McKinsey – Page 2 – Digital Finance Analytics (DFA) Blog

Omnichannel, not omnishambles

Good article from McKinsey on the problem of multi-channel strategy within banking. Although, I do not think they take the argument far enough. We need now to develop a “Mobile First” strategy for banking. Omnichannel is not good enough now.

Although consumers have quickly adopted digital channels for both service and sales, they aren’t abandoning traditional retail stores and call centers in their interactions with companies. Increasingly, customers expect “omnichannel” convenience that allows them to start a journey in one channel (say, a mobile app) and end it in another (by picking up the purchase in a store).

For companies, the challenge is to provide high-quality service from end to end, regardless of where the ends might be. That was the case for a regional bank that sensed that too many customers were falling into gaps between channels.

Mapping its customers’ journeys confirmed the suspicions (exhibit). Four out of five potential loan customers visited the bank’s website, but from there, their paths diverged as they sought different ways to have their questions answered. About 20 percent stayed online, another 20 percent phoned a call center, and 15 percent visited a branch, with the remainder leaving the process.

Exhibit

Mapping customer flows highlights pain points.

The channels’ differing performance pointed to specific problems. Ultimately, more than one-fifth of customers who visited a branch ended up getting loans. But in the online channel, less than 1 percent got a loan after almost 80 percent dropped out rather than fill in a registration form. Finally, in call centers, a mere one-tenth of 1 percent of customers received a loan—perhaps not surprising, since only 2 percent even requested an offer.

To integrate digital and traditional channels more effectively, the bank had to become more agile, with the understanding that its one-size-fits-most processes would no longer work. Complex registration forms were simplified and tailored to different types of customers. Revised policies clarified which channel took the lead when customers moved between channels. And new links between the website and the call centers enabled agents to follow up when online customers left a form incomplete. Together, these types of changes helped increase sales of current-account and personal-loan products by more than 25 percent across all channels.

Citi’s Mobile First Strategy

Good piece in the McKinsey Quarterly where the bank’s Head of Operations and Technology, Don Callahan, describes the bank’s efforts to accelerate its digital transition. Watch the video.

We know we have to be mobile first, and we are doing a lot there. In order to be all-in on mobile, we have set up a “lean team” in our Long Island City office, with about 100 people who are operating in a very agile way.

Callahan surveys the 21^st-century banking terrain: digital competitors are massing on every front—from fintech start-ups to new divisions of global institutions—while the speed of every banking process and customer interaction accelerates daily. All this change requires a focus on agility, Callahan says, which in turn demands a cultural rewiring.

At the helm of Citi’s digital transformation, Callahan is helping drive new thinking across the bank. He points to Citi’s digital lab for start-up innovations, powerful new apps for customer smartphones, and, internally, a push to expand capabilities across cloud computing and big data and analytics that enable automation and machine learning. In an interview with McKinsey’s James Kaplan and Asheet Mehta, Callahan describes what it takes to mobilize digital change at one of the world’s leading financial institutions.

The Potential For Digital Disruption In Insurance

The General Insurance sector is one of the laggards across financial services when it comes to digital transformation. However, according to a new report from McKinsey, whilst the sector lags in digital sophistication and so examples of the full benefits of digital are scarce; they suggest that the top 20 or 30 processes can account for up to 40 percent of costs and 80 to 90 percent of customer activity. Digitizing these processes can take out 30 to 50 percent of the human service costs while delivering a much better customer experience. And the benefits do not end there.

The nature of competition in property and casualty (P&C) insurance is shifting as new entrants, changing consumer behaviors, and technological innovations threaten to disrupt established business models. Though the traditional insurance business model has proved remarkably resilient, digital has the power to reshape this industry as it has many others. Innovations from mobile banking to video and audio streaming to e-books have upended value chains and redistributed value pools in industries as diverse as financial services, travel, film, music, and publishing. As new opportunities emerge, those insurers that evolve fast enough to keep up with them will gain enormous value; the laggards will fall further behind. To succeed in this new landscape, insurers need to take a structured approach to digital strategy, capabilities, culture, talent, organization, and their transformation road map.

