This article is the first in a series on how Swiss banks can transform their operating models towards a new normal. The Deloitte Financial Services Transformation team will be publishing on an ongoing basis its perspectives on the key implications, international best practice and potential solutions that banks might implement.
Existing gaps in banks’ operating models revealed
The global pandemic and related economic crisis have affected Swiss banks profoundly. The direct financial impact is likely to be in the form of loan losses, as we pointed out in a previous article. However, the crisis has also revealed weaknesses in banks’ operating models, which will affect their competitive advantage and key financial, risk and capital parameters unless appropriate and timely action is taken. The weaknesses include amongst others:
- Limited extent of process automation and digitisation: The increase in loan applications triggered by the emergency loan scheme overwhelmed banks and forced them to reallocate staff from other areas to handle the work. Onboarding of clients was also hindered by the difficulties in arranging personal meetings: according to our Wealth Management Onboarding Survey, biometric identification is not used widely in financial services, only 20% of Swiss banks use video identification, and most of them did not even plan to introduce it until this year. Only 29% of banks in the survey use a digital front-end for onboarding.
- Resilience of business processes and inflexibility of IT infrastructure: The move to working from home came at an unsuitable time, as many banks were unable to provide employees with secure and fast access to core systems. This damaged the resilience of business processes, as a number of services could no longer be provided to clients. The move to working from home also exposed banks to a large array of security risks. For example since employees logged on to IT systems remotely from their homes, it became more difficult to ensure data security.
- Lack of digital capabilities for customer interaction: The lockdown restrictions forced customers to conduct banking online, but the tools available from banks were not user-friendly enough, resulting in overwhelmed call centres and unsatisfied clients. Our Digital Banking Maturity study pointed out these shortcomings in the user experience in 2018 and findings were similar in 2020 – the user experience rating for Swiss banks is on average 72% lower than for leading EMEA peers. Clients expect an appealing digital experience, on both mobile and online banking platforms, and the demand will grow as an increasing number of financial products and services become available, even for less affluent clients. Today’s technologies enable the provision of high quality client advice on digital channels at lower cost – but most banks have not yet developed these possibilities.
These weaknesses are not specific to the current situation; rather they emerged over the past decade. The current crisis has simplify amplified existing trends and made the weaknesses in banks’ operating models more clearly visible.
The competitive landscape in which banks find themselves today has been shaped by a change in client behaviour, changes in the competition and new technological opportunities (see Figure 1). New and innovative providers with simplified products and a competitive advantage from a regulatory perspective have gained a substantial share of the market in some areas. Clients are increasingly open to testing the new offerings and in doing so their overall expectations regarding level of process automation and digitalisation is increasing. While most new players currently operate in market niches and offer specific standalone services (lending platforms, free credit cards, online saving accounts, mobile pillar 3a solutions, mobile trading) this is likely to change in the near future. As they gain traction, the digital challengers will aim to hollow out the long-standing customer relationships that traditional banks currently enjoy.
The impact of the new competitive landscape is already reflected in the financial performance of banks. For example in the mortgage business, traditionally the main source of income for Swiss retail banks, we estimate that margins have eroded by about 30% over the past decade, while market volumes increased by 72% over the same period. Compared to pre-financial crisis levels, banks now have a 35% higher cost-income ratio, despite efforts to increase efficiency. This ‘growth trap’ of pressure on both their top and bottom line has affected the ability of banks to create added value.
Figure 1. Overview of key drivers and impact on banks
Our analysis over a decade shows that the ability of Swiss banks to earn their cost of equity has deteriorated significantly (see Figure 2). While the average equity spread (the difference between return on equity and the cost of equity) was slightly positive (0.1 pp) in 2009, it was negative (about -2.1 pp) in 2019. This is especially striking since banks in 2009 were still recovering from the global financial crisis. The inability to create added value is also reflected in stock prices: quoted Swiss banks are mostly worse off than ten years ago and have dramatically underperformed the market.
