Volume III – Summer 2013 reTAIl BANKING€¦ · reTAIl BANKING AmericAS DiGeST IN THIS ISSue 1....

Financial Services

Volume III – Summer 2013

reTAIl BANKING AmericAS DiGeST

IN THIS ISSue

1. SmAll buSineSS bAnkinG challenging conventional Wisdom to Achieve Outsize Growth and Profitability

2. FinAncinG SmAll buSineSSeS How “new-Form lending” Will reshape banks’ Small business Strategies

3. enHAnceD PerFOrmAnce mAnAGemenT Driving breakthrough Productivity in retail banking Operations

4. innOvATiOn in mOrTGAGe OPerATiOnS building a Scalable model

5. cHASe mercHAnT ServiceS How Will it Disrupt the card Payments balance of Power?

6. THe FuTure “Ar nu” What We can learn from Sweden About the Future of retail Distribution

banking is highly regulated, intensely competitive and provides products that, while omnipresent in consumers’ lives, are neither top-of-mind nor enticing to change. These factors drive the role and form of innovation the industry can capitalize on. in traditional business history – the realm of auto manufacturers, microchip makers, logistics companies and retailers – the literature rightly hails disruptive, game-changing innovation as the engine behind outsized profits for the first movers. in banking, such innovation is very rare.

Disruptive innovations of the magnitude of the smartphone or social networking grab headlines, but are hard to leverage in the banking industry. There are simply too many restrictions on what banks can do, and too much consumer path dependency, to place all the shareholders’ chips on disruptive innovation plays.

instead, successful banks develop and execute strategies around less “flashy”, dare we say, small-scale innovation that can still reap outsize returns for their shareholders. This issue of the Oliver Wyman retail and business banking Digest takes a closer look at some key innovation opportunities available to banks today, including:

• Paths to success in small business banking through new form lending and other challenges to conventional wisdoms

• Process redesign opportunities triggered by advances in mobile technology, as in mortgage, or through performance management techniques

• learning from innovation abroad

This eclectic list illustrates one of the greatest benefits to small-scale innovation – there is always room for incremental upside. each effort, executed effectively, will drive additional gains, while affording the flexibility to react to new opportunities. Additionally, such innovation can be a key move in the game of “strategic chess”, such as the recent chase/visa partnership announcement (explored in this digest), which their competitors must now respond to.

i hope you find these articles thought provoking.

Michael ZeltkevicOn behalf of the

retail and business banking Practice

foreword

TABle of coNTeNTS

1. SmAll buSineSS bAnkinG 4challenging conventional Wisdom to Achieve Outsize Growth and Profitability

The Sb segment has long presented a significant opportunity for uS banks. However, strategies that meet small business needs, create differentiation and maximize potential economic returns have proven elusive. While many banks have settled back into conventional strategies, challengers to these standards can define a break-out strategy that gains material share from competitors and delivers higher growth and higher profits.

2. FinAncinG SmAll buSineSSeS 11How “new-Form lending” Will reshape banks’ Small business Strategies

“new-form lending” is a new approach to small business financing that will satisfy an unmet need for short-term cashflow financing for Sbs. new-form lending relies on the analysis and ongoing monitoring of daily cashflows to assess and control risk. This is a major profit opportunity that can also help improve traditional loan underwriting processes by lowering unit costs and improving risk differentiation.

3. enHAnceD PerFOrmAnce mAnAGemenT 16 Driving breakthrough Productivity in retail banking Operations

Years of relentless focus by retail banks on improving the efficiency of the operations function have left few residual opportunities to drive transformational savings without diluting service quality. by developing a new way of measuring employee productivity and compensation, enhanced Performance management (ePm) fills this gap by dramatically increasing employee throughput, while simultaneously improving risk, quality and the client experience.

4. innOvATiOn in mOrTGAGe OPerATiOnS 21building a Scalable model

The last 20 years have seen a number of innovations in the design of mortgage origination processes. looking ahead, however, we see three factors converging that will now provide both the opportunity and the forcing mechanism for institutions once more to rethink their approach to mortgage originations, driving fundamental progress in the core operations of the business.

5. cHASe mercHAnT ServiceS 28 How Will it Disrupt the card Payments balance of Power?

in the current power play between issuers, networks, and acquirers, JPmorgan chase has taken a first step towards creating a new 3-party network with chase merchant Services. This paper explores how this will impact chase’s competitors and its customers (merchants and cardholders), as well as the networks themselves.

6. THe FuTure “Ar nu” 33What We can learn from Sweden About the Future of retail Distribution

With high mobile and internet banking adoption, low branch traffic and heavy use of electronic payments, Sweden and its banks provide invaluable insight into the future of retail banking. This article explores the factors that enabled Swedish banks to accelerate evolution and evaluates what one can learn about the future of uS retail distribution and how to enable a smooth transformation.

boasting a base of more than 20 mm potential customers1 with a broad range of financial services needs, the Small business segment has long presented a significant opportunity for uS banks. recent Oliver Wyman research and analysis2 suggest that the Sb sector produces $14 bn of after-tax profit and $10 bn of after-tax economic profit3, annually – nearly 15% of the total uS financial services economic profit pool.

1 ~20% of small businesses in the uS have at least one employee in addition to the owner. Source: 2007 census.

2 A 2011 survey of 5,000 small business owners, from which we estimated the profit to banks from these businesses’ product and service usage.

The sector is also resilient: in the face of recent economic turmoil and uncertainty, 73% of business owners told us that their firms were either “very” or “reasonably” profitable, while 75% described them as being in “established” or “growth” mode.

However, strategies that meet small business needs, create differentiation and maximize potential economic

3 “economic profit” is the profit after tax earned by the bank over-and-above the required rate of return on capital held against the risks of the business; it is worth noting that today, most of this profit comes from high-balance checking accounts and high-volume merchant services accounts – and not from small business loans.

1. SmAll buSineSS bAnkinGcHAllenGinG cOnvenTiOnAl WiSDOm TO AcHieve OuTSize GrOWTH AnD PrOFiTAbiliTYby Anna epshteyn Whitney and Tim Spence

exHibiT 1: SmAll buSineSSeS Are HeAvY uSerS OF FinAnciAl ServiceS

40%

100%

20%

60%

80%

PRODUCT USAGE RATE (EMPLOYER SMALL BUSINESSES)

An

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epos

it

Ch

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ng

Savi

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s

Mon

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HY

Sav

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An

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car

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Stor

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An

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an

Mor

tgag

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Equ

ipm

ent

loan

Op

erat

ion

allo

an

Au

to lo

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leas

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Oth

er lo

an

An

yp

aym

ents

Mer

chan

tsv

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Rem

ote

dep

osit

Pay

roll

AC

H

Wir

e

Deposits Cards* Loans Payments & Treasury Services

0%

* card consists of cards used solely for the business; 44% of Sbs are also merchants (accept cards)

Source: 2011 Oliver Wyman Small business banking survey

copyright © 2013 Oliver Wyman 4

returns have proven elusive. Following the financial crisis disruption, the market has largely settled back into competitive equilibrium, with many banks – and their advisors – allowing a set of conventional wisdoms to constrain their thinking as they craft their strategies. A bank willing to challenge these conventional wisdoms, Oliver Wyman believes, can define a break-out strategy that gains material share from competitors and delivers higher growth and higher profits.