Though the P&C insurance business has long been insulated against disruption thanks to regulation, product complexity, in-force books, intermediated distribution networks, and large capital requirements, this is changing. Sources of disruption are emerging across the value chain to reshape:

Products. Semiautonomous and autonomous vehicles from Google, Tesla, Volvo, and other companies are altering the nature of auto insurance; connected homes could transform home insurance; new risks such as cybersecurity and drones will create demand for new forms of coverage; and Uber, Airbnb, and other leaders in the sharing economy are changing the underlying need for insurance.

Marketing. Evolving consumer behavior is threatening traditional growth levers such as TV advertising and necessitating a shift to personalized mobile and online channels.

Pricing. The combination of rich customer data, telematics, and enhanced computing power is opening the door to usage- and behavior-based pricing that could reduce barriers to entry for attackers that lack the loss experience formerly needed for accurate pricing.

Distribution. New consumer behaviors and entrants are threatening traditional distribution channels. Policyholders increasingly demand digital-first distribution models in personal and small commercial lines, while aggregators continue to pilot direct-to-consumer insurance sales. Armed with venture capital, start-ups like Lemonade—which raised $13 million in seed funding from well-known investors including Sequoia Capital—are exploring peer-to-peer insurance models.

Service. Consumers expect personalized, self-directed interactions with companies via any device at any hour, much as they do with online retail leaders like Amazon.

Claims. Automation, analytics, and consumer preferences are transforming claims processes, enabling insurers to improve fraud detection, cut loss-adjustment costs, and eliminate many human interactions. Connected technologies could allow policyholders and even smart cars and networked homes to diagnose their own problems and report incidents. Self-service claims reporting such as “estimate by photo” can create fast, seamless customer experiences. Drones can be used to assess damage quickly, safely, and cheaply after catastrophes. All these disruptions are being driven and enabled by digital advances, as illustrated with examples from auto insurance. No single competitor or innovation poses a threat across the entire value chain, but taken together, they could lead to the proverbial death by a thousand cuts: many small disruptions combining to fell a giant.

Fintech’s Attack All Banking Client Segments

Whilst most Fintechs are attacking the retail banking value chain, where the share of global revenue is highest, all segments are under attack according to a report published by McKinsey “The value in digitally transforming” credit risk management“. This chart which shows the footprint of Fintechs relative estimated share of bank revenue and client segments.

Whilst it may not be fully representative for any one segment or product, the chart is based on McKinsey’s financial-technology database which includes >350 of the best-known start-ups. “Commercial” includes small and medium-size enterprises, “large corporates” includes large corporations, public entities, and nonbanking financial institutions. The “financial assests and capital markets” includes investment banking, sales and trading, securities services, retail investment, noncurrent-account deposits, and asset-management factory.

The new competitors are beginning to threaten incumbents’ revenues and their cost models. Without the traditional burden
of banking operations, branch networks, and legacy IT systems, fintech companies can operate at much lower cost-to-income ratios—below 40 percent.

Fintechs can help incumbents, not just disrupt them

Interesting piece from McKinsey showing that the structure of the fintech industry is changing and that a new spirit of cooperation between fintechs and incumbents is developing. For example, in corporate and investment banking, less than 12 percent are truly trying to disrupt existing business models.

Fintechs, the name given to start-ups and more-established companies using technology to make financial services more effective and efficient, have lit up the global banking landscape over the past three to four years. But whereas much market and media commentary has emphasized the threat to established banking models, the opportunities for incumbent organizations to develop new partnerships aimed at better cost control, capital allocation, and customer acquisition are growing.

We estimate that a substantial majority—almost three-fourths—of fintechs focus on retail banking, lending, wealth management, and payment systems for small and medium-size enterprises (SMEs). In many of these areas, start-ups have sought to target the end customer directly, bypassing traditional banks and deepening an impression that they are disrupting a sector ripe for innovation.

