Wednesday, 28 May 2014

New NAB CEO faces challenge of what to do with Yorkshire and Clydesdale Banks


With Cameron Clyne leaving National Australia to spend more time with his family, incoming Group CEO, Andrew Thorburn, will have to face the perennial question of what to do with the bank’s UK businesses. For many years Yorkshire Bank and Clydesdale Bank have been seen as albatrosses hanging around the neck of the incumbent Group CEO of National Australia. With Nab’s focus on growing in their domestic market and Asia the two banks have long been seen as non-strategic.

During the financial crisis Nab had to invest nearly £1.5bn of capital into the business to shore up the balance sheet. There have been challenges with non performing loans as well as redress for misselling of PPI to add to the woes. As part of a plan to improve the performance of the business there has been a significant cost cutting exercise that resulted in the removal of 1,400 jobs and the closure of 29 banking centres. There has also been a withdrawal from London and the south of England.
However for many years both banks have been starved of any significant investment to improve them and to make them better able to compete in the UK market. It is not since the Brit John Stewart was Group CEO and fellow Brit Lynne Peacock was running the UK operations that any significant effort was put into innovation and growing the businesses in the UK. Indeed large parts of the strategy for the UK banks set out by Stewart and Peacock were reversed during the cost cutting exercise. (Recent news that Clydesdale Bank is to issue Britain’s first plastic £5 note hardly counts as innovation).
Nab in Melbourne have for a long time been very open about the fact that Yorkshire Bank and Clydesdale Bank are seen as non-strategic. The market has been sounded out for interest in acquiring the business. At one point it was rumoured that Santander was interested in acquiring the business but no deal has emerged. A key on-going challenge for the Nab Group CEO has been that there has been a significant gap between the value that the UK operations are held on the balance sheet and the price potential acquirers are prepared to pay. This situation has deteriorated even further since the crisis in 2008 with both bank valuations dropping and the interest in acquiring banks disappearing. For Nab, either no  Group CEO wanted to take that write off on their watch or the Board wouldn’t let him.
There is no doubt that there has been and continues to be a lot of dissatisfaction from analysts and investors about the financial performance of Nab in its local domestic market. It is seen as the laggard of the Four Pillars. The challenge for Andrew Thorburn is to turn around that perception. Whilst the UK operations are definitely not the highest priority in terms of fixing the business they are seen both as a distraction and requiring significant capital that could be better deployed elsewhere.
So as Andrew Thorburn starts his role as CEO in August 2014, will he do something to resolve this issue and what are his options for the UK operations?
The ideal outcome for the new CEO would be to sell the UK operations and minimise the write off. The question though is who would want to buy them?
On paper Yorkshire Bank and Clydesdale Bank could be challenger banks. They both have strong brands with loyal customers. The Yorkshire brand stretches way beyond the county boundaries. Clydesdale is seen very much as a Scottish bank and one that has managed to maintain its reputation far better than either Royal Bank of Scotland or HBoS, its two main rivals. This could make it attractive to Private Equity firms, for instance JC Flowers might wish to merge it with its OneSavings Bank. It could also be attractive to other Private Equity firms looking to establish a foothold in the UK retail banking market. However the timing for One Savings Bank is not good as they have already announced that they are to float and that is where their focus in the short term will be.
The challenge for anyone evaluating Yorkshire and Clydesdale is, apart from their customer base, what is there of value to acquire? Between the Yorkshire and Clydesdale they have 322 branches, a very similar number to the branches that Williams & Glyn (the challenger bank being created from the forced disposal RBS has to make) will have. However, as is becoming increasingly apparent to both established and challenger banks, the use of branches by customers is declining and therefore the value of having an extensive network of branches is reducing. As both RBS and Lloyds found out finding buyers for their branches was not easy with both, respectively, Santander and Co-op withdrawing their offers after long protracted negotiations. The additional challenge with the Yorkshire and Clydesdale branches is that significant investment by the buyer would be required to bring the branches up to  a standard customers expect today due to the lack of investment by Nab over the last few years.
If a new entrant was looking to acquire the Nab UK operations and they wanted to initially use the Nab IT platforms then if they wish to be competitive they would need to invest very heavily over the medium term on new platforms, as the Nab platforms are old and in need of retiring.
With a cost income ratio of 76% there is a lot of efficiency gains to be driven out by the right owner, but the question is the level of investment to achieve this and over what time period.
Given the level of investment that any new entrant would need to make in order to use the UK operations as a platform for competing in the UK retail banking market, the price that they would be prepared to offer is highly unlikely to meet the amount sitting on the Nab balance sheet.
Given Nab’s situation it is easy to understand why a couple of years ago Santander were rumoured to be interested in acquiring the UK operations. Santander has its own platform, Partnenon, and has a track record of being able to migrate bank accounts onto its systems – Abbey National, Alliance & Leicester and Bradford & Bingley. The challenge for Nab is that Santander is a distress purchaser and never knowingly overpays.
If Nab can’t sell Yorkshire and Clydesdale at an acceptable price then what about a flotation? Timing is a real challenge here as there has never been a time when more banks are coming onto the market. TSB, Aldermore, OneSavings Bank,William & Glyn, Virgin Money, Metro and Shawbrook have all announced intentions to come to the market over the next eighteen months. Investors are spoilt for choice. Along with the recent disappointing flotations (Saga, JustEat. AO, etc), albeit in other sectors, there will be a downward pressure on prices and consequently the amount of capital that will be raised.
Another option is to do nothing and let the two brands continue to operate as they are today, continue to reduce costs and improve performance with minimal investment and allow the business to slowly decline as customers move away to competitors when they are attracted by better offers.
There is no immediate need for Andrew Thorburn to make a decision about the future of the UK operations particularly given the uncertainty with the Scottish Referendum occurring in September 2014. The UK operations operate under a Scottish banking licence and a ‘Yes’ vote could create a long period of uncertainty and have a significant impact on the value of the UK operations.
However as a new CEO there is a grace period during which there is an opportunity as the new broom to look with fresh eyes at all the problems. It is an opportunity to announce write offs, set the bar and expectations low and then over-perform. Thorburn should take full advantage of this initial period of goodwill to be quite clear what his plan is for Yorkshire and Clydesdale to end the uncertainty for customers, colleagues and investors.

