Wednesday, 29 January 2014

Back to the future - a return to supermarket banking or the end of banking for all?

The report on the BBC News website that Barclays is looking at potentially closing 400, or a quarter, of its UK branches which was subsequentally retracted and replaced with a statement that Barclays is 'considering closing branches to reflect the that more customers are now accessing financial services online and via mobile devices',  reflects the sensitivity the big 5 banks have to announcing branch closures and comes on the back of a statement in November 2013 that in August 2014 it is to open four branches within Asda (the UK arm of the US supermarket behemoth Walmart), closing the standalone branches in the same towns. The model of putting bank branches into supermarkets brings back memories of the wave of supermarket banking experiments that took hold in the UK at the end of the last century with the launch of Sainsbury’s Bank (backed by Bank of Scotland), Tesco Personal Financial Services (backed by Royal Bank of Scotland) and Safeway Banking (backed by Abbey National). At that time the supermarkets were seen as a serious challenger to the established banks (despite being backed by them) and the world of banking was going to fundamentally change. It was also the time of the tie-up of Abbey National with Costa Coffee to create new and destination branches – very much building on the revolutionary Occasio branches that WaMu (Washington Mutual) launched in the US.
 
So what happened to all these new visions of banking? Abbey National was taken over by Santander who quickly took the axe to the partnership with Costa, Safeway was acquired byMorrisons who closed down the financial services arm and the remains of Washington Mutual following the financial crash of 2008 were acquired by JP Morgan Chase who effectively bulldozed the Occasio branches returning to a far more business like branch format.
 
Tesco Bank (as it became) with its 6.5m customers continues to make significant investments into becoming a full service retail bank. Sainsbury’s Bank bought out the Lloyds Banking Group share (that Lloyds inherited when it took on HBoSfollowing the financial crisis) in May 2013, however it made it clear that it has no intention of becoming a full service bank and is not planning to offer mortgages or current accounts.Sainsbury’s appear to have no intention of turning its supermarkets into bank branches.
 
In the meantime Marks & Spencer launched in late 2012 M&S Bank operated by HSBC offering a fee-paying current account. With Marks & Spencer continuing to struggle with their fashion lines the retailer is increasingly being measured principally as a supermarket. The jury is still out on how successful M&S Bank but there are no indications that it has been a runaway success.
So why is Barclays trying to re-visit the supermarket banking model? The reality is that it has very little to do with wanting to be in supermarket banking and much more to do with finding a way to reduce their costs by closing their branches. Barclays will benefit from the ability to sell or end the lease on the branches and will have significantly lower costs fromhaving an in store branch than a standalone one. It is also true that this move should make it easier for customers to visit their branches. As high streets increasingly become parking unfriendly through the use of parking restrictions combined with prohibitive parking costs where parking exists bank branches are becoming harder to just pop into or even to access (Metro Bank with their drive through branch opened in the mecca that is Slough would beg to differ). Typically supermarkets have large amounts of parking which will make it easier for customers to visit their banks if they are within a supermarket. It is not only the difficulty of parking that is reducing the number of visits by retail customers to banks. The increasing comfort and acceptance by consumers of all ages of carrying out activities online and the increased penetration of smart phones and tablets means that there are increasingly few reasons for customers to visit branches – cash withdrawals, making payments, getting foreign currency, paying in money into accounts no longer require a physical visit to a manned branch. Increasingly it is only at those key life moments such as buying a house, getting married, getting a loan, opening a bank account that a visit to a bank branch is necessary and some of that is driven not by the desire to talk to someone or to get advice but by the continued legal requirement to provide a physical signature on documents.
 
For those important financial transactions such as arranging a mortgage or a loan it is highly questionable how conducive a branch within a supermarket will be to have a meaningful discussionExchanging confidential information over the sound of the tills ringing and the promotional announcements over the loudspeakers is not what customers are looking for. Neither is taking out a mortgage or a loan one of those spontaneous purchases that supermarkets rely on to increase basket size. As a mother pushes her trolley around with her two screaming toddlers in tow she is unlikely to suddenly decide that she would like to talk to her banker about a loan.
 
