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01/12/2016

The changing face of a bank’s P&L

 

My apartment sits a couple of stories above my local pub O’Reilly’s. It’s got a pretty sweet beer garden too. On the rare warm Summer nights, we get here in Dublin, I’ll open my window and my God, the noise. Different topics, different opinions, getting louder, more vociferous and more entrenched as the night goes on.

Sometimes it feels the Fintech conversation is getting a bit like O’Reilly’s at ten o’clock in the evening. And, at the risk of making it worse, I do sometimes find myself lapsing back into my old life in Retail Product Management and thinking, “Yeah, all this tech is great, but show me the money!”

I accept technology will have unknowable and unforeseen impacts on the P&L. However, there are some points incumbent banks need to consider when cutting through the chatter to meet challengers who haven’t disrupted the industry yet but are starting to threaten.

Banks are going to have to adjust to the biggest changes to their profitability model since the introduction of computers in the 70s and 80s. The formula of interest income and fees offset against costs that has served so well for over 200 years is going to experience significant change, on both sides of the P&L.

 

Revenue

The increasing commoditisation of cornerstone retail banking products allied with market competition and disintermediation has led to a sustained trend of margin pressure across the industry.

“No industry has more commoditized itself over the past three decades than banking.” Click To Tweet

– Joseph Pine, author of Mass Customisation and The Experience Economy, regular TED speaker and Harvard Business Review contributor

 

This trend shows no signs of abating. A recent EY Bank Survey tells us that ‘developing/introducing new products’ doesn’t even rank in the top ten priorities for European banks in 2016.

However, incumbent banks still have one major advantage; their large customer base. Successful banks of the future will find a way to maintain key customer relationships and build new revenue streams that are presently alien to most banks.

I’m not gonna pretend to even guess at what all of these look like, but a couple of things banks should be considering are:

 

1. Developing new revenue streams by allowing 3rd party access

Allowing 3rd party product and service providers (financial and non-financial) access to the customer base will be important. Banks that succeed long-term will be able to deliver best in market innovation and services to their customers. Particularly when this is done in a way that truly delivers a more rounded and superior end-to-end customer experience.

From a bank’s perspective, they can:

  • Provide products and services in areas where they don’t hold core competencies or an innovation edge, without the build cost and maintenance overhead.
  • Build commercial arrangements with the 3rd party provider. By allowing access to a large customer base, while still acting as custodian to what can be delivered, banks can significantly drive revenue benefits and increase customer satisfaction.

 

2. Proper utilisation and monetisation of customer data

Historically, banks have looked at customer data all wrong. They view it as a cost line on their P&L. Something that has to be stored in big servers on the outskirts of town because the regulator tells them they need to hang onto it for seven years or so. All the while some of the biggest companies in the world (Google, Facebook et al.) have business models defined by information less rich then the banks have.

Sure these companies can say what you’ve browsed or ‘liked’, but a bank knows what you bought. The definitive consumer behaviour – gold for advertisers.

While it may be tempting to simply follow the Google/Facebook model and present customers with relevant ads and offers, it will be great to see which banks share the benefits with their customers. After all, it is their data!

Which banks are going to monitise the data in a safe way that passes on a proportion of the benefits in real, hard currency in their customer’s accounts? How are banks going to demonstrate in a very tangible way that they are using data to enhance their customer’s financial well-being?

 

Costs

Put simply, bank cost-to-income ratios are too high. Looking at challenger bank activity in the UK over the last five years, the KPMG Challenger Bank Report shows a number of new market entrants (e.g. Aldermore. Shawbrook, Secure Trust) have entered as greenfield plays with relatively traditional business models and delivered +15% improvement in CTI on incumbent banks.  And this gap is growing every year.

 

Challenger banks with greenfield plays are delivering 15% better CTI than incumbent banks Click To Tweet

 

Interestingly, this has not been achieved with any groundbreaking technological advances, but by good re-engineering of existing bank processes from scratch and focusing on a simpler product set in higher yield areas. Scale in banking has translated into complexity and over time those unwieldy IT legacy systems.

However, there is a new wave of cloud-native solutions that are going to radically alter the cost base model by becoming up to ten times more efficient than incumbent banks. By virtually eliminating IT CapEx and giving infinitely more efficient OpEx, they can deliver a very low and knowable IT cost structure.

While incumbent banks can start to move towards cloud usage, existing bank systems are not built to fully optimise the cloud and take advantage of these benefits. They can be retrofitted to an extent, but they were never designed with the cloud in mind. Banks need to figure out how to achieve this new CTI or risk facing competition that can compete on lower price, but maintain a better margin and more profitability.

 

Time to diversify revenue streams

All told, this is a really exciting time to be in charge of a bank P&L. There’s huge opportunity to diversify revenue streams, and who knows, in ten years time mortgage interest may not even be the number one revenue line in the business. And all of this can all be done while greatly improving the customer experience.

The cost side is a bit trickier and those legacy systems are not helping, but there are increasingly cleverer ways to move away from legacy to smarter, more agile platforms. It will require strategic flexibility, but the ability to achieve lower cost-to-income ratios will be important.

 

At Leveris we believe the solution lies in the use of a modern, modular, open API platform based in the cloud. Only by doing this can banks deliver the next-generation P&L advantages, embrace and respond to market innovations speedily, and deliver the future cost benefits that only a modern architecture platform can achieve.

Right, the O’Reilly beer garden may be long closed for the Winter, but the chatter, banter and laughter are in full swing at this time of year. I think I’ll go join them.

Happy Christmas

 

I am the Head of Product & Customer Propositions at Leveris. My background is retail banking, particularly product management, and I’ve 15+ years experience in Australia, Ireland and the UK managing large P&Ls, both for lending and deposits. I’m now focused on delivering innovative products and services using the next generation Leveris banking platform.

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