Friday, 16 May 2014

RBS forced to sell Citizens ending the most successful UK retail banking foray into US market

British businesses don’t have a great track record in breaking into the US retail market. You only have to look at the disastrous foray that the Marks & Spencer acquisition of Brooks Brothers was, Tesco’s humiliating and expensive attempt with the Fresh & Easy brand and, most recently, the failure of Yo Sushi! to realise how difficult it is for firms with strong brands in their domestic markets to make it across the pond.

The retail banking track record is no better with Barclays, Lloyds and Natwest all quitting the US in the late 1980s and 1990s. Losses from the acquisition of Crocker drove Midland Bank into the arms of HSBC. Even HSBC has not been immune to the problem with the disastrous acquisition of subprime Household continuing to hurt the bank to this day.

It is quite ironic then that RBSG is being forced to exit the one reasonably successful move into retail and commercial banking that British banks have made in the US. Whilst Fred Goodwin, the former CEO of RBSG, has been criticised for much of the way that he ran the global banking group (particularly paying over the odds for ABN Amro just as the wholesale markets were closing down) his strategy for building a presence in the US retail and commercial banking sector should be heralded as one his smarter moves.

Rather than trying to take on the large US retail banks where they were, at that time, competing aggressively with each other in New York, California, Texas and Florida, Goodwin decided to build his beachhead in the Mid-Atlantic by the acquisition of Citizens Financial Group. A series of small but strategically significant acquisitions followed that expanded it into New England and the Midwest. Citizens is now the 15th largest commercial banking organisation in the US. Whilst there have been challenges including writedowns following the acquisition of Charter One and recent issues with the way that capital is planned, overall Citizens is a highly capitalised and profitable bank. Yes its capital is under deployed but that is addressable. Indeed its reputation with its customers is far better than RBS’ in its own domestic market.

It is a great shame then for RBSG that due to having to take state intervention and becoming largely nationalised, primarily due to the acquisition of ABN Amro and the disastrous business in Ireland, that RBSG is being forced by the EU to dispose of its ownership of Citizens by the end of 2016.

As the first step of moving towards this in January 2014 Citizens sold off 103 branches in the Chicago area to US Bancorp.

