Financial Services

spring 2012 rETAiL BAnKing AmericAS DiGeST

in THis issUE

1 US Mortgage finance • JAmEs WiEnEr, micHAEL ZELTKEvic 2 Mobile PayMentS • Andy drEsnEr, cHAiTrA cHAndrAsEKHAr 3 c lient exPerience • JoE FiELding, KEnAn rodrigUEs, micHAEL d’Esopo 4 US conSUMer creDit Score Migration • pETEr cArroLL 5 r elationShiP Pricing • indErprEET BATrA 6 b ranch flexing • sUmiT sAHni, pAUL mEE, AAron FinE, mAssimo TEssiTorE Table of contents

1. US Mortgage Finance 1 What should the future look like? James Wiener, Partner and Head of the Americas Public Policy Practice | Michael Zeltkevic, Partner and Head of the Americas Retail and Business Banking Practice The financial crisis exposed fundamental deficiencies in the US mortgage finance system. This article explores the set of options faced by policy makers for driving the evolution of the single-family home finance landscape and outlines the importance of clearly defined objectives in this redesign.

2. Mobile Payments 7 Aligning strategy with opportunity Andy Dresner, Partner | Chaitra Chandrasekhar, Consultant Mobile payments are widely expected to become much more prevalent in the next few years, which will cause global players to examine their strategies and invest in new initiatives. This article describes the opportunities and threats for banks in both developing and developed markets, and how quickly change may unfold.

3. client experience 13 From strategy to execution Joe Fielding, Partner | Kenan Rodrigues, Senior Manager | Michael D’Esopo, Partner, Lippincott Recent economic times have reshaped the attitudes and needs of retail banking clients and catalyzed a significant and measurable negative customer sentiment towards the industry. This article describes the “client experience” – and why banks’ increased focus on it is critical in today’s marketplace. It also shares a structured approach for designing and implementing an improved client experience, with efficiency and profitability in mind.

4. US CONSUMER CREDIT SCORE MIGRATION 20 Observations and implications for credit risk management Peter Carroll, Partner A customer’s score can vary significantly across time due to a number of factors. This article discusses the effect of score change on default probability, score migration patterns and predictability, and the implications of such changes on customer credit risk management.

5. relationship Pricing 25 A strong lever to deepen customer relationships – if used wisely Inderpreet Batra, Partner Customers who have more products with an FI – and thus deeper relationships – are shown to be more valuable. This article argues that instead of offering traditional price discounts to help deepen existing relationships, a relationship pricing approach should focus on customer relationships where incremental value can be derived and leverage both price and product offerings to drive desired behavior, as the end goal.

6. Branch Flexing 28 An agile approach to cost management Sumit Sahni, Partner | Paul Mee, Partner | Aaron Fine, Partner | Massimo Tessitore, Partner Instead of simply cutting branches, retail banks must develop a more flexible operating model to manage against topline and cost objectives. This article describes different strategies of “branch flexing” and shows that unlike branch closing, branch flexing keeps the focus on preserving the sales and service experience for a bank’s best customers. 1. US morTGAGe FinAnce whAT ShoUlD The FUTUre look like?

By James wiener and michael Zeltkevic

inTroDUcTion originations are funded by Fannie mae, Freddie mac, and the FhA/VA. in February of last year, the Treasury The cataclysm of 2008-2011 exposed fundamental laid out three options to significantly reduce the role of deficiencies in the US mortgage finance system. government in the mortgage market2 by phasing out economic growth and financial stability require Fannie mae and Freddie mac. The options maintain that a comprehensive redesign of all aspects of the the government’s role should be limited to oversight financing of single-family home purchases. A new and consumer protection, targeted assistance for approach should be driven by a coherent set of policy lower-income homeowners and renters, and support for objectives, including: market stability under severe stress. • Stability of the overall financial system The mechanics of the redesigned role are where the • explicit government support for low to moderate three options differ. The Treasury’s plan to phase out income borrowers the GSes is meant to encourage more private sector • Privatization of risk taking outside of low to moderate involvement by increasing guarantee pricing to reflect income borrowers the same capital standards as private institutions, • enhanced protection for consumers primarily banks. This would encourage GSes to pursue The new architecture will also need to address the large additional credit-loss protection from private insurers, size of mortgage outstandings relative to the aggregate adjust conforming limits on loan size and minimum banking balance-sheet, changes to the risk profile of down payments, and wind down investment portfolios. 3 mortgages housed in the regulated financial system, and in February, the FhFA (conservator of the GSes) had challenges in the current model for mortgage servicing. taken first steps in this direction through its three- pronged strategic plan: Build – lay the framework for the A central element of any redesign will be a re-conception secondary market; Contract – reduce the dominance of of the role of the government-sponsored enterprises the GSes; Maintain – continue the offering of foreclosure (GSes1) – Fannie mae and Freddie mac. currently, alternatives and fostering credit availability. the overwhelming majority of US mortgage market

2 Department of the Treasury and Department of housing and Urban Development, “reforming America’s housing Finance market: A report to congress” (Feb 2011). 3 Federal housing and Finance Agency (FhFA), “ A Strategic Plan for enterprise 1 For simplicity, we will use the term “GSes” to refer exclusively to Fannie mae and conservatorships: The next chapter in a Story that needs an ending” Freddie mac. (Feb 2012). copyright © 2012 oliver wyman 1 in this paper, we examine the options for the future of The FUTUre oF The the GSes and make recommendations for the design of a SeconDAry morTGAGe new US mortgage finance system. These include: mArkeT: whAT Are • Design of a new risk intermediation structure to provide liquidity and efficiently transfer risk to the The oPTionS? capital markets in the current model (exhibit 1), the GSes, by • explicit guidelines for risk taking within the regulated standardizing mortgage terms, have created a valuable financial system source of capital markets based funding. in doing so, they • creation of a centralized registry for all mortgage transferred interest rate risk from borrowers to investors liens with names of the servicer (one of the under-appreciated aspects of the current GSe • changes to servicer compensation to an activity model is the efficiency of pricing the 30-year prepayment based model option to the borrower). As exhibit 2 illustrates, US • harmonization of regulator and investor servicing mortgage assets are far too large to be funded on bank guidance and modification programs balance sheets via deposits. Accordingly, any proposal for • Greater clarity on reps & warrants risk and the future of mortgage finance needs to maintain a vibrant servicing liabilities role for capital markets funding. exhiBiT 1: oVerView oF cUrrenT conForminG morTGAGe mArkeT moDel AnD role oF GSeS

PRIMARY MARKET SECONDARY MARKET

A CORRESPONDENT FANNIE OR FREDDIE ORIGINATOR BORROWER Potentially via broker Warehouse Floor of loans to Investment Market trading line of credit be aggregated portfolio Sales of MBS with MORTGAGE BANK C B credit guarantee Agreement to buy (e.g. TBA loans at specific price market) Originator Securitizer & guarantor INVESTOR Delivery of loan pools (servicing retained)

Collections/ Scheduled Aggregation modifications Primary Master P&I payments servicer servicer Monthly payments D Serving standards SERVICING Contractual Claims payments

MORTGAGE INSURER for high LTV

KEY VALUEADDS OF GSES TO MORTGAGE MARKET PARTICIPANTS A Borrowers: Mortgage products with desirable features (long term, protection from inflation, no prepay penalties) through efficient pricing of credit risk and management of prepayment risk B Originators: Standardization of underwriting standards, pipeline hedging, massive driver of added funding C Investors: Protection from credit loss, increased liquidity through TBA market and investment portfolio activities D Servicers/collections: Standardizing of protocols

copyright © 2012 oliver wyman 2 exhiBiT 2: US morTGAGe oUTSTAnDinGS VerSUS ensuring today’s levels of market liquidity would commerciAl BAnk BAlAnce SheeT comPonenTS, require a government backstop. yeAr-enD 2011 4 The government’s role would be that of a reinsurer $ TN of last resort. it would charge a fee for its role and it would be called upon only once considerable private 14 guarantor capital had already been consumed. 2.5 12 in the rare event of private insurer failure, the 1.3 10 $1 TN government should have some flexibility to adjust Other assets fees as appropriate to offset losses and maintain 8 2.9 zero taxpayer loss over a reasonable time horizon (as Cash 6 the FDic does). The government’s main role during 11.1 10.2 4 Securities times of calm would be the oversight of private 7.3 mortgage guarantors and underwriting standards 2 Loans and leases and reasonable pricing of reinsurance. The last of (approx. 1/3 0 residential these is important in order to prevent guarantors from Residential Commercial Commercial using the system and taking excessive risks because mortgage debt bank bank assets outstanding deposits reinsurance is underpriced.

imPlicATionS oF ThiS oPTion: in the following subsections, we consider three potential Borrowing costs are likely to increase somewhat once options for restructuring mortgage securitization: the GSes’ ability to leverage without paying a risk- 1. Private securitizers, with government playing premium is reduced. however, the approach should reinsurer role maintain a high level of investor demand for mortgages 2. industry consortium to help mitigate increases in borrowing costs and 3. covered bonds allow for the origination of mortgages which banks may not want to hold on balance sheets en masse (e.g. oPTion 1: PriVATe SecUriTiZerS, wiTh prepayable 30-year Frm). exPliciT GoVernmenT reinSUrAnce This approach would require strong regulation; This is effectively the third of the three options that has without it, the following could result: been laid out by the Treasury5. A small set of large banks • increased fragmentation and different rules or private insurers could step into the void left by the by guarantor, which is detrimental to investor GSes and provide guarantees of timely principal and transparency. (There needs to be a de facto setter interest payments on mBS. These private guarantors of underwriting and servicing standards) would price credit risk and demand risk mitigation • Bias towards larger institutions – as smaller lenders mechanisms (e.g. Pmi) as they see fit, and the existence and community banks could face unfavorable pricing of multiple guarantors would foster competition. from private guarantors due to lower volumes however, this structure involves significant “wrong As noted by the Treasury, an added benefit is that the way risk”. when mortgages go bad, there is a high government reinsurer’s broad presence in the market chance that financial institutions will also be in trouble, would allow it to more effectively provide additional regardless of how high their credit rating. Therefore, support during times of severe market stress.

