Rewriting the rules in retail banking

Retail banks have long competed on distribution, realizing economies of scale through network effects and investments in brand and infrastructure. But even those scale economies had limits above a certain size. As a result, in most retail-banking markets, a few large institutions, operating at similar efficiency ratios, dominate market share. Changes to the retail-banking business model have mostly come in response to regulatory shifts, as opposed to a purposeful reimagining of what the winning bank of the future will look like.

Retail banks have also not kept pace with the improvements in customer experience seen in other consumer industries. Few banks stand out for innovation in customer interaction models or branch formats. Marketing investments have traditionally focused on brand building and increasing loyalty: a reputable brand stood for trust and security and became a moat, providing protection against new entrants to the sector.

Today, the moats that banks have built are more likely to restrict their own progress than protect them from attackers. Four shifts are reshaping the global retail-banking landscape to the point where banks need to fundamentally rethink what it takes to compete and win. This should be an urgent priority for banks. The pace of change will likely accelerate, with a select set of large-scale winners emerging in the next three to five years that will gain share in their core markets and begin to compete across borders, leaving many subscale institutions scrambling for relevance.

Four shifts are reshaping retail banking

Over the next three to five years, we expect a few players to emerge from the competitive scrum to gain dominant share in their core markets and possibly beyond. These firms will have taken bold and decisive actions to capitalize on the following shifts that are reshaping the industry. In some cases, these winners will be incumbents that build on an already significant share; in others, they will be institutions newer to the banking industry, which use their agility, strategic aggressiveness, and sharp execution to attract customers.

1. The traditional distribution-led growth formula no longer applies

Until the financial crisis in 2007, a retail bank’s total share of deposits was tightly linked to the size of its branch network. Over the past decade, this relationship between deposit growth and branch density has weakened. Deposits at the 25 largest US retail banks have doubled over the past decade, while their combined branch footprint shrank by 15 percent over the same period. This reverse correlation is even sharper for the top five US banks—while reducing branches by 15 percent, they increased deposits by 2.6 times (Exhibit 1). While there have been previous periods of branch contraction, they were clearly tied to economic downturns; this most recent wave of retrenchment has persisted through a period of robust economic growth.

Retail-banking branch networks are contracting across Europe, North America, and the United Kingdom (Exhibit 2), although the pace of change varies considerably between regions. Those that are ahead of the curve have reduced branches by as much as 71 percent (Netherlands). Banks in North America and Southern Europe are reducing branches and growing digital sales at a more gradual rate.

The rate of branch reduction is often tied to customer willingness to purchase banking products online or on mobile devices. Eighty to 90 percent of banking customers in the Nordics, for example, are open to digital product purchases for most financial products, compared to 50 to 60 percent in North America and Southern Europe. While customer willingness to purchase products via digital channels varies, however, the common thread is that in all markets this readiness is far ahead of actual digital sales and will require banks to catch up to consumer needs and expectations. Within any specific market, of course, there are banks that have acted swiftly to adopt digital and remote as their main channel for interactions; these banks are pulling away from the pack and have taken decisive actions on several fronts:

• Set a bold aspiration for sales/service channel mix. Banks must do more than react to shifts in consumer preferences—they need to set aspirational targets for sales and service across channels. Some customers will self-select into digital channels, but banks can do more to encourage less motivated customers to make the shift. Banks in markets like the Nordics and the United Kingdom have reduced the number of customers using branches by up to 60 percent by focusing on how to serve the heaviest branch users effectively through other channels.
• Use advanced analytics to reshape the physical footprint. Optimizing the branch network requires a deep understanding of consumer preferences in every micromarket, and of the economics of making changes at the branch level. Leading institutions are using combinatorial optimization algorithms to optimize the net present value (NPV) of the network based on granular customer data on characteristics such as digital propensity, willingness to travel, needs based on transaction patterns and branch usage, and the size and space/format of branches.
• Develop cutting-edge digital sales capabilities. Achieving meaningfully higher levels of digital sales requires sophisticated digital marketing and an understanding of how to optimize each stage of the funnel. Most consumers already seek information on financial products on digital channels, but few institutions are highly effective at converting these inquiries into digital sales. Leading banks use first- and third-party data (for example, geospatial, browsing behavior), a robust marketing technology stack (such as 360-degree view of customer, omnichannel campaigns), and an agile operating model (for example, cross-functional marketing war rooms). With these elements in place, progress can be rapid; a North American institution tripled annual online product sales in 12 months.

