Digitalization in Retail banking: threats and opportunities
“Φάρμακον” (“Pharmakon”), in ancient Greek, means at the same time “poison” and “remedy”. French philosopher J. Derrida noted in his famous Plato’s Pharmacy that when this term refers to the sophists, “pharmakon” should mean poison, while when Socrates’ speaking, pharmakon should mean remedy. There is one concept, but two opposite consequences. It is the same when we talk about digitalization in the banking sector. On the one hand, it is a threat as digitalization increases competition and requires heavy investments. On the other hand, digitalization is a growth opportunity for the retail banking sector. This situation recalls the way the Internet disrupted the music market fifteen years ago.
Traditional players of the music sector had no choice but to adapt with this new trend. Some of them died, other has developed new strategies, and newcomers have revolutionized the value chain of the music sector. But the path conducting to profit, in this new era, was like Plato’s cave, shadowed by illusions and deceptive pictures, even if finally, the music market become dynamic again and full of opportunities. We believe that the analogy between the music market in the 2000s and the retail banking industry today is accurate because it gives to us, some lessons from the past.
The digitalization of the banking sector under constraint?
Digitalization and increased competition from GAFAs
Almost half of banks and credit unions consider large tech companies such as Alphabet Inc.’s Google, Facebook and Apple Inc. to be a “significant threat,” according to a Infosys Finacle survey of 300 bankers. In China, tech companies such as Alibaba Group Holdings Ltd. and Tencent Holdings Ltd. have already emerged as serious competitors to banks in offering online financial services. If the regulatory barriers are likely to restrict the entrance of these new players in the banking market, the idea of ending the centuries-old separation between banking and commerce has gained ground among regulators. However, a “Bank of Amazon” will not emerge overnight, because it deeply puts into question our regulation model. In fact, by erasing the frontier between bank and commerce, policy makers would worry that commerce use their lending activities to provide risky financing to in-house businesses.
But, over the short term, GAFAs and Fintech compete with banks in an area where they have a common know-how: the field of payments and consumer credit. Perhaps, the most spectacular attempt for a new comer to gain market shares in retail banking is the recent partnership between Goldman Sachs and Apple to launch a credit card offer. In France, Apple Pay service has established itself among banks which were eager to seduce geek and high-value customers (BPCE offered Apple service in 2016, Crédit Mutuel Arkéa in 2017, Société Générale in 2018, BNPP and La Poste will follow in 2019). In the field of consumer credit, Retailer Casino has launch a deferred payment “with very small fees”. Amazon has flexed its muscles by lending to small businesses, originating more than $3 billion in loans to merchants selling on its marketplace by June of this year.
Does online banking cannibalize the existing market ?
Digitalization is a powerful lever to gain clients and creates new market if a relevant strategy is followed. However, the frontier between new market and existing market is sometimes tenuous. It is often difficult to say if a business model contributed to enlarge the market or not. In fact, if the new business model cannibalizes the existing market, a company will hesitate to dedicate resources to develop it.
A good example of such a situation is the music market in the 2000s. Many Majors refused the principle of online streaming music which threatened their business model in place. They treated this trend as an epiphenomenon which should be framed by law, rather than considering it as a new way to consume music. New comers (like Amazon or Apple) were more able to adopt a new disrupting business model because they will not have a conflict between their new and their existing business model. As a result, GAFAs are now trusting the markets of retail music.
In the financial industry, situation is however a bit different. Investment in digital has always been a priority, as it transforms the customer relationship and enables to cut costs. Traditional retail banks did not wait for the arrival of new comers to propose digital banking experience. All traditional French banks have developped a low cost online banking offer : Société Générale with the purchase of Boursorama in 2014, BNPP with the launch of Hello Bank! in 2013, La Banque Postale will launch “Ma French Bank” in 2019…
Moreover, Retail Banks have developped a “two sided strategy” in order not to cannibalize their existing markets and network of bank branches. Contrary to what could be expected, digital low cost offer is not intended to a modest customer base but to informed client with digital knowledge. The marketing mix of this offer put emphasis on attractive fees to attract forward-looking client, who seize their livehood opportunities. Besides, emphasis is also put on reliability as digital banks are backed by big and classical banks.
Banks have to do the splits in order to address two client segments. One with a low price-elasticity, which is faithul to the classical offer and one with a high price-elasticity, ready to move from traditional offer to avoid any fee increase.
Is online banking a profitable business ?
The online banking model is still seeking its profitable business model. Boursorama has suffered from a €24 million loss in 2016, and net income of BforBank (Crédit agricole) was – €17 million. Hello bank ! and ING Direct (which have a 15 years experience of the market) do not published dedicated account but admit, according to internal sources, to be stuck in “an investment phase”. The only digital Bank which earned money in 2016 was Crédit mutuel Arkéa subsidiary, Fortuneo, which have taken the control of the Belgian online banking leader, Keytrade for an amount of €250 million.
Low rentability of online banking businesses is due to a scissor effect between great investments and sluggish margins relating to the overall banking sector. The decrease of the banking margin can be explained by several levers. First, financial income from clients’ liabilites has become less and less attractive due to low interest rate environment. At Boursorama, the increase in the number of clients, (from 750 000 to 975 000 between 2015 & 2016) has just offset the decrease in revenue linked to the interest margin. However, at a macro level, the increase in credit volume is still not sufficient to offset the deposit one. According to the EBA, the loan-to-deposit ratio has reached is lowest level in 2017 (107.07 % in the Eurozone), whereas, it was at 135 % in 2009. Second, the potential for collecting AUM of one of the traditional flagship product (i.e. life insurance) is put into question which such interest rates. While margin are decreasing, heavy investments are still required to develop this service. For instance, Crédit Agricole invested more than €290 million between 2009 and 2017 in its online bank, BforBank.
