New Decade- New Crisis--European Retail Banking Radar

Kearney, Chicago Kearney, Photo Karen by King

New decade, new crisis European Retail Banking Radar Contents

Foreword 1 Be bold, act now: the operating models of the future 12 The 2020 retail banking outlook: minimizing Universal banks: using mass scale to deliver both loss and maximizing customer trust 2 standardized and specialized products 12 Revenue will drop at least 20 percent 2 Specialist banks: a quality over quantity approach 13 Meanwhile, costs will by and large remain the same 3 Direct banks: a quicker, more convenient One in eight banks will face losses this financial year 3 form of banking 13 Lifestyle platforms: a new lifestyle companion 13 New decade, new crisis: lessons learned from the Banks need to commit to a new operating model 14 Global Financial Crisis and why this time it’s Doing more with less 14 different 4 Lessons learned from the Global Financial Crisis 5 The knowledge and skills that have helped banks get where they are won’t be enough to get them where In some ways, it’s similar. But in others, they need to be 15 it is very, very different 5 Time to make a decision 15 Banking for good 5 Regardless of the current cost position, the task at Life after COVID-19: building a new banking hand is the same for all: dramatically change the landscape through M&A 16 operating model 6 Post-crisis M&A shows promising results 16 European banks will need to reduce their cost base For some players, M&A may be the only option 17 by more than EUR 35 billion in order to survive 6 The need for efficiency—based on scale and focus— 2021 and beyond 6 will lead to divestment of non-core businesses and acquisitions to strengthen the core 17 A new normal: fortifying your distribution The rise of strategic partnerships 17 channels in a world post-COVID-19 7 Customers won’t go back to how things were, It’s not just about strategic mergers, acquisitions, so neither should banks 8 and divestments—it’s also about what follows 17 The lockdown has accelerated the trend toward A mixed outlook for fintechs 18 a cashless society 9 Why the only constant will be change 18 End-to-end online banking services have become more important than ever 9 Contact centers will go digital—and replace branches as the #1 point of contact for customers 10 Branch closures will continue… 10 …but we will see a new role for bank branches 11 Customers will expect a frictionless experience across channels 11 If it can’t be done in-house, banks will look to acquire a business that can do it 11 A new age for banking 11 Foreword

I am delighted to share with you a compilation of five Through identifying these key challenges we hope short articles we recently published under the banner to help retail banking leaders across the region title New decade, new crisis. identify the emerging opportunities we are seeing to support mid- to long-term growth for their The series stems from our successful European organizations. Retail Banking Radar which is now in its 11th year. Our recent 2020 headline analysis concluded that I hope you will find these articles insightful and if you revenue for retail banks across the region will fall by would like to discuss any of the themes covered in an average of 20% by year end, with one in eight retail more detail please do contact any member of the banks facing losses this year, and profitability per Kearney team. customer projected to reduce by approximately 60%. Retail banks are therefore having to weather enormous and unprecedented changes, intensified by the recent COVID-19 crisis.

In this series, we examine key opportunities and risks across retail banking over the next few years in light of the pandemic. After months of lockdown, customers’ banking habits—and indeed expectations—have Simon Kent shifted irreversibly toward digital banking. Retail banks Partner and Global Lead, Financial Services, Kearney have come under strain as revenues drop while Connect via Linkedin operating costs have not, leading to a critical review of existing infrastructure, specifically bank branches, employee skill sets, and even employee workplaces. Cost reduction is paramount, but it won’t be enough— banks need to consider a complete transformation of their operating model and articulate a new minimum viable operating model for the future of the bank. For many banks, M&A will be a viable way to make quick and impactful changes to their operating model and the resulting surge in M&A activity will present a multitude of opportunities. While the COVID crisis in Europe is subsiding, it is far from over. Only those who embrace the urgency for change, make bold deci- sions, and take quick action will survive.

European Retail Banking Radar 1 The 2020 retail banking outlook: minimizing loss and maximizing customer trust

Over the past few months, Our modelling shows that this combination of payment holidays, low base interest rates, reduced nationwide restrictions on travel, economic activity, and reduced revenue from work, and leisure across most management fees of financial assets under manage- European countries have led to a ment will result in an average 20 percent decline in retail banking revenues. This is a base scenario, dramatic drop in consumer spend. relying on a partial recovery toward the end of the Meanwhile, repayment holidays on credit cards and year. However, it’s very likely that revenues could drop loans and offers of interest-free overdrafts abound by 35 to 40 percent, depending on the starting point while base rates have been cut across most countries, and revenues mix between different European banks. leaving banks in a precarious position as their income levels drop while operating costs remain largely Travel, leisure, and entertainment unchanged. It is an unprecedented situation and our spend has ground to a halt and research predicts that despite best efforts,one in eight banks will suffer losses this financial year. Our customers are adopting a wait- modelling has identified three predictions for how and-see approach, especially COVID-19 will impact retail banking profits in 2020: on the lending side. Revenue will drop at least 20 percent

Banks are taking dramatic measures to make life easier for their customers. With government support, European banks are granting mortgage repayment holidays, cancelling overdraft fees, and increasing credit card limits. Many countries have also cut their interest base rates in a bid to keep the economy afloat, leading to an additional pressure on revenue for banks. While there are a few notable consumer areas where business is thriving—food shopping, streaming services, and online retail—customers have dramatically scaled back their spending habits. Travel, leisure, and entertainment spend has ground to a halt and customers are adopting a wait-and-see approach, especially on the lending side, where applications for new loans and mortgages have declined.