However Barclays might have liked to position the opening of branches within ASDA supermarkets as for the convenience of their customers, with the review of their branch network (and the denied closing of 400 branches) with no confirmation that all closed branches will re-open in Asda stores, Barclays are making a statement of intent about the role of branches going forward.



Had the report of the potential for 400 branches being closed stood, Barclays would have been credited with the courage to be the first of major high street banks to make its intentions clear. This would have made it easier for the remainder of the big five banks to annouce their own closure plans. The other banks have hinted at their desire to close branches but none have been bold enough to say how many. They will eventually have to do this because it is an undisputable fact that less and less customers visit their branches. Many of those that visit their branches only do so because there are not currently convenient alternative ways to carry out transactions such as paying in cheques. However with the increasing penetration of smartphones with cameras built in even paying in cheques may soon no longer require a visit to a branch.



The future of branch  base banking is at a cross roads where the big five banks must decide whether they wish to continue to support customers who want to use branches or whether they should encourage those customers to move to banks that see branch banking as fundamental to what they do such as Metro Bank, Handelsbanken, Umpqua Bank (in the US) and Bendigo Bank (in Australia). It maybe that the end of the universal bank serving all segments of customers is in sight.

Monday, 27 January 2014

How to be a successful challenger bank


So assuming you have got the capital raised and have got through the regulatory hurdles necessary to be a challenger bank what the critical factors for success?

Pick your battleground. Given that the big five banks (in the UK) or the Four Pillars (in Australia) or the equivalent in other markets are so called because they have the scale and the established track record trying to take them head on at their own game is a sure fire guarantee of failure. To paraphase the Chinese general Sun Tsu in his ‘Art of War’ only attack the enemy head on if you have a three to one advantage.  A bank that wants to take on the banks across their entire retail customer base is setting itself up to fail. The established big players have the depth of capital and the customer base to play the long game and can besiege the challenger bank until they have used up all their capital and their investors patience.

For challenger banks the better strategy is to ‘fragment’ i.e. to pick off part of the established banks’s customer base, preferably one of the more profitable segments.

By not having a clear customer segment strategy but simply competing for business that can be won from the established banks can end up with the so-called challenger winning the unprofitable business that the big five would happily like to exit.  

Handelsbanken have never sought to be a replacement for the big five banks in the UK for all their customers. They have deliberately adopted a strategy that focuses on small businesses in largely market towns where customers like to use branches, have face to face contact and are prepared to pay for that service. The result has been very high customer satisfaction along with high profitability.

First Direct (albeit owned by HSBC) set out to be a bank for customers that weren’t interested in visiting branches, liked to be able to talk to a person, liked a high quality of service and were prepared to pay for it. First Direct is very rarely at the top of the price tables. Equally First Direct has not tried to grow its customer base aggressively with its market share relatively stable and relatively small. What they have ended up with is the highest Net Promoter Score amongst the banks.

Consider competing from a position of better insight. The established banks have the scale, the benefits of a high margin back book and the deep pockets so competing purely on price is not a long term strategy. Neither is competing simply on not being one of them. Some of the legacy problems the established banks have is their data has grown up from individual product systems, there is a culture of not sharing data between organisational silos, their systems have often grown from a series of acquisitions and are based on old technology. This gives the challenger bank a real opportunity. Designing the bank from the start to be based around the customer not the product, designing the data infrastructure around the ability to analyse, model and forecast not only the customer, but the risk, the external environment and the way the business performance will be managed will give the challenger bank a significant advantage. By having better customer insight offers can be better tailored to what the customer actually wants (resulting in a reduced Cost Per Acquisition), pricing can be based on individual or segment risk (not only for lending but also for deposit pricing) and retention of customers can be significantly higher.

A good current/checking account offering is not optional. Without it being a real challenger is impossible. Unless you have a transactional product, one where the customer interacts with you frequently, you are not going to be able to own the customer relationship and whilst you might win in the short term it will only be for that. When you ask any customer who they bank with their first response will be the bank where their salary is paid into and which they use daily to buy goods and services with.

If the basis of competition is around taking  mortgages and savings market shares off the established banks, then effectively regardless of the ownership structure, this is a building society offering. Building societies have been around for over a hundred years and their attempts to be challenger banks can be seen in the demise of the likes of Alliance & Leicester, Bradford & Bingley and Northern Rock.