What are the conventional wisdoms restricting banks’ strategic thinking? We see five:

1. SeGmenTATiOn: “The size of the business is the best indicator of needs, profit potential, and sales and service approach”

2. relATiOnSHiP cOverAGe: “Assigning relationship managers is an effective means to attract new businesses, deepen relationships and decrease attrition”

3. cHeckinG: “Offering ‘free checking’ is a table-stakes competitive requirement”

4. SmAll buSineSS lenDinG: “credit process streamlining is the key to improving profitability and expanding Sb lending”

5. neW revenueS: “expanding into new service areas is the best path to increasing fee revenue”

Oliver Wyman research and analysis suggest that some of these conventional wisdoms are wrong, and others only half-right. Worse, they disguise powerful new insights that banks can leverage to upgrade performance substantially. let us examine them one-by-one.

1. SeGmenTATiOn: iS revenue Size All We neeD?

conventional wisdom places a great deal of weight on business size. For example, most banks use it to dictate how they organize, what prospects they target, and what products and delivery models they employ. businesses that are larger, the rationale follows, will carry higher deposit balances, have greater credit appetites, and need more complex payments solutions, thus making them more profitable relationships.

Oliver Wyman research validates the notion that larger businesses are more likely to be profitable. However, it also reveals two interesting findings that averages disguise. Firstly, 20% of businesses (the high value group) generate 95% of total segment profit. more surprisingly, more than half of the high value group have annual revenues less than $1 mm.

exHibiT 2: PrOFiT cOnTribuTiOn OF SmAll buSineSS cuSTOmerS rAnkeD bY relATiOnSHiP PrOFiT

CONTRIBUTION TO TOTAL SB PROFIT

Top

10%

80th

per

cen

tile

70th

per

cen

tile

60th

per

cen

tile

50th

per

cen

tile

40th

per

cen

tile

30th

per

cen

tile

20th

per

cen

tile

10th

per

cen

tile

Bot

tom

10%

73%

21%

11%6% 3% 1%

-2%

-13%


exHibiT 3: AnnuAl revenueS OF THe mOST PrOFiTAble SmAll buSineSS relATiOnSHiPS

<$249 K6%

$1-2 MM29%

$250-500 K7%

$500 K-$1 MM14%

$5-10 MM14%

$2-5 MM30%

TOP 20% OF ALL SMALL BUSINESSESBY PROFIT CONTRIBUTION

Note: Payroll businesses only



These small, but high-value customers – who “fly under the radar” of purely revenue-based segmentation – present a significant untapped opportunity. banks that embrace a profit-centric view and develop the supporting analytics could re-focus their new customer acquisition efforts to target only the most profitable prospects. And, because the average profitability of the high-value group is 3-4 times the market average, these banks could spend much more on the sales process and account-opening offers to entice the high-value group to switch. Similarly, the profit-centric view could be employed to re-focus cross-selling and relationship retention efforts (fee waivers, priority service) within the existing customer base.

2. relATiOnSHiP cOverAGe: HOW DOeS iT ADD vAlue?

conventional wisdom dictates that banks should assign dedicated relationship managers to increase growth and profitability of their small business customer base. most banks deploy dedicated Sb bankers or specially-trained branch managers in high-opportunity trade areas in an attempt to achieve these gains, asking them to manage a “book” of 75-150 relationships. The logic is that these individuals can build industry and local-market expertise and provide the superior service necessary to attract, deepen and extend small business relationships.

Oliver Wyman research and analysis suggest the current model is not delivering. As illustrated below, while businesses with rms have slightly deeper relationships, the added breadth does not compensate the bank for the significant added expense. Further, customers with rms exhibit higher, not lower attrition rates.

There are several factors that may contribute to these unexpected outcomes:

• First, many banks expect branch management to provide Sb relationship management, but it receives low priority in the context of other responsibilities

• Second, some rms do not develop much of a relationship with business owners: in our survey roughly one in five Sbs with an assigned rm could not remember the rm’s name

• Third, we have found that even successful dedicated Sb bankers can lower the retention rate for Sbs, in this case due to their own turnover. Sb bankers change jobs more frequently than the “natural” rate of Sb attrition, and, in doing so, these bankers take their best relationships with them. Hence, high rm turnover actually accelerates Sb attrition

• Finally, rms are expensive; with a typical “loading” of 100 businesses, each rm will probably have only two or three hours a year of client “face-time” but must add at least $1,000 of pre-tax contribution per business just to cover his/her fully-loaded cost

exHibiT 4: beHAviOr AnD PrOFiTAbiliTY OF SbS WiTH AnD WiTHOuT rm cOverAGe

Doesn’t have a RM

Has a RM

CUSTOMERS WITH RMS MAINTAINSLIGHTLY DEEPER RELATIONSHIPS… …AND ARE MORE LIKELY TO SWITCH…BUT ARE LESS PROFITABLE…

1.9

1.6

Products with primary bank

$1,670

$1,450

Average post-tax economic profit*

3.7%

7.3%

SBS switching primary banks

* Payroll businesses only



To improve the returns from relationship management assignments, banks could:

• Assign local rms to high-profit accounts or prospects only; measure and compensate rm performance based on the incremental value they create

• redesign rm job responsibilities to focus on skills and activities that make a material difference to clients, eliminating fulfillment-related activities that could be handled less expensively and with lower opportunity cost in the back office; increase account loading accordingly

• experiment with a team-based or “virtual rm” model to serve less valuable or lower-opportunity small business clients

• invest in building stronger institutional ties with the business owner, to mitigate the risk that he/she would follow the rm to a different bank

3. SmAll buSineSS cHeckinG: TO Fee Or nOT TO Fee?

conventional wisdom holds that if even one bank in a given trade area offers free checking, all banks will be forced to follow suit. Although “totally free” has given

way to “easily free”4 for many institutions, the working assumption remains unchanged: attract the relationship with no monthly maintenance fee and generate revenue through upselling, cross-selling and/or item fees for activity in excess of the included transactions and/or cash deposits.

Our recent research and analysis suggest banks should not compete on price, regardless of what competitors choose to do. The connection between market share and revenue production is tenuous. As exhibit 6 shows, the majority of small business free checking relationships generate minimal revenue and a significant portion of those will be loss-making on a marginal cost basis.