European Retail Banking Radar 2 Meanwhile, costs will by and Our research suggests that the large remain the same average cost-to-income ratio will

Along with most other sectors, banks are entering a increase to ~80 percent, with holding pattern where basic operations need to be some banks seeing costs kept afloat as they consider what they reopen and exceeding revenues. what they agree to restart following the introduction of a crisis operating model. Many banks are commit- This is not only the right thing to do, it’s also a shrewd ted to keeping their headcount—a move that plays move. Those banks will be remembered for the active favorably with both the media and public opinion, as participation they took in helping their customers well as being a sensible long-term investment. But through a challenging time. The trust they gain from while the attention is on management salaries and customers will not only be rewarded through bonuses, news is also emerging of pay cuts, reduced increased loyalty and new business but will also working hours, and voluntary unpaid leave across prepare the bank’s customer services for a world regular staff. post-COVID-19. After all, it is unlikely that customers will fully return to their pre-COVID-19 habits and the Most branches have ether closed or reduced their crisis is likely to become a catalyst for a permanent operating hours, and some governments have issued shift toward more digital banking habits. rent deferrals, which may alleviate some of the short-term operational costs. However, for the most One in eight banks will face part operations costs remain the same for banks, leading to a tight squeeze on profit margins. Our losses this financial year research suggests that this will push the average Even with modest impairments, it will be a tough year cost-to-income ratio up to ~80 percent with some for banks—along with most other sectors. Our banks seeing costs exceeding revenues. All of this estimates suggest that up to 12 percent of banks will need to be weathered before banks see an uptick could see losses in the current financial year, with in revenue. profitability per customer being reduced by as much as 60 percent compared to 2019. Some banks have also taken on the additional expense of launching new and improved digital services for The crisis presents unprecedented challenges, and its customers, such as Lloyds Bank providing free digital long-term impact is yet unknown. However, by training and issuing free tablets to elderly customers, looking after employees, proving value to customers, Intesa Sanpaolo launching preapproved credit lines preparing for the worst economic scenario, and to small businesses and families in need, and TSB fortifying core business activities, businesses stand setting up dedicated customer care chatbots among the best chance of emerging from the crisis stronger. other online features to channel customers toward Read more on our six steps to weathering the specific services designed to help those in need due COVID-19 outbreak. to the outbreak. Such examples demonstrate how banks are taking the opportunity to deliver high-value Many banks will be looking back to the last decade services at a relatively small cost, allowing them to and revisiting how they weathered the Global actively support customers during the outbreak. Financial Crisis and navigated the recovery. There are some obvious similarities—and differences—between the COVID-19 crisis and the Global Financial Crisis that we will examine in more detail in our next installment in the series.

European Retail Banking Radar 3 New decade, new crisis: lessons learned from the Global Financial Crisis and why this time it’s different

It is becoming increasingly clear Lessons learned from the Global Financial Crisis mean that this time banks are better prepared. that a rapid and full recovery in However, it will take a radical change in operating 2021 is unlikely. The resulting models to survive. Banks will need to invest in the recession from the crisis, dubbed digitalization of customer interactions and employee value propositions to ready themselves for a new the “Great Lockdown,” could lead banking era that addresses the needs of changed to a global GDP contraction of at behaviors and habits. Unlike previously, it will not be a least 3 percent in 2020, according case of doing “more of this and less of that” but about doing things differently, by tackling bold operational to the IMF, making this the worst decisions and significantly upgrading digital recession since the Great capabilities. Depression, and certainly much worse than the Global Financial Crisis. This throws everything we know about a recession into harsh relief—we are facing a much slower recovery, a higher rate of unemployment, and a long journey Banks will need back to the levels of consumer confidence seen just a few to invest in the months ago. digitalization of customer interactions and employee value propositions to ready themselves for a new banking era.

European Retail Banking Radar 4 Lessons learned from the Global In some ways, it’s similar. But in Financial Crisis others, it is very, very different

Banks emerged from the Global Financial Crisis In some ways, the two crises are similar—for the stronger, thanks to increased regulation and the banking industry at least. Both crises started in tough decisions each bank had to make to survive, other markets—the Global Financial Crisis started be it restructuring, streamlining operations, as a real estate crisis, which spilled over to the reducing headcount, increasing capital buffers— economy, and we are currently in a health crisis, or all of the above. which will do the same.

