Financial Services VOLUME III – SUMMER 2013 RETAIL BANKING AMERICAS DIGEST IN THIS ISSUE 1. SMALL BUSINESS BANKING Challenging Conventional Wisdom to Achieve Outsize Growth and Profitability 2. FINANCING SMALL BUSINESSES How “New-Form Lending” Will Reshape Banks’ Small Business Strategies 3. ENHANCED PERFORMANCE MANAGEMENT Driving Breakthrough Productivity in Retail Banking Operations 4. INNOVatION IN MORtgagE OPERatIONS Building a Scalable Model 5. CHASE MERCHANT SERVICES How Will it Disrupt the Card Payments Balance of Power? 6. THE FUTURE “AR Nu” What We Can Learn from Sweden About the Future of Retail Distribution FOREWORD Banking is highly regulated, intensely competitive and provides products that, while omnipresent in consumers’ lives, are neither top-of-mind nor enticing to change. These factors drive the role and form of innovation the industry can capitalize on. In traditional business history – the realm of auto manufacturers, microchip makers, logistics companies and retailers – the literature rightly hails disruptive, game-changing innovation as the engine behind outsized profits for the first movers. In banking, such innovation is very rare. Disruptive innovations of the magnitude of the smartphone or social networking grab headlines, but are hard to leverage in the banking industry. There are simply too many restrictions on what banks can do, and too much consumer path dependency, to place all the shareholders’ chips on disruptive innovation plays. Instead, successful banks develop and execute strategies around less “flashy”, dare we say, small-scale innovation that can still reap outsize returns for their shareholders. This issue of the Oliver Wyman Retail and Business Banking Digest takes a closer look at some key innovation opportunities available to banks today, including: • Paths to success in small business banking through new form lending and other challenges to conventional wisdoms • Process redesign opportunities triggered by advances in mobile technology, as in mortgage, or through performance management techniques • Learning from innovation abroad This eclectic list illustrates one of the greatest benefits to small-scale innovation – there is always room for incremental upside. Each effort, executed effectively, will drive additional gains, while affording the flexibility to react to new opportunities. Additionally, such innovation can be a key move in the game of “strategic chess”, such as the recent Chase/Visa partnership announcement (explored in this digest), which their competitors must now respond to. I hope you find these articles thought provoking. Michael Zeltkevic On behalf of the Retail and Business Banking Practice TABLE OF CONTENTS 1. SMALL BUSINESS BANKING 4 Challenging Conventional Wisdom to Achieve Outsize Growth and Profitability The SB segment has long presented a significant opportunity for US banks. However, strategies that meet small business needs, create differentiation and maximize potential economic returns have proven elusive. While many banks have settled back into conventional strategies, challengers to these standards can define a break-out strategy that gains material share from competitors and delivers higher growth and higher profits. 2. FINANCING SMALL BUSINESSES 11 How “New-Form Lending” Will Reshape Banks’ Small Business Strategies “New-form lending” is a new approach to small business financing that will satisfy an unmet need for short-term cashflow financing for SBs. New-form lending relies on the analysis and ongoing monitoring of daily cashflows to assess and control risk. This is a major profit opportunity that can also help improve traditional loan underwriting processes by lowering unit costs and improving risk differentiation. 3. ENhaNCED PERfoRMANCE MANAGEMENT 16 Driving Breakthrough Productivity in Retail Banking Operations Years of relentless focus by retail banks on improving the efficiency of the operations function have left few residual opportunities to drive transformational savings without diluting service quality. By developing a new way of measuring employee productivity and compensation, Enhanced Performance Management (EPM) fills this gap by dramatically increasing employee throughput, while simultaneously improving risk, quality and the client experience. 4. INNOVatION IN MORtgagE OPERatIONS 21 Building a Scalable Model The last 20 years have seen a number of innovations in the design of mortgage origination processes. Looking ahead, however, we see three factors converging that will now provide both the opportunity and the forcing mechanism for institutions once more to rethink their approach to mortgage originations, driving fundamental progress in the core operations of the business. 