Wednesday, 17 June 2015

This graph explains why banks need Digital Transformation

Digital Transformation is currently one of the hottest topics in Financial Services and there is no single day that financial newspapers do not dedicate an article on the topic although many of them still understand digital transformation as the transformation of channels.


BBVA Research has recently published this graphic that in my view explains why banks need to go through a complete digital transformation. Spanish banks ROE is below 10% when it used to be above it.  And this is not an isolated problem of the spanish banks. A recent KPMG study determined that among the top 50 banks in the U.S., only 28% had ROEs of 10% or greater (highest was 13.9%) in 2Q14. In contrast, in 2005, 84% of the banks had double digit ROEs (over 10% of the banks had ROEs greater than 20%). 

But the important fact here is that the average profitability will not return to the pre-crisis levels. The reasons are threefold: 

1)      Increasing costs on meeting new regulation

Actually, a recent study done by Oliver Wyman estimates that ~3% of total costs for North American, European and Australian Financial Institutions come from addressing regulatory demands.

2)      Need to meet new demands of digital, always connected customers.

To respond to this demand banks need to prepare in terms of capabilities and structure to be able to deliver digital experiences in a competitive cost and time to market. Easy to say, difficult to accomplish as normally banks structures are still those created in the pre-digital age.

3)      Raise of fintech, shadow banking, new players competition

A number of reports have highlighted the impact of new entrants on bank revenues. Early last year Accenture predicted that competition from digital players could erode as much as one-third of traditional retail bank revenues by 2020. Accenture analyzed the composition of revenues for major banks in Western Europe and studied seven areas of digital disruption (including consumer and SME peer-to-peer lending, alternative payments, low-cost checking alternatives).

In a publication in  January 2015, Mckinsey warned that incumbents only have a short period to adjust to the digital age reality or risk becoming obsolete. According to the consultancy company, Digital Innovation in banking offers potential rewards (of up to 45%) and losses (of up to 35%) of net profil in retail  banking. The potential threats would come from innovative new offers by competitors, margin compression and increased operational risk.

More recently, Golman Sach published a report titled The rise of the new Shadow Bank, in which the Bank estimate that $11bn (7%) of annual profit could be at risk from non-bank disintermediation over the next 5 years.

To respond to these new challenges there is no other way than Digital Transformation, of which pillars I wrote about last year. The alternative is not being running business in 5-10 years time.