The regulations were designed not only to strengthen The industry has been in a period of long-term low the industry, but to provide protection against future interest rates since the Global Financial Crisis and this crises. Banks are significantly better positioned as a is likely to continue in the years ahead in order to result. The Global Financial Crisis highlighted the need stimulate the economy post-COVID-19, much in the for banks to strengthen their capital adequacy and to same way that low interest rates were introduced maintain solid liquidity buffers, as the crisis showed post-Global Financial Crisis. In this respect, not much that a short-term lack of liquidity can bring down a will change. Banks will continue to operate in a similar profitable bank in a matter of weeks—both hard environment as before and it will weigh heavily on lessons learned that have made the industry signifi- their performance. cantly more resilient to future economic disruption. However, in most ways, this crisis will be different. It Banks are also now acutely aware that the hit from has happened quickly, hit very hard, and will remain impairments is not immediate but can have a long with us for some time. GDP forecasts for 2020 are tail. This time, banks know to prepare and account for already predicting a contraction of 3 percent, impairments extending far beyond the immediate compared with the post-Global Financial Crisis crisis. We predict that up to 80 percent of crisis-re- contraction of 1.9 percent in 2009. In some countries, lated impairments will come after 2020 and while it’s worse. This crisis is already showing signs that it will most impairments will hit in 2021, some local econo- last longer and cut deeper. It looks like the economy is mies will continue to feel the effects into 2022. in for a recession followed by a prolonged period of slow recovery, which could result in an unprecedented Since the crisis, the industry has also seen a huge shakeup in many industries and a battle for survival for shift toward digitalization, leading to significant cost small entrepreneurs and private individuals. efficiencies as branches have closed and operations have been further streamlined. Some would argue Banking for good that the banking industry is as strong as it has ever been. This time, they’re ready. In one significant way, this crisis will be different for a good reason. During the Global Financial Crisis, many banks had insufficient liquidity and inadequate capital. And they suffered for it. Now, due to lessons learned from the crisis, banks are well capitalized and have the capacity to support the economy—at least from today’s perspective. As the motor of economic recovery, banks will be expected to provide credit where it is needed most, to open “doors” and operate even if the rest of the economy is in a lockdown. This time, they won’t be standing in line for government aid and may instead be able to actively support the recovery, providing credit where it’s needed most. There is a compelling need to use the lessons learned from the past crisis to curb risks and ensure business continuity, while addressing the new challenges of social distancing and remote operations, which the lockdown necessitated.

European Retail Banking Radar 5 Regardless of the current cost European banks will need to position, the task at hand is the reduce their cost base by more same for all: dramatically change than EUR 35 billion in order to the operating model survive

Banks have been on an efficiency drive over the last While recent measures—branch closures, reduced decade. Since 2007, about 61,000 branches have headcount, improved operating efficiencies—may closed across Europe, representing around 36 have contributed between 15 and 20 percent cost percent of all branches, and approximately 600,000 reduction in the past decade, the effects are not employees lost their jobs, amounting to 22 percent of visible in the cost-to-income ratios of banks. total employment in the banking sector. Banks are all too familiar with cost reductions. Across Europe, banks will need to reduce their costs by EUR 35–45 billion over the next few years. This will And yet cost discipline is something they will need to require a reduction of at least an additional 20 explore further to fight the effects of the crisis. The percent of the cost base. This is by no means an easy picture is uneven across Europe, as each country has undertaking. During the peak of the Global Financial a different starting point and subsequent challenge Crisis, banks managed to reduce cost per client on ahead. While retail banks in Scandinavia and Poland average by EUR 20. In order to keep the 2019 cost-to- have already created efficient cost structures and income ratio of 62 percent, savings of EUR 80 per reduced their cost-to-income ratio below 50 percent, client will be needed from the current 305€ per two of the largest European markets—Germany and client. While this is a massive effort, the banks who France—struggle with fragmented markets and costs manage to move in this direction, diversify with more accounting for 70 percent+ of the revenue. digital services, and deliver a minimum viable operating model while at the same time staying close The easy cuts have already been made, leaving little to clients at this pivotal moment in their lifetime will room for further traditional cost reduction. But further have an opportunity to build upon existing client cost reductions are imperative. Banks will need to loyalty and increase their market share significantly. look at bolder, broader transformations. This means not simply cutting costs but rethinking existing 2021 and beyond operating models, digital transformation in both back-end operations and front-end customer To achieve such a sizable—and sustainable—cost services, and reviewing their core positioning to reduction, there is no alternative but to fundamentally ensure they are meeting the needs of a new era of transform the operating model with a new way to retail banking. serve clients and new way of working. For those who treat this crisis not as a hiatus to operations but as a catalyst for a new era of retail banking, they can expect to see a good chance of a strong recovery.

For the remainder of the series, we will explore ways to fortify distribution channels, the operating model of the future, and how to build a new banking land- scape through M&A. In our next article, we will examine the broader, bolder steps banks can take to prepare for the channel shift in retail banking and position themselves as a next-generation retail bank.

European Retail Banking Radar 6 A new normal: fortifying your distribution channels in a world post-COVID-19

The lockdown has led to a massive From a payments perspective, the banking industry is holding up well. While the total number of payments shift to online activity, as people has declined, online spend has increased amidst the take to the web for everyday tasks COVID-19 lockdown, with Visa and Mastercard and entertainment. What once reporting a 20 percent uplift in “card not present” transactions and a notable rise in customers trying served as a convenient alternative online payments for the first time. Online and mobile to the real thing has now become banking are helping customers to easily service their the sole link to the outside world. accounts remotely. For some individuals and busi- nesses, online services have helped them to cope Shopping, socializing, and with financial difficulties and banks have risen to the entertainment are now done online, challenge to offer more online help than ever before and thanks to delivery apps, even as a broadening range of customers visit their site in our eating habits have gone digital. lieu of a local bank branch.

None of this is new, of course. The trend toward As our collective familiarity with online banking digital has been around for years as technologies increases, it’s likely that a lot of these habits will improve and businesses expand their services to stick beyond the pandemic. So, what does this include better online capabilities. But this pandemic mean for banks? has accelerated that trend, regardless of industry or demographic group. Businesses that weren’t previ- ously offering online services are now frantically upgrading their capabilities and any Internet-averse individuals are receiving quick and basic tutorials by Shopping, their relatives over Zoom. socializing, and entertainment are now done online, and thanks to delivery apps, even our eating habits have gone digital.