Three factors explain why banks are generating so little revenue from such a significant percentage of the customer base:

1. in our experience, more than half of Sb free checking accounts will contain an average balance less than $5,000, providing limited interest margin

4 “easily free” connotes accounts whose fees are waived through simple, easy-to-qualify means that the vast majority of small businesses would meet. examples would include very low minimum balance requirements and waivers for opening one or two additional products where debit card, online statements and/or other no/low revenue options.

exHibiT 5: “DO YOu knOW THe nAme OF YOur relATiOnSHiP mAnAGer?” All SmAll buSineSSeS WiTH An ASSiGneD rm (uS$)

60%

100%

Under 250 K 250 K-499 K 500 K-999 K 1 MM-1.9 MM 2 MM-10 MM

0%

20%

40%

80%

Know first name

Do not knowfirst name

* Payroll businesses only



2. very few clients generate transaction – or cash deposit – based incidence fees. For most banks, 90-95% of small business clients will not exceed the established transaction caps, monthly, and less than 5% will order a wire or other fee-generating transaction

3. Despite ongoing efforts, most banks have yet to crack the code on cross-selling savings accounts, merchant services, cards and other products that generate real revenue streams

Additionally, checking does not need to be free to attract and retain customers. Our research suggests that small business owners spend very little time worrying about optimizing their financial services costs, and that the hassle associated with switching banks greatly outweighs the potential savings. in fact, more than 80% would stay with their current bank if a $10 fee was imposed on their account.

more importantly, small business owners will pay for value where they see it. Having tested dozens of potential account attributes, add-ons and service benefits, three areas emerge:

1. Simplicity and cost certainty: business owners prefer a single, bundled fee structure over more prevalent per-transaction pricing models. For example, the average business owner in our research would pay $8/month more to have unlimited transactions,

versus an account with 100 included transactions, despite the fact that more than 90% of businesses never exceed the 100 transaction limit

2. Working capital access and protection: Accelerated funds availability and small stand-by credit lines resonate very strongly. in fact, these register as the most powerful motivators of switching and carry incremental values of $5-15/month. check payment guarantees and fraud protection are also appealing

3. relationship benefits: The presence of relationship benefits, whether rewards programs, discounts on loans, savings interest rate bonuses and higher service levels (e.g., 24/7 phone support, dedicated business banker) all are accorded quantifiable values. interestingly, business owners appear to consider the presence of these benefits to be more important than the actual economic value conveyed

banks can capitalize on these insights by redesigning their core small business checking offerings, building each product around the preferences of distinct sub-segments and pricing for the value they deliver. Some may also choose to convert a subset or all of their existing free checking portfolios as a means to generating an immediate revenue lift. While this approach may result in more modest account acquisition and retention rates, it will materially improve the overall economics of the business and increase the focus on more valuable relationships.

exHibiT 6: SmAll buSineSS cHeckinG revenue cOncenTrATiOn

20%

40%

60%

1-24 50-99 250-499 >1,000

SB REVENUE CONTRIBUTION (US$)

SB CUSTOMERS

25-49 100-249 500-999

0%

Over 60% of small businesschecking accounts generate

<$25 in revenue

80%

<1

Bank 2example

Bank 1example

Source: Oliver Wyman analysis


4. lOAnS: A neW PrOceSS Or A DiFFerenT neeD?

Small business owners have long considered access to working capital their most important unmet need. in fact, in recent Oliver Wyman research, 70-80% of small business owners indicated it to be an important consideration in selecting a bank. And yet, while many have small business credit cards, auto loans or first mortgages, only 15% have an open operational loan or equipment loan/lease.

conventional wisdom dictates that if banks make the credit process less painful – whether by streamlining the application process, requesting less information, or making faster decisions – more small businesses will respond, increasing origination volumes and, by extension, profits.

Our research and experience suggest otherwise – that most Sb owners who value access to credit need something other than a traditional credit line or term-loan. rather, they describe a substantially smaller facility designed to address short-term gaps in cash flow (in effect, a payables-receivables duration mismatch), generally in the amount of half- to one-month’s revenues.

under the traditional credit process, even performing loans originated to address this need would fail to produce an accounting profit. To illustrate the point, consider a request for a $75,000 one-year term loan. Assuming a 3% interest margin over funding cost, such a loan would produce ~$1,225 in revenue over its term. The all-in origination cost per funded loan ranges from $900 to $1,800 for most banks, alone, without taking into account sales force compensation, credit risk and capital consumption costs. clearly, even a streamlined credit process isn’t a solution.

instead, banks should create an entirely new small business working capital loan product category, akin to (but not entirely the same as) offerings pioneered over the past 5-7 years by firms like capital Access network, OnDeck capital and Amerimerchant. This new product would be distinct in three ways:

1. Origination: The new loan would be sold to existing customers, primarily via a web-based interface, using existing data from other bank accounts or which could be sourced electronically from third parties and underwritten primarily on an automated basis, with limited manual intervention

2. underwriting: The bank would utilize direct observation of real, recent cash-flows from the business checking or merchant services account to predict future cash flows and, by extension, to determine the ability of a firm to take on credit

3. repayment: Payments would be remitted in small increments via an automated, daily remittance cycle, as a means of identifying at-risk loans more quickly and smoothing cash flow impact of the new loan on the business

Oliver Wyman research suggests this new category could produce billions in new outstandings and pre-tax profits. Seeing this potential, American express and Amazon.com have recently entered the market by making a portion of expected future receipts – Amex card receivables and Amazon marketplace sales volumes, respectively – available to their merchants in the form of an advance. However, banks should possess an advantage over both, due to insight afforded to them as holders of the primary checking account, thus enabling them to see the full breadth of a small business’s cash flows as opposed to just one slice.

exHibiT 7: Size OF creDiT line Sbs WOulD like TO be APPrOveD FOr

SBs INTERESTED IN CREDIT WITH ANNUAL REVENUESBETWEEN $100 K AND $5 MM

$5 K andbelow21%

$10-25 K20%

$5-10 K21%

Over 50 K20%

$25-50 K18%

Source: Oliver Wyman Small business lending Survey, march 2013


5. neW revenueS: neW OFFerinGS Or neW PAckAGinG?

in the face of the declining profitability of core product categories, generating new revenue streams has become a top priority for the banking industry. To this end, some banks have even begun to explore opportunities to expand the scope of services they provide to small businesses into other professional services areas, including aggregated procurement discounts, marketing services, business transfer services and employee health benefits administration. While one or more of these may emerge as a new, previously untapped wellspring, Oliver Wyman research suggests that more immediate (and much more certain) returns are available via a renewed focus on the fee-based payables and receivables services that most banks already offer.

remote deposit capture provides a useful case example. it meets a clear need for a significant share of small businesses – check payments make up 50-70% of receivables in non-retail sectors – and yet fewer than one in four Sbs make use of it. The issues are two-fold:

• Awareness remains low. A recent survey of small business customers at the ten largest banks showed that, depending on the institution, 35-75% of clients erroneously believed rDc was not offered by their bank

• Product configuration and pricing depress adoption. banks who exhibit the lowest penetration rates tend merely to have repurposed their commercial rDc product structures to Sb customers, as opposed to tailoring specific offerings that reflect their needs and business characteristics

Payroll, e-invoicing and electronic payments – all of which provide rich fee income streams – all face similar challenges. Targeted marketing campaigns, and refreshed product/pricing plans would help in each case, but banks should also develop service packages that incorporate the right mix of these services with the checking account. Our experience suggests more than 40% of new customers would opt for a correctly designed package over a stand-alone checking account, without any incremental incentive.

