Global Retail Banking 2016: Banking on Digital Simplicity

Despite a tentative financial recovery, the retail-banking industry faces unrelenting, disruptive challenges. Banks that hope to prevail must urgently pursue digital simplicity. That is, they must develop digital and data capabilities that radically simplify their businesses while dramatically improving the customer experience through greater efficiency, quality, and speed.

That mandate for digital simplicity is the central insight emerging from the research behind this sixth edition of BCG’s annual Global Retail Banking report.

For this year's report—Banking on Digital Simplicity—we have widened and deepened the perspective of our past research to provide a comprehensive and data-informed assessment of Retail-Banking Excellence, or REBEX by BCG—the abbreviation referring to our report and its underlying benchmarks, surveys, databases, and tools. Our intent is to identify actionable insights into the leading global trends, the best practices of top-performing banks, and the key levers available for improving performance.

This article—one of three publications composing the full report—includes an overview of the industry’s financial performance. BCG Banking Pools data shows that global retail-banking revenues rose 3% in 2015, to nearly $1.6 trillion, with wide disparities among regions. In this article, we discuss those regional results as well as growth trends and outlooks. ¹ 1 BCG Banking Pools is a proprietary database that tracks the industry’s global financial performance. It permits assessment by country, region, product, and banking segment, including corporate, retail, and private banking; asset management; and corporate investment banking. Retail-banking revenues in this report include banking receipts from small- and medium-size enterprises but exclude private banking. The global revenue total for 2015 is an estimate. Notes: 1 BCG Banking Pools is a proprietary database that tracks the industry’s global financial performance. It permits assessment by country, region, product, and banking segment, including corporate, retail, and private banking; asset management; and corporate investment banking. Retail-banking revenues in this report include banking receipts from small- and medium-size enterprises but exclude private banking. The global revenue total for 2015 is an estimate.

The article Customers Steer Digital Trends Driving Retail Bank Transformation reveals how the needs and expectations of consumers are forcing—and supporting—the digital transformation of banks. The article draws on information and insights from BCG’s Consumer Digital Banking Surveys of behavior and preferences in nine countries. In China, for example, the survey found that customers who use both human and digital channels are two to six times as likely as other customers to be affluent but are also more challenging to serve. The ramifications of the industry’s weak record of customer and brand advocacy are also assessed. BCG’s Brand Advocacy Index (BAI) shows that retail-banking brand advocacy lags that of most other industries, sometimes by more than 30 percentage points. The article concludes with a deep dive on financial-technology (fintech) competitors, examining the impact of fintechs and other upstarts that are challenging—and sometimes partnering with—traditional banks.

Another article, Retail Bank Operational and Digital Leaders Reap the Rewards, provides the results of BCG’s annual benchmarking of the operational and digital excellence among leading retail banks. It assesses the trends and capabilities that increasingly separate the top performers among the leading banks from the median. This year, once again, the best operational and digital performers reaped the lion’s share of financial rewards—for example, 50% higher average pretax profit per customer than the median.  As the world’s top-performing retail banks continue to widen their lead over the rest, banks that aspire to join them at the top will need to jump-start their digital transformation. The article also discusses specific steps banks can take to achieve that goal.

Tentative Recovery, Disruptive Challenges

Banks will have to make that digital transformation amid a welter of challenges and risks. While they are experiencing a tentative recovery, banks face continued pressure on margins. Digital technologies increasingly disrupt the industry, and competition is intensifying. Regulatory oversight will continue to tighten. Return on equity (ROE) will remain constrained as fines and restructuring costs affect profit, while revenue growth will struggle to keep pace with increased capital requirements.

Additionally, digital innovators like Amazon, Airbnb, and Uber have raised the bar for consumer expectations regarding service, speed, and convenience and have created the expectation that banks will interact seamlessly with customers through digital channels while offering human interaction at moments that matter. At the same time, fintech upstarts are increasingly disrupting the industry, eroding the profitability of traditional business lines, from lending to personal finance, payments, and retail investments.

These and other players—from inside financial services and beyond—threaten to disintermediate banks’ relationships with customers and transform the retail bank into little more than a utility in the eyes of consumers.