4 Federal reserve statistical release on mortgage Debt outstanding and FDic we should also note that this option would not require Statistics on Depository institutions (all insured commercial and savings banks). residential mortgage includes both single- and multi-family loans. massive changes in the way the industry operates. 5 Department of the Treasury and Department of housing and Urban Development, “reforming America’s housing Finance market: A report to much of today’s existing operational and business congress” (Feb 2011). mechanics could be preserved under this option. copyright © 2012 oliver wyman 3 oPTion 2: inDUSTry conSorTiUm oPTion 3: coVereD BonDS The government could remove itself from the The covered bond structure for future securitizations conforming space by mandating that a private could be combined in the two options presented consortium of banks and mortgage companies (and above, but given that this concept has been raised as a potentially even investors) pool assets to provide the possibility by a number of market observers since the credit guarantees on low-risk loans, similar to the crisis, we want to address it separately. Freddie mac structure pre-1990s when it was owned The covered bond has been a popular financing tool in by the FhlB system. mortgage market participants europe for a long time but has not made much headway sharing credit risk may drive prudent behavior, resulting in the US. covered bonds are corporate debt securities in a guarantor entity that is safer than any individual secured by a pool of assets (in this case mortgages) on the institution from an investor’s perspective. issuer’s balance sheet. The investor has recourse to both The detailed mechanics of this consortium must the pool and the issuer. This provides the issuer lower cost be structured to incentivize owners to maintain the funding than unsecured corporate debt (these bonds are guarantor function as a low-risk, efficient service provider usually rated triple-A) and provides investors with a way rather than simply a provider of profit. To prevent riskier to make slightly higher yields relative to similarly-rated lenders from arbitraging the system, each lender’s costs securities. The assets in the cover pool are subjected to would likely be tied to the performance of their own loans. monthly monitoring and, should one of the loans become over time, guarantee fees charged could be adjusted as nonperforming, the issuer is obliged to remove it and needed to maintain an appropriate capital base. replace it with a performing loan. Usually there will be overcollateralization – that is, more mortgage collateral ADVAnTAGeS relATiVe To oPTion 1: than the bond’s notional value – as an added measure of • Better inclusion of smaller institutions protection for investors. Bond payments generally come • may help promote better risk-taking from the issuer’s cash flows and in the event of a default • Greater consistency could be achieved across by the issuer, the cover pool of assets is segregated the industry as the consortium will be able to set and used to pay principal and interest payments on the industry-wide standards (with regulatory oversight) associated bond. imPlicATionS oF ThiS oPTion: This product has been noted as an interesting alternative structure to the current securitization model. it does As noted in the Treasury report, a downside of such an not involve the sale or resale of loans, offers fixed approach is that it may be difficult for the government terms desirable by investors, and incentivizes good to step in if needed as a final support mechanism in a underwriting. of course, the success of the product for severe crisis. Borrowing costs would go up in general, an issuer depends on the institution’s ability to evaluate and possibly more than in option 1 depending on and price the credit risk of the pool. whether the market buys into the solidity of the consortium entity. Again, the approach would help while the covered bond framework works in some maintain a high level of investor demand to allow for markets, US issuances have been severely limited6, mortgages, such as 30-year Frms, which banks may not mainly due to lack of clarity and agreement on how the want to hold on their balance sheets. bonds behave in the case of bankruptcy. in the event of a bank failure, assets pledged to a covered bond including option ii would also not represent a dramatic departure overcollateralization cannot be used to make depositors from the operational infrastructure of the industry. whole, which presents a risk to the FDic. Given the dearth of other alternative investments, several foreign mortgage players have taken advantage and issued 6 Two recent US issuances have occurred: one by washington mutual in 2006 and one by Bank of America in 2007.

copyright © 2012 oliver wyman 4 dollar-denominated covered bonds, in particular to on explicit rather than implicit terms. we believe that this US institutional investors. The US congress is working model is the best way to leverage the advantages of the toward enacting legal rules to allow for covered bonds to current system where standardization, risk transparency, be viable for US issuers7. and government ownership of the tail risk allows a highly liquid and efficient market for mortgage securities. if legal details are resolved in the US to make covered bonds a viable alternative to securitization structures, the investor demand means it could work for certain mAnAGinG riSk in The SySTem: segments, such as jumbos. however, there are GUiDelineS For reGUlATeD considerations which will hinder its usefulness in the “mainstream” conventional space. Although lower FinAnciAl inSTiTUTionS in risk, covered bonds present a more complex risk Addressing the secondary market alone will be for investors to understand and analyze. residential insufficient. The origins of the financial crisis lay in mortgage-Backed Security (rmBS) analysis was the collapse of the US single family home prices and complicated enough, but for covered bonds hybrid the associated mortgage and real estate derivatives corporate and mortgage risks need to be understood defaults. one empirical fact from the crisis is that to assess potential losses. Given the focus on investor different segments of mortgage credit experienced transparency, this could be an obstacle and it may hinder widely varying performance. At a high level, the most smaller investors from entering the market. predictive factor was mark-to-market lTV (mlTV), the with this option, the system-wide cost of credit risk will origination lTV adjusted for current changes in the home increase due to covered bonds being on banks’ balance price since origination. All other factors being equal, sheets, unless leverage limits are changed, which will lead mortgages with mlTV < 90 experienced a low level of to higher borrowing costs. Given the sheer magnitude of credit losses through the crisis. mortgages whose mlTV the US mortgage market, moving any sizable portion to increased to between 95 and 100 experienced rapidly the balance sheet would effectively be contradicting the escalating losses and mortgages with mlTV in excess push against “too big to fail” institutions. Since the end of of 100 experienced inordinately high credit losses. A 2010, only 25% of the over $11 Bn of US single and multi- similar pattern can be observed by looking at credit family mortgage debt outstanding was on commercial performance by consumer behavior score. 8 and savings bank balance sheets . in addition, other aspects of risk layering such in addition, option iii would represent the greatest as negative amortization products, low or no departure from today’s operational state. much of the documentation of income and assets, and payment existing capital markets and funding infrastructure options dramatically worsened credit performance. would have to be fundamentally re-thought and re-built; our recommendation is that guidelines be established this would be no small undertaking. for the risk profile of single family first mortgage loans originated and/or held within the regulated financial ProPoSeD APProAch system. our recommended starting point would be: we believe that the option i has the most promise • Full documentation of income and assets for maintaining efficient access to capital markets- • origination lTV < 90 based funding and effective risk aggregation and • Fico > 680 intermediation. in this model, we expect the existing • DTi < 40 GSes to continue to function but to rely on private sector loans outside of these risk parameters should be capital and insurance and the government reinsurance originated either via FhA programs to support low to

7 See house of representatives bill h. r. 940 (march 8, 2011). moderate income borrowers or by non-bank financials 8 Federal reserve Board statistical release: mortgage Debt outstanding (release date: march 2011). to finance subprime borrowers. copyright © 2012 oliver wyman 5 oVerhAUl oF SerVicinG: compensated by receiving an interest only strip of cashflows equal to 25 bps of unpaid balance (UPB). chAnGinG The STrUcTUre Servicers have service level agreements with investors AnD AliGninG incenTiVeS but the compensation structure still incents them to limit A striking aspect of the crisis is that it is repeating itself the investment in infrastructure. in addition, the servicing strip is highly volatile and must be capitalized on their first time as tragedy and the second time as servicing. The balance sheet. it creates significant risk management immense volume of seriously delinquent 1st mortgages challenges for the servicer. (through the crisis over 5 mm loans have been seriously delinquent) that require time and resource intensive we believe that a number of changes to the structure actions has overwhelmed the system. Added to the and compensation of servicing are necessary to restore sheer volume are a long list of new mortgage foreclosure the economic viability of mortgage businesses. alternatives that need be implemented and a high level of • creATion oF A cenTrAl rePoSiTory oF legal and regulatory scrutiny with respect to the integrity morTGAGe lien AnD TiTle inFormATion: This of the foreclosure process. The servicing crisis has will facilitate greater transparency and efficiency highlighted a number of issues: throughout the default servicing process and • legal uncertainty if using the mortgage electronic potentially facilitate the replacement of merS in the registration System (merS) to stand in the place of foreclosure process with the actual debenture holder. debenture holders in foreclosure proceedings it will also allow first lien holders to force restructuring of second liens (when they exist) before impairing • Quality control around all aspects of the first liens foreclosure process • STreAmlininG ForecloSUre AlTernATiVeS: • capacity and flexibility to implement new Agreement on a small standard set of modifications modification programs and foreclosure alternatives and foreclosure alternatives along with government • lack of clarity around allocation of responsibility in incentive payments to allow servicers to optimize the rep and warranty agreements efficiency and quality of these programs • Severe misalignment of servicer, investor, regulatory, • AliGninG incenTiVeS: change the structure of and policy maker incentives in the default servicing compensation to 12.5bps of UPB and a servicing process series of activity based payments. This will greatly These issues are leading to negative consequences for reduce the financial risk in the servicing asset, keep the housing recovery. Uncertainty with respect to these investor and servicer incentives aligned, and create large potential costs and liabilities has led originators incentives to invest in complex and resource intensive default servicing activities to exceptionally conservative underwriting standards • clAriFyinG rePS AnD wArrAnTS: Standardizing (most tellingly tighter standards for GSe products representations and warranty contracts to clarify legal than GSe requirements where they bear no credit treatment and ensure comparability of loans with the risk but retain the servicing) and extreme caution in same/similar characteristics. This would significantly implementing new public policy initiative where they reduce the occurrence of loan buyback disputes (as might waive their rights or incur new liabilities with are being observed in this crisis) respect to these issues. At a more strategic level, most restoring the health of the US mortgage market will large mortgage players are planning to downsize their require changes across the board from origination to commitment to the business. securitization to servicing over the life of the loan. Both A contributing factor to these issues has been the the public and private sector will need to be involved in structure of servicer compensation. Servicers are moving the agenda forward.

copyright © 2012 oliver wyman 6 2. moBile PAymenTS AliGninG STrATeGy wiTh oPPorTUniTy

By Andy Dresner and chaitra chandrasekhar

The belief that mobile payments will be ubiquitous in swiftly cannibalize these revenues and intermediate the global retail payments arena in the next few years incumbents. This article discusses the importance requires all players to examine their strategies. The of banks assessing their operating environments for infrastructure and marketing investments required are framing a mobile payments strategy – in particular, expected to be material, while the rate of consumer we highlight key contrasts between developing and adoption is still unknown. Against this challenging developed markets. backdrop, incumbent players in the legacy payments ecosystem (issuers, acquirers, networks, processors, There are material differences in what we mean by “mobile terminal vendors, and merchants) all want to ensure payments” between the developing and developed their position is enhanced in an emerging mobile worlds. in exhibit 1 below, we highlight these key ecosystem, while insurgents (mnos1, mobile oS2 differentiating characteristics. in exhibit 2, we compare owners, and startups of every variety) are hoping to mobile enrollment vs. financial services usage. exhiBiT 1: moBile PAymenTS in The DeVeloPinG VS. DeVeloPeD worlDS

the develoPing world the develoPed world Paradigm characteristic (Bottom-uP aPProach) (toP-down aPProach) customer segment served • low-income consumers in the least • Top half of consumers in the richest countries developed countries Phone requirements • Basic “feature” phone • Smartphone • Prepaid plan • Data contract Form of mobile payments • Telco-centered • card-centered • SmS • near field communication (nFc) Type of payments • largely P2P • largely c2B • largely micropayments • Standard retail PoS tickets Debit and credit card role • no role for plastic • clearing and settlement through legacy networks • credit risk avoided by prepaid model • Banks provide underlying credit and DDA accounts customer value proposition • only source for secure, convenient • merchant “offers” electronic payments in these markets • convenience vs. plastic

1 mobile network operators. 2 operating System. copyright © 2012 oliver wyman 7 Differences in the two cases are driven by the state of a facilitate settlement. in other words, mobile payments country’s legacy payments infrastructure: in developing are deployed as an enhancement to the legacy payments countries, most of the population is unbanked; but even in infrastructure rather than a replacement for it. There is still the poorest of these markets, a relatively large and growing a threat to incumbent revenue streams, but it comes not segment of the population has prepaid cell phones. in competition for balances or transaction volumes, but rather for control over the interface that sits between the in developing countries, card-based payments are limited consumer and the legacy payments infrastructure. This to the economic elites. PoS networks are clustered in interface is known as the mwallet. tourist venues, major metros, and higher-end merchants. Prepaid cards have potential to serve the unbanked, but Bank’s centrality in the payments system is at risk in both today are only usable at the wrong venues – they are zones, but for different reasons. The next sections outline largely absent from smaller, neighborhood retailers and why these threats arise and what banks can do about them. rural areas. instead, the prepaid mobile phone account is evolving into an alternative, mass market banking system. The DeVeloPinG worlD The developed countries have a universal banking As banks look to the developing world, a striking tradition (with the notable exception of the US), most phenomenon is the “leapfrogging” that has occurred people have debit cards, and many have credit cards. with respect to traditional infrastructure build-out. Almost all retailers have PoS terminals; prepaid cards mobile payments players in these geographies avoid are the preferred solution for the narrow segments of infrastructure investments in PoS terminals, payments the unbanked like immigrants and teenagers. in these switches, and fixed-line data networks. instead, the countries, prepaid mobile plans have no white space to local mobile network operators (mnos) have launched replace the legacy payments infrastructure. person-to-person (P2P) payments services that leverage As a consequence, mobile payments in the developed prepaid mobile accounts and text messaging (SmS). The world are aimed at the upper end of the income stream original “killer app” here was cross-border remittances where expensive smartphones and data plans are from advanced markets; but, once the value was most common and credit or debit cards are available to transferred, a market for domestic transfers evolved, exhiBiT 2: PrePAiD moBile PeneTrATion VS. BAnkeD PoPUlATion