However, our most recent analysis suggests that the structure of the fintech industry is changing and that a new spirit of cooperation between fintechs and incumbents is developing. We examined more than 3,000 companies in the McKinsey Panorama FinTech database and found that the share of fintechs with B2B offerings has increased, from 34 percent of those launched in 2011 to 47 percent of last year’s start-ups. (These companies may maintain B2C products as well.) B2B fintechs partner with, and provide services to, established banks that continue to own the relationship with the end customer.

Corporate and investment banking is different. The trend toward B2B is most pronounced in corporate and investment banking (CIB), which accounts for 15 percent of all fintech activity across markets. According to our data, as many as two-thirds of CIB fintechs are providing B2B products and services. Only 21 percent are seeking to disintermediate the client relationship, for example, by offering treasury services to corporate-banking clients. And less than 12 percent are truly trying to disrupt existing business models, with sophisticated systems based on blockchain (encrypted) transactions technology, for instance.

Assets and relationships matter. It’s not surprising that in CIB the nature of the interactions between banks and fintechs should be more cooperative than competitive. This segment of the banking industry, after all, is heavily regulated.¹ Clients typically are sophisticated and demanding, while the businesses are either relationship and trust based (as is the case in M&A, debt, or equity investment banking), capital intensive (for example, in fixed-income trading), or require highly specialized knowledge (demanded in areas such as structured finance or complex derivatives). Lacking these high-level skills and assets, it’s little wonder that most fintechs focus on the retail and SME segments, while those that choose corporate and investment banking enter into partnerships that provide specific solutions with long-standing giants in the sector that own the technology infrastructure and client relationships.

These CIB enablers, as we call them, dedicated to improving one or more elements of the banking value chain, have also been capturing most of the funding. In fact, they accounted for 69 percent of all capital raised by CIB-focused fintechs over the past decade.

Staying ahead. None of this means that CIB players can let their guard down. New areas of fintech innovation are emerging, such as multidealer platforms that target sell-side businesses with lower fees. Fintechs also are making incursions into custody and settlement services and transaction banking. Acting as aggregators, these types of start-ups focus on providing simplicity and transparency to end customers, similar to the way price-comparison sites work in online retail. Incumbent banks could partner with these players, but the nature of the offerings of such start-ups would likely lead to lower margins and revenues.

In general, wholesale banks that are willing to adapt can capture a range of new benefits. Fintech innovations can help them in many aspects of their operations, from improved costs and better capital allocation to greater revenue generation. And while the threat to their business models remains real, the core strategic challenge is to choose the right fintech partners. There is a bewildering number of players, and cooperating can be complex (and costly) as CIB players test new concepts and match their in-house technical capabilities with the solutions offered by external providers. Successful incumbents will need to consider many options, including acquisitions, simple partnerships, and more-formal joint ventures.

McKinsey’s Asia–Pacific Banking Review 2016

McKinsey has just released its latest banking annual report “Weathering the storm” which finds an industry facing challenges to maintain its growth, but significant opportunities remain.

Over the past decade, the Asia–Pacific region has propelled global banking. Of the industry’s $1.1 trillion global profits in 2015, some 46 percent came from the region, up from just 28 percent in 2005. The bulk of this increase was the result of growth linked to dynamic economies throughout Asia–Pacific, especially China, which accounted for about half of the region’s banking-revenue pool in 2015.

Yet our annual report, Weathering the storm: Asia–Pacific Banking Review 2016, finds that the momentum from this golden decade is already fading. Margins and returns on equity are shrinking—for instance, the Asia–Pacific banking industry’s ROE slipped to 14 percent in 2014, from 15 percent a year earlier. The region and its financial industry seem to be settling into a new era of slower growth and greater challenges in generating economic profit.

They say slowing macroeconomic growth, disruptive attackers from outside the financial-services sector and weakening balance sheets may come together in a powerful storm that could cripple ROEs by 2018. Indeed, banks already see the impact of the changing environment. Their analysis of 328 banks in the region showed that while 39 percent posted an economic profit in the period from 2003 to 2006, only 28 percent did so from 2011 to 2014.