Banks need to act urgently to prevent this erosion of the customer relationship. Strategy and culture must be transformed. No longer can banks be product centric; instead, they must truly fulfill the evolving needs of digitally enabled customers. Distribution models should seamlessly blend digital and human interaction. The customer-led migration to digital channels is starving traditional banks of foot traffic in branches. Banks need to be more proactive and precise in targeting and engaging customers. To survive, they must reimagine every element of the customer experience—deepening, broadening, and customizing the customer relationship in a newly agile manner.

Banks Must Simplify—and Do So Radically

The best banks will learn from, and sometimes partner with, emerging fintech players to integrate new digital solutions and deliver exceptional customer experience. To cooperate and take advantage of fintechs, banks will require new partnering capabilities. To heighten their understanding of customers’ needs and to deliver products and services that customers truly value, banks will need new capabilities in data management and analytics.

Most banks today have a considerable distance to travel on the journey to overcome the compromises and frictions that degrade the customer experience. To get started, banks must simplify. And they must do so radically. The technological revolution creates an opportunity to achieve digitally enabled simplicity—by moving beyond incremental change and instead fundamentally challenging complexity in every area of their business. Digital simplicity includes rightsizing product portfolios, redesigning customer journeys to create natural pathways across channels, and using digital technologies to industrialize core processes from end to end. The payoff can be measured in an improved experience for the customer and significantly increased efficiency for the bank.

Leading banks are making progress by both measures, as the results of BCG’s sixth annual Global Retail-Banking Excellence benchmarking show. They are reducing cycle times for core processes, such as account opening, while achieving higher rates of straight-through-processing and improving productivity. At the same time, the REBEX leaders are reallocating resources from back- and middle-office functions to customer-facing advisory roles. Almost all banks in the benchmarking are making operational advances. But the gap between leading banks and the rest is significant and growing.

In short, the competitive standards for operational and digital excellence and radical simplicity are becoming more demanding, and the table stakes are rising, with opportunities for median players to reduce operating expenses by 15% to 25%, increase pretax profit by 20% to 30%, and boost pretax profit margins by 5 to 10 percentage points.

Embedding and sustaining such change requires transforming the entire organization. That is much easier said than done. Agile approaches to development are needed in order to design and adopt fresh ways of working. Cross-functional teams of personnel responsible for product development, marketing, operations, legal and compliance, IT, and testing must be deployed, working in short cycles, to reduce time to market. Scarce entrepreneurial talent must be attracted and retained, and a program of culture change must be implemented to embed a digital mind-set that supports organization-wide collaboration and risk taking.

The Four REBEX Requirements for Leadership

In the next few years, the disparity in performance between the leading banks and the laggards will widen further. To rank among the leaders, a bank will need to achieve four primary goals:

• Understand, strengthen, and deepen customer relationships. Move from being product-centric to become customer-centric. Consider extending offerings to include nontraditional services through digital platforms.
• Reimagine customer journeys from front to back using digital technologies. Understand natural customer pathways across channels to overcome hidden customer compromises and frictions. Include middle and back offices in digital roadmaps.
• Create agile, simple, and highly collaborative organizations. Build a digital-ready culture. Deploy cross-functional teams that work in short cycles. Become more comfortable with making decisions amid uncertainty. Compete for scarce entrepreneurial talent.
• Enhance digital capabilities. Fail fast and fail cheap, and build digital capabilities through direct experience.

On the basis of BCG’s global client experience, we believe that these goals represent the levers employed, and the practices followed, by leading retail banks in continuously improving their performance.

Toward Financial Recovery

After a difficult period of variable growth, margin pressures, and intense and increasing regulatory intervention, global retail banking has entered a tentative recovery phase. Stability and growth are gradually, if unevenly, returning to markets and economies. Nevertheless, interest rates track decade-long historic lows, with no consensus about when they might rebound. (Other macroeconomic trends are discussed in the related article Customers Steer Digital Trends Driving Retail Bank Transformation.)

Global retail-banking revenues rose by an estimated 3% in 2015, from $1.54 trillion to $1.59 trillion, BCG Banking Pools research found. (See Exhibit 1.)