POTENTIAL FOR MOBILE PAYMENTS PREPAID MOBILE ENROLLMENT VS. FINANCIAL SERVICES USAGE IN SELECTED COUNTRIES % OF MOBILE USERS ON PREPAID PLANS 100% Philippines Nigeria India 90% Bangladesh Italy 80% Brazil Mexico South Africa 70% Greece 60% UK 50% Singapore 40% Spain 30% Austria France Higher potential 20% United States

10% Lower potential 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% % OF HOUSEHOLDS WITH ACCESS TO BANKING

Source: Bank of America/merrill lynch Global wireless matrix 4Q10 – what’s in store for 2011; world Bank/cGAP – Access to Financial Services and the Financial inclusion Agenda around the world, Jan 2011

copyright © 2012 oliver wyman 8 including payments between individuals and businesses The major challenge we see for banks (and networks) in (c2B). Beacon markets include kenya and the Philippines, the developing world is that growing, prevalent forms of as shown in exhibit 3 below, but similar systems are mobile payments in many geographies could satisfy local developing elsewhere. demand before a ubiquitous debit/credit infrastructure can be established – permanently leaving banks on For remittances, these methods represented an advance the periphery. over conventional money transfer services (e.g. western Union3) in terms of speed, safety, and cost but they were an Similar services, by the way, have migrated to the enhancement and not a step-change revolution. however, developed world to address comparable needs. The the domestic transfer application leap-frogs these markets most common users are unbanked teenagers making into the electronic payments world. These are mostly micropayments to online gaming services. These micropayments by developed world standards (averaging “Premium SmS” services like Allopass & mopay in europe $5-10 in key markets) but represent the only accessible and Zong & Boku in the US address this niche but are non-cash payment method for most of the population. not credible alternatives to mainstream payments. most These new solutions are still evolving; in particular to importantly, the mnos charge 20-50% of face value for address cash-out services which ATms perform in the the service, making it uneconomical outside digital goods developed world, as well as clearinghouse functions markets, like gaming. The mnos also cap monthly usage between mno networks, but they are gaining momentum at low enough levels that the services are unlikely to break for key segments of the market. out of these narrow, online niches.4 exhiBiT 3: SUcceSSFUl SmS-BASeD money TrAnSFer SerViceS – m-PeSA AnD GcASh

M PESA: 2007 LAUNCH IN KENYA GCASH: 2005 LAUNCH IN THE PHILIPPINES M PESA GROWTH GCASH GROWTH REVENUE GROWTH IN USD MM FY 2008 11 REVENUE GROWTH IN USD MM FY 2008 11 $200 $200

$150 $150 146

$100 $100 96 80

$50 $50 50 38

$0 5 $0 FY 2008 FY 2009 FY 2010 FY 2011 2009 2010

Source: company reports

3 western Union has been actively pursuing partnerships in the mobile space 4 korea is an exception, where the “direct operator billing” model has reduced – including agreements with m-Pesa (kenya), Gcash (Philippines), maxis mno charges below 10% of value and made the service more competitive with (malaysia), and canada (enstream) to provide cross-border mobile money conventional payment methods. This model is expanding to other developed transfer services in these countries. countries, but will likely remain a niche relative to debit and credit due to higher costs to the merchant and relative low caps on monthly usage. copyright © 2012 oliver wyman 9 The DeVeloPeD worlD merchants who can make targeted offers to receptive consumers. The offers can even be proximity-based, in developed markets, the mobile payments paradigm since the GPS chip in the phone allows the offer to leverages the legacy payments infrastructure rather be timed for when the consumer is near a particular than displacing it – arguably keeping traditional players merchant location. it is no surprise that Google is (incumbents) at the center of market evolution, though first-to-market here with its Google wallet – leveraging not necessarily well-advantaged against insurgents. both Google ads & offers technology and its Android The emerging mobile payments ideal here is that a smartphone oS. See exhibit 4 for a comparison of SmartPhone app or “mwallet” app, containing all details mwallet providers. of a consumer’s payment account, initiates payment via it was not from lack of trying that the mnos did not an onboard near Field communications (nFc) chip. The replicate the telco-focused network model from the chip communicates payment details to a “contactless” developing countries. in the US, the iSiS consortium of reader5 leveraging existing “contactless” standards major mnos tried to establish a stand-alone network established to speed up debit and credit card payments. leveraging the Discover card merchant footprint; mobile nFc simply embeds the chip in the phone instead but they ultimately transitioned to an mwallet model of the card. The technology has the added benefits of in the face of massive investments to replicate what multiple payment options (as more than one card may be mastercard and Visa already had7. in France, there held in the mwallet app) and enhanced security6 (as the are still two initiatives to create parallel infrastructure: consumer must log into the app for each transaction). internetPlus and Buyster, but neither has much traction mwallets go beyond contactless plastic in one crucial yet beyond select online niches. way – they intend to seamlessly serve up customized As with SmS payments in the developed world, there “Ads and offers” to their users. in theory, mwallet may be a small niche for nFc in the developing world, vendors will track consumer spending patterns, both in tourist zones or business-oriented hotels and online and off, to understand a consumer’s shopping restaurants. But nFc ubiquity in the developing world is preferences. This intelligence will be made available to very far off indeed. exhiBiT 4: mwAlleT ProViDerS

googlewallet isis v.me By visa current strategy • online & PoS payment • nationwide mobile • initially for online commerce only solution that favors commerce network • nFc capabilities to be introduced marketing & loyalty Payment • citi mastercard • Any credit/debit card • All major credit and debit cards methods accepted • Google prepaid card • reloadable iSiS cash card main partners • Development: Google, citi, • Development: Joint venture between • Usage: partnered with several banks First Data, Sprint, mastercard Verizon, AT&T, T-mobile for integration with online banking • PoS: hypercom, Verifone, • PoS: Verifone ingencio, and Vivotech • Device: any Smartphone • Device: Android revenue sources • charges retailers for ads • Banks pay fees for loading • revenues from merchants for and Google Single Tap payment credentials routing, funds transfer, Pci- (loyalty points management • charges retailers for ads, loyalty compliance & coupon) points management, etc. Timeline • launched may 2011 • mid-2012 roll-out in key geographies • launch in 2012 for • Accepted at ~20+ retailers − Utah Transit Authority to be isis- online transactions • nFc capabilities to be • Several pilots nation-wide, enabled including ~300 chevron subsequently added locations in cA and Subway

5 Typically attached to a conventional PoS terminal. 7 Another alternative to the nFc chip is cloud-based wallet systems, e.g. PayPal, 6 in non-emV (“chip and Pin”) markets (e.g., the US), the log-in provides an added mobilePay, where the secure element is stored in the cloud and communication layer of security missing from plastic cards. may be through Qr codes, tokens, or online storefronts. copyright © 2012 oliver wyman 10 even in the developed world, mobile nFc faces major disadvantaged in mwallets: Pin debit cannot be used at hurdles to adoption: all and Plccs are likely to decline faster as consumers set 1. SmArTPhone UBiQUiTy. Smartphones with nFc a “default card” in the wallet to reduce complexity. will take time to achieve ubiquity. not only will it But more importantly, mwallets use the merchants own take time to replace the current installed base of customer data to facilitate ads and offers from their instruments, but mwallets need to function across competitors. There is no opt-out in the existing models. the three major oS platforms: Apple ioS, Google Furthermore, mwallets will train more consumers to look Android and microsoft/nokia (windows Phone/ for discounts before buying. in other words, mwallets Symbian) undermine consumer loyalty by design. And to add insult 2. PoS TerminAl UPGrADeS. it will take time for to injury, the merchants are funding the PoS upgrades retailers to upgrade their PoS equipment with that facilitate the whole ecosystem! contactless readers. many will wait for the natural There are more merchant-friendly options. For example, replacement cycle of their existing terminal kit consider the Starbucks mobile app. it is proprietary, so 3. merchAnT VerTicAl (inDUSTry) ADoPTion. data sharing is not an issue; it works off existing bar-code The contactless plastic initiative was aimed at small- scanners, so no PoS upgrade is required; it actually ticket, high frequency venues like fast food, transit, reduces payments costs, by aggregating many small taxis, and drug stores and never expanded much transactions into a few bigger ones; and it is tightly beyond that. The proposition was targeted to their coupled to an existing loyalty program. The app has needs: it reversed liability, while waiving the need for been downloaded over 2 mm times and generated over a signature on low-value transactions and therefore 25 mm transactions. it avoids all the downsides of “open” improved line speeds. A similar vertical, petroleum, mwallets while delivering real value to consumers. mobil didn’t adopt due to the cost of upgrading pumps. SpeedPass is an older attempt to accomplish similar goals high-ticket verticals saw no advantage and also didn’t and still has a loyal, if niche, following. adopt. mobile nFc will need to provide a compelling proposition to overcome these challenges The big open question is whether merchants will simply accede to the current mwallet paradigm or resist by 4. conSUmer ADoPTion. The contactless plastic avoiding contactless investments (mwallets won’t initiative did not succeed in changing consumer work if there is nowhere to use them). At present, many behavior given its focus on transaction speed. The key prominent merchants are installing the readers despite here is whether smartphones are a more convenient the drawbacks, and if enough do, the hold-outs may have form factor (“i already have it in my hand”) and no choice. however, the recently announced wal-mart/ whether the “ads and offers” model provides a Target initiative may be an attempt by merchants to grab compelling value proposition control of the mobile payments paradigm before it moves All key stakeholders – mnos, oS providers, banks, and against them. merchants – are staking their claims in the new landscape. mnos are challenging oS owners for control of the chip Banks have somewhat less to lose from mwallets in the (“the secure element”). This was most prominently seen short run. A consumer still needs a debit or credit card to when Verizon, a founding iSiS member, restricted the use use an mwallet, leaving banks with their legacy revenue of Google wallet on its phones. while the other major streams intact. The threat for banks is longer term: can oS vendors, Apple and microsoft, have yet to launch the mnos and/or oS providers extract rents for mwallet mwallets, it is likely they will do so soon, challenging both usage or placement? This kind of intermediation is a perennial question for banks, having fought off similar Google wallet and iSiS. threats from Aggregation Services (yodlee), Personal merchants have the most to fear from the mwallet Financial management software (intuit), electronic Bill initiatives. The wallets embed conventional payments Payment vendors (checkfree), and others. in all cases, fees which they already view as too high. Additionally, the insurgents ended up co-existing with the banks the merchants’ favorite two payment methods, Pin- rather than “eating their lunch”. mobile payments may debit and Plcc (Private label credit cards) are actually be no different.

copyright © 2012 oliver wyman 11 exhiBiT 5: DirecT To conSUmer SolUTionS

STARBUCKS MOBILE APPS EXXON MOBIL SPEEDPASS

• Launched in Jan 2011 as a smartphone • Pioneering "contactless" payment system app for payments using bar codes introduced by Exxon Mobil in the late 90s • Within 2 months of launch, 2 MM+ • Drivers wave a Speedpass in front of a sensor at users bought through the app the pump to pay for gas and purchases

