2020 will be an interesting year for the banking industry. There are plenty of clouds on the horizon and there’s a risk that the weather might change far quicker than predicted. I hope we don’t see a year of destructive storms that echo those of a decade ago, but I think it’s unlikely that the global banking weather will remain sunny and warm in 2020.
Meteorologists draw a distinction between the long-run trends of climate change and the fluctuations of day-to-day weather conditions. I’m taking the same approach to my banking predictions this year. Although there are predictable, multi-decade-long forces reshaping the industry, the industry was shocked by how the U.S. mortgage squalls of 2007 quickly strengthened into 2008’s destructive hurricane of liquidity crises and bailouts.
There’s an argument to be made that 2020 could be the year in which the long post-financial-crisis recovery of the banking industry and the rise of fintechs as major industry players both get blown off course. Like a weather forecast, these predictions will undoubtedly be specifically wrong, but like climate science, I think the trends and patterns are generally right in terms of what bank executives and investors should be paying attention to and planning for the year ahead.
Good job on profitability. Now grow revenue.
Banks must keep using technology to drive efficiency – and not just for the benefits of a media splash in the innovation arms race. In markets like the U.K. and Germany, aggressive cost cutting will remain critical for most banks. But the leaders also need to show that they can deliver differential revenue growth by taking share from digital laggards. This is happening in the U.S., where massive technology investments are driving consolidation of assets and liabilities to the largest banks, trapping most regional and community banks in a low-growth model. Tech-led growth will need to come from the big gears of banks’ economic model—the ability to generate assets, liabilities, and material fee-income streams. By improving the customer experience, providing better in-the-moment advice, leveraging Open Banking, and generally going on the offensive, the best digital banks must show that even in a “long and low” interest rate environment they can generate profitable, double-digit revenue growth.
A pot of gold at the end of the customer acquisition rainbow?
The WeWork debacle has changed the fintech weather for 2020. Celebrity-backed Aspiration Bank’s struggles to close a new funding round hints that new entrants now need to show that there’s a pot of gold at the end of their customer acquisition rainbow. So far, slick user experiences and product innovations have driven impressive customer sign-ups. Accenture research shows that in the U.K. alone there are now over 18 million new-entrant bank accounts, up 35% in just six months, with a trend line to 25 million very soon. But, most are low-balance, secondary accounts, as two-thirds of these new customers keep their old bank accounts open. They are also heavily dependent on shrinking debit interchange fees for revenue. So even at scale, these banks will struggle to justify their lofty valuations without a more clearly defined profit model. Will they be balance sheet driven, low-cost versions of traditional banks? Or will they attempt a Spotify-style, data-driven banking subscription model (and do it better than big tech)? Or, can they achieve the massive scale required to capture material fee income from a platform model that focuses on advice and spend intermediation?
Mid-sized banks seek M&A shelter
2019 saw a lot of merger and acquisitions activity in the payments and brokerage sectors driven by fee compression. 2020 is likely to be a year in which we’ll see more traditional bank mergers driven by similar pressures, akin to the Trust deal between SunTrust and BB&T. In many markets, second tier banks are struggling to grow, with revenue leaking to both new entrants and industry titans. These banks find themselves stuck in the middle, with neither scale nor an innovative business model. If mid-sized banks can’t rely on digital leadership to reduce costs and improve profitability, many will turn to M&A as a tried-and-tested way to reduce costs, either through whole bank deals or selective business acquisitions. The smart deals will emphasize technology scale and in-market distribution overlaps. Continental European cross-border retail banking deals might make sense when banks can build a true common operating model, but we’re still years away from Europe-wide deposit insurance and other enabling factors. So, expect the action to be concentrated in fragmented domestic markets, like the U.S., and expect many smaller banks to huddle together for warmth in 2020 as the weather turns colder.
Intelligent tools get relationship managers flying high
The Marvel Cinematic Universe kicked off over a decade ago with Tony Stark in a dusty cave building a suit of armor capable of turning his beaten-up body into an effective weapon. Despite all the talk of AI and robotics, the banking world is still going to need plenty of Tony Starks: smart and inventive employees capable of being augmented and improved through the right technology support. One 2020 impact will be in the world of commercial banking – as relationship managers (RMs) start to benefit from AI-enhanced decision support. Interpersonal skills, like industry knowledge, client empathy, and the ability to negotiate pricing, will remain critical, yet they will increasingly be augmented by Jarvis-like AI support. This augmentation will help RMs better allocate their scarce time and make smarter decisions regardless of the broader industry climate. Many commercial banks have laid digital foundations through investments in improved CRM, loan origination platforms, and commercial data analytics. 2020 will likely see those investments start to pay off in a more integrated fashion. A componentized approach will break down silos between Small Business, Commercial, and Corporate Banking divisions, allowing the best banks to create a continuum of offerings that map to a sophisticated understanding of the needs and behaviors of each business customer. This year, the best commercial RMs will be protected from the weather and will begin to fly. The rest of the industry may not know what hit them.