* * * * *

Small business remains a big opportunity for uS retail banks. However, as competition continues to increase for the best relationships within the segment, those who abide by conventional wisdom will achieve suboptimal returns. Those who challenge it will enjoy outsize growth and profitability.

Anna Epshteyn Whitney is a Senior manager at Oliver Wyman.

Tim Spence is a Partner at Oliver Wyman.

exHibiT 8: DOeS YOur PrimArY bAnk OFFer remOTe DePOSiT cAPTure cAPAbiliTY?

Yes

No

40%

RESPONDENTS FOR SELECT BANKS

Bank 1 Bank 2 Bank 3 Bank 4 Bank 5 Bank 6 Bank 7 Bank 8 Bank 9 Bank 10 <$2 MM $2 MM+

60%

20%

80%

Annual revenue

0%

100%



A new approach to small business lending is emerging in uS banking. We refer to this new approach as “new-form lending”. it is based on a simple but powerful insight: the data in a small business’s checking account can be a strong real-time indicator of that business’s creditworthiness.

We believe that this new approach will rapidly be adopted by all major uS banks and become the basis for satisfying what has mostly been an unmet need for short-term cashflow financing for small businesses. industry-wide, this could be a $2 bn profit opportunity for lenders.

new-form lending will also help improve banks’ traditional loan underwriting processes by lowering unit costs and improving risk differentiation.

Finally, new-form lending, by improving the whole approach to Sb lending, will strengthen banks’ overall value proposition, allowing them to win and retain the most attractive small business relationships.

WHAT reSeArcH TellS uS AbOuT Sb bOrrOWinG neeDS

Oliver Wyman research reveals many interesting characteristics of small businesses and their owners1. One particularly important finding relates to small business funding: while many say they have Sb credit

1 in 2011 Oliver Wyman surveyed ~5,000 Sbs including their profitability to banks; Sbs were defined as “in business at least a year” and “have fewer than 100 employees”; please contact us to obtain a summary.

cards, car loans or first mortgages, only 15% report having an “operating loan” or “an equipment loan or lease”. That is: small businesses don’t actually have many “small business loans”.

Our research also reveals something else that’s curious: although only ~15% of Sbs have a “small business loan”, 70-80% of business owners say that “access to credit” is an important consideration to them when selecting a bank. The majority of these owners seem not to want a traditional credit line or term loan. rather, they describe the need for a line of credit that would be available to act as a reserve and buffer against occasional short-term cashflow gaps. We have asked respondents to say roughly how large such a line would need to be. in most cases, their answers translate into an amount equal to between half and one month’s revenues. For example, businesses with annual revenues of around $500,000 tended to ask for credit lines of between $20,000 and $40,000.

This is consistent with other Oliver Wyman research findings that show how a small business’s average DDA balance is a reflection of the cashflow and cashflow volatility that the business experiences. if two businesses have the same monthly average cashflow but one experiences more volatility, the second one will maintain a higher average DDA balance as protection against coming up short when needing, for example, to meet payroll. Dealing with cashflow volatility is a perpetual worry for small business owners and in the absence of a standby line of credit, they currently resort

2. FinAncinG SmAll buSineSSeSHOW “neW-FOrm lenDinG” Will reSHAPe bAnkS’ SmAll buSineSS STrATeGieSby Peter carroll and ben Hoffman


to various tricks and evasions when faced with a payroll to meet or a large bill to pay, and a downtick in receipts. banks have been missing the opportunity to meet this need for cashflow volatility protection.

The research suggests that most business owners feel a need for a cashflow protection product driven by the inherent volatility of their businesses’ cashflows.

TrADiTiOnAl Sb lenDinG DOeSn’T Serve THiS neeD Well

The traditional small business lending model used by banks does not meet this particular need very well. We have known for some years now that banks’ small business loan portfolios are not particularly profitable. The banking industry’s use of economic capital and risk-based measures of return led to the realization that small business loan portfolios typically show positive accounting profits but negative economic profits “through the cycle”. Further analysis revealed the root cause of the profitability problem: the factors that drive Sb loan economics are unit cost, cost of funds, loan losses, economic capital, and loan pricing (gross yield). Among these, unit cost is undoubtedly the main culprit. High capital and inadequate loan pricing also contribute.

Faced with these economics, banks have experimented over the last 10 or more years with approaches to small business lending that are more “consumer-like”. These semi-automated methods, using credit scores on the business or its owner – or both – as key inputs, promised to reduce those troublesome unit costs but largely did not. Why? Partly because banks deployed automated underwriting only for the easy cases (very good and very bad applicants) and kept the traditional process in place for applicants in the so-called “grey area”. in the end, relatively few loan applications ended up being decided only via the “automated” path; and so unit costs didn’t shrink as much as planned. even the use of credit scores proved troublesome, in part because the available data on small businesses are simply not as robust and predictive as in the consumer sphere.

in fact, data quality has been a perennial problem for banks when it comes to small businesses. The traditional underwriting process for small business loans frequently calls for the business owner to provide the bank with at least two years of audited or unaudited financial

statements, and/or 2-3 years of tax returns. either way, these data are essentially out of date by the time the bank reviews them – and may not have been that accurate to begin with.

neW-FOrm lenDinG TO THe reScue?

We see a new approach to small business lending emerging in uS banking that we refer to as “new-form lending”. it is based on the simple but powerful insight that the data describing a business’s cashflows can be a strong real-time indicator of that business’s creditworthiness. One source of data on a small business’s cashflows can be its merchant services account (if the business accepts credit cards for payment). Another source is the business’s primary checking account (whether the business is, or is not, a merchant).

We believe this new approach will rapidly be adopted by all major uS banks and become the basis for meeting the hitherto unmet need for short-term cashflow financing described briefly above. it will also provide a key underwriting input to banks’ traditional loan underwriting processes and thereby help to lower unit cost and improve risk differentiation (and hence pricing).

