The Phoenix Rises: Remaking the Bank for an Ecosystem World (2017 Global Banking Annual Review)

remaking the bank for an ecosystem world - article

 Despite signs of renewed health with regard to capitalization, liquidity and costs, the global banking industry’s performance continues to be lackluster, with ROE stuck in a narrow range between 8% and the 10% figure that most consider the industry’s cost of capital.  Moreover, the industry is facing an accelerating digital threat, both from new digital competitors and from customers’ rapid and widespread adoption of digital banking.  Left unchecked, this threat could lower the industry’s ROE to 5.2% by 2025, according to the 2017 McKinsey Global Banking Annual Review released today.

The accelerating pace of digitization represents not only a threat, but also an opportunity for banks, says the McKinsey report.  To counteract the digital threat, banks first need to fully deploy the digital tools available to them to industrialize their operations to boost revenue, improve capital usage, and especially cut costs.  McKinsey estimates that fully digitizing, along with significantly improving skills in digital marketing and analytics, could add $350 billion to the banking industry’s bottom line over the next three-to-five years.  Secondly, the digital ecosystems, characteristic of the integrated economy now emerging, represent a growth opportunity for banks, if they can find ways to compete effectively with platform companies like Amazon, Alibaba and Tencent.  Banks that develop and execute a successful ecosystem strategy could achieve an ROE between 9% and 14% by 2025, according to the report, entitled The Phoenix Rises:  Remaking the Bank for an Ecosystem World.

The McKinsey Global Banking Annual Review 2017 is based on insights from McKinsey’s proprietary Panorama Global Banking Pools, a database that covers banking markets in more than 90 countries, and Panorama FinTech, a database that includes more than 3,000 Fintech innovations globally, as well as interviews with a number of banking industry leaders.


An Immediate Full-scale Digital Transformation Essential for Banks

Today, banks are facing “the four horsemen of the e-pocalypse:”   disintermediation from their customers, unbundling of their services, commoditization of their products, and invisibility as customers fail to connect with bank brands, says the McKinsey report.  The impact is manifested in the loss of the customer relationship and margin compression, primarily in retail banking, leading to sluggish growth and diminished profitability.  Globally, revenue margin declined by approximately 4% from 2014 thru 2016, which lowered ROE by 1.5 percentage points.

“A full-scale digital transformation is essential, not only for the economic benefits, but also because it will earn banks the right to participate in the next phase of digital banking,” says the report.

Seven initiatives offer banks the most potential to capture digital productivity improvements:

  • Building better marketing skills, as excellence in digital marketing is now a core foundational capability
  • Reshaping the distribution architecture to create a true multi-channel experience for customers
  • Using digital tools and analytics to enhance sales productivity, e.g., by equipping relationship managers with a digital workbench
  • Industrializing operations through automation and artificial intelligence, e.g., robotic process automation and cognitive technologies
  • Reimagining underwriting, using data and analytics, to build a truly data-driven underwriting process and capabilities
  • Embracing cloud computing, open APIs, and other essential technologies, such as shared digital utilities
  • Creating an agile organization that is both stable (resilient, reliable and efficient) and dynamic (fast, nimble and adaptive).

However, while undertaking this comprehensive digital transformation is essential to prepare the bank for a digital and data-driven world and can improve the bottom line, it may not be enough to ward off the threat from major platform companies or to achieve sustainable economics, says McKinsey.  That may require banks to learn to compete effectively in the ecosystem economy beyond banking, and for many banks, the most attractive growth opportunities will lie in developing a successful ecosystem strategy.


Remaking the Bank for an Ecosystem World

The greatest threat to banks from digital competitors no longer comes from fintechs, which have often struggled to scale and have entered into partnerships with banks, but rather from what the McKinsey report terms “a formidable new force” -- platform companies.  These firms are creating digital ecosystems in which they provide customers with intuitive and pleasing ways to shop for a wide range of products and services through a single access gateway.  And now they are beginning to target the retail distribution end of banking, where there is huge value at stake.  According to McKinsey’s report, distribution, i.e., origination and sales, accounts for 47% of banking revenues and 65% of profits, with an ROE of 20%.  

Banks, however, are well-suited for the ecosystem world in a number of ways and hold several advantages over these new competitors, in particular higher levels of customer trust than tech firms, vast stores of customer data, and regulatory experience.  A successful ecosystem strategy can not only help banks improve profitability by retaining customers, improving cross-selling and lowering customer-acquisition costs, but it also has the potential to attract new customers and bring in new non-banking revenues, says the McKinsey report.  All of which could lead to a significant increase in ROE.

Achieving success in an ecosystem world will require banks to have more than top-notch digital capabilities and skills.  “Banks need to have the speed and flexibility to change shape in response to a fluid environment,” according to the McKinsey report.  Beyond this change in “mental models,” the report identifies four essential steps that banks must take for ecosystem success:

  • Organize into two main units – a platform of vital resources and an at-scale “incubator,” operated as a venture capital unit
  • Create a culture that encourages transparency and entrepreneurship and align the compensation structure with key performance indicators
  • Actively form and rigorously manage partnerships across ecosystems
  • Modernize the bank’s IT to unleash the value of data.

Banks could play several potential roles in an ecosystem.  The most basic ecosystem strategy would be joining a partner’s platform as a participant, primarily to cross-sell to new customers.  A second strategy would be for the bank to mesh its business system with partners in other sectors to provide a seamless customer experience.  A third option would be to create an entirely new ecosystem to fill an unmet customer need. 

For banks that choose not to pursue an ecosystem strategy, McKinsey sees two options:  (1) white-label balance sheet operator, or (2) focused or specialized bank.  White-label balance sheet operators will greatly expand their balance sheets, as they lend to companies with stronger customer relationships.  This model is narrowly focused on wholesale activities.  A focused or specialized bank will concentrate on either a business line (e.g. private banking or investment banking), a specific segment of the value chain, a product category, a geography, a customer segment, or a service model (e.g., a stand-alone digital bank).

To download a summary and to request a full copy of the review, just follow this LINK