2. Customer experience is beginning to generate meaningful separation in growth

Across all retail businesses—including banks—customers now expect interactions to be simple, intuitive, and seamlessly connected across physical and digital touchpoints. Banks are investing in meeting these expectations but have struggled to keep pace. Many are hampered by legacy IT infrastructures and siloed data. As a result, few banks are true leaders in terms of customer experience. Even for institutions ahead of the curve, typically only one-half to two-thirds of customers rate their experience as excellent.

The impact of this less-than-stellar performance is measurable. For example, McKinsey analysis shows that in the United States, top-quartile banks in terms of experience have had meaningfully higher deposit growth over the past three years (Exhibit 3). The few “experience leaders” emerging in retail banking are generating higher growth than their peers by attracting new customers and deepening relationships with their existing customer base. Highly satisfied customers are two and a half times more likely to open new accounts/products with their existing bank than those who are merely satisfied.

These experience leaders are adopting tactics pioneered by digital-native companies in other sectors such as e-commerce, travel, and entertainment: setting a “North Star” based on proven markers of differentiated experience (for example, user-experience design, carrying context across channels), redesigning journeys that matter most for digital-first customers and not just digital-only customers, and establishing integrated real-time measurement that cuts across products, channels, and employees. These banks know that customer experience is not just about the front-end look and feel, but that it requires discipline, focus, and investment in the following actions:

• Focus on the journeys and subjourneys that matter. The relative contribution of subjourneys (such as app downloading; activating account) in determining overall customer experience varies considerably. In fact, ten to 15 subjourneys have the biggest customer-satisfaction impact for most products and should thus be the first priority. For instance, when opening a new deposit account, the researching options subjourney has eight times the impact on customer satisfaction than other account-opening subjourneys, on average. For banks, the key is to prioritize these high-impact subjourneys and systematically redesign them from scratch—a process that can take about three to four months and result in at least a 15 to 20 percent lift in customer satisfaction.
• Change the way you engage with customers. Experience leaders understand that digitization is not just about creating a cutting-edge online and mobile experience, and that satisfaction is shaped by customer experience across channels. The experience should be seamless, especially on journeys that are more likely to take place over multiple channels, such as new account opening, financial advice, or issue resolution. One wealth manager equipped its frontline relationship managers (RMs) with robo-advice algorithms that are in sync with what customers see on the self-directed channel—and provided the RMs with daily and weekly next-best-action recommendations to nudge their clients. Banks need to deploy these tools broadly and empower their frontline staff to play a more consultative role that blends human and digital recommendations. They will also need to revisit how these employees are incentivized, shifting to a longer-term view of relationships and profitability rather than just product sales.
• Translate data into personalized products and real-time offers. The amount of data available on individual customers or prospects has exploded in recent years. The challenge is to convert these data into actionable nudges and highly relevant offers for customers that are delivered at the right moment. Credit-card companies have long offered discounts on specific spending categories or with specific retailers. Today, they can improve loyalty and share of spending by providing location-specific offers right when a customer enters a coffee shop, movie theater, or car dealership. South Africa’s Discovery, as an example, is launching a bank with product features that are informed by behavioral science and incentive-design research.

3. Productivity gains and returns to scale are back

Larger retail banks have historically been more efficient than their smaller competitors, benefiting from distribution network effects and shared overhead for IT, infrastructure, and other shared services. Our analysis of over 3,000 banks around the globe shows that while there is variation across countries, larger institutions tend to be more efficient both in terms of cost-to-asset and cost-to-income ratios. However, beyond a certain point, even larger institutions struggle to eke out efficiencies or realize benefits from scale.

We expect this paradigm to change over the next few years, as structural improvements in efficiency ratios and increasing returns to scale enable some large banks to become even more efficient. The reason is twofold: first, advances in technologies such as robotic-process automation, machine learning, and cognitive artificial intelligence—many of which are now mainstream and commercially viable—are unleashing a new wave of productivity improvements for financial institutions. Deployed effectively, these tools can reduce costs by as much as 30 to 40 percent in customer-facing, middle-, and back-office activities, and fundamentally change how work is done. Dramatic change has already taken place in banking sectors such as capital markets, where algorithmic trading and automation are radically changing the talent profile.