European Retail Banking Radar 7 Customers won’t go back to Our study reveals that 53 percent of European banking customers do not use physical channels at all how things were, so neither when researching and buying products (see figure 1). should banks As customers become more familiar with online banking, due to the lockdown, we predict that this is Customers have shown that they can and will interact set to increase to 65 percent in 2025, requiring with banks digitally. The key is to do it in the right order, European banks with branch-heavy operating models and at pace. This is a great opportunity for banks to to focus on developing their digital channels further. audit their customer processes—particularly offline processes and their connectivity to digital processes— Digital banking should now be considered the and prioritize these areas for further investment and preferred way for customers to engage with their improvement. For those customer processes that have bank. If banks continue to improve their processes at been rapidly digitized in the early days of the the same speed and agility demonstrated at the pandemic, these now need to be stress-tested and beginning of the pandemic, they could be in a improved as required to ensure long-term operational significantly stronger position by the end of the year. resilience. The same goes for any digital processes that were already in place, which also need to be Those that don’t will miss the opportunity to continue stress-tested for a more integrated and digital banking the momentum created by customers’ new digital era. It’s a win-win situation—digital banking is not only habits, structurally change their cost base, and better for the customer, but cheaper for the bank. dramatically improve customer experience. Whatever happens, don’t expect to turn everything back on and go back to the old world.

Figure 1 100% 100% Although signi icant dierences exist between Austria, Spain, and countries, at European Portugal are the most level more than half of traditional markets, where Physical channels 35% >65% of customers customers do not use — Bank branch perform their operations physical sales channels 47% only in branches and to research and buy — Independent through advisors advisor new products

Customers choosing physical vs. remote channel Norway, UK, and Sweden (%, all countries and are the most innovative product types combined) Remote channels markets, where 70% of 65% customers rely on remote — Online channels to research and — Mobile 53% purchase products — Call center

2020 2025F

Source: Kearney analysis

European Retail Banking Radar 8 The lockdown has accelerated End-to-end online banking the trend toward a cashless services have become more society important than ever

Since the lockdown, we have become almost com- Our study also shows that customer online sales tend pletely reliant on digital payments, whether through to be lower than customer online research, indicating e-commerce payments or contactless transactions. that they revert to bank branches or customer In fact, the contactless payment limit has been support services when it comes to finalizing their increased in 29 countries across Europe in an effort to purchase (see figure 2). reduce human contact for in-store payments. As we gradually return to normal life, equipped with face However, the pandemic has forced us to make better masks and hand gel, it’s hard to imagine going back use of digital channels, a convenient way of banking to the practice of handling coins and notes that have that’s likely to have lasting appeal, and we predict that changed hands many times across the population. 70 percent of account openings, deposits, consumer For retail, this means a huge shift away from cash loans, and credit card applications will happen payments and more investment in online payment digitally over the next three years. capabilities. In turn, cash withdrawals will decline, cashiers and onsite security in branches will be less in However, this depends on the end-to-end capabilities demand, and most banks will move to cashless of the bank; whether it’s a case of simplifying the branches, providing access to cash only through documentation process—Monzo allows customers to self-service machines—especially for smaller send a screenshot of their passports or driving license branches and larger urban centers. to open an account, for example—or a case of updating systems, herein lies an opportunity for banks to not only streamline their operational efficiency but to also offer an improved seamless service to their customers. Less clicks, less fuss.

Figure 2 Clients research products more often in digital channels, but more purchases still happen of line, driven by, among other things, banks’ lack of end-to-end digital capability

Preferred channels in product research vs. sales (%, by region)

21% 18% 24% 27% 35% 33% 42% 39% 46% 46% 11% 50% 53% 10% 1% 62% 13% 11% 67% 10% 2% 11% 13% 2% 2% 14% 21% 13% 9% 9% 22% 2% 6% 7% 5% 20% 70% 8% 17% 5% 59% 61% 60% 52% 2% 6% 45% 39% 6% 34% 38% 35% 27% 23% 21% 15%

Research SalesResearchSales Research Sales Research SalesResearchSales Research SalesResearchSales United Kingdom Sweden Italy Poland France Germany Spain Norway Austria Portugal

Bank branch Call center Independent advisor Digital (online + mobile)

Source: Kearney analysis

European Retail Banking Radar 9 Contact centers will go digital— Branch closures will continue… and replace branches as the #1 Thanks to the increasing adoption of online banking, point of contact for customers which has become even more popular since the pandemic, the role of the bank is becoming less Call centers are also feeling the effects of shifting relevant for customers in its current format and trends to online browsing as customers increasingly branch numbers will continue to decrease, perhaps at go online to research and buy banking products and an even faster rate than before the pandemic. Our services. However, those who still wish to speak to study indicates that we are likely to see as many as someone in-person are more likely to use customer 40,000 branches (25 percent of all branches in services, either through webchat, video calls, Europe today) close across Europe in the next three chatbots, or by phone, than visit a branch. This years. The rate and extent of branch reduction will provides contact centers with a continued role in the differ by market, as some have already made dramatic omnichannel mix as they take on more complex reductions with European branches numbering customer enquiries and provide support for online around 165,000 in 2019, down from 209,000 in 2014 research and sales, providing the personal human and 240,000 in 2009 (see figure 3). contact of a branch visit without the inconvenience of visiting one. While the starting points will be different, the trend is the same across all European countries: banks will operate with less branches in the future.