Nationwide Building Society has shown that by having a good current account offering that they are a real challenger to the established banks. (Nationwide has done more than that as well but the current account has been a key building block to their success).

What’s more the current account offering needs to be designed to attract the customer segment that has been selected as part of the fragment strategy.

Most customers see one current account being the same as another. A lot of customers will also have been made more cynical because of the ‘value-added’ or packaged current accounts that were sold in the run up to the financial crash. These were accounts where it was questionable whether the ‘added value’ was worth the monthly fee. There are very few ways of differentiating a current account but certainly for a challenger bank it needs to be designed for being used on mobile devices such as smartphones and tablets. The established banks, whilst they may have deeper pockets, have old and under-maintained systems which should give challenger banks an advantage (see the comments about IT below)

The danger of coming out with a simple, low function current account is that the challenger bank ends up with the low income, highly unprofitable customers that established banks are obliged by governments to offer to the unbanked. While this may make the challenger bank popular with government it will do nothing to help investors and if that is not the customer segment being aimed for will only lead to brand confusion.

Design the business from the outside in. One of the biggest challenges the existing banks have is their organisation structure which is built around silos, largely product-based and very hard to change. This brings inflexibility and high cost. Challenger banks have a real opportunity to do something different, even if they have come into existence by acquiring an existing player. The way that the bank’s processes are designed should be driven by the experience that its customers, partners (intermediaries, aggregators, suppliers) want and then decide how it can be delivered profitably. Experience doesn’t just apply to getting a customer to purchase a product but also what happens after that. On-boarding is even more important now for retention, profitability and customer advocacy, particularly where business comes from brokers or comparison websites.

What typically happens is that organisations where there is any conscious design are built from the perspective of the bank and how it is easiest to manage, not from the customer’s or strategic supplier’s perspective. The challenger who gets this right will only be able to attract customers at a lower cost (reduced CPA), will reduce customer attrition and achieve higher customer referral rates.

Invest in talent and experience. Everybody thinks they are an expert in retail banking because everyone has a bank account. This is the equivalent of saying that everybody is a doctor because they have a body. If retail banking was really that easy and that profitable there would be no need for challenger banks. It is not only since the financial crash in 2008 that people have looked down on bankers and treated them as of less value than estate agents or tabloid journalists. Prior to the crash many banks employed retailers because they thought bankers were just staff who didn’t know how to sell properly. A probable consequence of the introduction of this retail talent was the PPI (Payment Protection Insurance) and the Structured Investments scandals, where sales techniques borrowed from the retail industry were applied to the banking industry. There is no doubt that the banking industry can benefit from the insights and experience of industries that deliver better customer service and use technology more smartly but that needs to be counterbalanced with deep experience of retail banking. Current account-based retail banking is far from the same as simply attracting deposits and selling mortgages. If retail banking was so easy why have the building societies (Nationwide excepted – see comment above) been so unsuccessful in making a significant dent in the established banks market share? To be a successful challenger bank investment in real expertise of current account banking is not optional.

Just because technology can do something doesn’t mean customers want it. There are plenty of digital gurus out there who are coming up with very imaginative ways of doing banking whether it is different ways of making payments (at least once a day someone somewhere in the world announces a new way of making payments), identifying the customer, wearing technology, and interacting in branches, but just because you can do it doesn’t mean you should. Unless it makes it more convenient for the customer (and many of the novel ways of making payments are cool but take longer than conventional ways of paying) then don’t do it. Being sexy is not a requirement to be a challenger bank.

Start from the goal of zero IT ownership - exploit the cloud, SaaS and outsourcing. The established banks have very expensive and old IT systems which they need to maintain. This comes from the legacy where banks were amongst the first organisations to use IT and therefore had no option but to build up their own expertise. With the maturity of the both the IT and the outsourcing industries there is no reason for banks to own or manage their own IT. Given the problems established banks have had with their legacy systems over the last few years their competency as an IT provider has been seriously tested. Not only does putting IT out to third parties save overall money but it also allows the challenger banks to focus on what is important and that is the provision of banking to their customers.

For many banks using the cloud to provide banking services has been unthinkable. However Commonwealth Bank of Australia (CBA), the former public sector bank, has its internet banking hosted by Amazon. (See http://www.itsafinancialworld.net/2012/12/commonwealth-bank-of-australia-run-by.html) If a traditionally conservative bank has done that why wouldn’t challenger banks adopt that approach?

