience in supporting clients, financial and retail, with their strategy and customer proposition as well as modelling the financial implications of their options.

Call or email Ewen Fleming on +44 (0)20 7015 8716 or ewen.fleming@navigant.com for more information.

Mobile Banking – A Technology Moving At Pace

Keith Green | keith.green@navigant.com | +44 (0)20 7015 2338

On the 2^nd June 1875 Alexander Graham Bell transmitted the sound of a plucked steel reed using electromagnet instruments. The invention of the telephone resulted in an evolution in communications technology. As in 1875, today we stand at the forefront of a new evolution in technology with the advent of mobile communications and the opportunity it offers in a payment and banking context.

These mobile payment and mobile banking opportunities have five main components which have far reaching implications for the traditional view of “Banking”:

• Money management – financial information, statements, transactions such as deposit and withdrawal, and branch finder apps
• Commerce – online shopping, location-specific offers, merchant payments
• P2P (person to person) – transfers via mobile phone number (such as Barclays PingIt)
• NFC (Near Field Communications) – instant and contactless payments by card or mobile phone
• Customer relationship – using information from the above transactions to better understand and support customer need and experience.

In the UK, the evolution of these components indicate that within ten years mobile payments will exceed ATM cash withdrawals although current research also indicates we will never reach a cashless society, regardless of how developed technology becomes. This is reinforced by observations on more evolved mobile financial markets such as Asia.

The market trend is that all banks are currently restructuring, or considering restructuring their consumer services around digital - there is no doubt in the recognition of technological changes for the banking industry, of which mobile is a part, as a threat to steady state evolution. What is not clear is the exact response that will prove successful in such an unstable and fragmented environment.

There are however technological and social trends which will help us to look at the future of payments and opportunities for payment firms. As with the telephone, this evolution will take time and a number of challenges will need to be overcome before customers identify with mobile banking and mobile payments more than they do with the traditional banking interactions of branch, ATM, online, or card:

1. Customer Demand

The evolution of mobile payments and banking in the UK has been relatively slow and outstripped by developing economies to date. There have been more than 100 mobile-money deployments in emerging markets, at least 84 of them in the past three years, partly driven by a gap in the provision of services to the high proportion of unbanked customers, and a general lack of supporting banking and payment infrastructure in these economies. This is very different to developed economies, such as the UK, since 96% of the UK population has a bank account and already has access to existing payments technology such as cash, credit cards, debit cards and cheques. There is not a burning platform driving take up.

2. Security

Customers have strong perceptions around the security of their accounts and providers will need to ensure customers feel “protected”. The focus on cybercrime is evidenced by the level of investment from the payment industry in new fraud detection technology, which has lead to an overall 9% decline in transaction fraud losses. The reputational risk of inadequate security and consequences can be seen in the front page news headlines when breaches occur. This may result in products and services which are not customer friendly to use in the short term. In addition with customers changing their mobile on average every 18-24 months they will need to be convinced that data can be erased and transferred to new handsets easily.

3. Supporting Infrastructure

Merchants are sceptical and the usefulness of mobile technology will to a large extent be dependent on the take up rates across the market – e.g. installation of NFC terminals in retail outlets and customer adoptions of innovations, alongside hardware developments such as the reliability of mobile signal/coverage and phone battery life.

4. Customer Proposition

This will need to be strengthened as financial services providers increasingly view mobile banking/payments as a key part of an integrated distribution strategy. Mobile payments will need to be easier, cheaper, faster and more convenient with customers being reluctant to adopt mobile payments or use mobile banking that do not offer additional benefits to their current interactions or cater to their particular desire in the use of that technology.

Innovative companies are already exploring new opportunities to build relationships with customers in the digital world, as banks look to further engage their consumers, driven by market competition from the new challenger banks taking advantage of reputational damage caused to traditional banks following the credit crisis and LIBOR scandal, and the need to create differentiation in an increasingly challenging environment. For example:

• Mobile apps for Smartphone’s and tablets can facilitate conversation and provide resources for customers after they leave the branch
• Some apps, like Citibank’s iPad app, connect customers to banks’ twitter feeds and other service-based platforms
• Google’s partnership with Sprint and MasterCard in launching Google Wallet offers customers all the benefits of credit and debit cards but consolidates all of the plastic into mobile chip technology
• Barclays PingIt and O2 Wallet which allows customers to make P2P payments via their mobile phone

Presenting customers with alternative resources and educating them about the ease of use of mobile features will ultimately promote a seamless cross-channel experience and encourage efficient multichannel use amongst retail banking customers. What is important is taking action and developing capabilities, not waiting until the muddy waters clear.

Banks which do not embrace the new evolution in mobile payments and mobile banking may find it increasingly difficult to engage with their customers as competitor organisations build new relationships with customers on superior technology. With new parties entering the space of traditional banks such as Google Wallet, O2 Wallet, PayPal, and V.me by Visa, they may no longer own the direct relationship with the customer and become a behind the scenes processing factory for these new brands.

Conclusion

In the UK, mobile payments and mobile banking are on the verge of evolving into the dominant form of payments technology in the UK. There are still challenges to overcome but this evolution will pose opportunities and threats to existing incumbent business models. If you are not taking the right key steps to success (such as having a defined strategy, fast and efficient roll out and a single complete deployment of a mobile banking infrastructure), your business model may be left behind with new challenger banks and non-banks taking a dominant role in this space.

How can Navigant Help?

Navigant works at the very heart of the Banking industry and has provided consulting advice to a number of high profile firms, both challenger and traditional banks, and mobile phone companies, on their digital strategy and mobile wallet programmes.

For more information, contact Keith Green on +44 (0)20 7015 2338, or email keith.green@navigant.com.