Why traditional banks still outcompete FinTechs
- The retail banking sector did not wait for the arrival of neobanks (also known as online banks or internet-only banks) to begin its digital transformation.
- It was after 2008 that the transformation accelerated, when the collapse of interest rates reduced the return on loans. The sale of other services became increasingly important.
- Platformisation and data enhancement are the two rising trends: banks are trying out new businesses.
- In parallel, the banking business is being taken over by a myriad of players, not only digital players.
- But with the complexity of core banking and the difficulty of making small customer bases profitable, traditional players are protected by high barriers to entry.
The retail banking sector seems to be more resilient than others in the face of new digital players. Why is this?
Banking has always been a technology-driven industry and the sector did not wait for the arrival neo-banks to challenge itself. In retail banking, the transformation started more than 30 years ago with computerisation and dematerialisation. Customers were able to access basic operations directly, such as transfers or current account consultations. Digital technology has also facilitated access to financial savings and contributed to the democratisation of the stock market.
Yet, this transformation has raised questions like: do bank branches still have a purpose? At first, the exploration of digital technology went hand in hand with an extension of the branch network. They were not contradictory: in a business based on human relations, the physical network is important, particularly for first contact. Branch networks made it possible to win over a customer base and build up their loyalty. It is a logic has not disappeared. And even if numerous ‘digital’ banks have appeared in the last ten or fifteen years, none of them have really replaced a local bank.
Nonetheless, this new autonomy of the customer in daily operations has led to the evolution of branches. The counter-payer was replaced by advisors, some of them specialised, whose role was to accompany the customer throughout his or her life.
Until the 2000s, banks were able to invest in both physical and digital channels. But in the wake of the 2008 financial crisis there was a massive switch to digital. Why did this happen?
This shift in investment corresponds to a very rapid change in business model. Before the financial crisis, the bulk of payment was based on the outstanding amounts, which enabled credit to be granted. The bank made its margin on intermediation, and its income therefore depended mainly on the volume of outstanding amounts and their rotation.
After 2008, with the collapse of interest rates, the remuneration of loans became very low. The intermediation margin fell sharply. To rebuild their margins, banks played on two fronts: reducing costs through digital technology (given that the revenue/cost ratio was historically very low in this sector) and selling products.
Retail banks have therefore started to sell differentiated service packages, especially to a “mass affluent” clientele that is not rich enough for private banks, but is willing to pay for premium services such as Gold or Premier cards. The banks are trying to sell advantages and privileges: specialised advisers, ticketing. They are also thinking about rewards: information, training, events on finance or sustainable development, meetings between peers.
Is the wealth of data available to them useful here?
Yes, data is crucial: but banks still exploit this wealth very little, even though they have databases that are both very large (millions of customers) and very precise (hundreds of transactions for each one), much larger than those of insurance companies, for example.
Their historical positioning is that of a trusted third party, which has confidential information and keeps it. But this could change, under pressure from FinTechs (digital start-ups in the financial sector) which do not have these concerns. In particular, banks could exploit this data to better serve their own customers, but also sell (anonymised) marketing insights to other industries.
They could also contract with their customers to pass on or exploit some of their data. This aspect is only just emerging and, contrary to what one might think, the interested customers are not those with the lowest incomes but people belonging to the CSP+, who expect more efficiency and personalisation thanks to the exploitation of customer knowledge and therefore of their data. These developments are visible in the United States. In Europe, where regulations are stricter, banks are testing and experimenting.
Another aspect is platformisation, which enables them to enter the ecosystems of customer needs, as banks have already done by providing insurance or telecommunications services. Retail banks are particularly interested in the ecosystems of mobility, health and entertainment. The forays into these ecosystems are enabled by an enabling technology, the API. But interconnecting information systems does not solve everything. They need to define the right strategic positioning in worlds that are already highly coveted and ensure sufficient sources of revenue.
The questions a bank asks itself are which ecosystems it can be an entry point into and, in the others, what are the right partnerships to gain market share. It has a competitive advantage that is not negligible: on the screen of your smartphone today, you inevitably have your bank’s application.
Aren’t FinTechs and neobanks better equipped to enter these ecosystem dynamics?
They are more agile, no doubt, and both their managers and their teams spontaneously enter into this logic. In fact, we are now seeing the rise of a myriad of players, including not only digital pure players: telecom operators and insurers are also very present.
However, in retail banking services, no major digital players are emerging, and the sector’s historical players are doing quite well. There are several reasons for this. First of all, customers still express the need to have a bank that is well established, especially as banks have continued their digital transformation: customer feedback shows that there is no major difference between banks and neobanks in terms of experience.
Secondly, we are not so much witnessing an upheaval as a consolidation: banks are buying the right FinTechs, finding partners and integrating them. This is in line with the mindset of startups and the investors who back them: they are most often looking for an “exit”, which in effect means either an IPO or a buyout.
Neobanks often remain secondary banks, attracting their customers with targeted offers such as everyday banking, foreign operations, micro-credit… Those that have survived are often subsidiaries of traditional banks. Neo-banks such as N26 or Revolut have not taken a large share of the market: we are far from the exponential growth observed in other sectors that have been shaken up by digital pure players. It should be noted in passing that the customers of neobanks are often “multi-banked”: they have accounts in several institutions. But these customers are not easy to make profitable. The profitability of a bank is no longer related to the volume of its outstandings, but size still counts for a lot.
However, in this highly regulated business, the management and industrialisation of core banking are complex (core banking refers to all the basic software components that manage the services provided by a bank to its customers) if one wants to cover the different clienteles and the whole range of their needs. This is a formidable barrier to entry for newcomers.