Metro Bank, one of the challenger banks in the UK, has bought the use of its core banking service on a per transaction basis (SaaS – Software as a Service). Its IT is outsourced. When the time it took to Metro Bank to launch its current account is compared with Tesco Bank (which is building its own platform based on a core banking package) then there is a clear argument for considering SaaS.

 Taking modern technology and commercial approaches should give challengers a great advantage; however it isn’t always turning out that way.  A number of challenger banks are being created by the acquisition of assets from existing players. They would argue that by having existing proven platforms that they can be up and running faster than starting from scratch. This is true in the short term but rather than being able to offer a truly differentiated service what they offer is a smaller but more expensive (due to the smaller scale and, in some cases, having to pay one of the big 5 banks to support the IT) version of the established banks. This is the situation that both TSB (the former Verde Lloyds Banking Group 630 branches) and William & Glyns (the 316 RBS branches) find themselves in.  (See http://www.itsafinancialworld.net/2013/07/can-tsb-be-challenger-bank.html) In the longer term this is not a viable solution for a challenger bank.

Challenger banks who have acquired legacy IT, need a transformational CIO working alongside the bank’s executives, to put in place a plan to get off the legacy and onto modern platforms enabled for mobile and digital as quickly as possible. They also need to be experts in strategic supplier management. The challenger banks need to educate their investors that this is not optional.

Have an exclusive relationship with major investors and get them committed for the long haul. There are plenty of hedge, private equity and sovereign funds who are interested in investing in challenge banks, however a number of them have placed investments in more than one challenger bank in the same sector in the same country. What does that say about their commitment?

To build a sustainable challenger bank will take time particularly given the limited availability of off the shelf banking technology and the time it takes to implement a new business model. Equally getting a return on these investments is not going to be quick, so investors who aren’t in for the long haul should be politely shown the door.

This isn’t meant to be an exhaustive list of what a challenger bank should be looking at but highlights some of the areas where the difference can be between success and failure.

Saturday, 11 January 2014

Removing incentives won't stop bank mis-selling


The news that Lloyds Banking Group has been fined £28m ($46m) by Britain’s FCA (Financial Conduct Authority) for having a bonus scheme that put pressure on sales staff to mis-sell products once again brings the spotlight to bear on the culture of banks and specifically, in this case, retail banks.  In Lloyds’ case it was not only the benefits of meeting or achieving targets that created inappropriate behaviour but the sanctions for missing targets including demotion and base salary reduction that put staff under pressure. For at least one sales person they felt under such pressure not to fail that they inappropriately sold products that they could not afford to themselves and their family as well as their colleagues.

The typical media and political response to incidents such as this is to suggest that incentives are bad, that remuneration shouldn’t be related to achieving targets as incentives lead to the wrong sets of behaviours.

However simply removing the explicit link between sales performance and pay will not remove the pressure to achieve sales targets.

The pressure comes right from the top. While the new CEOs of banks may publicly talk about changing the culture of banks, putting the customer at the heart of the bank, winning through providing a differentiated service and they may be completely sincere in those sentiments, by the time that that message is passed down through the organisation to the sales people at the frontline it will be measured in terms of targets, which will need to be achieved. Anglo Saxon businesses are run with a performance management culture where achieving or exceeding targets and  giving greater rewards to those who meet those targets than those who don’t  is fundamental to how those businesses operate. While it may never have been the intention of Antonio Horta-Osario, CEO of Lloyds Banking Group, that the staff be put under such pressure that they coerced customers into buying products that they did not need, by the CEO setting his or her direct reports stretch targets that was the almost inevitable consequence.

The reason for this is simple: banks are commercial businesses that have investors who are looking for returns and always have the option to invest their money elsewhere if the return is better. As such CEOs of banks are competing for investment and are accountable to their shareholders. This applies as much to new entrants and challenger banks as it does to the established banks. All of the new entrant banks without exception have investors backing them whether it is parent companies such as retailers, hedge funds, Private Equity funds or individual wealthy investors. Even the building societies and mutual have to look to the external market for capital and those who lend capital have options as to where they lend to and are doing to achieve competitive return.

