Commercial banking has been so far underinvested, resulting in customers being underserved. More attention has gone into transforming retail banking, and in Business Banking plain vanilla solutions have been provided for SMEs, neglecting some of their main needs. In Corporate banking, change has been even slower thanks to higher barriers to entry. However, none of this will stay the same.
In this short article we will take a look at the business model of commercial banks, and how Digital will impact the value chain, creating threats and opportunities for the different players.
The traditional Commercial Banking Business Model
It is useful to briefly describe the business model of a commercial bank before looking at how Digital is impacting the sector. Commercial banks have mainly two types of customers: depositors and borrowers. The bank acts as an intermediary, using trusted money from depositors and lending it to borrowers at a higher interest rate. Commercial banks segment their customers into different groups, the general classification is: small companies, mid-size enterprises and large corporates. The way that these classifications are done is not strict; every bank does it slightly differently. It is generally based on turnover, entity type (whether it is a sole trader, a limited company, and unlimited company, etc.), and the complexity of the products they require.
Commercial banks offer different value propositions to different segments, as different companies have different lending needs. There is a clear differentiation between Business banking, more similar to retail banking, and Corporate banking, where relationships are more personal, products more complex and reach is more international.
Banks will use multiple channels to serve their customers. They will setup branches, relationship manager centers, ATMs, and call centers to serve with customers. With Digital, banks are leveraging the Internet and mobile channels to offer more convenience to customers. Even though commercial banks intend to automate as much as possible, a network of relationship managers is often used to serve with the high value customers.
Commercial banks have two main revenue streams, income from interest (typically 53% of their income according to McKinsey) and fees that they charge. Customers in the Commercial segment, unlike in the Retail Banking, are used to paying fees for all sorts of transactions. The main fee earners are merchant services, card issuing, non-card transaction fees and maintenance fees.
The principal blocks in the commercial bank value chain are:
- Managing the customer relationship
- Designing products and platforms
- Providing funds
- Running operations
The implications of Digital on Customer Relationships
With the emergence of new technologies, customers’ expectations keep on increasing. They want a bank that is easy to do business with, that meets their needs and that is enjoyable. Most company owners have indicated that digital capabilities are an important factor when choosing a Commercial Bank.
Commercial customers expect flexibility, convenience and good support when dealing with their bank. In order to offer this, banks will need to up their Internet and Mobile banking game in order to keep their customers and attract new ones. Differentiators such as cash flow, tax, pension, and credit card management will help to attract customers. Community banking, where companies can learn from other business in a similar position and share experiences will also become an attractive element. Fidor Bank has already been using this concept successfully on the retail side.
The introduction of Application Programming Interfaces (APIs) will soon make commercial banking a much more open environment. Effective optimization of products across different providers, which can employ several people inside corporates, will become much easier. Companies will seek to get the best deal for their needs. The emergence of aggregators offering financial products from different vendors is a serious threat to profitability, especially for business banking.
Big Data, the analysis of extremely large data sets that may be analysed computationally to reveal patterns, trends, and associations may become a key differentiator. This concept, already being explored by companies such as Starling Bank, will empower relationship managers to manager their demanding client portfolios better and help them suggest products that are right for them. Data needs to be used for understanding customers better than competitors, and to personalize their experience.
The implications of Digital on the Product offering
The introduction of Digital has already shown an impact on many products. Correspondent banks are losing their edge with the introduction of new models from players such as Ripple, which allows banks around the world to transact with each other directly, and margins are being eroded. It is still to see whether a direct company-to-company payments model leaving out banks will emerge in the medium term. This is what many predict, an ‘Uberization’ of banking.
For this element of the value chain, Big Data analysis might also become fundamental to create tailored products that cater for individual company. New banks and fintechs, which don’t have the constraints of working with old legacy systems have got an advantage to create and evolve their products.
The implications of Digital on Lending
The lending process has been a frustrating process for customers. Banks used to require a current account to be setup before applying for lending. Also, customers had to endure a long due diligence and provision of securities. With new unbundling rules and the introduction of technology, lending is becoming simpler and faster.
This means that profitability on lending is also likely to be affected, as new entrants such as LendInvest, FundingCircle and Crowdcube appear, bringing alternative finance solutions such as peer-to-peer lending and crowd funding. This is not only seen in small loans, but covers receivables financing and trade solutions too. Banks will need to invest in digitalizing their self-service portals for complex products to keep themselves efficient.
The implications of Digital on Operations
Digitalizing bank processes can reduce operational costs significantly, and it is expected that this should reduce non-card transaction fees. This will probably exclude cash in / cash out transactions, which might become more expensive, as banks keep on closing down branches.
Credit decisioning has already been streamlined quite a bit. Account opening is a great target for automation, and at the same time improving customer experience. Customers desire accounts opened quickly and conveniently, and banks that can’t offer this will suffer. This applies not only to current accounts but also to lending products. However, extensive banking regulations, requiring KYC, FATCA, CRS, as well as sanctions and PEP screening means it is quite a hard objective to achieve.
Banks need to think creatively in order to utilize technology to its best. Using third party databases for prefilling data, and electronic identification are some solutions that are currently being introduced effectively. A good benchmark for a simple account opening is Holvi Bank from Finland, who claim that it takes 3 minutes to open a standard business account.
Commercial Bank, open up or disappear
Having looked at the different pressure points on the value chain, I can only conclude that only Commercial Banks that acknowledge the new reality and adapt to it, by being fast at implementing change, will succeed. Banks need to recognize what their core offering is, and be open to partnerships to complement this.
Innovation becomes key for anyone that aspires to flourish under the new ecosystem. The customer needs to be understood better, and put at the centre of any new offerings. Firms need to focus on speed to market, having a culture that fosters innovation as well as a strong innovation plan, one that is consistent with the business strategy.
Senior bank leadership has been served one of the biggest challenges in history. In five to ten years time, we will know who thrives, and who fails to survive.