The growth rate of global revenues is expected to show relative recovery during the second half of the decade, rising close to precrisis levels. (See Exhibit 2.)

In 2015, the Americas and Western Europe accounted for 62% of the global market—but less than 30% of its growth. Emerging markets, particularly those in Asia, were the engine of revenue growth, and that trend is likely to continue.

Revenue growth outpaced the rise in operating costs, producing a steady increase in operating profits. Although regulatory fines and restructuring costs continued to escalate, overall risk costs fell because loan loss provisions shrunk.

Profit growth did not reduce pressure on ROE, however, as capital requirements continued to increase in tandem with profit.

Regional Growth Trends and Outlook

The performance of retail banks continued to vary significantly by region in 2015, as did their near-term outlook. Asia retained its role as the industry’s growth engine, and Western Europe remained sluggish. In North America, signs of growth appeared.

In December 2015, the US Federal Reserve inched rates higher for the first time in almost a decade, a move that was regarded as the potential start of a gradual tightening of monetary policy. Three months later, the European Central Bank (ECB) moved in the opposite direction. It cut its main interest rate and bank deposit rate, increased its “quantitative easing” bond-buying program, and reduced its economic-growth forecast for Europe. The contrasting moves—amid volatile markets and anxiety about financial stability—heightened concerns regarding whether the Fed, the ECB, and other leading central banks, including the Bank of England, the People’s Bank of China, and the Bank of Japan, could coordinate monetary policies.

Americas (37% of Global Revenues). In North America, retail-banking revenues grew by approximately 1% in 2015. Many players saw flat or slightly declining growth. Deposits grew strongly and asset quality was robust, but profits grew slowly owing to continuing low base rates and modest consumer loan growth.

Regulations are pushing up North American banks’ costs and complexity. Despite efforts, performance on operating efficiency has been flat at best. In this environment, banks are starting to decisively make major strategic investments in multichannel capabilities. These include new branch formats, digital sales and service, and advanced data and analytics. The best banks proactively identify near-term tactical initiatives to “fund the journey.” These include pricing, simplifying the operating model, reengineering end-to-end processes, and sourcing. At the same time, these banks define a clear strategy and operating model for the medium term. They also identify critical enablers, such as more agile ways to deliver innovation and the development of talent in digital and analytics.

In Latin America, growth was sluggish in 2015, especially in US dollar terms. ROE decreased as a consequence of devaluations, a challenging interest rate environment, and higher costs of risk and regulation. However, average ROE remained in the 15% to 25% range. Despite cost-to-income ratios that were often below 50%, Latin American banks are still working to become more efficient. They are also looking to increase fees and commissions so that they will be less reliant on net-interest income. And Latin American banks are innovating, especially in electronic payments, to increase banking penetration from today’s relatively low levels. Recent waves of regionalization-driven M&A in Latin American banks are subsiding; the number of deals will decline, and banks will shift their focus to postmerger integration to reap the benefits of past deals.

Western Europe (25% of Global Revenues). Income growth was sluggish, as interest rates remained at historically low levels in the Eurozone, the UK, and other Western European markets. Impairments returned to long-term levels in many markets, as higher-quality lending displaced precrisis loan books, but in some markets, banks continued to work through the difficulties. Regulatory costs and fines rose considerably in many markets, while increased capital requirements placed further pressure on ROE. As a result of these trends, we see a widening disparity of financial performance across the region, with the best retail banks targeting cost-to-income ratios of 40% to 45% but many others struggling to get below 70%.

Many Western European retail banks have deleveraged their balance sheets, refocused on franchise customers, simplified their organizations, streamlined product ranges, and worked through their impairment legacy. This has left white space in the market for specialist players and fintechs to target specific customer niches. At the same time, Western European retail banks have experienced a fairly sizable migration of transactional flow out of the branches and into direct channels. This has created a dilemma for those banks: they seek to rationalize their branch networks (to reduce the cost to serve) yet to simultaneously retain their reach (to serve customers in key moments when human interaction is favored).

Looking forward, Western European banks will remain focused on income growth by serving as customers’ main bank and providing multiple products, improving service through multichannel optimization, controlling costs through branch optimization and end-to-end digitization, improving operations and agility, and making compliance a way of doing business rather than an independent process.