Figure 3 Since 2008, Southern Europe has seen a 49% decrease in branches, while Eastern Europe has reduced its branch network by just 33%

Regional branch network evolution (annual percentage change)

Nordics and Switzerland Western Europe Southern Europe Eastern Europe

2008 100% 100% 100% 100% 2009 -5.6 -2.6 -1.9 -1.9 2010 -4.7 -0.9 -1.9 -0.6 2011 -2.8 -0.8 -3.9 2.4 2012 -2.7 -2.1 -3.6 0.8 2013 -3.0 -1.3 -7.5 0.8 2014 -2.3 -2.3 -3.9 -5.9 2015 -7.7 -1.8 -2.7 -1.7 2016 -3.2 -3.4 -5.4 -3.9 2017 1.3 -3.4 -5.2 -2.0 2018 -10.9 -4.6 -6.8 -6.5 2019 -5.1 1.3 -6.2 -4.8 53.4 75.4 50.9 76.7

Nordics and Switzerland includes Denmark, Finland, Norway, Sweden, Switzerland; Western Europe includes Austria, Benelux, Germany, France, United Kingdom; Southern Europe includes Spain, Italy, Portugal; Eastern Europe includes Czech Republic, Croatia, Hungary, Poland, Romania, Slovenia, Slovakia 2008‰2015 data for Serbia and 2008‰2012 data for Croatia are estimates obtained by considering the percentage amount of branches included in RBR tool for 2019 Sources: ECB number of branches, domestic – home or reference area (UK data since 2015 from ONS via NOMIS database, Norway data from Finansnorge, Switzerland data from SNB); Kearney analysis

European Retail Banking Radar 10 …but we will see a new role for Customers will expect a bank branches frictionless experience across

The relevance of bank branches continues to channels spark debate, especially when it comes to financial Even though online banking is becoming increasingly inclusion for those living in rural areas or those who popular, it will always be part of a broader, omnichan- prefer to bank in-branch, notably older generations. nel offering due to the variety of products and It’s therefore unlikely that bank branches will services offered, particularly when it comes to more disappear, although they will need to be adapted to complex products. Banks will need to invest in an better suit this new age of retail banking. As customer omnichannel concept with simple and smooth adoption of online banking increases, bank branches handover between channels. This isn’t a new idea— will be primarily staffed by higher-qualified advisors banks have been trying to get this right for years and to focus on more complex products, such as mort- while many banks have made significant improve- gages, life insurance, pensions, and investments ments, many still lag behind. If there was ever a time advice. In some countries, such as the UK, there are to invest in providing a seamless customer journey regulations requiring advised sale for certain across digital and offline channels, it’s now. products, further adding to the longevity of Customers will expect a frictionless experience. If advisory services for retail banking. they start an application online or a conversation on the phone, they will expect to be able to resume their This isn’t the only change that we will see in local enquiries at a later date using any channel. Seamless branches. connectivity will be expected as standard.

Remote working, forced by the pandemic, has led to companies and employees alike adjusting to a new If it can’t be done in-house, banks way of working that has in the main proven to be will look to acquire a business considerably cheaper for businesses and more that can do it convenient for staff. Suddenly, those big city-based headquarters seem to make less sense than they did In the race to become a frictionless and optimized a few months ago. The CEO of Barclays recently omnichannel offering, some banks may not be in a spoke about reducing its head office space and position, either financially or strategically, to develop even repurposing local bank branches as sites for the necessary capabilities in-house quickly enough. employees holding centralized roles. If others follow In fact, our first article in this series predicted that suit, we may well see a mass repurposing of local European banks would need to reduce their costs by bank branches into hybrid space for both custom- EUR 35 billion over the next few years. er-facing staff and head office staff. The pandemic has also proven that remote working can work under We therefore predict a rise in bolt-on M&A acquisi- the right circumstances, so it’s likely that we will not tions or strategic partnerships as banks build out their see a return to the five-day commute but instead may digital proficiency—something we will focus on in see desk-based employees, such as contact center more detail in our next article in the European and head office staff, splitting their time between Banking Radar Series. office and remote working. Indeed, banks are already starting to set up investment programs to support A new age for banking the new way of working. The pandemic has proven to be a catalyst for many changes already underway in the banking industry. The shift to digital banking, the reduction of branches, and the need for more connectivity between channels are not new trends, but the pandemic has significantly accelerated demand for these changes to happen, and quickly. By necessity, the industry has found new ways of doing things that wouldn’t have previously happened, resulting in a new way of doing things that may even prove to be for the better in the long run for customers and banks alike.

European Retail Banking Radar 11 Be bold, act now: the operating models of the future

With a history of both reduced The starting point is different across Europe. Some banks have already embarked on their chosen model revenues and rising costs per which will need to pivot for a post-COVID-19 market. customer, coupled with the Some banks will have more limited options, as not all macroeconomic headwinds, four models described below will be viable. However, for the majority of European banks, they need to act decisive strategic change is now, challenge their current trajectory, and make a needed in retail banking. The strategic choice: what model will work best for us? most efficient and intuitive way to achieve this is by deploying Universal banks: using mass the appropriate “minimum viable scale to deliver both operating model” for your standardized and specialized organization and market. The products pre-crisis model needs to adapt By taking advantage of their enormous infrastructure to the post-crisis world. Operating of branches, employees, and mass operations, many bigger banks will be ideally suited to deliver a broad models will look very different, range of good value and standardized services at a very quickly, and not every bank lower cost. Scale brings market power, pricing will have the same setup. In fact, advantages, and high share of customer wallet. However, standardization by no means implies a we will see a move away from the limited offering or basic products. By virtue of scale, “generalist” operating model as these banks will also have the capability to pick and banks have to make choices to choose a selection of specialized products and business to suit different customer segments, all deliver improved efficiency and delivered through highly disciplined, automated to deliver a compelling customer processes and back-end operations. This model might proposition. eventually evolve into a utility service that may also be used for smaller banks as a back-end function—as a bolt-on to their own banking customer interface.

