Four important trends are changing the terms of success in retail banking. New research by McKinsey & Company looks at what banks need to act now to develop new skills. Mohamed Dabo reports

Retail banks, like most companies, face an urgent imperative to reimagine themselves, with Covid-19 accelerating consumer behaviour shifts and causing significant earnings challenges given the tough macroeconomic context and extensive risk of financial distress for both consumers and businesses.

Management consultancy McKinsey & Company has identified four shifts that are reshaping the global retail banking landscape to the point where banks need to fundamentally rethink what it takes to compete and win.

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% over the same period. This reverse correlation is even sharper for the top five US banks – while reducing branches by 15%, they increased deposits by 2.6 times.

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.

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

2. Customer experience is generating 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 US, topquartile banks in terms of experience have had meaningfully higher deposit growth over the past three years.

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.

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.

McKinsey’s 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 realise benefits from scale. In its research, McKinsey reports that it expects this paradigm to change over the coming few years, as structural improvements in efficiency ratios and increasing returns to scale enable some large banks to become even more efficient.

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.

4. The unbundling and ‘rebundling’ of retail banking

The tight one-on-one retail banking relationships of old are un-bundling. Some 40% of US households today hold a deposit account with more than one institution. It is common to have a mortgage with one bank, an unsecured loan with a different lender, and separate deposit and investment accounts. The banking relationship is fragmenting even faster in countries with higher digital adoption.

This decline of customer loyalty provides a perfect context for firms seeking to enter banking in a selective way – focusing on the most profitable segments. Some attackers have demonstrated that while they cannot compete with incumbent banks’ broad access to customer data, they can compete effectively on customer experience coupled with aggressive pricing.

New entrants in financial services typically begin by focusing on a niche – making either a product- or segment-focused play. Their ambition, however, is often to own the full banking relationship of this segment over time – providing cards, mortgage products and broader banking services.

The open banking movement, heralded by Europe’s second Payments Service Directive and the UK’s Open Banking Standards, has the potential to accelerate the un-bundling of banking in the regions where it applies, leading to increasingly intense competition over the next few years.