 It has been announced that the next step will be to float or sell 20-25% of its share of Citizens. A flotation is more likely as there have been few signs of interest from potential buyers. However for Canadian, Japanese or Spanish banks that want to significantly grow their presence particularly in the Midwest and given that it is a forced sale it could be an interesting opportunity.

The flotation will help to rebuild its balance sheet, but the sale is what is really needed as that could release more than $3bn of capital, which would help RBSG reduce the government holding in the bank.

This is all a sad ending to what could have been had RBSG scaled back its ambition to be global investment bank.

As a footnote, British banks should not give up on being able to build a presence in the US retail and commercial banking market. RBSG has shown that it can be done. Barclays is having success with its Barclaycard US operation building scale to take on the other cards providers, however this is a monoline not a full service retail banking offering.

The British banks can also look to the Spanish banks, Santander and BBVA which with respectively the acquisition of Sovereign Bank and Compass Bank, are demonstrating that it is possible for Europeans banks to build a presence in the US retail banking market. It takes time, patience and recognition that whilst both the US and European markets have the words ‘retail banking’ in their names that they are quite different.

Thursday, 24 April 2014

The challenges facing the next RBS CIO

With the news that Mike Errington, CIO of RBSG, is retiring the bank will be looking for a replacement. The new CIO will have an overflowing inbox, so for those considering taking on the role what are some of the challenges that he or she will have to face?

The immediate on-going work is to ensure the stability of the existing systems. Having had a number of serious, customer-impacting outages over the last few years (including a problem with Ulster Bank ATMs on the day this was written), the work of applying patches to and building resilience into both hardware and software needs to continue. RBS is not the only bank that in earlier times avoided doing maintenance as a way of saving costs and subsequently is feeling the impact of doing that in terms of reliability of systems.

The second tactical exercise is the simplification of the IT infrastructure. However this is far easier said than done as the IT systems have evolved over many decades, creating great complexity and the number of people who understand the older systems and how they interrelate is rapidly declining both as the result of retirement and cost cutting within the bank. Simplification is about retiring and rationalising systems and infrastructure. Given the complexity that exists this is alike disarming a booby-trapped Second World War bomb requiring both high levels of skills and nerves of steel.

Both of these steps are akin to re-arranging the deckchairs on the Titanic, given the ages of the systems. There is no doubt that there has been significant underinvestment in IT since way before the RBS/Natwest integration. Whoever is the new CIO they should use the opportunity of as part of their taking the role to negotiate a commitment to a wholesale replacement of the core retail banking system as the likes of CBA (Commonwealth Bank of Australia), Nationwide Building Society and Deutsche Bank have carried out. However this would involve spending measured in the low to mid billions of pounds and a programme taking 3-5 years to execute. This is where making such an essential change becomes particularly difficult specifically for RBS as RBS is not just any bank, it is a state-owned bank. Such is the political pressure to see the bank returned profitably to the private sector and within the first couple of years of the next government i.e. almost certainly by the end of 2018, that it is highly unlikely that the funding for such a major investment programme will get approval from the key shareholder. However that is what both the CIO and the CEO should be looking for if RBS is to once again become a truly competitive UK bank.

There are however other major transformation programmes that the new CIO will have to pick up, drive and deliver.

Having negotiated an extension of the deadline to the end of 2016 for the disposal of the 308 branches that RBS was forced by the EU to sell as a result of receiving state aid, creating a separate clone of the RBS systems for the new Williams & Glyn’s bank to run on is another top priority for the new CIO. This is not dissimilar to the exercise that Lloyds Banking Group had to perform to create the platform for TSB to run on. However the Lloyds Banking Group platforms were in a far better state than the RBS systems benefitting from coming on the back of creating a single set of systems for the Lloyds TSB/HBoS merger. Even having that advantage for Lloyds Banking Group creating the separate TSB platform was not simple or easy with the eventual cost being in the order of £2bn. Delivering the William and Glyn’s separation to the 2016 deadline will be a major achievement.

This is not the only separation programme that the CIO will have to oversee. The IPO of the Citizens business in the US in Q4 2014 and the complete disposal by the end of 2016 will also need to be executed. This will entail the disengaging of Citizens from the Group systems.

In addition there is the question of what to do with Ulster Bank. The preferred option is to dispose of it by selling it to one of the challenger Irish banks e.g. Permanent TSB, Danske Bank. If that is to go ahead then the new CIO will have to look at the separation of Ulster Bank from the Group systems and supporting the clone until it is integrated into the buyers' systems.