But is a culture that is about beating the competition, about achieving the best that you can for your organisation really such a bad thing? Certainly the impression that many politicians gives is that yes it is. The sentiments being expressed have strong parallels with the period where some schools banned competitive sports because politicians believed they were harmful to children.  It wasn’t good for children because it meant that some of them would have to experience losing.

The politicians who rally against the banks and banker compensation schemes can’t have it both ways. On the one hand they say don’t want those in banks to be incentivised to sell customers products but on the other hand they want competition. Competition by its very nature requires a level of aggression, it requires you to play to win and for your opponents to lose.

To demonstrate that they are not solely focussed on financial outcomes most banks today use a balanced set of financial and non-financial measures to monitor the performance of the bank and their employees.   Typical non-financial measures include Net Promoter Score (NPS), customer satisfaction, numbers of complaints and staff engagement.  The argument being that by having a balanced set of measures sales staff are incentivised to treat customers fairly and to only sell customers what they need.

Some banks such as Barclays and HSBC have removed all financial incentives for their staff to sell customers products. Instead their staff are paid a basic salary with the ability to share in a bonus depending on the performance of the bank. However, even when that is the case, every customer facing bank employee who has responsibility for helping a customer to apply for a mortgage or open a savings account knows that, at the end of the day, when it comes to the annual performance review whether they have achieved or missed their financial targets will always be more important than whether they have achieved their non-financial ones. They know that their opportunity to receive a pay rise, to get a bonus or to progress their careers is dependent upon their ability to deliver profits for their bank. The financial incentive may not be explicit but it is still there.

There exceptions to this.  A bank that has taken a very different approach is Handelsbanken. At this bank if the profitability exceeds the average rate of its peers, then surplus profits are put into a fund and distributed to all the staff. However they can only receive these accumulated benefits when they turn 60, thus encouraging long-term thinking and loyalty. The staff, including the executives, have flat salaries with no bonuses. There are no sales or market share targets. Handelsbanken has very high customer satisfaction and is highly profitable. The bank has had no problems with mis-selling or wrongdoing.

However this model will not suit everybody. This is very much a Scandinavian model and the pace of growth whilst highly profitable will not be attractive to all investors. Detractors of this approach will argue that no highly talented executive would be attracted by this reward model when there are banks across the globe prepared to reward more in the short term. The sustained excellent results that Handelsbanken have delivered speak for themselves.  Handelsbanken  would probably argue that it has no desire to attract the sort of executives who are interested in only the short term and will move from bank to bank simply for better rewards.

Given that the reality is the Handelsbanken model cannot and should not be imposed upon all banks, what is the answer and how can this type of mis-selling be avoided in the future?

The reality is that it will never be totally eliminated. Indeed if there were never any complaints or if there were never any practices that could be open to question it would suggest that the hunger to be the best, the passion to grow the business was missing. Every sportsman who wants to be the best knows that you have to go the edge to succeed.   There will always be employees who are too aggressive or dishonest. It is that they are identified and the way that they are handled that sends out the signal to their fellow employees as to what is acceptable behaviour. That has to be called out loud and clear and demonstrated by actions from the top of the organisation.

Secondly, while many banks operate a balanced scorecard of financial and non-financial metrics to measure the performance of the bank, the financial rewards need to be truly aligned to that Scorecard and not just to the bottom line. Not only must reward be aligned to the scorecard it needs to be seen to be aligned. This means that for instance if customer satisfaction or employee engagement scores are part of that scorecard and those measures are not met or regulators impose fines despite financial targets being met, that the executives’ rewards are significantly financially reduced. This is something that has not been reflected across the banking industry despite the enormous financial fines handed out to the likes of JP Morgan and Barclays.

Thirdly there needs to be a recognition by investors that the days of retail banks being a licence to print cash are over, that most banks need significant investment both in terms of capital to fund the business but also to provide the infrastructure that a bank needs to have to compete in the 21st century and finally that an investment in a bank is for the long term – measured in double digit years.

Changing the culture of retail banks is not as easy as simply removing incentives, neither it is something that can be done overnight. To have a vibrant and competitive banking industry there needs to be some friction and a world without it will be a lot worse for the consumer.