Asia-Pacific (30% of Global Revenues). Asia continued to serve as the growth engine of retail banking, with profit increases in the high teens. Given the rapid expansion of many emerging markets in this region, sales force effectiveness and branch network optimization have been important capabilities for capturing market share. Recognizing that end-to-end digitization is important as a way to drive efficiency, reduce costs, and enhance the customer experience, incumbents across the region launched innovative digital offerings at an accelerated pace. Developments at the national level helped spur growth, including interest rate liberalization and new differentiated bank licenses in India.

Even though Asia’s emerging markets are heterogeneous, the emergence of nonbank digital players has been a common theme, particularly in payments and consumer lending. Many of these players are designed to be “mobile first,” an approach that may help the region make big strides in financial inclusion. In addition, inspired by innovation in China, leading retail banks across the region are enhancing ecosystem collaboration to expand their reach and encourage customer engagement.

Australian banks continued their strong performance, with ROEs in the high teens and low cost-to-income ratios. These results were supported by a relatively high interest income and a robust housing market. Australia has significantly outpaced its global peers in digital-channel usage. As a result, service is migrating out of branches at an accelerating pace; branch staff and size have fallen and total branch numbers have remained flat. Productivity improvement and cost reduction remain opportunities for Australian banks, especially compared with banks in other markets. Nonbank digital players are entering the market in Australia in increasing numbers but have yet to significantly erode traditional banks’ market share. While the regulatory burden facing Australian banks is increasing, it lags that in other developed markets, such as the UK, by several years.

Central and Eastern Europe (4% of Global Revenues). In 2014, retail banking in Russia was negatively affected by financial turmoil. The swift devaluation of the ruble, market volatility, and a scarcity of funding as well as negative assessments by rating agencies led to stagnating revenues (compared with previous year-on-year growth of 25% to 30%).

Russian banks responded in 2015 by aggressively downsizing their branch networks and moving customers to remote servicing. In some cases, government authorities took over weak players. If the Russian economy improves in 2016, retail banks should record greater profits and lending volumes, driven by reduced risk and funding costs. The benefits of 2015’s cost-reduction measures are also likely to be felt in 2016, easing the pressure on profitability.

In Poland, many retail banks sharpened their focus on segmenting customer bases using customer relationship management systems. They also sought to improve the customer experience through more effective onboarding, enhanced mobile-banking capabilities, and digitally driven simplification.

Elsewhere in the region, channel optimization and sales force effectiveness were strong themes. Banks also strengthened their consumer finance businesses to tap the growing spending power of consumers.

Middle East and Africa (3% of Global Revenues). In 2015, banks in the Middle East continued to see ROE in the midteens, thanks to the low cost of funding themselves from customer deposits and relatively low risk costs. Any rise in interest rates would be good news for the region’s banks, as low-cost deposits would allow better margins. Especially in the Gulf Cooperation Council zone, banks generated solid asset growth of 8%. They also responded to tighter liquidity by running promotions and sales campaigns to gather more deposits. As in other markets, digital has been at the top of the agenda. Local banks have launched digital propositions to tap into high Internet and smartphone penetration. The first digital challenger bank in Saudi Arabia, Meem, the retail-banking arm of Gulf International Bank, was launched in 2016.

In 2016, Middle Eastern retail banks should expect continued pressure on margins and liquidity; the cost of funds is anticipated to rise by 50 basis points on average. Banks will continue to respond to increases in fund costs by pricing more keenly, revisiting their operating models to become lean, and investing in digital capabilities. They will also seek to address the challenge of acquiring new customers from among a relatively young and tech-savvy population that is confronting rising unemployment.

In North and sub-Saharan Africa, banks concerned themselves in 2015 with setting up the infrastructure and capabilities to succeed in the medium term. Their priorities included establishing clear strategy and value propositions, segmenting customer bases to offer differentiated propositions, and future-proofing their IT and sales organizations.

As in other regions, mobile financial services, particularly money transfer and payment offerings, continued to expand rapidly in Africa, providing many sub-Saharan Africans with their first formal banking experience. (See Africa Blazes a Trail in Mobile Money, BCG report, February 2015.)