BENEFITS TO THE CONSUMER BENEFITS TO THE CONSUMER • Savings can exceed 20% • Convenience: Quick and easy way to pay for purchases at – Per drink (e.g. free syrup) participating Exxon and Mobil stations nation-wide – Every 10-15 purchases – No handling of money, cards or secure codes – On your birthday • Savings of up to 20% • “My phone is already in my hand” – One-off promotions e.g. 15% off with online registration • Plastic or mobile – New user rebates/gift cards • Plastic or mobile BENEFITS TO STARBUCKS Loyalty/marketing Reduced payments cost BENEFITS TO EXXON (per $50 load) • Customer loyalty/retention • Link to loyalty • Debit • Sales uplift – 4% uplift observed on introduction • Proprietary spend data – Exempt ($.97) • New customer acquisition • Upsell – Regulated ($2.19) • Existing infrastructure • Credit ($1.02) – Bar-code readers • Float & Breakage – “Apps” capability • Over time can save more – Existing, card-based – Migrating credit to debit loyalty program – Migrating all to ACH however, a key issue for banks is not what they stand imPlicATionS to lose through mwallets, but how they might gain if they could control the technology. The ads and offers The developing and developed worlds are taking revenue contemplated by Google and others would different paths to mobile payments with little likelihood help offset bank revenue losses from the cArD Act, of cross-over; but each represents a threat for local Durbin, and reg e regulations. Furthermore, the bigger banks’ ambitions: banks could deliver more value to customers than their • in the developing world, the mno-centered mobile smaller brethren because they have more data – and this payment paradigm may evolve into a real parallel might offset the revenue advantage that Durbin gave banking system before conventional debit/credit to the smaller banks. Services like cardlytics, linkable technologies can ever take hold networks, and offermatic already use payments data to serve up ads and offers on statements, but there is • in the developed world, the mwallet may transfer more potential in mobile delivery. For example, big loyalty and revenue to the mno or oS vendors banks might create their own “closed loop” networks (Google, Apple, microsoft) while banks continue that link their consumer customers to proprietary offers to bear most of the costs for maintaining the from their Sme customers. At present, banks are largely payments infrastructure leaving the field open to third parties. in both cases, as other stakeholders aim to drive the agenda, banks need to understand how quickly the changes will occur, what investments are required to play, and the role for both individual and collective action to protect and grow their interests – essentially, align their strategy with opportunity. copyright © 2012 oliver wyman 12 3. clienT exPerience From STrATeGy To execUTion

By Joe Fielding, kenan rodrigues, and michael D’esopo

inTroDUcTion A. eVery inTerAcTion mATTerS – we are in the midst of a dramatic shift in how perceptions are shaped. ongoing financial and economic turmoil in recent years Gone are the days of a carefully crafted message being has reshaped the attitudes and needs of retail banking the primary lever towards building customer perception. clients and catalyzed a significant and measurable customers develop a view of brands based not just on communications but also their personal experiences with negative customer sentiment towards the industry. a company and its offerings. This holds doubly true for Though banks were already becoming more client- service-oriented companies such as banks. customers focused before the crisis, the stakes in getting it right form an opinion of their client experience via their have since only increased. Paying lip service to the interactions with the bank, from the mundane and routine customer’s needs is easy, but actually delivering a to the complex and emotional. interactions can be of any consistently positive client experience – across media, kind – sales or service – and via any channel, face-to-face or personal interactions and operations, supported by the click-to-click. From the customer’s perspective, the bank right organizational culture – is the current challenge for is seen at a holistic level across all types of interactions. it banks that want to be end-game survivors. in this paper, is therefore important to recognize every touchpoint the we aim to describe exactly what client experience is – customer has with the bank, whether it is an in-person and why banks’ increased focus on it is critical in today’s encounter at the branch or a virtual one online. marketplace. we also share a structured approach B. exPerience oBJecTiVeS Are imPorTAnT – every for designing and implementing an improved client customer interaction needs to have a defined experience experience with efficiency and profitability in mind. objective. it is challenging to create a consistently positive experience without knowing exactly what the intended objective is and consciously working towards clienT exPerience – whAT iS that objective. For example, Starbucks consciously iT, exAcTly? creates a certain environment in their coffee shops combining look, feel, color and smell. Beyond the in theory, the client experience is best defined as being individual attributes, efficiency through speed and the sum-total of how a client engages with a bank across all consistency of product are all purposefully designed to channels and through their entire customer life-cycle. what provide a specific intended client experience outcome. does this mean in practical terms? Banks need to think and act similarly.

copyright © 2012 oliver wyman 13 exhiBiT 1: mAnAGinG The clienT exPerience

EXPERIENCE OBJECTIVE CLIENT TOUCHPOINTS CLIENT

The opinion formed by the customer around their total experience of the bank across interactions “WE MAKE BANKING REFRESHINGLY SIMPLE.” The target characteristics and competencies to be Collection of customer feedback and recognized by the customer active realignment of touchpoints through his/her aggregate with intended experience objective interactions with the bank

c. The whole iS The SUm oF The PArTS – eventually, and loans – have remained fairly stagnant in the last customers form an opinion about their client experience several years. based on a combined view across interactions (see B. recenT reGUlATory chAnGeS Are hUrTinG exhibit 1), with different and sometimes counterintuitive BAnkS AnD cUSTomerS – The recently passed weightings. For example, things could go wrong – perhaps, Dodd-Frank Act was intended to work in the interest a customer did not receive a new debit card on time. A bank of customers. For example, the act called for drastic can put things right by acknowledging the issue, correcting reduction in debit interchange fees. Banks, looking it and if warranted, making it up to the customer via some for ways to fill the profit gap caused by reduced debit modest gesture. customers will remember the combined interchange fees, conceived new ways to pass on costs experience – if they feel their bank tried to correct a mistake, to their customers (e.g. a monthly maintenance fee on they will appreciate it. The “sum of the parts” is highly deposit accounts). customer reaction was negative, dependent on where the majority of customer interactions to say the least, and eventually most banks reversed come from. For example, some clients may visit a branch their decision to apply monthly fees. That said, pricing once a year or less but use phone support frequently. A increases are likely coming in other areas as banks face frustrating/poorly-designed phone menu or long wait times revenue pressure, and customers know it. can be a deal-breaker in these cases. Awareness of where c. TrUST in The BAnkinG SySTem hAS Been the volume in customer touchpoints lies, and how that eroDeD – The recent financial and economic crisis cast distribution varies across different types of customers, is key. considerable doubts in customers’ minds about the integrity of banks leading them to lose faith that banks are working in the interest of consumers. customer clienT exPerience – why iS iT attitudes towards financial institutions indicate that So imPorTAnT? although customers post-crisis are now more likely to be ‘satisfied’ with their primary bank than at the height There are three issues confronting US retail banks of the crisis, banks that try to project trust and true today that underpin the importance of focusing on partnership with their clients still face an uphill battle. client experience: To address this issue, some banks have recognized that A. BAnkinG iS increASinGly commoDiTiZeD wiTh they need to take significant action to rebuild trust and ProFiT mArGinS UnDer conTinUeD PreSSUre – reduce the risk of relationship disaggregation or outright retail banking has increasingly become a commodity attrition, especially before clients reach their next life to consumers. Products like debit and credit cards were stage where new financial products will be needed. introduced decades ago. while innovation in banking customers want to see tangible action from their primary continues, especially in the online space, the basics banks that warrant their continued patronage. Thus, the of retail banking – deposits, credit and debit cards situation is ripe for an end-to-end improvement of the copyright © 2012 oliver wyman 14 client experience, along key customer contact points clienT exPerience – how Do yoU from routine service to complex problem resolution and DeSiGn AnD execUTe iT well? sales. For banks to deliver an improved experience, close coordination is required across operations, human Bringing the client experience to life can be challenging, capital management, marketing and the lines of business. even daunting for many organizations. A major aspect Sustained and consistent improvement in the client of this challenge is lack of clarity in terms of where and how to start developing the target client experience experience drives up customer satisfaction and promoter and the absence of a structured process to get there. scores, which are embedded in many front line and oliver wyman has developed a five-step approach management dashboards and performance metrics. more that successfully does this (see exhibit 2) – enabling importantly, it is a primary lever (rather than an indicator) clear definition of the target client experience, that improves retention, results in higher share of wallet identification of specific actions to achieve the target and drives customer referrals that boost acquisition and and a programmatic way for implementing the most revenue generation. compelling set of actions.

exhiBiT 2: FiVe-STeP clienT exPerience APProAch

1 DEVELOP CLIENT EXPERIENCE 2 IDENTIFY TOUCHPOINTS AND ASPIRATION TARGET CLIENT EXPERIENCE • Develop a clear target state view of what • Use the client experience map to lay out the client experience should be and prioritize the key touchpoints, i.e. • Use the brand strategy and the ‘voice of interaction points between the customer the customer’ to define a high-level target and bank experience • Specify emphasized brand attributes for each touchpoint benefit

3 IDENTIFY AND PRIORITIZE ACTIONS REQUIRED TO ACHIEVE TARGET CLIENT EXPERIENCE • Identify specific actions required to get from the current state to the future state • Prioritize identified actions based on client experience impact and net financial benefit

4 DEVELOP AND EXECUTE 5 MONITOR AND CONTINUALLY PORTFOLIO OF INITIATIVES IMPROVE • Translate prioritized set of required • Define, monitor and review client actions into clear initiatives experience metrics and link them to • Manage portfolio of initiatives in order performance objectives and compensation to create an umbrella client • Collect and act on direct customer feedback experience program • Put in place continuous improvement measures

copyright © 2012 oliver wyman 15 STeP 1 – DeVeloP clienT indication that their “making banking refreshingly exPerience oBJecTiVe simple” brand promise is not being delivered to the client and that actions need to be taken to align actual The first step in the process is to develop a clear target experience with objectives. The brand and customer state view that specifies what the client experience feedback should collectively shape the client experience should be. The best starting point for this is the external objective, and more specifically, any internal strategic or brand positioning of the bank, both at the overall level operational initiatives aiming to address it. Very often, and at the client segment level, where branding is banks undertake an effort to deliver a well-intentioned differentiated to appeal to various customer types. A improvement, only to find that it is less valuable to the clearly articulated positioning – one that defines what customer than anticipated due to a misalignment with the the bank stands for, why it is different, and the clear objective. The objective should eventually take on a target value proposition to customers – is a powerful filter to operating model definition, along with internal guiding ensure that a client experience isn’t simply efficient, but principles – it should be intrinsically reflected in the way conveys the personality of the institution and builds a the bank designs and delivers its products and services. stronger connection with its customers. So for Bank x, the client experience objective could be to The brand typically embodies the personality of the “ensure that our clients find the process of banking with bank and identifies its products and services to its us refreshingly simple, with this intention clearly reflected various constituents, from customers to employees. in our products, services and interactions with customers. There are several facets of the brand, including strategy, our employees help translate this promise into reality by essence, promise and attributes. eventually, what is being straightforward, efficient and always putting the most visible to the client is the brand “front line”, i.e. the client first”. bank’s tagline, logo or color scheme, all of which are a powerful way to express the desired client experience. STeP 2 – iDenTiFy ToUchPoinTS AnD however, the message cannot be purely superficial; TArGeT clienT exPerience it should be real and reflected throughout the client experience for consistency. For example, if hypothetical once the broad client target experience is developed, Bank x’s brand talks about “making banking refreshingly full stock must be taken of all the touchpoints through simple”, the target client experience should clearly which the client interacts with the bank, from account reflect this concept – not just in marketing, but in opening to customer service. The experience objective service and operations, even carrying through to comes to life in the illustrative client experience map internal implementation, tracking and management of shown in exhibit 3, which lays out each of the key operational initiatives to make it a reality. customers touchpoints of customer interaction. For each of these of Bank x should experience this simplicity through touchpoints, the map: their various interactions with the bank – through its • lays out a clear client experience objective specific personnel, service, marketing, products and problem to that touchpoint, as well as the specific brand resolution, across the customer life cycle. The client characteristics and competencies to be emphasized experience objective should be all about simplifying • Specifies which elements are central to the banking process for customers (e.g. easy product that touchpoint choice, easy application process, easy onboarding, easy access to relevant features and services, etc.). For example, the experience objective for the “new account opening” touchpoint could be expressed as Another element that should influence the target client “we make the account opening process surprisingly experience is direct customer feedback – both positive easy. it marks the commencement of a long and trusted and negative. most banks conduct surveys and/or relationship with our customers.” The key elements for focus group discussions to understand how customers this touchpoint are the in-branch appointment with perceive their products and services. For example, if a specialist, the paperwork, or in the case of a remote Bank x discovers that their customers find the new account opening, the user interface and application account opening process cumbersome, that is a clear form online.