European Retail Banking Radar 12 Specialist banks: a quality over Lifestyle platforms: a new quantity approach lifestyle companion

Some banks may choose to specialize and focus on Some banks will move away from the traditional the client interface in a niche segment of banking. As concept of banking to fully integrate into a customer’s more banking products become digitized, especially everyday life. Using data gleaned from everyday everyday banking, banks may choose to reallocate customer spending habits and retailer and leisure resources to more customized and complex products, preferences, such platforms will have the insights such as mortgages, insurance, and investments, needed to anticipate and recommend offers and where returns are higher and can be protected from services across all businesses—retail, entertainment, universal banks. By focusing on specific “verticals,” household bills, travel, and so on. A one-stop solution these banks will become specialists in a subset of to the customer’s daily needs, they will no longer be services and products. While they may continue to just a bank. They will become a lifestyle platform. This offer everyday banking, they will be best known as the model is also an option for entrants from other gold standard for offering highly personalized industries—especially large e-commerce and social propositions. Such specialist banks will deploy networking platforms that have a loyal client base and technology, offer excellent end-to-end service, collect from where banking, especially everyday banking, data and analytics to get to know each client individu- provides an opportunity to broaden the services to ally, better understand patterns of banking product their clients and solidify existing relationships. use, and offer products with more relevant context and purpose. For this specialism and insight, the bank can develop a mutually better outcome for both the customer and the bank.

Direct banks: a quicker, more convenient form of banking

Not surprisingly, the number of direct banks is set to increase, with challenger banks leading the way. These banks will focus on setting the new standards for digital capabilities and embrace strategic acquisi- tions and partnerships to grow or fill product gaps. The target audiences for these banks will be digitally savvy customers who are comfortable with online banking and familiar with digital processes and interactions, much preferring the convenience of apps and chatbots over in-branch banking services. They benefit from lower-cost operations, modern flexible architectures, and a customer-first mindset. Most European Their challenge is growing the returns for the business in line with the growth in customer numbers. banks need to act now, challenge their current trajectory, and make a strategic choice: what model will work best for us?

European Retail Banking Radar 13 Banks need to commit to a new Doing more with less operating model As with many industries, digitization will significantly It’s been a long time coming, but the effects of improve operational efficiencies and will inevitably COVID-19 have accelerated the need for banks to lead to a lower headcount and a different mix of skill make a choice about the type of bank they want to be sets. Operations will be the most-affected depart- in the future and to make those changes now, ment as it becomes largely automated with straight harnessing the transformative potential of minimum through processing (STP). Banking models will evolve viable operating models and adjusting accordingly. with certain banks opting to share processing Up to now, most banks have strived for size and scale, infrastructure with others to reduce overall costs. This trying to be everything to everyone. This has led to will be particularly true where combining undifferenti- inefficient cost structures and a generic customer ated activities helps gain scale efficiencies, for offer that are unsustainable in the longer term. example in cash handling or basic KYC processing. Advanced analytics will also increase as it integrates Irrespective of size or geography, most institutions into almost every aspect of retail banking from manage their cost base in line with the expectation predictive sales and gauging client price sensitivity to about the development of revenues. Bold changes in fueling more robust risk models and better managing the operating models—either toward significantly internal capacities. leaner cost structure or stronger focus on client and top-line opportunities—are rare. The case for change is clear in both the high operating costs and reduced income per customer shown below (see figure 4).

While the choice of the operating model is crucial, bringing it to life will be even more challenging. The changes will touch on almost every aspect of business and most employees in retail banks.

Figure 4 70% Banks have historically 60% clustered in the same 50% operating model, with no real 40% breakout performance from customer 30% r the norm, and then scaled up pe 20% s or down accordingly 10% cost Evolution of income per g 0% customer vs. operating -10% -20% operatin costs per customer—

of -30%

Europe, dierent relative n market position1,2 -40% 3,4 (20152019f, % ) olutio -50% Ev -60%

% business volume -70% in their country -70% -60% -50% -40% -30% -20% -10% 0% 10%20% 30% 40%50% 60%70%

Evolution of income per customer Leader Follower End tail

1 Europe includes Germany, Austria, Spain, France, Benelux, Italy, UK, Portugal, Switzerland, Nordics, Czech Republic, Hungary, Slovenia, Slovakia, Poland, Croatia, Romania, and Serbia. 2 Relative marketing position is computed on the basis of the percentage of business volume (client deposits and loans) of each bank vs. its country; in some cases, an adjustment was required. 2019 data is partially based on actual annual igures, partially on forecasts based on Q3 2019 results.  When analyzing changes of indicators denominated in Euros, we applied 2019 constant exchange rates to present growth in real terms. Source: Kearney 2020 Retail Banking Radar