The idea of examining a small business’s near-real-time cashflows to derive risk insights seems to have originated in the world of merchant receivables financing. Starting 10-15 years ago, firms like capital Access network and Amerimerchant emerged to advance funds to card-accepting merchants based on an analysis of the patterns in their monthly charge volumes. extending that logic, firms like On Deck capital now use a combination of merchant-account and/or DDA cashflow patterns to assess a business’s creditworthiness. The wider view is rapidly becoming the standard template for “new-form lending” and makes this approach work for both merchants and non-merchants.

As the merchant receivables financing market evolved, lenders needed new analytical methods to automate the interpretation of recent cashflow patterns and make predictions about future receipts. in recent years, lenders have expanded their models to incorporate DDA cashflow patterns in addition to – or instead of – the merchant account in order to assess a business’s creditworthiness. This wider view takes a more complete


cashflow picture than merchant receipts alone and more-than-doubles the total market by making financing available for both merchants and non-merchants.

The central premise underpinning this approach is that direct observation of real, recent cashflows provides a reliable guide to predict future cash flows – at least in the near term – and, by extension, to determine the ability of a firm to take on credit.

A second innovation of new-form lending is the use of a daily remittance cycle to administer the loans. A key early feature of this type of financing was the idea that advances would be repaid directly from the merchant services account. This led to the deployment of daily remittance platforms that could connect directly to a merchant services account (or, later, to a DDA account), and process small loan principal and interest payments on a daily, as opposed to the more traditional monthly, basis.

in a daily remittance cycle, the borrower accepts a commitment to repay interest and a slice of principal in small increments each day over the term of the loan, rather than the standard monthly remittance cycle of

almost all other bank lending. The daily remittance cycle offers two benefits. First, by monitoring the advances and payments on a daily cycle, the lender is more on top of things and in a better position to respond to late payments – as well as to adjust and potentially increase or decrease the loan or line size. This makes intuitive sense: if a lender is reviewing monthly, weekly and daily cashflows as a basis from which to infer creditworthiness, i.e., to underwrite a loan, then he would also administer the loan on a daily remittance cycle.

Second, compared with monthly remittance, the use of a daily remittance model helps smooth the cash flow impact of the new loan for the Sb; after all, monthly remittance introduces yet another source of cashflow “lumpiness” – and cashflow volatility was the issue the business owner needed the loan to address in the first place.

recognizing the market opportunity, over the last year, several other lenders have taken innovative steps in this new financing arena. Amex launched American express merchant Financing, a commercial lending option for medium-to-large merchants who accept Amex cards

exHibiT 1: THe relATiOnSHiP beTWeen bAnk, SmAll buSineSS, mercHAnT Acquirer AnD inDePenDenT neW-FOrm lenDer

Non-card sales receipts(checks, wires, cash etc.)

Credit, debit and charge card receipts

Loan advances

Daily loan repayments, fees and interest(for merchant cash advances)

Daily loan repayments, fees and interest(for new-form bank loans)

Deposit the rest of amount after repayment

SMALL BUSINESS

PRIMARY BANK(with DDA)

BANK

MERCHANT ACQUIRER/MERCHANT SERVICE BANK

“NEW-FORM LENDER”

1

2a

3a

3c

2b

3b


that, in effect, provides receivables financing. Amazon also introduced a financing option for merchants who sell over its web platform; and Amazon has excellent risk analytics that it can deploy against these merchants, observing first-hand the ebb and flow of purchase volume and merchant conduct.

Despite the origins of new-form lending as a merchant financing device, and despite recent innovations that extend the device within the merchant space, we believe that banks, with their extensive small business deposit bases, have a significant information and relationship advantage in this interesting new arena. Whereas Amex, Amazon and other merchant receivables financing firms see only the component of cash flow which flows over their platform, the primary checking bank sees essentially all sales receipts as well as all outgoing payments. banks, in other words, have a more complete perspective and are not limited to the merchant segment (a little less than half of all Sbs accept cards). They also already “own” all of the primary DDA relationships with Sbs.

GeTTinG STArTeD WiTH neW-FOrm lenDinG

How can banks interpret their Sb customers’ daily cashflow data to assess credit-worthiness? Our recent client experience suggests that various metrics derived from 4-6 months of checking account and payments activity prove to be a reliable guide to a firm’s ability to handle a given loan amount. What kind of metrics? Things like: daily average balance, balance volatility, cashflow volume (in relation to average balance), cashflow “lumpiness”, mean and variance of daily receipts, mean and variance of daily outgoing payments, the “decay rate” of balance after a large deposit, and customer mix/revenue concentration. Of course, while these metrics may apply to some degree in any Sb sector, their significance varies according to the specific industry in which the firm operates; the metrics that matter most are different for a restaurant than for a manufacturer.

As with other types of lending, the ability to generate the most accurate and reliable models is partly a function of expertise but also a function of data. Only after accumulating some “bad” outcomes can one develop significantly better predictive models. This is a factor that gives a temporary competitive advantage to the larger, more experienced players in new-form lending.

new-form lending can be a profitable new financing product that banks can offer their Sb customers and drive significant improvements in banks’ traditional lending processes and associated economics. it can:

PrOviDe buSineSS OWnerS WiTH AcceSS TO A neW kinD OF SHOrT-Term creDiT THeY SAY THeY WAnT

new-form lending can allow the bank that provides a business with its primary DDA to pre-approve it for a standby line of credit suitable for covering episodic and short-term cashflow balancing. The amount of such a line or loan could be dynamically adjusted to growth or other changes in the business’s financial status, as continuously revealed through the “pulse” of its DDA cash balances and cashflows. The cost of marketing, underwriting and administering this new product category can be a very small fraction of the current costs of a traditional line of credit.

Despite the much lower unit costs, banks will need to design this product carefully as it will, by its nature, generate limited volumes of revolving balances and spreads. For example, if a business with revenues of $500,000 and a line size of $20,000 took advantage of it every single month for an average of two weeks, then it would generate the equivalent of a standing $10,000 loan. in practice, some businesses might take advantage of the line even less than this.

A key part of the product design, therefore, is to get the fee and rate structures right, with a line commitment fee, as well as possible draw-down fees, in addition to any interest on outstanding balances. Of course, if possible, the design also needs to avoid a countervailing sense of “nickel-and-diming” the customer.


We estimate the uS market for this type of standby line-of-credit very roughly as follows:

Potential number of standby lines ~8 mm

Potential “equivalent” revolving balances $80-120 bn

Potential additional after-tax profit $1.5-2.5 bn2

imPrOve THe ecOnOmicS OF TrADiTiOnAl lenDinG

The two central principles of new-form lending – the use of near-real-time, accurate cashflow data, and daily remittance – can also be used to improve traditional lending procedures. All three of the key cost components flagged earlier as problem areas for traditional lending can be improved by adopting (and adapting) these principles in the way traditional lines & loans are handled.