copyright © 2012 oliver wyman 16 exhiBiT 3: clienT exPerience mAP

touchPoints elements attriBute emPhasis exPerience oBjective a part of the activity a component of a touchpoint – be it a the target characteristics and chain that involves process, a form, or a human interaction competencies to be recognized by the interaction wit h customer through their interaction with

the cu stomer Sincere clear empathetichelpful efficient the bank at a specific touchpoint • Advertising, word of mouth, • “we create long-lasting relationships marketing, mail, website, with our clients. we help you make Awareness sponsorships, branch/ATm signage, the financial decisions that are right social media, community involvement for you” • consultation rooms, employee • “we explore your financial needs, needs talking points, needs assessment, position the most appropriate solutions assessment offsite meetings and explain how they fit your needs”

• Face-to-face interaction, application • “we make the account opening new account forms, supporting documentation, process surprisingly easy. it marks the opening terms and conditions commencement of a long and trusted relationship with our customers” • Service set-up, materials, rewards • “we take the hassle out of account enrollment, access to funds, credit transitions and follow up to ensure our onboarding adjudication, follow up solutions are working for you”

• Statements, mail, seminars, tools • “we provide clear and timely regular and resources communication about your financial commun- ications relationship with us and we support you with ideas to fulfill your goals” • credit cards, loans, mortgage, • “we review your financial situation Adding/ deposits/small business, products regularly in order to identify potential linking products offered by partners changes in your needs. we invite you to discuss solutions that are relevant to you” • routine customer service (balance • “we provide simple and efficient service inquiry, change of address) vs. for routine inquiries” customer problem resolution (lost card, • “we listen to your feedback and issues. service access trouble) we work hard to resolve any problems as swiftly as possible and keep you updated along the way” • Proactive communications, sales • “we remind you about renewals & effort pitch upcoming renewals” closeouts • Understanding reason for closure, • “our goal is to keep you as a customer but “win back” attempt, account closure we understand if you choose to leave”

By defining each touchpoint’s experience objective and online’) or only specific elements (‘simplify the format of elements, the map helps highlight the areas where the an application form’). Step 3 introduces a prioritization current client experience falls short and where actions framework for sifting through the laundry list of potential for experience enhancement can be taken. An action actions and assessing which ones hold the most can apply to an entire touchpoint (‘shift the account untapped value for the bank and its customers. opening process for a simple product from in-branch to

copyright © 2012 oliver wyman 17 STeP 3 – iDenTiFy AnD PrioriTiZe − onGoinG: what is the difference between AcTionS reQUireD To AchieVe the estimated steady-state per-customer cost TArGeT clienT exPerience of the action vs. continuing with business as usual? in the online account opening example, Taking a customer-centric view is crucial to assessing the ongoing cost of the action is likely lower what that financial impact of an action is likely to be. in than today’s cost by cutting real-time employee the example of opening an account online, potential interaction requirements actions for improvement may include: Using this framework will yield a natural separation • making it easier for the customer to find the account between low and high impact actions. however, since application page from the bank’s homepage each action is viewed through a vacuum and costs • Shortening the online application form are estimated on a standalone marginal basis in this • removing the step of speaking to a representative step, this alone does not provide a roadmap of how over the phone in order to finalize an application to act strategically. Step 4 outlines how to combine our framework for prioritizing each action examines individual action into clear initiatives, a more integrated short-term and long-term revenue and cost potential: implementation plan and a timeframe that is consistent with the bank’s broader strategy and capabilities. • customer benefit and revenue potential − cUSTomer AcQUiSiTion & reTenTion: how is the action likely to affect customer acquisition and STeP 4 – DeVeloP AnD execUTe retention? while it is challenging to predict this, PorTFolio oF iniTiATiVeS it is also often the most important with regards to once actions have been rated by potential impact on a the bottom line. customer feedback and behavior standalone basis, an umbrella client experience program metrics are critical for anticipating and measuring should be developed by taking a more integrated the dimension of an action’s revenue potential portfolio view. when creating a portfolio view of −c onVerSion: what are the immediate impacts initiatives, the considerations that should be taken into on sales volume? For example, do analytics show account include, but are not limited to: that a segment of customers stop a new online • corPorATe STrATeGy: ensure that the portfolio product application at the point that they would prioritizes initiatives that align with the corporate have to speak to a representative to finalize strategy. For example, if growing the customer base their enrollment? An increase in this segment’s is a priority, awareness/branding may be pushed to application completion rate would be considered the forefront. conversely, if the goal of the bank is to a conversion effect. many actions will not have hold on to the few customers that contribute most a conversion effect – for example, improving to profitability, the touchpoints to prioritize may be the customer issue resolution process will not customer service and renewals. immediately improve revenue, but it may improve • Time To imPlemenT/meASUre: Determine how retention (see below). quickly the initiative can be rolled out and how long it • cost of roll-out will take to measure its effectiveness. Some initiatives − UP FronT: how large is the investment this show immediate efficiency improvements while action requires? For example, if the process for others will only demonstrate their value in the long opening a specific type of account is currently run by increasing customer retention. fully integrated into the online user interface and • orGAniZATionAl STrUcTUre: Allocate initiatives requires a phone call, how much would it cost to to lines of responsibility or departments within build out the front-end and back-end capabilities the bank. Developing a sound implementation to offer a fully web-integrated solution? plan requires a holistic view of which touchpoints match each department’s capabilities and on which resources the stress of implementation is likely to fall.

copyright © 2012 oliver wyman 18 • oPerATionAl SynerGieS: Take into account which attribution, by the use of pilot vs. control groups to investments and processes are shared across sets of isolate the financial impact of each initiative. monitoring initiatives. An initiative may become more attractive if enables a fluid shifting of gears that allows initiatives its roll-out cost is diffused across a larger portfolio. with higher than expected impact to be accentuated and those with lower than expected impact to be The portfolio view helps inform an integrated deprioritized or improved. implementation program for the bank so that all client experience improvements are centrally planned, internal change management and communication are key managed and coordinated. The risk of not doing to instilling a metrics-driven, continuous improvement this is a fragmented effort resulting in potentially culture in a bank. ways to enable this change are to: inconsistent, conflicting, and ultimately unsatisfying • ensure that client experience is a top-down program customer interactions. with strong support from senior leadership examining synergies and aligning initiatives with the • leverage quick wins – showcase examples internally broader corporate strategy is a necessary step, but at and celebrate and reward successes the end of the day, it is a prospective process. Step 5 • Treat client and employee experience metrics seriously highlights the importance of monitoring and measuring – embed them in team and individual goals and link the initiatives within the implementation plan and if them directly to employee performance objectives and necessary, changing course. variable compensation

STeP 5 – moniTor AnD conclUSion conTinUAlly imProVe client experience is the area of focus banks will need The client experience is not static or entirely predictable, to embrace in order to win in today’s retail banking in that: environment. we believe delivering an improved client • not every action is going to have the intended impact experience in a profitable manner is possible, and can • The environment and client needs are dynamic serve as a useful anchor for organizing and prioritizing initiatives in a world of scarce investment dollars • The target itself should be moving so that the bank and management bandwidth. The keys to success in continually adapts and improves establishing a client experience-driven culture start it is therefore critical to monitor the overall program with recognizing that every interaction counts, followed and specific initiatives so that the client experience and by using a structured design and implementation financial impact are clearly understood. monitoring is process that delivers on specific objectives as well best done with both a set of client experience metrics as drives financial benefit. Finally, different parts and financial metrics. Direct customer feedback should of the organization must be aligned and incented be solicited for the client experience metrics. Financial around the overall goal and be metrics-driven, so that metrics should be carefully tracked to ensure true improvements can be measured.

copyright © 2012 oliver wyman 19 4. US conSUmer creDiT Score miGrATion oBSerVATionS AnD imPlicATionS For creDiT riSk mAnAGemenT

By Peter carroll

in the early days of credit scoring, each consumer was the accuracy and consistency to reveal each person’s thought of as having a “natural score” that in some “natural score”. way reflected his or her unique self—an indicator of Today, we no longer see scores as a kind of “payment deep-seated personality traits that could permanently behavior DnA”; we realize that someone’s scores can distinguish between mr. Smith and mrs. Jones, and the vary across time—perhaps even significantly—and propensity of each to repay a loan. if one person’s score that they do so because of real changes in the person’s was different when calculated at two different times, it situation. we even know some of the factors that will was not seen as a reflection of a change in that person’s cause someone’s score to change, such as incidence of nature—it was more likely to be considered a problem late payments, excessive credit utilization, or frequent with the scoring model, or perhaps an issue with the inquiries for more credit. input data. The statistical models that generated these scores were understood to be imperfect but, gradually But the extent to which scores actually vary is still not refined, it was thought they would eventually achieve widely appreciated. exhiBiT 1: miGrATion oF 50 inDiViDUAl VAnTAGeScoreS