European Retail Banking Radar 14 As the number of bank branches decreases, staff The knowledge and skills that numbers will also decrease with remaining roles expanding beyond semi-skilled cashiers to skilled have helped banks get where advisors. Technical support departments, ironically, they are won’t be enough to get will decline by 25 to 30 percent as banks increasingly them where they need to be outsource to technological specialist players. It will be crucial to change the resource mix in order to These changes will mean a significant transformation orchestrate and control the IT platform design and its of employee skill sets, requiring a balance between evolution. Generally, many departments will reduce reskilling existing staff for business continuity and a headcount as automation and predictive analytics selective onboarding of new talent. Millennials and lead to greater transparency and data availability (for Gen Z now make up 59 percent of the global work- example, risk management could decline by 10 to 15 force and they are driving a more flexible, progres- percent). While overall headcount will decline, there sive, and purpose-led working culture and a trend for will be some notable growth areas. Remote advisory, shorter employment tenures. Like many industries, for example, is likely to gain popularity once again as financial services will also need to move away from customers increasingly shift to digital channels, hierarchical and matrix structures and adopt flatter, leading to banks finally breaking through the long- more flexible structures. standing threshold of 10 to 15 percent of customers using this channel. In financial services, the people agenda has become a crucial challenge for the boardroom—not just for It’s also important to rethink the IT governance and attracting the best talent, but attracting talent to the operating model, consolidating and focusing only on financial services industry as a whole. As roles those partners that help the bank reach their operat- become more technical, banks will not just be ing and business objectives, as significant cost competing among themselves but also with technol- reductions will unlock resources that can then be ogy companies and will need to offer a compelling invested in business model transformation programs. employee proposition—not just financially but in This includes reviewing the vendor base to minimize terms of career progression, learning opportunities, supply chain risks related to a changing business and purpose—to acquire and retain the best talent. landscape and improving service levels to meet the new customers’ needs. Meanwhile, it’s important to Time to make a decision evaluate existing stratified and stand-alone solutions for new business efficiency, looking for new services Retail banking is always evolving, but we are now and solutions (such as end-to-end investment witnessing an acceleration of trends—across all platforms and powerful advisory tools). industries—forced by the COVID-19 pandemic. It’s no longer just about cost reduction, but a fundamental transformation of the operating model. It’s time for banks to critically evaluate their operating model in order to best position themselves for a more digi- tized, customer-centric world.

Rather than being everything to every customer, now is the time to choose scale, specialism, becoming fully digitized, or making the transcendent step out of financial services and becoming a lifestyle platform.

The people agenda is a top priority as the business adapts to a new operating model. While headcount reduction is both cost-effective and easy to measure, the biggest focus should be on reskilling existing staff and becoming an attractive employer for both technology specialists and younger generations.

Finally, banks should consider developing their partnership ecosystems—starting in the technology area—to accelerate their shift to a new operating model, something we will explore in our fifth and final article in this year’s European Retail Banking Radar series.

European Retail Banking Radar 15 Life after COVID-19: building a new banking landscape through M&A

While the banking industry has Post-crisis M&A shows been in a state of transformation for promising results years, the COVID-19 pandemic— Following the financial crisis of 2008–2009, the both through changing customer number of mergers and acquisitions briefly surged, habits and a radically shifted followed by a slump during the eurozone crisis of 2010–2012 when pan-European M&A activity stalled. economic landscape—has put Since then, cross-border acquisitions have decreased immense pressure on retail banking and remain at a two-decade low, with most transac- performance, accelerating the need tions occurring in-market ever since. While the pandemic lockdowns have stalled international to reinvent the operating model. activities and might not be conducive to cross-border This will require new capabilities— M&A, we anticipate that the number of domestic and fast. As a result, we expect to transactions will significantly increase. see a rise in mergers and Our Retail Banking Radar database shows that eight acquisitions but also divestitures out of 10 domestic mergers and acquisitions follow- over the next couple of years as ing the financial crisis of 2008–2009 outperformed their local retail markets—in terms of profit growth banks seek to reduce costs in the per customer—in the three years after completing short term, refocus the core business their integration. This indicates that crisis-driven M&A for the long term, and ultimately can and does improve performance. Many banks will need to consider M&A as the most efficient means to transform their operating models. radically reshape their business portfolio—for both Our study shows that one in four banks will see their buyers and sellers—to achieve the required scale of cost-to-income ratio surge above 80 percent as cost reduction and transformation before it is too late. revenues fall but operating costs prove stickier. There will be some winners, but some notable losers also as our study shows that one in seven banks will have a cost-to-income ratio that might exceed 90 percent. For those banks, M&A may be their only option to survive by delivering cost synergies, strengthening their focus on selected client segments or products, and improving their ability to innovate or to engage clients. Those who are shrewd and quick to act with strategic acquisitions and divestments will succeed, whereas those who lag will suffer. The resulting shakeout might even see some big names disappear, as based on our analysis more than half of the banks with exceptionally high cost-to-income ratios are national champions and well-known brands.