They conclude that although the coming storm is a potent and clear threat to most banks in the Asia–Pacific region, it may also provide the kind of significant industry disruption that creates opportunities for those that recognize it. The most aggressive banks will not merely survive the turbulence but also be strengthened by it.

The Disruptive Potential of Blockchain

Blockchain has the potential to become a powerful and disruptive force across financial services, calling into question the future role for financial intermediaries and offering the potential for profound innovation.

On 10th May, Blockchain Revolution – How the Technology Behind Bitcoin Is Changing Money, Business, and the World By Don Tapscott and Alex Tapscott will be published. From the introduction:

The first generation of the digital revolution brought us the Internet of information. The second generation—powered by blockchain technology—is bringing us the Internet of value: a new, distributed platform that can help us reshape the world of business and transform the old order of human affairs for the better.

Blockchain is the ingeniously simple, revolutionary protocol that allows transactions to be simultaneously anonymous and secure by maintaining a tamperproof public ledger of value. Though it’s the technology that drives bitcoin and other digital currencies, the underlying framework has the potential to go far beyond these and record virtually everything of value to humankind, from birth and death certificates to insurance claims and even votes.

This technology is public, encrypted, and readily available for anyone to use. It’s already seeing widespread adoption in a number of areas. For example, forty-two (and counting) of the world’s biggest financial institutions, including Goldman Sachs, JPMorgan Chase, and Credit Suisse, have formed a consortium to investigate the blockchain for speedier and more secure transactions.As with major paradigm shifts that preceded it, the blockchain will create winners and losers. And while opportunities abound, the risks of disruption and dislocation must not be ignored.

Tapscott was interviewed by Mckinsey. Its worth reading their article.

What if there were a second generation of the Internet that enabled the true, peer-to-peer exchange of value? We don’t have that now. If I’m going to send some money to somebody else, I have to go through an intermediary—a powerful bank, a credit-card company—or I need a government to authenticate who I am and who you are. What if we could do that peer to peer? What if there was a protocol—call it the trust protocol—that enabled us to do transactions, to do commerce, to exchange money, without a powerful third party? This would be amazing.

The financial-services industry is up for serious disruption—or transformation, depending on how it approaches this issue. For the research for Blockchain Revolution, we went through and identified eight different things that the industry does: it moves money, it stores money, it lends money, it trades money, it attests to money, it accounts for money, and so on.

Every one of those can be challenged.

A digital crack in banking’s business model

Mckinsey says low-cost attackers are targeting customers in lucrative parts of the banking sector. The rewards for digital success are huge. Capturing even a tiny fraction of banking’s more than $1 trillion profit pool could generate massive returns for the owners and investors of “fintech” start-ups. Little wonder there are more than 12,000 on the prowl today.

The rise of digital innovators in financial services presents a significant threat to the traditional business models of retail banks. Historically, they have generated value by combining different businesses, such as financing, investing, and transactions, which serve their customers’ broad financial needs over the long haul. Banks offer basic services, such as low-cost checking, and so-called sticky customer relationships allow them to earn attractive margins in other areas, including investment management, credit-card fees, or foreign-exchange transactions.

To better understand how attackers could affect the economics of banks, we disaggregated the origination and sales component from the balance-sheet and fulfillment component of all banking products. Our research (exhibit) shows that 59 percent of the banks’ earnings flow from pure fee products, such as advice or payments, as well as the origination, sales, and distribution component of balance-sheet products, like loans or deposits. In these areas, returns on equity (ROE) average an attractive 22 percent. That’s much higher than the 6 percent ROE of the balance-sheet provision and fulfillment component of products (for example, loans), which have high operating costs and high capital requirements.Digital start-ups (fintechs)—as well as big nonbank technology companies in e-retailing, media, and other sectors—could exploit this mismatch in banking’s business model. Technological advances and shifts in consumer behavior offer attackers a chance to weaken the heavy gravitational pull that banks exert on their customers. Many of the challengers hope to disintermediate these relationships, slicing off the higher-ROE segments of banking’s value chain in origination and sales, leaving banks with the basics of asset and liability management. It’s important that most fintech players (whether start-ups or China’s e-messaging and Internet-services provider Tencent) don’t want to be banks and are not asking customers to transfer all their financial business at once. They are instead offering targeted (and more convenient) services. The new digital platforms often allow customers to open accounts effortlessly, for example. In many cases, once they have an account, they can switch among providers with a single click.