The marketing cost of attracting qualified loan applicants will be significantly reduced through the likely mechanism whereby many small business customers will be pre-approved for a “new-form loan” and later “upgraded” when they qualify for a more traditional line that does not need to be “cleaned up” on a monthly basis. And from there, successful, growing businesses may further qualify for multi-year term loans.

The cost of underwriting and approval for traditional lines and loans, even when the target Sb has not been a bank customer before, should be significantly reduced. using recent merchant account and/or DDA data, a bank can generate a more accurate assessment of creditworthiness than it could the old-fashioned way, and get to this point much quicker and more cheaply. Of course, the underwriting process will likely use additional inputs besides the new-form lending emphasis on recent DDA cashflow patterns. but for smaller lines or loans, an adequate assessment of risk can be made at low cost, through a combination of new-form principles and selected use of traditional credit scores and tax returns.

The cost of loan administration can also be reduced by placing traditional lines on a daily remittance basis and adopting new-form lending’s more systemic approach to portfolio monitoring and early warning delinquency triggers.

2 This represents an increase in total bank profits from small businesses of approximately 15-25%.

WHere DO i GeT A DAilY remiTTAnce PlATFOrm?

Getting started in new-form lending has some practical challenges for banks. One of the biggest is that banks do not have daily remittance loan systems, with relatively few options for obtaining one. One option would be to create such a system from scratch, but we see few banks with the appetite for this. instead, some banks have opted to negotiate an arrangement with one of the handful of firms that does have a viable daily remittance platform. This allows them to get started on the other challenges. These arrangements have typically also allowed for a way to share Sb applicants between the bank and the platform provider; since these firms are also lenders, the banks often approve and book loans to the higher credit quality applicants while their turndowns are re-underwritten by the independent firm.

THe brOADer imPAcT OF neW-FOrm lenDinG

We have already outlined two important ways in which new-form lending will improve bank lending to small businesses. but more lending options with better economics could turn out to be only part of the overall impact of new-form lending.

recent Oliver Wyman research determined that the majority of Small business banking profit currently derives from high-balance checking accounts, merchant services accounts and credit cards3. The growth of new-form lending will certainly add to that profit pool. The biggest positive impact of new-form lending for an individual bank, however, may not be the profit that it adds directly, but the role it can play in crafting a winning value proposition that is used to “win over” high-value prospects in the sales process and protect existing high-value customer relationships against competitive inroads.

Peter Carroll is a Partner at Oliver Wyman.

Ben Hoffman is a Partner at Oliver Wyman.

3 See the Oliver Wyman “Point of view” titled “A Profit Growth Strategy for Small Business Banking”.


inTrODucTiOn

retail banking operations covers a myriad of activities including onboarding clients, decisioning credit, fulfilling loans and processing transactions among others. Given its increasing scale and scope, the operations function has been relentlessly targeted for efficiency improvements. Amongst others, transformational levers such as centralization, automation, process reengineering, outsourcing and offshoring have been used to improve the efficiency and effectiveness of operations. As a result of such intense and sustained industry scrutiny, there remain few residual opportunities to drive transformational savings in operations without diluting service quality.

Oliver Wyman research indicates that one such breakthrough opportunity does still exist. The central theme is that of latent productivity. Our studies indicate significant variability in performance across comparable individuals in operations functions. This variability is often masked and propagated by the lack of transparency of results at the individual and team level, and weak alignment between performance and pay. To address this inefficiency, Oliver Wyman has developed a solution framework called enhanced Performance management (ePm), which improves the way institutions manage and pay for productivity. ePm improves productivity by objectively measuring organizational value-add, setting measurable targets for individuals and teams based on opportunity to perform, and explicitly aligning variable compensation

to performance. The impact of applying this approach is significant, typically around 20% productivity improvement1. importantly, this improvement can be driven rapidly and with few technology dependencies.

THe cASe FOr cHAnGe

retail banks are increasingly looking for “intelligent” cost reduction – methods to trim costs while maintaining or improving service quality and revenues. ePm fits this mold, given its ability to enable doing “more with less”. banks have traditionally focused ePm-like improvements on sales functions given the potential for significant revenue lift. conversely, manufacturing companies have traditionally focused similar performance management improvements on operations functions given the productivity and quality benefits. We have found that the principles that have worked in both of these situations can be combined to improve operations productivity in the banking industry.

moreover, the timing is right for banks to deploy ePm in operations. First, retail banking profit margins are under continued pressure, creating the right impetus for change. banks are increasingly looking for opportunities to structurally reduce and variabilize the cost base. Second, the culture within operations functions has seen a shift. Operations has traditionally been viewed as a back-office, transaction-oriented function. However, with operations playing an increasingly

1 After normalizing for other factors.

3. enHAnceD PerFOrmAnce mAnAGemenTDrivinG breAkTHrOuGH PrODucTiviTY in reTAil bAnkinG OPerATiOnSby Amit bhandari and kenan rodrigues


important and visible role in improving the client experience, the culture within the function has become increasingly open to change. Third, the systems and data environment within banks has matured enough to enable the granular level of performance measurement required for ePm to work effectively. Additionally, technology like workflow and imaging enables dynamic capacity management with work intelligently routed based on skill alignment and available capacity. Together, these conditions create an environment in which ePm can successfully deliver the direct cost and quality benefits the operations function strives for.

THe OPPOrTuniTY

The core issue with most performance management systems in operations is that they try to do too much. Take the example of a leading north American bank (see exhibit 1).

This bank used a balanced scorecard approach to measure employee performance in operations. The illustrated example for a transactional function had three categories of performance – productivity, client experience and risk balance, with weights of 60%, 30% and 10% respectively. “Productivity” comprised both qualitative and quantitative criteria, with the latter including more than 10 kPis, some overlapping and beyond the direct control of the individual. The “client experience” and “risk balance” criteria were highly subjective with no clear linkage to measurable goals. These measures were then somehow aggregated to come up with an overall performance rating at the end of the year, which drove 70% of variable compensation. The remaining 30% was driven by business unit and bank performance. Given this complex measurement model, the relationship between an individual’s

incentive payout and their real “value-added” contribution (which we will define shortly) was nearly non-existent (see exhibit 2).

managers were only using two or three of the available five performance bands. There was hesitance to use the highest and lowest performance bands, thereby implying that all individuals were performing at an average level. everyone in the middle bands received a similar annual incentive, keeping the average employee happy but not rewarding outstanding employees for their performance nor providing non-performing employees motivation to improve. employees with very different productivity levels got the same reward and, perhaps most importantly, the capped incentive structure did not encourage superior performance.