European Retail Banking Radar 16 For some players, M&A may be The rise of strategic partnerships the only option In addition to a rise in M&A, we also predict a rise in During the previous global economic crisis, financial strategic partnerships, particularly across smaller distress was a key driver of M&A. This time, banks banks, as they seek to gain reach quickly and effi- are better capitalized in general, but a prolonged ciently. We have previously explored four new recession and resulting rise in impairments could lead business models—universal, direct bank specialist, to some banks facing capital shortfalls. As a result, the digital, and lifestyle platforms—as possible strategies potential balance sheet stress driven by a sharp for retail banks to reshape their cost base, but increase in impairments, together with a decline in conversely, as banks differentiate themselves in a new revenues, could lead to some lenders being forced retail banking landscape, we may actually see an into M&A. Our database analysis indicates that increase in partnerships and collaborations as banks domestic mergers and acquisitions are often driven by leverage capabilities off others through back-end the need for scale and cost reduction. In 80 percent operations, technology platforms, or shared supplier of cases, the acquired entity had substantially higher networks. This need for efficiencies will drive a culture cost-to-income ratio than the acquirer and well beyond of retail banking partnerships. the European average of 60 percent. Organizations with either of these issues should take heed. It’s not just about strategic mergers, acquisitions, and The need for efficiency—based divestments—it’s also about on scale and focus—will lead what follows to divestment of non-core Let’s not forget that M&A is just a facilitator for a businesses and acquisitions much broader plan. As already discussed, making an to strengthen the core acquisition just after a crisis—when valuations are low and targets plentiful—is not enough. Every M&A is a As retail banks revise their future operating models massive change. How companies create value from and refocus their core business offering, some might the acquisition and how they manage the integration seek to divest assets where they are unable to is key. The process requires: maintain competitive edge in the mid-term, such as asset management subsidiaries given the rapidly — Strong due diligence and realistic synergy consolidating industry brought about by lower costs expectations and better performance of the global asset manage- ment giants. Some retail banks will need help in — A practical and realistic plan for integrating both bolstering and scaling up their core business (for entities, including multiple dependencies example, profitable segments or products) or strengthening their franchise in certain geographies. — Consistent care and communication to all Some might opt to “source” new capabilities, such as stakeholders, such as clients, employees, and analytics or AI. One way to achieve this—quickly—is investors through acquiring businesses that help improve scale and deliver cost synergies. — Paying close attention to external market conditions and not being consumed with internal Meanwhile, the fintech landscape has seen an integration operations emerging dichotomy with the valuations of estab- lished players with a track record of profitability at — High rates of employee retention and strong all-time highs, while those that are still unprofitable employee motivation may become a distressed acquisition for opportunis- tic buyers looking to acquire new technologies or a — A conscious commitment to fuse and align the new customer base. unique cultural working practices of the two organizations

A realistic and actionable post-merger plan will be the difference between a successful and canny strategic investment versus an expensive and potentially irreversible mistake.

European Retail Banking Radar 17 A mixed outlook for fintechs Why the only constant

While the fintech industry covers a broad spectrum of will be change business models, one issue remains the same for all: Recent socioeconomic disruption has radically capital raising for fintechs has been declining in 2020, changed the economic outlook. Never has there been putting pressure on the industry. While some business a better opportunity—or more dire need—for retail models will be more resilient than others, many banks to reshape their cost base and revise their fintech start-ups have struggled during the lockdown, long-term future operating model. Quick to appear with several not qualifying for government subsidies. and slow to recede, this crisis is unprecedented in magnitude and the economic relief we are seeing Those who offer loan products need to be sensitive to across Europe will only be temporary; banks will changed client behaviors—decreased demand for continue to feel the effects of the crisis for the next lending and increased risk of default could be a two to three years. Banks cannot carry on as before. potent combination creating a difficult future and Change is needed for the vast majority of European potentially failure. Challenger banks less reliant on retail banks, requiring bold decisions and quick action. lending may be in a better position based on strong brand positioning and their ability to scale up their In this series, we have examined and summarized key digital operations to meet the needs of a more opportunities and risks across retail banking over the digitized banking landscape. However, these banks next few years in light of the COVID-19 crisis. After will also face challenges to their top line due to months of lockdown, customers’ banking habits—and reduced consumer spend and cross-border travel. indeed expectations—have shifted irreversibly toward digital banking. Retail banks have come under strain Technology fintechs, such as payment providers, as revenues drop while operating costs have not, might find new partnership opportunities with banks leading to a critical review of existing infrastructure, and retailers. specifically bank branches, employee skill sets, and even employee workplaces. Cost reduction is We believe that many mid-sized and small fintechs paramount, but it won’t be enough—banks need to will come under funding pressure, which will divide consider a complete transformation of their operating the industry into winners and losers. For some, the model, incrementally implemented through minimum only option will be to sell. For others, this could viable operating models to shape the future of the provide opportunities to augment their capabilities at bank. For many banks, M&A will be a viable way to a good price and expand their partnership ecosystem make quick and impactful changes to their operating to include, for example, established banks. model and the resulting surge in M&A activity will present a multitude of opportunities. While the COVID crisis in Europe is subsiding, it is far from over. Only those who embrace the urgency for change, make bold decisions, and take quick action will survive.

European Retail Banking Radar 18 Authors

Simon Kent Daniela Chikova Partner, London Partner, Vienna [email protected] [email protected]

Krystian Kamyk Ettore Pastore Partner, Warsaw Partner, Milan [email protected] [email protected]

Roberto Freddi Sameer Pethe Principal, Milan Principal, London [email protected] [email protected]

European Retail Banking Radar 19 As a global consulting partnership in more than 40 countries, our people make us who we are. We’re individuals who take as much joy from those we work with as the work itself. Driven to be the difference between a big idea and making it happen, we help our clients break through. kearney.com

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