5. ChasE MERCHANT SERVICES 28 How Will it Disrupt the Card Payments Balance of Power? In the current power play between issuers, networks, and acquirers, JPMorgan Chase has taken a first step towards creating a new 3-party network with Chase Merchant Services. This paper explores how this will impact Chase’s competitors and its customers (merchants and cardholders), as well as the networks themselves. 6. THE FUTURE “AR NU” 33 What We Can Learn from Sweden About the Future of Retail Distribution With high mobile and internet banking adoption, low branch traffic and heavy use of electronic payments, Sweden and its banks provide invaluable insight into the future of retail banking. This article explores the factors that enabled Swedish banks to accelerate evolution and evaluates what one can learn about the future of US retail distribution and how to enable a smooth transformation. 1. SMALL BUSINEss BaNKING CHALLENGING CONVENTIONAL WISDOM to ACHIEVE OUTSIZE GROWTH AND PROFItaBILITY By Anna Epshteyn Whitney and Tim Spence Boasting a base of more than 20 MM potential customers1 The sector is also resilient: in the face of recent economic with a broad range of financial services needs, the Small turmoil and uncertainty, 73% of business owners told Business segment has long presented a significant us that their firms were either “very” or “reasonably” opportunity for US banks. Recent Oliver Wyman research profitable, while 75% described them as being in and analysis2 suggest that the SB sector produces $14 BN “established” or “growth” mode. of after-tax profit and $10 BN of after-tax economic profit3, annually – nearly 15% of the total US financial However, strategies that meet small business needs, services economic profit pool. create differentiation and maximize potential economic EXHIBIT 1: SMALL BUSINESSES ARE HEAVY USERS OF FINANCIAL SERVICES PRODUCT USAGE RATE EMPLOYER SMALL BUSINESSES 100% 80% 60% 40% 20% 0% CD Any Any svcs loan loan ACH Wire lease Payroll Money market deposit deposit Savings Remote HY Sav/ Any loan Any card Checking Merchant Mortgage payments Store card Other loan Auto loan/ Equipment Credit card Operational Charge card Deposits Cards* Loans Payments & Treasury Services * Card consists of cards used solely for the business; 44% of SBs are also merchants (accept cards) Source: 2011 Oliver Wyman Small Business banking survey 1 ~20% of small businesses in the US have at least one employee in addition to the 3 “Economic profit” is the profit after tax earned by the bank over-and-above the owner. Source: 2007 Census. required rate of return on capital held against the risks of the business; it is worth 2 A 2011 survey of 5,000 small business owners, from which we estimated the noting that today, most of this profit comes from high-balance checking accounts profit to banks from these businesses’ product and service usage. and high-volume merchant services accounts – and not from small business loans. Copyright © 2013 Oliver Wyman 4 returns have proven elusive. Following the financial EXHIBIT 2: PROFIT CONTRIBUTION OF SMALL BUSINESS crisis disruption, the market has largely settled back into CUstoMERS RANKED BY RELatIONSHIP PROFIT competitive equilibrium, with many banks – and their CONTRIBUTION TO TOTAL SB PROFIT advisors – allowing a set of conventional wisdoms to constrain their thinking as they craft their strategies. A 73% bank willing to challenge these conventional wisdoms, Oliver Wyman believes, can define a break-out strategy that gains material share from competitors and delivers higher growth and higher profits. 21% 11% What are the conventional wisdoms restricting banks’ 6% 3% 1% strategic thinking? We see five: -2% 1. SEGMENTATION: “The size of the business is the -13% best indicator of needs, profit potential, and sales and service approach” Top 10% 2. RELATIONSHIP COVERAGE: “Assigning percentile percentile percentile percentile percentile percentile percentile percentile th th th th th th th th Bottom 10% relationship managers is an effective means to 80 70 60 50 40 30 20 10 attract new businesses, deepen relationships and decrease attrition” Source: 2011 Oliver Wyman Small Business banking survey 3. CHECKING: “Offering ‘free checking’ is a table- stakes competitive requirement” Oliver Wyman research validates the notion that larger 4. SMALL BUSINESS LENDING: “Credit process streamlining is the key to improving profitability and businesses are more likely to be profitable. However, expanding SB lending” it also reveals two interesting findings that averages disguise. Firstly, 20% of businesses (the high value 5. NEW REVENUES: “Expanding into new service areas group) generate 95% of total segment profit. More is the best path to increasing fee revenue” surprisingly, more than half of the high value group have annual revenues less