One of the core strategies of RBSG is to scale back the investment bank, reducing costs to be aligned with the smaller bank and to return the bank to be more focused on the UK and supporting UK businesses. This will inevitably require changes to the investment banking platforms as businesses are closed or sold off. To achieve the reduction in costs and the required flexibility as volume drops will almost inevitably mean looking at further outsourcing of platforms and operations to third parties.

On top of the RBSG specific initiatives the new CIO will also face the plethora of transformation programmes and projects that will need to be implemented as a result of regulatory changes. One of the core ones will be the implementation of ring-fencing once that is fully defined. This will mean a significant change in the governance of RBSG and there is a question as to whether the role of Group CIO can persist under the new rules, requiring in a significant restructuring of Group Operations.

All of this will need to be delivered whilst digital, mobile and the use of data analytics for both competitive advantage and risk management continue to move at pace in an increasingly competitive banking market.

The new RBS CIO will need to face up to this hugely challenging environment all within the constraints of  a bank operating very much in the public spotlight, with the need to rebuild trust and the financial constraints imposed by  having the government as the largest shareholder. Only the bravest should apply.

 

 

 

Tuesday, 25 March 2014

Should the CIO be on the Executive Board?


The news that the CIO of Co-operative Group (which has a minority holding in Co-operative Bank), Andy Haywood, is to move off the Executive Board but to remain Group CIO brings a further spotlight onto what is the role of the CIO going forward and, whilst not directly related to the demotion of Mr Haywood, specifically what is the future role of CIOs in banks.

The reporting lines of CIOs have evolved with the increasing use of technology in organisations. Even the title of the person responsible for IT has evolved alongside the technology.

When computers were first introduced into banks their sole purpose was to act as a giant calculator and move what was held in physical ledgers onto computers so that the bank’s financial position could be calculated. The person responsible for making that happen would have had one of a few titles including EDP (Electronic Data Processing), MIS (Management Information Systems) or simply Computer Manager. The role would have reported to the Finance Director or Chief Accountant as that was the department that was primarily serviced by computers. Indeed today in many organisations today IT continues to report to the CFO.

As automation started impacting the back office operations of the banks and IT started being used outside of Finance, the Head of IT or CIO may have found the reporting line moving to the Chief Operating Officer. For many banks today that continues to be the case.

However with the rise of digital, IT has increasingly permeated beyond the back office and accounts departments and an increasingly large proportion of IT expenditure is being consumed by Marketing.

Banks in particular, where fundamentally the vast majority of their commercial, money-making operations are conducted electronically and not in the physical world, IT is increasingly seen as the lifeblood of a successful business. You only have to observe how little a bank can actually do when its IT systems crash and customers cannot access their bank accounts or their card transactions are not processed to see how important IT is to the operation of a bank.

There have been some interesting experiments in terms of what the right organisation structure for IT should be.

For instance at Barclays when Shayghan Kheradipir was Chief Operating and Technology Officer, he had a model where the COO and CIO of each business unit jointly reported to the CEO of that unit. (See CIO/COO joined at the hip). This meant that IT had a voice at the table for the key strategic decisions for that business unit rather than merely being represented by the COO.  With Mr Kheradipir leaving Barclays to be the CEO of Juniper Networks, it will be tempting for Barclays to revert to the more traditional model.

Commonwealth Bank of Australia has gone further than Barclays did by having the CIO reporting directly to the CEO. It is interesting to note that subsequent to that organisational change Commonwealth Bank has spent significantly more as a proportion of overall costs than other banks on refreshing its IT but as a consequence has one of the most advanced IT architectures and platforms of any retail bank of size globally. It is now being able to exploit that new platform to launch new products and services far faster than its competitors.

However with IT increasingly being outsourced, (whether it by the traditional route of selling IT assets to an outsourcer and buying back services or through the use of the cloud), the demands of digital and increasingly Business Intelligence and data analytics, there is a bigger question as to whether there is a role for the traditional CIO at the Executive table? If it isn’t the traditional CIO then who should be providing the strategic input of the role that IT can do to both lead and serve the bank? The skills are far more aligned with a business savvy enterprise architect who has no vested interest in building an internal organisation but is more interested in providing a pragmatic solution, wherever it is sourced from, who knows how to form strategic alliances, both within the bank and outside and who is driven by the desire to use technology to deliver the best value to both internal and external customers.