Figure 2. Equity spread and stock price development
Operating model transformation: a strategic necessity to return to sustainable value creation
We believe that market trends will alter the current value chain configuration of banks. Unlike other industries, banking has so far preserved a traditional integrated value chain. Both regulatory and technological barriers have helped maintain this. However, for most banks, this value chain configuration will not remain sustainable in the future.
As new technologies emerge and the pressure on regulators increases to lower entry barriers, it will become possible to disaggregate the value chain and in doing so improve the client experience. Once this disaggregation occurs, it will make sense from a business and an economic perspective for banks to focus on certain parts of the value chain. We already see examples in the market; both in Switzerland and abroad (see Figure 3).
As banks specialise and leverage their core competencies, they can create a competitive advantage, intensifying pressure on players with integrated value chains, which will find it increasingly hard to maintain a business case for this strategy. Only a small number of large banks might succeed in maintaining a traditional integrated value chain, particularly in retail banking, where most products are commodities. For other banks, specialisation in selected stages in value chain steps is likely to be the sought-after solution. There are already examples of initiatives by traditional banks to diversify by embracing digital business models (e.g. Hypothekarbank Lenzburg with NEON, BLKB with a new Swiss digital bank, WIR Bank with VIAC), and these could be a sign of transition. However, for now such initiatives are an enlargement of services rather than specialisation, since it will take time until the traditional channels can be reduced. While we believe that it might be possible for banks to focus on multiple steps in the value chain over the next five years or so, in the long run only ‘pure players’ will remain successful – because technology will eventually enable specialisation and at this point disaggregation of the value chain will become a reality. This trend is already visible in other industries with less complex value chains (e.g. the travel industry, car manufacturing). The time is now ripe in banking: digitalisation has advanced a long way in the past couple of years, enabling the decoupling and modularisation of the value chain. The market will not be big enough for every player independently to offer every (digital) service; and banks must consider their options carefully and choose now their target operating model for the future.
Figure 3. Target operating model (TOM) development
(Note: Examples are Deloitte outside-in view)
Taking traditional retail banks such as cantonal banks as an example, the ability to create an emotional connection with customers is increasingly their main differentiator in the eyes of their retail customers. A focus towards Distribution Excellence and Trusted Advisor to secure a central role in the customer relationship is therefore a prime strategy. It is less about selling products and more about gaining the trust of clients to being the advisor of choice for resolving important financial issues. Figure 4 shows elements that a retail bank needs to establish in order to secure this central position. While providing advice is key, it needs to be complemented by compelling digital personalised experiences.
Figure 4. Three tectonic moves to transform retail banking
There are also examples where traditional banks have successfully focused on steps in the value chain that are less client-facing (e.g. GLKB Kreditfabrik). This shows that multiple operating model archetypes can succeed if done right.
The future needs to start now, with a clearly designed path to the target
The transformation to a desired target operating model does not happen overnight. It is a process that needs a step-by-step approach and a carefully crafted balance between small incremental changes and large radical transformations. A bank needs to optimise its current business while creating in parallel the foundations for more radical change, selecting relevant levers and pulling them at the right time. For example, a move to an advisory operating model can require sales enablement as well as ecosystem and platform development.
We have identified a selection of the most important levers to move towards the selected target operating model, ordered by complexity and execution time (see Figure 5). Over the course of this series of articles, we will look in detail at successful examples of how these levers can be applied in practice and demonstrate how the transformation to a new normal can be completed. As a starting point for the journey, bank executives need to ask themselves six elementary questions:
- Which strategic target operating model (TOM) archetype should we aim for to position us competitively in the market in the future?
- What do customers of that TOM archetype want and how should we improve our offering to grow our customer base?
- What cost structure do we need to aim for to be able to operate competitively?
- What technological elements should our TOM archetype have in-house and which should be bought-in along the value chain?
- Where in our value chain should we therefore work with competitors, FinTechs or technology companies?
- Which levers do we need to focus on to reach the TOM archetype effectively and efficiently?
Figure 5. Levers to achieve strategic ambition
- Previous A moving target: Refocusing risk and resilience amid continuing uncertainty
- Next What is the best governance structure for climate change risk?