Powerful forces are now operating to alter retail banking for a new digital era of empowered customers. Mohamed Dabo reports on four of these trends that research tells us are at the very heart of the transformation

Driven by customer expectations and the evolving regulatory landscape, change management has become a constant feature for banks. As new technology emerges, and customers expect digital access to goods and services around the clock, banks will need to keep their eyes on the following trends to stay ahead.

1. The size of branch network no longer determines the size of deposits linked to the size of its branch network.

Until the financial crisis in 2008, 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.

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, although the pace of change varies considerably between regions. The rate of branch reduction is often tied to customer willingness to purchase banking products online or on mobile devices.

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2. Customer experience to generate meaningful separation in growth

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.

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.

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.

“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,” wrote McKinsey researchers.

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.

The second factor leading to a wave of productivity improvement in retail banking is the shift from physical to digital channels for customer acquisition.

Banks with scale—and skills in leveraging that advantage—will achieve customer acquisition costs of up to two to three times lower than their smaller peers.

4. The unbundling and ‘rebundling’ of retail banking

The tight one-on-one retail-banking relationships of old are unbundling. Forty percent 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. Either by 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 United Kingdom’s Open Banking Standards, has the potential to accelerate the unbundling of banking in the regions where it applies, leading to increasingly intense competition over the next few years.

The trend toward unbundling in financial services is well under way, but where it will lead is still an open question.