Platforms such as NerdWallet (in the United States) or India’s BankBazaar.com aggregate the offerings of multiple banks in loans, credit cards, deposits, insurance, and more and receive payment from the banks for generating new business. Wealthfront targets fee-averse millennials who favor automated software over human advisers. Lending Home targets motivated investment-property buyers looking for cost-effective mortgages with accelerated time horizons. Moneysupermarket.com started with a single product springboard—consumer mortgages—and now not only offers a range of financial products but serves as a platform for purchases of telecom and travel services, and even energy.

Across the emerging fintech landscape, the customers most susceptible to cherry-picking are millennials, small businesses, and the underbanked—three segments particularly sensitive to costs and to the enhanced consumer experience that digital delivery and distribution afford. For instance, Alipay, the Chinese payments service (a unit of e-commerce giant Alibaba), makes online finance simpler and more intuitive by turning savings strategies into a game and comparing users’ returns with those of others. It also makes peer-to-peer transfers fun by adding voice messages and emoticons.

From an incumbent’s perspective, emerging fintechs in corporate and investment banking (including asset and cash management) appear to be less disruptive than retail innovators are. A recent McKinsey analysis showed that most of the former, notably those established in the last couple of years, are enablers, serving banks directly and often seeking to improve processes for one or more elements of banking’s value chain.

Many successful attackers in corporate and investment banking, as well as some in retail banking, are embracing “coopetition,” finding ways to become partners in the ecosystems of traditional banks. These fintechs, sidestepping banking basics, rely on established institutions and their balance sheets to fulfill loans or provide the payments backbone to fulfill credit-card or foreign-exchange transactions. With highly automated, scalable, software-based services and no physical-distribution expenses (such as branch networks), these attackers gain a significant cost advantage and therefore often offer more attractive terms than banks’ websites do. They use advanced data analytics to experiment with new credit-scoring approaches and exploit social media to capture shifts in customer behavior.

Attackers must still overcome the advantages of traditional banks and attract their customers. Most fintechs, moreover, remain under the regulatory radar today but will attract attention as they reach meaningful scale. That said, the rewards for digital success are huge. Capturing even a tiny fraction of banking’s more than $1 trillion profit pool could generate massive returns for the owners and investors of these start-ups. Little wonder there are more than 12,000 of them on the prowl today.

Building a digital-banking business

From Mckinsey.

Banks have been using digital technologies to help transform various areas of their business. There’s an even bigger opportunity—go all digital.

The digital revolution in banking has only just begun. Today we are in phase one, where most traditional banks offer their customers high-quality web and mobile sites/apps. An alternate approach is one where digital becomes not merely an additional feature but a fully integrated mobile experience in which customers use their smartphones or tablets to do everything from opening a new account and making payments to resolving credit-card billing disputes, all without ever setting foot in a physical branch.

More and more consumers around the globe are demanding this. Among the people we surveyed in developed Asian markets, more than 80 percent said they would be willing to shift some of their holdings to a bank that offered a compelling digital-only proposition. For consumers in emerging Asian markets, the number was more than 50 percent. Many types of accounts are in play, with respondents indicating potential shifts of 35 to 45 percent of savings-account deposits, 40 to 50 percent of credit-card balances, and 40 to 45 percent of investment balances, such as those held in mutual funds.¹ In the most progressive geographies and customer segments, such as the United Kingdom and Western Europe, there is a potential for 40 percent or more of new deposits to come from digital sales by 2018.

Many financial-technology players are already taking advantage of these opportunities, offering simplified banking services at lower costs or with less hassle or paperwork. Some upstarts are providing entirely new services, such as the US start-up Digit, which allows customers to find small amounts of money they can safely set aside as savings.