That doesn’t appear to be what the latest announcement from the Co-op regarding the role of the CIO is saying, indeed the organisational change sounds like a regressive step. But then the Co-op has far bigger problems to address than how to more effectively exploit IT.

Friday, 7 March 2014

This is not just any fee-free current account, this is a Marks & Spencer fee-free current account

Marks & Spencer have announced that they are to launch a fee-free current account. The account will have no overdraft fees, the first £100 of which is interest free and a (relatively) low interest rate for overdrafts of 15.9%.  For those who transfer their main banking account to M&S they will receive a £100 gift card. A key attraction for M&S customers will be the loyalty scheme where points are earned for debit card spending in M&S stores and online. It also passes the critical requirement of allowing customers to bank online as well as on the phone or in store.

A key differentiating feature is not charging a transaction fee for ATM cash withdrawals made with the debit card abroad. For both Metro Bank and Nationwide the lack of transactions fees when abroad attracted customers; however that feature was withdrawn and both now do charge fees for transactions abroad.

On the face of it this is a competitive offering and should be attractive to to both M&S and non-M&S customers alike.

This is not a new market entry for Marks & Spencer (they launched their fee-charging account with a similar loyalty scheme in September 2012) but rather a change of their positioning re. free banking. M&S claims that their fee-charging account has been successful with M&S customers, so this does raise some questions as to why they should launch a fee-free product and at this time.

One of the dangers to M&S of having similar current account products with one offering a fee and one not is self-cannibalisation. Will customers of the current fee charging account be happy to see that whilst they are paying a fee other customers are not paying one for what seems a remarkably similar product? Will some of those customers look to switch to the fee free product? M&S is allowing these Premium Customers to switch their accounts to the free one and will even give them a £100 gift card if they switch their main account to M&S.

Of course this is not just a current account this is an M&S current account. Except it isn't. It is actually an HSBC current account as it is HSBC that is not only behind M&S Bank but owns 50% of the bank. While M&S may position itself as being good for current account competition in the UK market, with HSBC behind it the impact on the market share of the Big Four banks will be none.

Another question that M&S will, hopefully, have considered is what types of customers will be attracted to this account? With no mandatory minimum monthly amount that needs to be paid into the account, customers may only open this account for the loyalty scheme and maintain minimum balances or, as Nationwide found with its credit card, only use the card for cash withdrawals abroad. For a current account to be profitable for a bank it is important for it to become the primary customer account where the customers salary is paid into and the mortgage and other core regular payments come out of it. Without high current account balances or large overdraft fees (which the account does not charge) current accounts for banks are loss leaders. For M&S they need to demonstrably see the customers of their current accounts spend significantly more in M&S stores and online than non-current account customers for the bank to be deemed a success.

For those championing an end to so-called free banking, the launch in September 2012 by M&S of fee-charging current accounts was seen as setting an example to others that would help to accelerate the end of so-called free banking. For those championing an end of free banking, this recent news from M&S that they are launching fee-free accounts will be seen as a step backwards delaying the end of free banking further.

So why have M&S made this announcement at this time? There are already successful non-Big Four banks, particularly Nationwide, Metro Bank and Santander (with their 1-2-3 account) as well as HSBC-owned First Direct who have been taking advantage of the delays and the problems that other challenger banks have been facing in getting their current account propositions right. Now however with Tesco having announced that it will (finally) launch its current account offering this summer and Virgin Money expected to launch its basic bank account later this year, M&S is clearly keen to get to the potential switchers ahead of the others.

But why have M&S decided to launch fee free products given the issues and risks discussed above? It can only because of the need for volume. Running a profitable current account business with all the investment in infrastructure such as contact centres and IT, in personnel and marketing requires scale. Clearly M&S, despite their protestations, haven't achieved this with their fee charging accounts and they see this as an opportunity to build a bigger customer base which will reduce the marginal cost of running a bank.

It will only be some months after the launch of the both the new M&S fee-free accounts and the Tesco current account that it will be clear whether this move was good news for M&S' beleaguered shareholders and customers or not.