VANTAGESCORE 1,000 950 900 850 800 750 700 650 600 550 500 2005 2006 2007 2008 2009 2010

copyright © 2012 oliver wyman 20 exhibit 1 shows the five-year migration path, by month, attention to during model building and not just during of a group of 50 people whose VantageScores in the initial use of the finished model. in real time, there is additional month were all very close together, between 741 and 760. volatility due to incomplete data inputs (for example, a large bank may fail to report to the credit bureaus in a it is visually very clear – and quite surprising – that the particular quarter). scores significantly migrate. After five years the score range has grown from 20 points to virtually the full 490 points The answer to the third question is clearly very dependent (VantageScores range from 501 to 990). what is even more upon the answer to the second. if we can indeed discover surprising is the shape of the “envelope”. These scores do patterns in score migration data – if we can predict how not migrate slowly and then finally, after five years, achieve people with the same score today will change score a wide dispersion. instead, they migrate quickly, straight in the months ahead – it would substantially change out of the gate, so that a majority of their total five-year (and improve) approaches to risk assessment and to migration has already occurred after 18-24 months (which underwriting, pricing, and portfolio management. is the predictive window of the score itself). even if migration paths cannot be predicted, the simple knowledge of this degree of score migration might if we take similar samples of scores from other starting influence both underwriting and portfolio management in score ranges, we see the same thing. Scores drawn from a the general direction of “caution”. high score range disperse widely too, although on average they end up lower after five years. Similarly, scores drawn on the question of predictability, analysis conducted from a lower score range migrate and disperse widely, and by experian’s statistical experts shows that a score then, on average, end up higher after five years. migration path contains no material added information beyond the latest score. if your score today is x, it does Upon seeing these score migration data, three questions not matter if it was previously 2x, x, or x/2 – your prior come to mind: scores and your score path (to x) do not add predictive power. Future score migration is also not easily 1. Do the changes in score reflect changes in predictable. At least, it is not predictable using variables default probability? chosen from the same set of independent variables 2. Are there any patterns — can the migration paths used to develop the score itself. This is fairly logical: be predicted? the process by which a score is developed involves a detailed examination of hundreds of variables to see how 3. what are the implications — how does this each one individually, and eventually several of them in change our approach to consumer credit? combination, can best predict the chosen dependent variable. (The dependent variable is a “performance” The answer to the first question is basically “yes”. variable, typically a degree-of delinquency measure According to analysis performed by experian’s statistical such as a 90 days past due event within an 18 to 24 1 experts , a freshly computed credit score is still the month performance window.) if a score is well-built, best guide to delinquency and default performance it will already have derived the best insight into future in the next 18-24 months. There is a second part delinquency behavior from the available variables. Put to that question which is whether the changes in another way, if there were a single variable that readily scores exaggerate the underlying changes in PD. By predicted score-change (or score-migration), it would construction, changes in score correspond to changes already be in the score itself. in PD and so there should not be a bias. A score model, however, could have properties that introduce noise into note: Throughout this document, we use the VantageScore as our reference score. we believe the principles laid out here regarding score migration would hold in a the system over time (for example, the use of bucketed/ similar way for other industry generic (i.e. non-proprietary) scores. discrete variable in the scoring model or the fact that the The VantageScore ranges from 501 to 990, with a low number indicating worse “bad odds” and a high score indicating better “bad odds”. overall scoring model is actually composed of multiple we sometimes use the following system to refer to VantageScore bands: sub-models and a “jump” may occur as someone crosses score Band designation name among sub-model segments). This suggests that score 901-990 A Super-prime 801-900 B Prime stability/volatility should be something that lenders pay 701-800 c near-prime 601-700 D Sub-prime 501-600 F Deep sub-prime 1 experian was the source for the VantageScores in our analysis; they provided us The data used to generate the analyses in this report come from a sample of 12 mm with a sample of the monthly scores of 12 mm consumers over 5 years. records from experian’s primary data file on consumers. copyright © 2012 oliver wyman 21 of course, this does not mean that the propensity using only credit bureau attributes. Based on analysis for someone’s score to migrate in a certain way is not oliver wyman has performed on the score data, it appears predictable using other types of data. however, even this possible to divide a group of people with the same credit intriguing possibility can be restated as follows: if there score into high, medium, or low volatility sub-groups, is a source of non-traditional data that could predict without the ability to call the net direction of movement. score-path for a traditionally built credit score, it would while this is less dramatic, it is still useful. it is especially probably be most productive to rebuild the traditional useful when we recall that the relationship between score to incorporate the new variables into a modified likelihood of default and credit scores is non-linear. Thus, score. This is currently happening around the industry as it is proportionately worse if one migrates down than up. various new sources of data are examined for their ability So if a group of people with the same initial score migrate to refine the ability of traditional scores to differentiate with low volatility, they are less risky than a group who credit risk. Alternative data sources include information start in the same initial score range but migrate much from firms like lexis nexis (public records attributes), more—even though the two groups may keep the same l2c (non-traditional data sources such as payday loan average scores. applications, phone, and cell-phone records), and ewS it would also be helpful to separate a group of consumers (DDA account balance and transaction summary data). with the same score into sub-groups based on their These data elements have been shown to add ‘lift’ to relative sensitivity to an economic downturn. This would traditional credit scores, at least for certain segments of take the form of a conditional probability in which two the credit population. people with the same score today would be regarded as Stepping back from the temptation to predict score having the same probability of default if the economy migration paths – a form of “Quest for the holy Grail” – it stays in a steady range but different probabilities in the might nevertheless be useful to know whether scores are event of a recession. likely to be more, or less volatile. in terms of exhibit 1, that we have analyzed this possibility. exhibit 2 shows how would mean abandoning the attempt to predict where the scores in US metropolitan statistical areas (mSAs) each score will go, but settling for an ability to say at the changed during the recent economic downturn. The beginning, before the scores all start to disperse, which mSAs are ranked by an index that reflects the degree of ones will exhibit more stable month-to-month changes deterioration (a positive change in index = deterioration) and which will exhibit larger or more frequent changes. in their macro-economy, specifically their decline in it turns out that this is somewhat predictable – even home prices and their increase in unemployment. exhiBiT 2: AVerAGe mSA VAnTAGeScore chAnGeS in reSPonSe To chAnGeS in The locAl mAcroeconomy

CHANGE IN CHANGE MACROECONOMIC INDEX IN VANTAGESCORE 50 5 Greater Deterioration 40 4

30 3

20 2

10 1

0 0

-10 -1 Vantage Score Change -20 -2 Greater Macro Index Improvement -30 -3 Change MSAS RANKED BY CHANGE IN MACROECONOMIC INDEX FROM WORST TO BEST copyright © 2012 oliver wyman 22 During the period march 2007 to February 2009, the however, when we then examined the consumers in the economy worsened in all but a handful of mSAs. over top and bottom deciles of score change, we found that that same period, the average VantageScore of all there are some variables available at T=0 (i.e. in march consumers in those mSAs changed, and in a manner 2007) that predict whether a consumer’s score is more that was broadly correlated with the macroeconomic likely to be in the top versus the bottom decile. Among changes: in the weaker mSAs scores worsened, and in the variables with predictive power were: the stronger mSAs, scores rose. • Total number of inquiries while the broad overall correlation is striking, what is • overall balance on all trades, last six months actually quite surprising is the very low degree to which • Total amount paid down on all types of mortgage the economic changes cause changes in average score. trade, last six months The entire right-hand-side axis of average score changes is basically about 5 points in a 500-point score range. • Average months since a revolving trade was opened These variables act as a “sensitivity-to-downturn” indicator. This finding corresponds with other work we have done At least, they did for the downturn we just had. The recent which suggests that score averages are relatively sticky and hard to change—even while individual scores, as we and ongoing economic downturn had a particular set of have seen, are very volatile. Another way of saying this causes, heavily related to the housing/mortgage market, is that variability in individual scores is large relative to and inflected with very poor underwriting practices for systematic variations in score caused by the economy. recent mortgage and home equity vintages. while it is interesting to note the apparent predictive power of certain exhibit 2 raises a further question: if we examine the variables in recent months, these could very well prove individuals within selected mSAs, would we find that not to be predictive in a different kind of recession—for their dispersion somehow reflected the impact of example, in the kind of “high energy price recessions” we the macro-economy? experienced in the 1970s. exhibit 3 shows, for the 20% of mSAs with the worst nevertheless, with further work, and with all due macro-economic changes (i.e. the ones on the left in caution, these variables could be formed into a exhibit 2), how individual scores migrated over the two- secondary score whose predictive value could be year period. expressed as follows: “For a group of consumers who have the same score today, i can generate a second exhiBiT 3: in “weAk” mSAS, inDiViDUAl ScoreS metric that will say how the score is likely to change, STill miGrATe SiGniFicAnTly in the event of a regional or local recession”. even if only AVERAGE VANTAGESCORE® directionally correct, such a secondary score would be 901 immensely useful. what we have done here is to move away from the idea 9 of general predictability of score movement or score

801 change in VantageScore®

8 Deciles based on the path, to the idea of predicting movements in score that 7 are conditioned on a change in the macro-economy. 6 701 5 whether we choose to predict the macro-economic 4 3 changes themselves is a separate challenge that we will 2 not consider here. But even if prediction of such macro- 601 1 economic changes is regarded as infeasible, differing susceptibility to such changes is a risk factor in its own right. 0 501 The third question posed earlier was: “what are March, 2007 March, 2009 the implications?” The implications clearly depend upon the degree to which score movements can be predicted, whether in absolute terms, directionally, or what exhibit 3 demonstrates is that even in the mSAs conditionally. Any reliable degree of prediction could with the worst macro-economy, almost as many be immensely helpful in improving risk assessment and consumers saw their scores increase as decrease. risk management. copyright © 2012 oliver wyman 23 even if reliable prediction proves to be impossible, the The odds table allows a certain score to be translated into fact of significant score variance, and the changes in the probability of a “bad outcome” within 24 months. But default probability that brings, suggests a few simple if a bank makes a loan with a longer term, perhaps for 60 changes of emphasis. one is that portfolio monitoring months, it may wish to estimate the bad odds in months and portfolio management increase in importance, 25-36, 37-48, and 49-60. The score migration data relative to initial underwriting and pricing. of course, provide a basis for making such estimates. recent regulatory changes have decreased lenders’ degrees of freedom to act in a portfolio management in general, the longer-term odds for low-score borrowers setting. one interesting idea is to try to reintroduce will improve, while the odds for high-score borrowers some degrees of freedom through product and package will worsen. exhibit 4 shows the impact after five years redesign: put back some levers that can be changed as a given initial scores. customer’s score goes down or up. one example could be a tiered rewards package in which the “exchange exhiBiT 4: iniTiAl VS. (imPlieD) FinAl rate” for both earning and redeeming rewards is DeFAUlT ProBABiliTy related to the customer’s credit score. in the current environment, some creativity—and liaison with the legal % OF SCORES ACROSS BADS department —may be called for in this endeavor. 50% The observable fact of high consumer score migration could also lead to the development of a consumer 40% equivalent of what, in commercial banking, has been used for some time: ratings migration. The performance 30% period for the VantageScore is 24 months. Users of the Initial score can translate an applicant’s score into a default 20% default probability via an odds table: probability 10% Implied 90+ rate 90+ rate good/ default score range interval cumulative Bad odds probability 0% after 5years 501-530 46.87% 6.12% 1.1 501-530 611-630 711-730 811-830 911-930 531-550 38.61% 5.42% 1.5 551-570 32.75% 5.03% 2.0 571-590 26.76% 4.57% 2.7 591-610 20.58% 4.03% 3.7 when we track a cohort of consumers who have scores 611-630 15.15% 3.50% 5.5 at a certain starting point, not all of them still have a 631-650 12.52% 3.00% 6.8 score five years later. Some consumers die, for example. 651-670 9.49% 2.52% 9.4 others cease being active in the credit markets and 671-690 7.36% 2.08% 12.4 fail to generate sufficient data to compute a score. The 691-710 5.66% 1.67% 16.5 analyses presented in this paper are only for consumers 711-730 4.43% 1.35% 21.4 who had a score throughout the four- and five-year 731-750 3.19% 1.08% 30.2 periods we examined. we separately analyzed the credit 751- 770 2.26% 0.84% 43.1 771-790 1.63% 0.66% 60.1 scores of people who had a score at the beginning but 791- 810 1.24% 0.53% 79.3 not at the end of our observation periods. The pattern 811-830 0.99% 0.42% 99.5 of “last valid scores” did not seem anomalous. in fact, 831-850 0.64% 0.32% 154.7 they generally reflected a similar degree of migration 851-870 0.42% 0.26% 236.3 and dispersion—up to the point of the last valid score 871-890 0.31% 0.21% 323.9 —as did those people with valid scores throughout the 891-910 0.21% 0.16% 472.6 observation window. 911- 930 0.15% 0.13% 674.3 931-950 0.12% 0.12% 818.2 951-970 0.15% 0.12% 659.9 971-990 0.10% 0.10% 1011.7

copyright © 2012 oliver wyman 24 5. relATionShiP PricinG A STronG leVer To DeePen cUSTomer relATionShiPS – iF USeD wiSely

By inderpreet Batra

retail financial institutions – banks, brokerages, • availability of richer behavioral data from existing insurance companies – are all focused on “deepening” relationship. A bank or an insurance company existing customer relationships, driven in large part by has better internal data to underwrite an existing recent regulatory changes. in other words, they would customer than that afforded by external information like their customers to not only do more business with alone. in certain cases, underwriting based on DDA them, but all of their relevant business with them, if transaction data outperforms underwriting based on possible. customers who have more products with a credit bureau data financial institution are shown to be more loyal, more • Positive inter-relationships between behaviors on profitable, and stronger advocates of the brand1. different products. A customer who has a credit card Pricing such relationships hence starts to move away from the same bank where she also has her primary from a pure product-pricing paradigm. Traditionally, checking account, for example, tends to have higher relationship-based pricing decisions have centered on balances than a customer who does not have a credit offering discounts, a practice which at best can have card from the bank, all else being equal mixed effectiveness and at worst can leave significant These differences in value argue for a different approach value on the table. we instead argue that the right to pricing. in order to use a value lens to get relationship relationship pricing paradigm should (1) recognize pricing right, financial institutions need to address three incremental value that can be derived from deepening key questions: an existing customer relationship vs. that from a new prospect and (2) leverage both price and product 1. what relationship deepening opportunities exist offerings to drive desired behaviors. The sources of value within the book of business? from deepening customer relationships are typically in three areas: 2. how effective a lever is pricing in driving deeper, more fruitful relationships? • Privileged access to existing customers through 3. what are the right pricing “constructs” multiple channels. customers have more touch- that will result in high adoption and desired points and are more likely to pay attention to incremental behaviors? solicitations. Direct mail and email “open rates” are higher for solicitation from an Fi with which an individual has an existing relationship