A new model: Digital-only banking businesses

While it’s important for banks to digitize their existing businesses, creating a new digital-only banking business can meet an evolving set of customer expectations quickly and effectively. This is especially true in fast-growing emerging markets where customer needs often go unmet by current offerings. The functionality of digital offerings is limited, and consumers frequently highlight low customer service at branches as a key pain point.

So how should banks think about a digital-only offer?

Because banking is a highly regulated industry and a stronghold of conservative corporate culture, there are tremendous internal complexities that need to be addressed. These include the cannibalization risk to existing businesses and the need to foster a different, more agile culture to enable the incubation and growth of an in-house “start-up.” The good news is that our work shows it is feasible to build a new digital bank at substantially lower capex and lower opex per customer than for traditional banks. This is due not only to the absence of physical branches but also to simplified up-front product offerings and more streamlined processes, such as the use of vendor-hosted solutions and selective IT investment, that reduce the need for expensive legacy systems.

Fintechs – What’s Different This Time?

McKinsey has published an article about the rise of Fintechs “Cutting through the noise around financial technology”, and suggests that this time, unlike the dotcom bubble, more is at stake for existing financial services companies. Here is an extract, but we recommend the entire article.

Banking has historically been one of the business sectors most resistant to disruption by technology. Since the first mortgage was issued in England in the 11th century, banks have built robust businesses with multiple moats: ubiquitous distribution through branches; unique expertise such as credit underwriting underpinned by both data and judgment; even the special status of being regulated institutions that supply credit, the lifeblood of economic growth, and have sovereign insurance for their liabilities (deposits). Moreover, consumer inertia in financial services is high. Consumers have generally been slow to change financial-services providers. Particularly in developed markets, consumers have historically gravitated toward the established and enduring brands in banking and insurance that were seen as bulwarks of stability even in times of turbulence.

The result has been a banking industry with defensible economics and a resilient business model. This may now be changing. Our research into financial-technology (fintech) companies has found the number of start-ups is today greater than 2,000, compared with 800 in April 2015. Globally, nearly $23 billion of venture capital and growth equity has been deployed to fintechs over the past five years, and this number is growing quickly: $12.2 billion was deployed in 2014 alone.

So we now ask the same question we asked during the height of the dot-com boom: is this time different? In many ways, the answer is no. But in some fundamental ways, the answer is yes. History is not repeating itself, but it is rhyming.

The moats historically surrounding banks are not different. Banks remain uniquely and systemically important to the economy; they are highly regulated institutions; they largely hold a monopoly on credit issuance and risk taking; they are the major repository for deposits, which customers largely identify with their primary financial relationship; they continue to be the gateways to the world’s largest payment systems; and they still attract the bulk of requests for credit.

Some things have changed, however. First, the financial crisis had a negative impact on trust in the banking system. Second, the ubiquity of mobile devices has begun to undercut the advantages of physical distribution that banks previously enjoyed. Smartphones enable a new payment paradigm as well as fully personalized customer services. In addition, there has been a massive increase in the availability of widely accessible, globally transparent data, coupled with a significant decrease in the cost of computing power. Two iPhone 6s handsets have more memory capacity than the International Space Station. As one fintech entrepreneur said, “In 1998, the first thing I did when I started up a fintech business was to buy servers. I don’t need to do that today—I can scale a business on the public cloud.” There has also been a significant demographic shift. Today, in the United States alone, 85 million millennials, all digital natives, are coming of age, and they are considerably more open than the 40 million Gen Xers who came of age during the dot-com boom were to considering a new financial-services provider that is not their parents’ bank. But perhaps most significantly for banks, consumers are more open to relationships that are focused on origination and sales (for example, Airbnb, Booking.com, and Uber), are personalized, and emphasize seamless or on-demand access to an added layer of service separate from the underlying provision of the service or product. Fintech players have an opportunity for customer disintermediation that could be significant: McKinsey’s 2015 Global Banking Annual Review estimates that banks earn an attractive 22 percent ROE from origination and sales, much higher than the bare-bones provision of credit, which generates only a 6 percent ROE.