Sunday, 2 March 2014

Why 0% BT cards and teaser rates have no role to play in customer centric banks

The announcement by Ross McEwan, RBSG CEO, that RBS and Natwest will remove teaser rates from savings products and scrap 0% interest credit card deals is another step on the road to recovery for RBSG. RBSG is not the first banking group to identify the unfairness for existing loyal customers when these types of offers are made to new customers. It is however the first of the Big Five UK banks to make this stand.

Banks that scrap short term special introductory rates on products for customers, while they position this as for the benefit of existing customers are not simply being altruistic. They are doing this because they know that by adopting a customer- rather than a product-centric approach to running their bank there can be a significant improvement in the long term profitability of their businesses.

Over the past few years there has been a significant price war in the 0% Balance Transfer (BT) credit card market. As one competitor has extended the length of the 0% interest period by one month the next has extended it a further month. Six months ago the market thought that no one would go further than a 28 month (2 years three months) period but it has now got to the point where Barclaycard is offering a 31 month interest free period. It could be argued that this is really good news for customers as fierce competition is driving better deals for consumers. However what is interesting to note is that the top three places in the BT card table are all being offered by one of the Big Four banks - Barclays, HSBC and Lloyds Banking Group. With their very large deposit and current account bases they have large amounts of low cost money to lend which they, it could be said, are using to keep other competitors out, particularly the smaller players who have to resort to the wholesale markets to fund these loans. By extending the periods so long it makes it too expensive for smaller players to compete.

But why are the big banks so keen to lend customers money apparently free for so long? There is of course an up front a fee based on a percentage of the balance being paid - in the case of Barclaycard it is 3.5% which is reduced to 2.99% by a refund (nothing like simplicity!). What this gives the banks offering these products is short term fees, which, with interest rates being so low, fee income is particularly important for short term profits. None of the banks that offers these products has a competitive APR (Annual Percentage Rate) for additional transactions. The banks also know that these are customers who do not pay off their credit cards every month otherwise they would not have got a balance to transfer in the first place. Until recent regulation came into place forcing banks to pay off the most expensive debt first (in this case the new transactions not the 0% balance) this was almost a licence for banks to make money as every payment customers made was used to pay off the 0% balance meaning every new tranaction that was rolled over the month end would continue to rack up high interest rate charges. Even with the change in legislation, whilst these cards are positioned as a way for customers to pay off their debts, the banks concerned are certainly hopeful that their customers will continue to use their credit cards accruing the bank interchange and other fees for every transaction as well as building a large balance for when the 0% interest rate expires.

The problem with BT customers is that they have had the nous to transfer the balance for a 0% period. This means that they are likely to be price conscious and therefore when the next good deal comes along or when their free period ends some of them are likely to be off again to the next bank or credit card company offering a good deal. Others are likely to rack up debts that they cannot afford and go into arrears. For a bank that is looking to develop long term mutually profitable relationships with its customers the majority of these are the wrong type of customers. These are not customers who are looking to or have the money to take out other products from the bank. Banks who offer these types of products are, on the whole, product-centric. Banks who the only credit card they offer is a Balance Transfer is not customer centric.

Moving onto the removal of teaser rates from savings products. The primary reason banks offer short term attractive rates is to build volumes of deposits in order to be able to lend the money out to other customers in the form of a loan or mortgage. It is also a way of raising the brand of the bank by getting it into the best price tables, on the first screen of the aggregator websites such as Moneysupermarket.com and getting it mentioned by Money Savings Expert Martin Lewis. However being successful at doing this can have at least two downsides. Firstly the bank can end up with more low or no margin deposits than it has the demand to lend which leads to losses and secondly it attracts price sensitive customers aka, price tarts. The problem with price tarts, as the name implies, is that as soon as the introductory rate expires they will be off taking their money and giving it to the next bank that has decided to get offer a teaser rate. Just like the with Balance Transfer Card these are not the types of customers that a long term profitable bank should be built upon. With both product strategies it is a case of quantity being sacrificed for quality and taking a product perspective over a customer one.

