By Raja Bose, retail banking consulting leader at Genpact
For traditional banks, learning to compete with nimbler fintech competitors is nothing new. Now, however, they face the emerging challenge of larger, well established technology companies beginning to offer financial services to consumers.
Add to this the competition they face from the larger banks with deep financial resources, and these mid-tier and smaller banks are in a difficult position. They must discover new ways to compete in order to survive. Counterintuitively, smaller banks may have a real opportunity to be bolder and to transform their model and create partnerships that enable them to remain competitive, but there are a series of challenges that they must overcome first.
Historically, a bank’s physical location was one of the main factors that determined where customers would take their business. Today, as digital banking becomes the primary channel for most consumers, the need for location convenience that once gave small and medium-sized banks equal footing is now irrelevant. By 2022, it is expected that 57.5 million US millennials will be digital banking users, accounting for more than three-quarters of the millennial population. Instead of remaining loyal to one bank, these consumers look for digital capabilities and personalised banking in real-time and across multiple providers. Unfortunately for the mid-tier and smaller banks, developing such capabilities requires a vast amount of investment in technology and expertise, which they simply do not have at their disposal.
For medium-sized banks, there are even more obstacles to overcome. Most have similarly complex infrastructures as large banks, but without the same ability to acquire customers who are looking for an increasingly digital experience. Smaller banks on the other hand may have simpler infrastructures, enabling them to be more agile. As a result, medium-sized banks have the worst of both worlds, as they’re unable to fully benefit from their size or capacity.
By 2022, it is expected that 57.5 million US millennials will be digital banking users, accounting for more than three-quarters of the millennial population.
Invest in end-to-end partnerships
Larger financial institutions already have the platform and infrastructure that they need to succeed, so many of them are partnering with (or acquiring) fintechs in a pointed way to address specific gaps in their offering or capabilities. For the small and mid-tier banks that don’t have the end-to-end capabilities, this is not a viable option, so they need to take a more holistic approach and partner with fintechs in order to develop these end-to-end solutions. Their smaller size means that they are not bound by traditional large organisational silos and should be able to partner more easily, making this a favourable option.
For smaller banks, fintech partnerships can also help them by leveraging advanced analytics capabilities to uncover customer insights and deliver better end-to-end customer experiences (CXs). A good example is the growing trend of fintechs supporting more intelligent lending, improving the underwriting process using data analytics. Fintechs can use AI to better analyse the criteria for underwriting loans and decide whether someone is a good credit risk, allowing banks to make better informed decisions and in turn reduce risk. Rather than building this capability themselves, smaller banks can integrate these fintechs into the end-to-end lending process.
To capitalise on their strengths, regional banks should consider focusing their attention on a select set of customers which they can serve uniquely.
Focus on value-added services
Given the financial pressures that small and medium-sized banks are under, it is vital that they use their resources wisely. These banks need to focus on optimising higher value services and consider outsourcing those that do not add value. By outsourcing operations that are not core to the value proposition of their business, they can reduce overall operating costs and improve capabilities where it matters most. An additional benefit of outsourcing non-value-added work is the consistency of expense that smaller banks prefer. With an external provider charging a regular fee each month, smaller banks can reduce some of the volatility associated with running customer-servicing operations.
Find a niche and lean in
To capitalise on their strengths, regional banks should consider focusing their attention on a select set of customers which they can serve uniquely. Most regional banks are already very capable in the small business lending space because they have strong connections within their local communities, so this could be a good choice. In the presence of a large competitor, a regional bank may struggle to drive their consumer deposit business, but they can offset this by leveraging their local ties in their community, presenting potential opportunities to drive small and medium sized business lending.
Furthermore, Genpact’s Banking in the Age of Instinct report highlights whole-system planning as one of the macrotrends that will shape the world and banking in 2030. Whole-system planning refers to a shift in focus from economic growth at any cost to sustainable goals that prioritise humanity and ecology, and we’re increasingly seeing medium-sized banks altering their business practice to do just that. For example, TD Bank, based in Canada, works actively to reduce its carbon footprint and is committed to building more branches that are LEED (Leadership in Energy and Environmental Design) certified, among other measures.
ultimately some banks may find that merging with another bank can free up resources to invest in technology as well as broaden banks’ geographical footprint.
Similarly, Bank of the West in the US recently announced that it would no longer support ventures that it finds to be “environmentally destructive”. Meanwhile, the world’s biggest banks increased their funding in fossil fuels in 2017 by 11% to $115 billion. As consumers will demand increased transparency on where the investment funds are going and which third parties are involved, a focus on whole-system planning can serve as a competitive advantage for all banks, including small and medium sized ones.
Expansion through merging
Despite all these strategies, ultimately some banks may find that merging with another bank can free up resources to invest in technology as well as broaden banks’ geographical footprint. In February of this year, US-based SunTrust Bank and BB&T announced their intent to merge to, “…take advantage of its enhanced scale to make significant investments… in technology to create a sustainable competitive advantage in an increasingly digital-first world.”
We expect to see a new wave of mergers between second and third-tier banks so they can achieve better economies of scale and expand their access to more regional, if not national, sets of customers. Mergers may be the most dramatic and most complex undertaking to stay competitive, but they can provide smaller banks with a new lease of life.
None of these solutions are easy to implement, but by embracing the opportunities open to them, small and mid-tier banks can gain access to new customers, investments, and technology that will prove critical to success amongst a new wave of competition.