Open Banking powers new business models
Open Banking in the EU was initially intended to increase competition by severing the link between transaction accounts and payments. Now, Open Banking is shifting from payments initiation to giving customers control over how their banking data is shared. In 2020, the banking industry must show it can be trusted with aggregated customer information and, critically, add value by using that data to improve customer’s financial health – without asking consumers to do all the work. By sharing data, customers could automatically get low-cost insurance when they buy a car or installment credit when they need a new washing machine. Data sharing will also power new business models, like Mortgage Gym, which focuses on product suitability. The downside: shared data could be a circular firing squad, wrecking the economics of the banking industry. The risk of data breaches also rises, so look for lots of talk of trust engines, data tokenization, and managed consent. Expect the best banks to accept that vertically integrated banking is dead, and to use shared data to try to claim the advisory high ground, intermediating the offers of other firms for the benefit of their customers while also protecting their personal data.
The era of purpose-driven banking arrives. Maybe.
Last summer, the U.S. Business Roundtable declared that the purpose of a corporation is no longer just to serve shareholders, but “to create value for all our stakeholders” with the signatories including many big bank CEOs. In Europe, many banks have now made carbon emission reductions and broader social responsibility goals part of their corporate purpose. Banks can play a vital role, investing in renewable energy and withdrawing or raising the price of capital in less ethically sound sectors. 2020 will begin to show whether purpose-driven business models will reshape banking, or if this is all just talk. If banks do begin to reshape their asset and investment portfolios to help address social issues like climate change, will shareholders applaud, or will they put profit before purpose? We will also see whether customers will vote with their wallets to favor the ethical and inclusive over the cheap and efficient.
Will banks stop raining fees on struggling customers?
Fee income is in steady decline – and it would be even more dramatic if consumers weren’t persistently making bad financial decisions. Making a payment when you don’t have sufficient funds still costs around $33 per incident in the U.S., netting the top three banks $1.5 to $2 billion each. In the U.K., overdraft fees and related charges account for a third of all transaction banking income. Fintechs, like Dave in the U.S., are targeting these fees by helping customers with low-cost, short-term loans and even connecting them to gig economy jobs to supplement their income. Subsidiaries of big banks, like RBS’s new UK digital bank Bó, are positioning to help customers become “better with money” to minimize those “bad with money” costs. As new entrants use AI and behavioral finance techniques to reduce poor decisions, the question for 2020 is whether any big bank will break ranks and aggressively cannibalize their own remaining “bad decision” fee income to build customer trust. In a world of growing income inequality, it rains a lot on customers who are living paycheck to paycheck. Fear of unexpected account charges is a reason why there are nearly 50 million under-banked adults in the U.S.
Watch the credit-quality barometer
Credit quality as measured by impairment charges peaked in 2014 and has been getting worse ever since. That trend is about to accelerate as benign global macroeconomic conditions come to an end. Accenture projects impairments will rise by 5% to 6% a year through 2022. How will the past decade of structural change in banking shape those numbers? In the U.S., middle-market, non-bank institutions now hold the majority of both bilateral and syndicated lending assets. Many consumer lending markets around the world are now dominated by non-bank originators. There is evidence that major banks in North America and Europe are shifting their loan mix towards pass-through sales and away from holding loans to minimize risk exposure. The question is: how will these huge pools of non-bank assets perform in even a mild downturn? Will credit models used to underwrite consumer loans to Grab drivers in Malaysia prove robust? Will credit asset managers amplify a mild down cycle by taking quick write-offs and selling assets at fire sale prices? Banks should play close attention in case the expected macroeconomic tropical depression suddenly shows signs of strengthening into a far more damaging credit hurricane.
More than a token effort: the emergence of digital currencies.
In 2019, there was plenty of innovation in the digital currency space, but also plenty of blow-back from regulators concerned about losing control of the financial system and possible encroachment on their monetary policy prerogatives. Despite aggressive boosterism, digital currencies remain a sideshow in mainstream financial services, functioning mostly as a speculative asset class. Stable coins might have a moment in the sun as a settlement mechanism for cross-border transactions, but widespread adoption of digital currencies is still tiny. 2020 could change that. After five years of development, the People’s Bank of China seems ready to launch a central bank digital currency. Most developed economies have two sorts of money: cash and coin in circulation, and “bank money” created through the reserve system and held as digital bank balances. 2020 could see the introduction of a third: tokenized central-bank-issued currency capable of being cleared and settled instantaneously between trading partners. I expect developed world central banks to launch their own tokenized digital currencies, although probably not this year. There’s cautious enthusiasm and interest in Europe, with tangible progress in markets like Sweden, while, in contrast, we see at least public skepticism from the U.S. Federal Reserve.
Calling the “Challenger” Cops
Banking has become a lot more diverse, but there’s a dangerous lack of clarity regarding the taxonomy underlying new business models, which all get lumped together as “challenger banks.” New entrants range from narrow payments specialists, like Revolut targeting cross-border transactions fees, to broader but purely digital banks, like Atom, to newish, full-service banking alternatives, like Handelsbanken in the U.K., complete with branch networks. These new entrants have taken market share from incumbents and attracted huge amounts of venture capital. In 2020, I suggest that the label “challenger bank” be replaced in strategy documents with terms that have business model specificity. A good taxonomy of new entrants would distinguish e-money players that don’t have a balance sheet from proto-banks that have a regulated balance sheet but offer a narrow range of products via purely digital channels from true “challenger banks” that can compete with incumbents across a wide range of products and services through innovation and service differentiation. Last year I pleaded for bankers to limit their use of the term “platform,” as it had become largely meaningless. Add “challenger bank” to this year’s list.