However  it would be wrong to think that there are no downsides to a strategy that strictly adheres to the principle that existing customers should never be disadvantaged over new customers. In 2001 Nationwide Building Society, under the previous CEO, introduced a policy that all its mortgage offers would be made available to both new and existing customers. It resulted in retaining a higher proportion of its mortgage customers than other banks but with significantly impacted profitability. Nationwide has moved away from that purist implementation to a more pragmatic approach. It doesn't seek to be in the top of the price tables for its products but rather it seeks out customers that are looking for a long term relationship with the building society as its Save to Buy offering for first time buyers illustrates. The result has been a very significant growth in profitable business.

Ross McEwen sees the turnaround of RBSG as taking at least another five years. The announcements of the changes to the retail product strategy will potentially have a negative short term effect for the retail bank, but in terms of moving RBSG towards being a customer centred bank these are sensible steps as long as the shareholders and other interested parties have the patience to see them through. What he has recognised is that 0% cards and teaser rates have no role to play in a customer centric bank.

Thursday, 20 February 2014

Challengers salami slice away at established banks dominance

The news that Paragon Bank (with an initial capital of only £12.5m) has become only the second new bank to be launched in the last one hundred years (Metro Bank being the first one), the first one to be authorised by the PRA (Prudential Regulation Authority) and to take advantage of the move by the regulator to simplify the process of setting up a new bank, is hardly going to have banks such as Barclays, Lloyds and RBS quaking in their boots. But is this just one more step in a trend that the big banks cannot afford to be complacent about?

The primary reason that Paragon has decided to apply for a banking licence is not so it can take on the established banks with a full offering of consumer current accounts and mortgages. It is so that it can take consumer deposits as a means of funding loans for the existing Paragon Group business. With interest rates low but expected to rise this should mean a lower cost of capital for the loans that they make than going into the wholesale market. With the experience that Richard Doe, the former ING Direct UK Chief Executive, brings from his former employer the new bank should be a success in competing for deposit balances. The low cost direct model for deposits has already been proven by the likes of the now defunct Egg and ING Direct. Whilst the press release from Paragon may talk about offering loans and asset finance it is clear from the recruitment of Richard Doe that the new bank will be initially focussed on raising the all important deposits.

Paragon Mortgages specialises in the Buy To Let (BTL) market for the residential market and has been very successful at this surviving during the crisis where the likes of Bradford & Bingley and Alliance & Leicester failed. It is this focus on a specific customer segment that gives it the advantage over the Big Five UK banks - Barclays, RBS, Lloyds, HSBC and Santander. It has taken the opportunity to build deep expetise in Buy To Let and are front of mind for mortgage brokers looking to play BTL business.

Competition in the BTL sector was decimated following the financial crisis with many small players and building players going out of business. However competition is picking up again with all of the Big Five, Nationwide and some of the other building societies increasingly attracted by the bigger margins that the Buy To Let market attracts over owner-occupied residential mortgages. Paragon is, to many extents, the incumbent that the other banks have to shake. It should still be able to succeed in this market because it isn't just another business for them it is the only business segment they are in. Paragon does not have the cost of running expensive branch networks distributing either directly or via brokers. As long as they can continue to excel in the service they provide to brokers and to landlords they should be able to continue to punch above their weights against the larger generalist players.

While the politicians champion the idea of a few large challenger banks coming into the market to take on the Big Five banks and reduce their market shares in deposits, current accounts and lending, with the Labour Party suggesting that they will break the banks up should they come into power, a different reality is going on in the market. The likes of TSB (still owned by Lloyds Banking Group but due to float), William & Glynn's (owned by RBSG and, again, due to float) and Tesco Bank attract the most attention from politicians and the media, but in the background smaller niche players have quietly gone about picking off rich segments of the traditional banks market share.

Handelsbanken with its 170 branches, largely in market towns, has targetted SME customers and private customers with above average earnings who appreciate having a local branch with a local manager who is empowered to make decisions rather than leaving it to the computer or Head Office has quietly gone about building a sizeable, highly profitable and satisfied customer base. Aldermore launched in 2009 focussed on SME customers has lent more than £3bn pounds. Metro Bank has focussed on customers in urban areas that like both visiting branches and having extended hours. There are other focussed challengers either already out there or preparing to launch.

Competition to the dominant banks from challenger banks is already here, it may not always be head on and obvious but rather by quietly salami slicing away the better, more profitable cuts from the market share of the established players, while the big banks are left with less desirable segments. It is for this reason the launch of Paragon Bank should be welcomed as just one more step forward towards a more competitive banking market.

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.