THe cHAnGe

Oliver Wyman architected an “enhanced Performance management” solution to transform the way performance was measured and rewarded at this organization. enhancing the performance management model started with a change to the way performance was measured. For each major functional area within

exHibiT 1: PerFOrmAnce meASuremenT mODel

Risk balance3 criteria

Client experience4 criteria

ProductivityMultiple criteria

>10 KPIs

60% 30% 10%

exHibiT 2: PerFOrmAnce PAYOuT mODel

2,000

8,000

6,000

4,000

200 400 600 800 1,0000

AVERAGE CREDITS PER DAY

0

10,000

ANNUAL INCENTIVE ($)

OPERATIONS AGENTS INCENTIVE VS. PRODUCTIVITY

Same reward acrosswide range of productivity

Different reward forsame level of productivity



operations, all value-added activities were identified and weighted based on relative effort or value. As an example, within a transactional group focused on loan fulfillment, a “credit grid” was designed depicting each value-added activity performed by the group and the credits associated with each activity (see top half of exhibit 3) based on relative effort. in this case, “processed applications” is assigned a value of 30 credits while “reviewed applications” is assigned 10 credits since the former activity takes about three times as long as the latter. importantly, errors are also on the grid and are assigned negative credits. This ensures that due attention is paid to service quality in a model that motivates faster throughput. At the end of each measurement period, an individual’s credits are summed and then compared to a pre-decided hurdle for that same measurement period (see lower half of exhibit 3).

The difference between credits accumulated by an individual and the hurdle become the “value-added” credits, which are then converted into an incentive payout using a fixed, pre-assigned dollar value per credit. For example, let’s say employee A worked 8 hours in a day, has a hurdle of 500 credits and achieved 750 credits. employee A earns 250 value-added credits which are converted into an incentive payout at say 10 cents per credit, which translates into $25 in earned incentive for that day. employee b may be on a part-time

schedule and therefore worked only 4 hours, so their hurdle is halved to 250 credits.

This improved performance measurement model ensures that individuals focus on value-added tasks, that they work harder and smarter to achieve their hurdle and that there is a direct relationship between productivity and incentive payout (see exhibit 4). individuals who do not meet their hurdle get no incentive, while there is significant upside for the best performers. most importantly, such a reward model does not cost an organization anything incremental for a given amount of work performed. rather, incentive dollars are distributed differently to align with individual performance.

To ensure that ePm focuses on team performance adequately, the ePm payout model includes a team component, which is measured by aggregating the value-added credits earned by all members on a team. For individuals, a small portion of their overall incentive (say 20%) is driven by the team component. For team leaders, a significant portion of their overall incentive (say 80%) is driven by the team component with the rest driven by higher-order goals, e.g., performance of the entire department or function. This team component ensures that individuals are motivated to collaborate with their peers and team leaders are rewarded based on the aggregate performance of their teams.

exHibiT 3: enHAnceD PerFOrmAnce meASuremenT mODel

AcTiviTY creDiTS Per uniT

Processed application 30

reviewed application 10

edited application 20

Serviced dealer call 10

errors -30

Individual

CREDITS HURDLE PERFORMANCE

Singlehurdle

Value-addedcredits

Pay-out

exHibiT 4: enHAnceD PerFOrmAnce PAYOuT mODel

2,000

8,000

6,000

4,000

200 400 600 800 1,0000

AVERAGE CREDITS PER DAY

0

10,000

ANNUAL INCENTIVE ($)

OPERATIONS AGENTS INCENTIVE VS. PRODUCTIVITY

No incentive if hurdle isnot met

Significant upside for high performers



The example just described is for a transactional function in operations, where throughput is the key measure of productivity, subject to a certain minimum quality standard. Oliver Wyman has developed ePm models for risk-based, call-based and expert-based operations functions (see exhibit 5), each varying slightly to emphasize the performance management dimensions most critical for that particular function.

As an example, risk-based operations like adjudication or fraud emphasize risk as the foremost performance management dimension, with quality, client experience and throughput being additional but secondary elements. Similarly, call-based operations such as inbound contact centers focus primarily on the client experience and throughput, the idea being that performance for individuals in these functions should focus on ensuring a positive client experience on every call while maximizing the number of calls handled. expert services include head-office functions or more knowledge-based activities like business architecture or program management. The ePm model for expert services is not as formulaic as the other categories given the broad and unpredictable nature of the underlying activities. ePm tries to strip out subjectivity and behavioral elements and instead, focus on measurable and controllable outcomes.

THe imPAcTThe impact from transitioning to an ePm model is significant. We have observed productivity improvement

of 20+% in pilot groups across transactional, risk and call-based operations within 6 to 12 months of implementing ePm. The jump in productivity is driven by a combination of two factors. First, ePm enables improved visibility and understanding of performance by measuring true organizational value-add. Second, ePm ties compensation directly to performance, thereby creating the right motivation for team leaders and individuals to improve their productivity. Additionally, we have observed that ePm-driven productivity lift is consistently accompanied by a parallel improvement in quality, with the best performers typically making fewer errors than before. Team management also improves, with team leaders becoming more engaged with their team and using value-added credits as an objective way of discussing individual performance while highlighting opportunities for improvement based on learning from the best.

The team component of ePm also creates the right incentives for team managers to keep the capacity of their teams aligned with volumes. Situations of over or under-capacity compromise the opportunity to earn value-added credits. This creates the right “tension” in the system for team managers to make the appropriate capacity management decisions keeping in mind the overall productivity of the team and the available or expected volumes.

more broadly, ePm also serves as the foundation for other structural improvements. For example, the productivity lift observed within the bank via ePm can be extended to outsourcing firms that provide

exHibiT 5: ePm FrAmeWOrk bY AcTiviTY

TRANSACTIONALPROCESSES

RISK-BASEDOPERATIONS

CALL-BASEDOPERATIONS EXPERT SERVICES

Definition

Throughput

Quality

Risk

Client experience

E�ciencyfocused

E�ectivenessfocused

Mix of e�ciencyand e�ectiveness

Relative focus of dimension is low Relative focus of dimension is high

Highly codified, repeatable, predictable, controllable processes

Repeatable processes, however, risk judgmentrequired which impactspredictability

Client facing phone-based activities that aresomewhat routine basedbut need to be flexed based on client situation

Ad-hoc services which are outcome oriented and less routine, limiting the predict-ability and controllabilityat the unit level

Perf

orm

ance

m

anag

emen

t dim

ensi

on


operations services. banks can push third parties to conform to the same productivity standards as in-house operations functions and can also variabilize their third party spend by paying on a per transaction basis, based on ePm-generated productivity standards, instead of a per person basis. Additionally, ePm serves as the driving force to re-think and streamline the organization structure in operations. by deploying a consistent performance management model across each activity bucket, ePm enables resource sharing and organizational synergies, pushing banks in the direction of organizing “like” functions together.

imPlemenTATiOn

implementing ePm is an eight to twelve month journey for most banks. Assuming an operations headcount of a few thousand employees spread across multiple locations and sub-functions, the best way to initiate an ePm program is to develop a foundation (i.e., current state assessment) while concurrently designing pilots to test ePm in a few functions (see exhibit 6).