1 This is demonstrated even after accounting for selection bias. copyright © 2012 oliver wyman 25 1. iDenTiFyinG relATionShiP – 2. eFFecTiVeneSS oF Price DeePeninG oPPorTUniTieS AS A leVer The starting point is for financial institutions to identify the After identifying customers who are both good targets “anchor product” for their existing customers: what is the for specific additional products and expected to first product that the customer gets when they commence represent a profitable relationship, a financial institution a relationship? For banks, this is often the checking should determine how effective a lever price can be for account/DDA, and for brokerages it is the investment driving penetration. This test involves considering the account (managed or transaction-based). price elasticity of customers for specific products, i.e., the degree to which pricing can drive behavior required The next step is for firms to understand their existing for value generation. This can be quantified through penetration levels of various products vis-a-vis the anchor consumer research and by using a variety of analytical product. Some products lend themselves to more natural techniques such as conjoint analysis, sequential choice sales, e.g. savings accounts for a checking customer, analysis, and many others. while others are less intuitive, e.g. mortgages for a brokerage customer. The lower the existing penetration, Somewhat unsurprisingly, customers are not equally the greater the opportunity – but it is also more likely that price-sensitive across all products. This is a function of greater effort will be required to realize that opportunity. the value they derive from a particular product and how 2 exhibit 1 shows representative penetration levels of other important price is relative to that perceived value. For banking products among checking account customers. example, customers are extremely sensitive to interest rates on first mortgages. They often shop for the lowest The final, critical step here is to quantify the profit pools rates, and even a small reduction in rate can have a available if x customers incrementally adopt y products. significant incremental impact on volumes. on the There are large value skews almost everywhere in other hand, they are not as sensitive to pricing on their retail financial services, and these need to factor in a investment relationships – many customers are not relationship-deepening strategy before tactical product/ pricing decisions enter the picture. exhiBiT 2: relATiVe imPorTAnce oF VArioUS FAcTorS in DriVinG conSoliDATion For exhiBiT 1: BeST-in-clASS PeneTrATion leVelS SmAll BUSineSSeS AmonG conSUmer DDA hoUSeholDS % oF resPondents considering 100% Factor Factor as most imPortant Better pricing on your 36% overall relationship 80% Privileged access/better 20% service levels 60% Best-in-class products 19% across categories

40% A multi-product 12% rewards program Best- Access to better information 4% 20% practice and advice to run your among business better leading negotiated discounts at 2% 0% banks leading business suppliers

CD Discounts on financial 2% management technology

Savings or software Mortgage Credit card Investments

Home Equity Home other 6% Personal loan

Source: oliver wyman proprietary consumer survey, client experience Source: oliver wyman Survey of Small Business Finances 2011

2 This is often referred to as “mental accounting”, a term coined by richard Thaler, Professor of Behavioral Science and economics at the University of chicago Booth School of Business. copyright © 2012 oliver wyman 26 even aware of how much they pay their financial advisor. and it incentivizes behavior that the customer cares while puzzling, both of these behaviors can be argued about (rewards), while nudging her to give back in the to be rational. in the former case, a monthly mortgage form of retention for a product the bank cares about payment is likely the highest monthly expense for an (deposits). Such a continuous give-and-take component individual; hence even a small reduction in rate has a ensures positive economic outcomes for both the bank meaningful impact on spending capacity. in the latter and the customer. Another example is in merchant case, customers see their trusted relationship with their acquiring, where a bank with a merchant services arm advisor as providing a more “intangible” service. could charge a small business a discount rate that’s based not only on its monthly sales volume, but also on in most cases, pricing can drive behavior change. its deposit and loan balances with the bank. The small Small businesses, for example, view pricing as the most business receives a lower discount rate only as long as it important lever for consolidating their relationship maintains a minimum balance of deposits and loans and with a particular bank and almost twice as important as provides a strong incentive for consolidation. service levels and product sets (see exhibit 2). A pricing construct we observe to be somewhat less effective is one where the incentive is linked to a valuable, 3. DriVinG ADoPTion but one-time customer behavior. A common example is a discount on a loan in return for additional deposits. The For the target customers and specific products where challenge with such structures is in converting the one-off pricing could be an effective lever, the Fi now needs to behavior into an ongoing one, given the richness and define the “construct” within which the relationship non-replicable nature of the one-time offer. pricing offer should sit. Product bundles are extremely common throughout the industry and offer an easy way to implement relationship pricing. For example, chase conclUSion offers 1% cash back3 on the mortgage interest paid if the customer signs up for automatic debits from her chase Developing deeper customer relationships should be a checking account. Several brokerages offer loans at rates key element of a financial institution’s growth strategy. that are tiered according to the total assets held by the Pricing can play a key role in profitably accomplishing this customer – the larger customers get the lowest rates. objective. while offering discounts is relatively easy, it can offer mixed results and severely damage profitability. As we believe that to the extent possible, pricing should outlined in this article, we recommend using a value-lens reinforce the value of the relationship and hence based approach for relationship pricing where the goal is recommend pricing structures which drive incremental value-generating behaviors (see exhibit 3). behavior on an ongoing basis. For example, consider a credit card that offers 20% bonus rewards to customers Using this approach in your business is not as easy as who maintain a minimum deposit balance of $50,000 conventional discounting, but the rewards are worth the with the bank. This structure links behaviors on both effort. As with life choices, the hard road here is the right products – DDA and credit cards – on a consistent basis, one to take. exhiBiT 3: VAlUe-BASeD relATionShiP PricinG – recAP

Estimate profit pools from Assess price Devise the right Identify “anchor” Determind the incremental sensitivity (and its construct for products where best aditional penetration; effectiveness as a relationship existing customer penetration prioritize lever) for those pricing to generate relationship is opportunites opportunities customers and incremental strong accordingly products profitable behavior

3 See https://www.chase.com/chf/mortgage/mortgage-cash-back. copyright © 2012 oliver wyman 27 6. BrAnch FlexinG An AGile APProAch To coST mAnAGemenT

By Sumit Sahni, Paul mee, Aaron Fine, and massimo Tessitore

Since the spectacular end of the pre-2007 credit boom, in the current economic and regulatory climate, the profits of retail banks have come under intense and increasing revenues by anything like 12% a year is sustained pressure. even after the recent rebound, the practically impossible. Sales are likely to remain slow as average return on equity for regional banks remains property markets remain flat, economic growth remains roughly half of pre-crisis levels. The causes of this decline sluggish and households and businesses continue to are familiar – reduced lending growth, higher capital deleverage despite extraordinarily low interest rates. costs, deposit margin contraction caused by exceptionally nor can banks easily increase their prices given the low interest rates and regulatory restrictions on fee intense scrutiny of media and politicians. retail banks income (e.g. regulation e and Durbin in the US). must again look to regain profitability by cutting costs. yet the scale of the challenge may be less well making material cost reductions will require a re- appreciated. For example, to maintain profit levels in the examinationof branch networks, which typically face of a post-crisis and regulatory-reform decline in net contribute between 40% and 60% of a modern retail revenue of about 32%, US banks would need to increase bank’s costs. revenues by 12% a year for the next three years or cut The simplest way to reduce the cost of a branch costs by 18% a year, or a combination of the two. network is to either reduce capacity across the board in proportion to the decline of transaction volume or exhiBiT 1: eSTimATeD imPAcT on neT DePoSiT to reduce the network’s size: that is, to close down reVenUe For US reTAil BAnkinG branches. But this threatens revenues because, despite the growth of mobile and internet banking, face-to-face -32% meetings in branches remain the most effective way of 32% selling banking products. A mistaken strategic decision to cut too deeply is expensive to reverse.

36% instead, retail banks must develop more flexible Non operating models, which can adopt capacity and costs interest 68% income in line with the opportunity to capture customer value. 64% Given that the manageable costs of branches are Net primarily personnel costs (see exhibit 2), this means interest income better aligning branch staff capacity to value creation, 2010 2012 thereby increasing staff productivity. in an environment where revenue growth is hard to find, this will naturally copyright © 2012 oliver wyman 28 exhiBiT 2: AliGninG The reTAil BAnk coST STrUcTUre wiTh cUSTomer VAlUe

OVERVIEW OF RETAIL BANK VALUE BASED FLEXING COST STRUCTURE ALIGNING BRANCH CAPACITY WITH CUSTOMER VALUE

100% 100% Granular disaggregation of network profitability characteristics by branch/geography Other Region BRANCH 2 B BRANCH 1 Region BRANCH 3 A BRANCH 2 Non- Fixed branch (~50%) BRANCH 1 Costs Occupancy Opportunity to flex ~20-30% VALUE BASED CAPACITY MAP % CUSTOMER ACCOUNTS capacity away from low to negative value generating activities

Semi-fixed Profitable (~20%) Unprofitable Branch Personnel Account mix Account mix Service capacity Sales capacity Costs ~50-60% mix mix 40-60% Variable* Pre-crisis Post-crisis (~30%) “De-averaging” of branch profitability Sales and service capacity mix as distinct characteristics by customer profile dimensions of optimization

* in some markets, labor regulations will constrain the extent to which personnel costs can change, at least in the short term, and therefore will significantly increase the fixed cost percentage result in tailoring the total hours worked at the branch more than 10% of customers are not covering even to demand and value creation, by use of flexible hours, marginal costs (see exhibit 3). part-time workers, and reduction of the workforce. Such findings reveal the importance of better aligning The key to properly “flexing” a branch is understanding branch resources with customer profitability. in most the relationship between the activities in which the branches, a small minority of customers contribute well branch is engaged – which, broadly speaking, are either over 100% of profits, with the rest reducing value. A making sales or servicing customers’ current products program of branch flexing must ensure that costs are – and the value being created by these activities (see cut in a way that insulates the best customers from any exhibit 2). The value a specific branch creates can differ degradation in their sales and service experience. markedly from the value ordinarily attributed to it, The specific strategy for flexing will depend on the because accounts are frequently serviced and products nature of the branch – i.e. the value mix of customers sometimes sold at branches other than a customer’s that use the branch and the profile of the branch official branch of record. nor does the time that branch (see exhibit 4). There are three generic strategies for staff actually spend on various activities always conform branch flexing: to the official story. Understanding the connection between activities and value creation requires a genuine • overall reinvestment and upgrading of the sales and empirical study of customer value, branch usage and the service experience for those branches where the linkage between staff activity and value created. overwhelming majority of customers are high value • highly differentiated service experience for The results of such a study can be startling: analysis those branches with an even mix of low and high performed by oliver wyman for one major institution value customers revealed that, post-crisis, 60% of deposit accounts serviced through the branch network are loss- • An on-average retrenchment of service and sales making when the cost load is properly accounted for, capacity and conversion to a lower specification representing a 220% increase in unprofitable accounts. branch configuration for those branches where an overwhelming majority of customers are lower value copyright © 2012 oliver wyman 29 exhiBiT 3: chAnGe in DePoSiT cUSTomer ProFiTABiliTy (DiSGUiSeD clienT exAmPle)

DEPOSIT CUSTOMER PROFITABILITY* DEPOSIT CUSTOMER PROFITABILITY MIGRATION SIGNIFICANT SHIFT AWAY FROM PROFITABILITY 6% 20% 22% 52% Totals Change

