Walk into the Bank of America in uptown Charlotte and you’d hardly know you’re in a bank. Instead of tellers behind high counters, you’ll find an interactive touch-screen learning wall, a video-conferencing room, a table showcasing new technology features, and a digital greeter.
In almost every country, you’ll find flagship branches attempting to reinvent the full-service bank, even as four out of five transactions are conducted online. The business model aspiration that these branches embody is for banks to become "digital relationship managers." This business model sticks close to the traditional full-service banking model of the last couple of centuries, while at the same time acknowledging that both tech giants like Amazon and Alibaba, and a slew of focused fintechs, are making real inroads into the traditionally protected world of banking. In the digital relationship manager model, banks look to protect their position across the value chain, from balance sheet management to distribution and customer advice, while recognizing they need to play defense on the digital customer experience.
But an argument can be made that attempting to remain an integrated player means swimming against a tide of fragmentation. Some of that fragmentation is coming from regulatory pressure such as the EU’s Revised Payments Service Directive (PSD2) and the U.K.’s "Open Banking" initiative.
But there is also fragmentation pressure coming from the evolution of technology that makes it simple to plug-and-play component pieces of a banking proposition. Just as Google Maps is ubiquitous on every mobile app or website because it is easy to integrate, we are entering a world where it will be just as easy to integrate payments, credit and financial advice functionality into other transactions. That is why we are beginning to see the rise of platform banking models like Solaris that don’t manufacture, but simply assemble.
Fragmentation is also evident in Accenture’s Global Consumer Research, which found that 40% of consumers globally would consider ditching their traditional bank and curating their own set of financial services. This willingness to self-curate is partly driven by technology self-confidence, but also in large part by the lack of trust that many consumers have that banks will act in their best interest.
However, there are other options to attempting to evolve the traditional vertically integrated banking model into a compelling digital alternative. One alternative is the equivalent of selling shovels in the digital gold rush, rather than mining yourself. This means adopting a utility or partnership model that can sell the component pieces to the customer-facing organizations (many of which have far higher levels of customer trust than the banks themselves). Some of those components may be fintech widgets that do one thing very well, like a robo-advice algorithm, or a solution like Transferwise provides for retail foreign exchange. But there will also be opportunity for organizations that can provide low-cost, large-scale, back-office services such as processing loans or running loyalty programs.
In the U.K., Bank of Ireland is a great example of a partnership bank model in action. While it maintains full-service branches in the Republic of Ireland, in the more crowded British market it offers banking services through the Post Office and the Automobile Association (AA). The Post Office and the AA benefit by offering banking services (and generating origination fees) without having to maintain a regulated balance sheet, while the Bank of Ireland can scale its business without having to build its own distribution network and invest in a customer-facing brand. In a rising interest rate environment where balance sheet spreads will become a more important source of profitability, these types of third-party origination models could become increasingly attractive.
In Australia, Bendigo Bank offers a bank-in-a-box approach that is more akin to franchising, where a community bank can own the balance sheet, but Bendigo provides the entire back-office and operational infrastructure. Bendigo can scale its operations while the community bank can concentrate on building its customer base, delivering exemplary local customer service and using its local knowledge to make better decisions.
The utility/partnership model reflects Adam Smith’s theory of the specialization of labor and how it lowers the barriers to entry in the banking business. For example, ClearBank in the U.K. is now offering clearing and settlement services for fintechs in a manner akin to Amazon Web Services offering web hosting. Low-cost standard technology is making it easier for digital ideas to be brought to life by entrepreneurs across all parts of the economy and banking is not immune to that competitive pressure.
The challenge for most incumbent banks is that it is hard to stop doing what they have always done and narrow their business model. There are a few great examples, like Mellon Bank and Bank of New York ditching their retail banking to focus on what they did best—managing custody accounts for other banks—but, these examples are few and far between. In a case like the Bank of Ireland, the utility/partnership model is a vehicle to grow in a second market, rather than a radical change in how its home market franchise is run.
Of course, working from behind the curtain is not without risk, as over time services can be commoditized as other providers compete and compress fees. Success depends on strong relationships, but unfortunately, many marriages end in divorce. Two of the most successful de novo banks in the U.K. over the last 20 years have been Sainsbury’s Bank and Tesco Financial Services. Both started as partnerships with established banks, and both are now fully owned by the retailers themselves.
To thrive, successful utility/partnership business models must be cost competitive and remain innovative to help their partners win over and keep customers — whether that’s being Alexa-compatible or driving product innovation. They also must make life easier for their partners by providing reassurance on cybersecurity and regulatory compliance.
The business of banking is changing into one that will become more dependent on partnerships. While the path of least resistance for many institutions is simply to try and evolve into a digital version of what they have always been, there are alternatives. One of those alternatives is to sell shovels in the gold rush by focusing on being a supplier and partner in what may become an increasingly fragmented, competitive and challenging financial services market.
