Ever since the 2008 financial crash, the banking system has been facing mounting pressure to change. But amid today’s perfect storm, on the back of disruption and a fresh wave of economic uncertainty, the sector could emerge as a better, more purposeful global force, according to the new ‘Banking for Tomorrow’ expert report by Dutch strategy consultancy Fincog.
Banks reached their heyday in the 2000s when profits peaked. They engaged in ever more complex financial engineering, large international mergers & acquisitions, arguably loose credit standards, and low capital reserves. The financial crisis in the late 2000s forced the industry to undergo a fundamental change via higher regulatory scrutiny and record-high fines for non-compliance. Conduct authorities introduced new standards for consumer protection, requiring a shift of mind and new ways of working. Banks typically refocused on their core markets and expanded their capabilities in regulatory compliance (i.e., KYC, AML), amongst others.
Yet after a decade of reforms, banks’ economic performance is lagging; in the aftermath of the financial crisis, European banks have achieved on average a return on equity (RoE) of around 3.0-5.0 percent, as opposed to 10.0 percent pre-crisis, not making up for the required cost of capital generally viewed to be around 8.0-10.0 percent to remain viable – one must note that this fall in RoE can be largely attributed to higher capital requirements and consequently lower leverage ratios, as return on assets (RoA) has remained broadly flat at around 0.4 percent.
Today, several trends are creating pressure from within the sector. One of many outlined in Fincog’s report is the transformation of the financial ecosystem. As opposed to banks traditionally covering the full value chain across a wide variety of products, customer segments, and geographies, fintech startups have conversely unbundled the value chain by focusing on specific product segments and niches, offering better customer experience and more efficient operating models. In addition, fintech startups provide space for new technology and Banking-as-a-Service (BAAS) providers. These white-label solutions offer fully integrated financial services that clients can run under the umbrella of their own brand via APIs, adding new and enriching existing services. Banks must thus realise they are now part of a broader, more diverse, and complex ecosystem. Amidst the rise of the platform model, collaboration seems to be the best way forward and banks must be supportive to clients that are looking for solutions outside their own organisation.
But it is not only fintechs which may eat into the customer base of traditional banks. We see increasingly blurring lines between industries with new types of players, such as bigtechs and super-apps expanding their offerings by entering the financial services vertical providing an integrated and seamless customer experience.
Banks are rather slow to change, less efficient, and less innovative. This limits any efforts to become future-proof. Nevertheless, the dismantling of incumbents is driving the progression of the financial ecosystem forward, opening space for new types of banks to thrive with new technology, services, and means of distribution.
As banks are navigating the storm, not all may stay afloat. Smaller and weaker players are likely to disappear and converge into stronger, better capitalised, modern banks. This consolidation process will vary from country to country, segment to segment, and as consolidation happens, we expect a survival of the fittest scenario. The outcome will be mergers and acquisitions both within and across countries, creating larger and ultimately stronger financial institutions across the European market.
Before engaging in cross-border mergers, however, banks need to critically review their rationale to capitalise on their full potential. While large mergers will take all the focus of management, executives must keep their attention on keeping up with what’s happening outside of the bank. To ensure a well-functioning banking market, both politicians and regulators need to embrace reality and allow for consolidation, rather than continuing to hold onto potentially redundant workforces or fully returning to state aid programs. Despite the difficult reality of accepting employment losses and lower valuations, continuing to stick to the two latter options will only make the market less efficient in the long run.
For the banking sector, customer experience is becoming the focal point of differentiation. Services are being provided in ever more personalised ways, at the right place, and in the right form for clients. This is particularly enabled by Open Banking, allowing banks to build upon customer data and advanced analytics to deliver enhanced capabilities and customer experience. Open Banking can be leveraged to optimise the entire customer journey, from the point of orientation and acquisition to post-sale customer care.
Another critical progression in the financial services industry is instituting effective ESG practices. Historically, the banking industry has not been sustainable, socially responsible, or inclusive, but nowadays banks are already becoming more conscious of the role they have in making a positive change. Banks’ efforts are now going beyond the initial scope of ESG practices, expanding to the core of the bank’s operations, for example, developing a net-zero emissions balance sheet by offsetting the carbon footprint via the financing of green initiatives such as renewable energy.
Similarly, banks are becoming more inclusive reaching previously unbanked customers. Across the globe, bank account ownership grew from 51% to 76% between 2011 and 2021 (World Bank – Global Findex 2021). With the help of technology and digital payments, banks can further improve financial inclusion – particularly in developing countries.
Taking note of market developments, it is critical to understand that the digital economy is not in the far future, it is not tomorrow, but it is in fact already happening, and therefore requires holistic and long-term action to be implemented in the coming quarters.
Fincog’s report provides a methodology for how banks can embark on this digital transition. The approach advises banks to first define a future-proof strategy, and then build and transform across seven key capabilities outlined in the report that serve as pillars for banks to be successful. Banks are urged to act on immediate priorities while in parallel building new capabilities for the long term. Traditional banking models need to be re-imagined so that customers can enjoy wider choices and enhanced customer service.
Jeroen is the Founder and Director of strategy consultancy Fincog. He builds on over 14 years of international experience in financial services. Since establishing Fincog, he successfully supported a large variety of banks and fintechs, to transform existing organisations and build new digital banks. Worked for clients across Europe, the Middle East, the Caribbean, and beyond.
The Fintech Consultancy Group (Fincog) was established in 2017 to help clients stay ahead of the curve and create better, more cost-efficient, and inclusive financial services. Fincog supports clients to define their strategy, optimise operations, and guide implementation so that clients can capitalise on financial innovation. Our team offers a global network of senior industry experts covering all key challenges for leaders in the financial services industry. Discover how Fincog is shaping the future, visit fincog.nl.
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