27% Above 0.5x † Above hurdle G hurdle‡ 27% 27% 52% † F

Profitable Below hurdle 16% Below 0.7x 16% 16% hurdle FUTURE Profitable C D E Marginal + 15% 22% 9% 46% Crown jewels 22% A B 46% Marginal+** 2.3x Marginal − 6% 5% 11%

Unprofitable Recently underwater Marginal Marginal Below Above 20% − + hurdle hurdle Unprofitable 11% Marginal- 1.8x 6% Unprofitable Profitable Unprofitable 2007 2011 PAST

Source: oliver wyman analysis * Profitability calculated across all deposit products (checking, saving, time) † Fully loaded profit = net interest margin + net interest income − net interest expenses − Taxes ‡ Based on Total expense ÷ Total revenue ≤75% ** marginal + defined as profitable after marginal cost exhiBiT 4: key oPTionS For BrAnch FlexinG – DriVen By VAlUe mix AnD BrAnch ProFile

PRIORITIZATION FOR EACH OPTION 1 Deploy technology for peerless servicing experience 1 SERVICE LEVEL IMPROVEMENT AND RETENTION High • Enhance value proposition through deployment of low cost remote service tools

2 SERVICE & SALES TIERING • Realign sales and service capacity to highest VALUE MIX value opportunity Value 2 Differentiate service adjusted (e.g. “Preferred lines”, sales and targeted staffing to 3 ACROSS THE BOARD CAPACITY REDUCTION service put best associates in • Reduce sales/service capacity to reflect lower demand front of best customers) value customer mix

3 Remove service capacity and realign Low sales capacity to high value opportunity

ATM/VTM* Full Service Flagship BRANCH PROFILE * Automated teller machine/video teller machine in most branches today, the majority of customers are service approach (option 2 in exhibit 4) should be value destroying but the number of high value customers considered, where the experience of the best customers is is sufficiently large to make across-the-board cuts in sales protected while other customers are encouraged to alter and service capacity very risky. Therefore a differentiated their branch usage behavior. copyright © 2012 oliver wyman 30 exhiBiT 5: BrAnch FlexinG TAcTicS By cUSTomer TyPe (PoTenTiAl ScenArio)

Current % Dedicated Assisted self-service Self-service Final sales/ Customer % service/sales teller (in-branch web, Upgrade service segment Accounts capacity* access In-branch† Telephone/Video‡ ATM/VTM) option capacity

~$10 monthly ~25% Maintain Unprofitable 26% 26% Full access Full access ~10%**

fee to upgrade capacity (A + B + C) service service level

Recently Access Access ~$ 5 monthly †† Underwater 31% 31% with with Full access Full access fee to upgrade ~15% (D + E) wait time wait time service level original Protect ~40% service service ~40% capacity Crown Priority Priority No need for Jewels 43% 43% Full access Full access ~40% access access upgrade (F + G) (no lines) (no lines)

~∆10-40% reduction in sales and service capacity ~65 Total 100% 100% ~∆35% Priority/complete access Have access (with wait time) No access

* Assumes that current service/sales deployment distribution is same as customer distribution † Tellers assisting clients with use of in branch self-service machines ‡ call center, virtual teller, online banking chat, etc. that can be accessed within the branch ** All in branch service capacity is removed for this client segment; however, 1/3rd of service capacity re-invested for telephone/virtual (i.e. out of branch) assisted service for this and other two segments †† clients re-directed to assisted self-service. Assumes assisted self-serve teller productivity is 3 times that of the dedicated teller productivity level (31% ÷ 3 = ~10%) and then half as much added for dedicated teller access but at lower service levels (i.e. higher wait times)

The tactics of flexing will depend on the objectives and to product offerings at a lower cost to the branch by context of the specific institution. one potential scenario changing the primary channel used to access services. for providing customers with different levels of service when these cost savings are realized, some of these according to their value is outlined in exhibit 5. customers will become profitable, improving the bottom line in lean times without losing the customer base, who in exhibit 5, the flexing of service levels reduces branch in a better economic climate would be more valuable. staff time allocation to the two lower-value customer categories while holding it constant for high value To keep the entire customer base satisfied, a number customers. The net result can be anywhere from a 10- of measures can be taken to improve staff efficiency in 40% reduction of staff capacity for branches that are servicing all classes of clients. These fall into four broad above minimum threshold size. This delivers a gross (i.e. categories: protective, pre-emptive, operational, and before reinvestment and restructuring costs) branch service model. cost reduction of 5-15% (assuming the breakdown of Protective measures aim at preserving the service branch and variable costs shown in exhibit 6), equivalent experience of the highest-value customers and retaining to as much as 10% gross reduction in overall retail bank the profitable customer base. These include: costs. This is a high quality and material cost saving that • Distributing lists of the top 100 customers by branch requires no branch closures. its benefits are realized to the managers and having managers phone these relatively rapidly and the means are adjustable or, if high-value clients a couple times per year to express necessary, reversible. gratitude for their business as well as identify unmet The branch flexing discussed above involves tiered client needs service levels and, importantly, reduced service capacity • Setting up a high-value customer experience allocated to unprofitable customers. The upside of framework, where high-value customers are given a flexing is that, unlike branch closing, it allows for differentiated/personal experience when interacting unprofitable customers to maintain the same access with the bank

copyright © 2012 oliver wyman 31 exhiBiT 6: GroSS BeneFiTS oF VAlUe BASeD FlexinG (orDer oF mAGniTUDe)

IMPACT ON OVERALL COST STRUCTURE BENEFITS OF BRANCH FLEXING APPROACH GROSS ECONOMIC BENEFITS 100% 100% ECONOMIC BENEFITS 92% • Significant plausible gross savings (before reinvestment & restructuring costs − 5-15% of branch costs • No branch closures Other • Immediate realization of benefits Costs ~∆2-8% reduction OPERATIONAL BENEFITS in total • Optimize sales and service capacity costs • Reversible

50% STRATEGIC BENEFITS ~42% • Ability to optimize operational capacity will enhance Fixed next generation footprint design (e.g. hub and spoke, virtual branches, etc.) 50% ~∆5-15% reduction Branch in branch Costs 50% Semi-Fixed costs 20% • Achieving savings beyond 10% will likely require Flex half by ops/tech enablement and value proposition redesign ~∆10-40% Variable • Extent of reinvestment for high value customers likely 30% Flex all by to decrease realized net savings to 2-12% ~∆10-40% • We anticipate ~5% attainable net save in the short term Overall bank costs Branch costs… …after flexing

• Setting up an attrition management framework, operational measures aim to deal more efficiently with segmented by customer value to handle and to set off the customers who do ultimately come to the branch. alarm bells if attrition is rising among the high-value These include: customers (e.g. sending an alert if an account closes • rostering to demand, so that staff numbers vary with or balance drops by more than 50%) customer numbers. This already happens to some Pre-emptive measures aim at reducing the amount extent but the work-blocks used are typically still of work that customers direct towards branches. too big. A teller working for just two to four hours These include: some days (e.g. during peak periods such as lunch • Promoting and incentivizing the use of advanced hour) would not only help to match staff numbers to payments technology, such as mobile phone-based customer traffic but may also be considered a flexible check deposit, that gives customers convenient employment benefit alternatives to using branches for simple transactions • Smoothing the issue of statements through the • web-based appointment booking, which reduces the month and across branch catchment areas to administrative burden on branch staff generate a balanced flow of customers coming to the branch with queries • Special fees for non-bank customers. For example, the use of coin counting machines is being charged at • increasing the availability of self-service options in 3%-6% of the amount counted by some banks branches, such as ATms, check reading machines, coin counting machines, direct-line phones and • A “guru support” type of service that helps customers interactive kiosks (with a person available via video with queries via remote channels. not only do these phone if help is needed) staff operate from a lower cost basis, but they are also able to offer specialized service more efficiently and • Using machines rather than tellers to dispense plastic more productively (via flexible capacity utilization) cards (credit, debit, pre-paid) when card applications are completed at a kiosk or online

copyright © 2012 oliver wyman 32 Sales and service model measures aim at more directly the process. The ideal format of a branch – that is, its size re-aligning the in-branch capacity mix to the branch and the services offered at it – depends on its location customer profile and traffic patterns: and the type of customer traffic it will therefore attract. • Focusing customer acquisition efforts by compiling The analysis performed to align service with customer the addresses of the best customers and prompting value, combined with demographic statistics, can be branch managers to go after customers in the used to determine the type of branch that will be most same neighborhoods cost-effective in any location (see exhibit 7). • Generic customer Assistants (GcAs) to serve Banks vary considerably in their proximity to best all customers’ basic needs (sales, inquiries and practice. Before embarking on a branch flexing program, transactions when needed) instead of the currently management should assess their current distance from siloed service paradigm (tellers for service vs. the ideal, ensure they understand the optimal branch relationship managers for sales); GcAs can be format for each location and identify the changes that augmented with product specialist support as needed will be easiest to make. This last bit of information is • instituting hybrid roles (e.g. branch manager with difficult to come by except through a test-and-learn sales responsibilities, senior teller with greeter approach – especially as the reactions of staff, unions, responsibilities) for low/medium traffic branches customers and the local competition can be difficult (e.g. suburban footprint) to predict with absolute certainty. This is why we • multi-branch spans of control for some roles strongly recommend piloting flexed branches before (e.g. compliance officer) to improve operational undertaking a network-wide program. not only does it staff leverage reduce the risks, but it will provide information that will allow the fine-tuning of the approach ultimately taken. As banks flex their branches in such ways, they must bear in mind the type of branch that will emerge from exhiBiT 7: BrAnch FormAT oPTimiZATion – BASeD on micro-SeGmenTATion

GEO  DEMOGRAPHIC DATA ANALYSIS TOOL EXAMPLES

KIOSK/MOBILE

BASE LEVEL BRANCH Branch Manager Assistant Consultant

• Extract customer profiles and LENDING AND predicted behavior from INVESTMENT BRANCH BUILDING BLOCK MENU geo-demographic data Branch Manager Business desk Assistant • Identify key geographic Consultant demand drivers (e.g. Financial Late shopping centers, mass + Lender advisors Lender hours Lounge transit terminals, commercial districts) WEALTH BRANCH Branch Branch Manager Mobile ATM Internal • Assess optimal location, manager kiosk type and features of channels Assistant for portfolio alignment Consultant Lender Assistant Consultant Teller Parking window • Continuously monitor + Financial Advisor existing channel portfolio to changing demographics, BUILDING SITE Face to face roles Facility options including dispatch of mobile branches/ATMs Lender

copyright © 2012 oliver wyman 33 TAkinG AcTion how a given bank pursues a branch flexing strategy will vary by institution. in our experience, five steps typically form the backbone of a strategic and practical approach. 1. leArn more – conduct a rapid diagnostic to more accurately understand the cost associated with serving customer segments, the contribution by customer, and how the segments map to the branch network at the micro-segmentation level 2. iDenTiFy FlexinG oPTionS AnD leVerS – determine what can be flexed at the branch level, how flexing could be deployed, and the associated dependencies (e.g. online capabilities, more sophisticated rostering, in-branch technology, etc.) 3. TeST AnD leArn – apply a flexing program to a cluster of representative branches: baseline their performance, then track and adjust through the deployment of different and incremental flexing levers/capabilities 4. rolloUT whAT workS – implement those flexing capabilities and approaches proven to be effective more broadly across the branch network 5. PrePAre To PUrSUe more STrUcTUrAl chAnGe – accessing certain benefits is likely to prove harder where the requirements are more structural in nature (e.g. overhauling the branch configuration). in parallel with the actions above, more fundamental changes and redesign options need to be identified, developed and deployed for the longer term The cost imperative is clear. The fast-rising wave of digitization will amplify the challenge with a real risk that branches begin to rapidly look poorly configured, inflexible, and burdensome from a cost point of view. The winners will be differentiated by their clear, lean growth strategy across all channels and customer touchpoints, most significantly their branches.

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