What are the top 3 Digitalization Opportunities?
- The benefits of diversification
Based on these remarks, strategies of diversification is a lever of growth. The idea is to better off and complete the current banking offer with complementary services. In this field, new comers like FinTech have benefited from digital technologies to enter in the banking industry (Peer-to-Peer lending, online pot, participating funding, online estate managements…). Banks endure today what other industries knew before: the overtaking of classical channels of distribution by the disintermediation offered by e-commerce players. Many Banks bought Fintechs to provide complementary services (Compte Nickel bought by BNPP in 2014, Pumpkin by Credit Mutuel Arkéa in 2013 for instance).
Compared to its competitors, Fortuneo’s is quite successful. With more than €30 000 of liability per client (against €18 000 for Boursorama), Fortuneo has a high value client base even if it has less clients than Boursorama (670 000 vs 880 000). The key of Fortuneo’s success relies on the fact that the offer supplied is complete and integrated with life insurance products, credit solution and day-to-day bank services, while emphasis has been put on cost control. This complete offer enables client to use it as their main bank and Fortuneo is the digital bank with the highest domiciliation of clients’ income Other factor of success is Fortuneo’s pioneer advantage in terms of client segmentation. At the beginning in the 2000s, Fortuneo was specialized in stock market investments and life-insurance. It enabled the bank to retain high-value customers, who had used Fortuneo as their main bank later on, when Fortuneo launched its complete banking offer.
Boursorama, has also experienced a significant growth but its external growth strategy has been costly over the short-term. It has weighed on profitability.
- The Long tail theory
Another parallel can be drawn between online banking market and the Music industry where diversification is key. The long tail theory is used to describe the retailing strategy of selling a large number of unique items with relatively small quantities sold of each usually in addition to selling fewer popular items in large quantities. It is a well-known concept in the music industry where the dematerialisation and the Internet enable retailer to sell few quantities of a great diversity of product. This theory has found application in the music sector because this industry has 2 characteristics : (i) channel of distribution are quasi unlimited through the internet and (ii) marginal costs are low. Some of the most successful Internet businesses (as Amazon and iTunes Store) have used the long tail as part of their business strategy. Other plateforms like Soundcloud has made their success from offering a great amount underground/niche music or young producers.
If we transpose this theory in retail banking, what would be the result ? Long tail in banking creates a mass market of niche customers. It would allow banking to expand its customer diversity and enables the unbanked and underbanked customers to avail services pertinent to their needs. The greater the number of different consumer segments, the longer is the tail.
Microfinancing, PayPal, social lending sites like Zopa and Prosper, prepaid cards, and mobile payments are the many ways in which the banks can reach out those customers whose needs are different from the usual ones . However, access to the long tail should be done at a very low costs for banks and all these services cannot be developed internally. That is why partnership with fintechs are of paramount importance for banks. For instance, Santander announced a partnership with American Fintech Kabbage, in order to break into the English market of SMEs funding. In Africa, Société Générale has signed a partnership with fintech TagPay to develop innovative payment solutions, which are suited to the local markets.
The niche transactions, that occur over the internet, involve no overhead costs for their management. As the niche transactions build up, the small profits become big. Although the customers targeted by long tail in banking have no established credit history, they form a significant niche market, and are a crucial component of economic growth globally.
- Bank as a platform
The bank of tomorrow is often seen as a platform which provides a multitude of services and benefit from the cost effectiveness of this business model. The idea is to build a marketplace of financial products and services in which the bank sells its products along with its competitors, collecting data from their clients. As Citigroup CEO puts it, clients’ data is still undervalued and could be used by banks to change their business models. Big data could be used by banks in order to develop customer proximity, to provide better advice and to reduce costs. Wells Fargo created its Big Data lab in 2014 to pioneer the use of emerging technology and data science to drive customer experience, prevent fraud and develop customer insights. For instance, we could imagine that predictive marketing could help bank advisors to supply their clients with targeted products . Imagine a situation in the near future in which your banking advisor has access to the best data analytics tools. Even if you have never met him, he would know that you have made internet search on cars, that you have children among whom, one wants to study in an expansive business school etc. Knowing all this information in advance is time-saving for the advisor, who can directly make you accurate offers. In this case: car insurance or student loan. Other interesting initiative in Big data is the commercialization by CommBank of a set of apps and smart payments terminals to small businesses. These terminals collect data from the client, and combined with a business analytics platform, it enables to know better the habits of customers.
Marceau Guillaume, « Banques en ligne : Du mimétisme au “e-business model” bancaire », Gestion 2000, 2011/4 (Volume 28), p. 49-65. DOI : 10.3917/g2000.284.0049. URL : https://www.cairn.info/revue-gestion-2000-2011-4-page-49.htm
Chris Anderson , “The Long Tail: Why the Future of Business Is Selling Less of More”, Wired, 2004
 Marceau Guillaume, « Banques en ligne : Du mimétisme au “e-business model” bancaire », Gestion 2000, 2011/4 (Volume 28), p. 49-65. DOI : 10.3917/g2000.284.0049. URL : https://www.cairn.info/revue-gestion-2000-2011-4-page-49.htm
 Chris Anderson , “The Long Tail: Why the Future of Business Is Selling Less of More”, Wired, 2004