The foundation helps create a compelling case for change by demonstrating the variance in performance across comparable individuals and highlighting the overall misalignment between productivity and pay.

Pilot design focuses on developing an ePm model in a few functions or sub-functions that are relatively high on the maturity curve, i.e., their leaders welcome the change and the basic foundational data exists to quickly

enable a transition to ePm. Once pilots are designed and underway, the positive results from pilots typically build the momentum required for ePm to be implemented across the organization. The program expansion phase can be realized fairly quickly as long as the program is resourced appropriately. Of course, the entire journey of ePm needs to be enabled by strong governance and top-down steer from executives, which helps critically with change management.

importantly, ePm can be implemented with little to no technology change. The key information requirement for ePm is tracking of individual and team performance, which typically leverages existing performance management systems and reports.

cOncluSiOn

Operations continues to be scrutinized for cost and service improvement opportunities, however few residual opportunities remain. ePm fills this gap by dramatically increasing employee throughput, while simultaneously improving risk, quality and the client experience. Organizations that have embraced ePm have witnessed a 20+% improvement in employee productivity. most importantly, these benefits have been realized rapidly given that for most organizations, ePm has few dependencies on new technology.

Amit Bhandari is a Partner at Oliver Wyman.

Kenan Rodrigues is a Partner at Oliver Wyman.

exHibiT 6: imPlemenTATiOn APPrOAcH

Governance and executive steer

2-3 months 2-3 months 4-6 months

Foundation

Program expansion

Pilot design

Operational readiness/communication Pilot implementation

PHASE 1 DEVELOP FOUNDATION AND DESIGN

PHASE 2DEPLOY PILOTS

PHASE 3EXPAND AND MATURE


inTrODucTiOn

Taking the long view over the past 20 years, the mortgage industry has made tremendous advances in operations and technology, raising the bar considerably from its highly manual starting point in what nonetheless continues to be a people-led, paper-intensive business. more recently, however, the industry has been hit by a double distraction that has caused progress to stall: swamped by the after-effects of the “great recession” (in the form of persistently elevated foreclosure volumes and a barrage of recent regulatory changes) and struggling to keep pace with continued high volumes of refinance applications. These two bodies of work have consumed the bulk of both managerial and workforce capacity across the industry and have made it largely prohibitive to pursue any significant fundamental operational enhancements over the past few years. looking ahead, however, we see three factors converging that will now provide both the opportunity and the forcing mechanism for institutions once more to rethink their approach to mortgage originations, driving fundamental progress in the core operations of the business. This paper explores both why we believe these factors have set the stage for a new period of innovation in mortgage origination and what we see as three key themes of the coming redesign.

SeTTinG THe STAGe FOr A neW PeriOD OF innOvATiOn

The last 20 years have seen a number of innovations in the design of mortgage origination processes. The

most prominent of these – automated underwriting (e.g., Fannie mae’s Desktop underwriter®), barcoding/ indexing electronic documents, e-signatures, automated valuation models, miSmO standards – have resulted in significant improvements to both customer experience and operations productivity.

but realizing these types of advancements is incredibly complex and resource intensive. Since 2004, the industry has been in a continual state of flux – first with the housing bubble, then with its after-effects, stricter underwriting standards, a fast-changing regulatory landscape and historically low interest rates. in this environment, most lenders have focused on survival more than on innovation. However, a confluence of three factors is now providing the right environment for lenders to reinvest in innovation and improvement.

1. THe recenT DiSTrAcTiOnS OF elevATeD FOreclOSureS AnD PerSiSTenTlY HiGH reFinAnce vOlumeS Will SubSiDe

The combination of a surge in non-performing loans and a prolonged refinancing boom has kept the industry working flat-out over the last five years. The latest forecasts from mbAA, the imF and the GSes, however, all point to a decline in refinancing volume of as much as 70% in the next two years. This decline in industry activity levels is part of the inherent cyclicality of the business. As such, we expect most management teams to recognize the forthcoming activity lull as a window of opportunity—rather than a persistent “new

4. innOvATiOn in mOrTGAGe OPerATiOnSbuilDinG A ScAlAble mODelby Samrat kansara, narayan nallicheri and lucia uribe


normal” – allowing management finally to allocate attention and resources to making real underlying business improvements.

2. DeADlineS FOr imPlemenTinG cOmPlex reGulATOrY requiremenTS Will lOOm

A barrage of recent regulatory changes have made the workload for each loan originated higher than ever. Failure to achieve timely compliance with these changing standards, of course, comes with potentially debilitating operational risk and expense. Over the coming period, lenders will devote an increasing number of resources to operational compliance. And while the pace of change may slow, one of the lessons learned from this period has been that lenders’ operating models need to be flexible enough to accommodate a wide variety of process changes and to be able to assimilate these changes seamlessly, without reliance on ever-increasing headcount. The non-discretionary nature of compliance should serve as a catalyst for innovation in process changes that will not only address the regulatory requirements currently on the table, but will also better prepare lenders to adapt to additional changes that may arise in the future.

3. THe mArkeT Will SHiFT TOWArD PurcHASe mOneY mOrTGAGeS, cOnFrOnTinG lenDerS WiTH STeePlY eScAlATeD cOnSumer DemAnD ArOunD exPerience quAliTY

The decline in refinancing volume over the coming period also means that the market will shift to being purchase money dominated for the first time since 2008. in this environment, lenders will find it much more difficult to generate new business. in “refi boom” periods as we have experienced over the past several years, many originators operate at maximum capacity. They may even turn business away at the margin by holding pending applications in a production queue long enough that the applicant goes elsewhere, or by pricing uncompetitively. in a purchase money market, however, volume is scarce and event-driven; each loan must be won in open competition, often based on reputation and word-of-mouth recommendation. A refinancing transaction is essentially financial in nature, but a purchase transaction is one in which borrowers are more emotionally engaged. if the lender does not deliver a high-quality experience, borrowers will be upset and may both go elsewhere and create negative word-of-mouth for the lender, at a time when exactly the opposite is needed.

exHibiT 1: mOrTGAGe OriGinATiOn AcTuAlS AnD FOrecAST bY lOAn PurPOSe

Forecast

4%

5%

3%

0%

1%

9%

8%

7%

6%

2,000

500

1,000 2%

1,500

2,500

3,000

3,500

4,000

0

4,500

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

1-4 FAMILY MORTGAGE ORIGINATIONS ($BN)

Purchase

Refinance

30-yr FRM

Source: mortgage banker’s Association Forecast, Feb 22, 2013


Furthermore, while lenders have been distracted with other priorities over the past few years, the world has become more digitally connected and huge technology advances in other industries have trained consumers to expect very high levels of service and always-on information availability. For example, in many industries, consumers can now press a button on a mobile app to trigger an agent callback rather than waiting in a call queue. real-time online tracking tools at Fedex and uPS let us know the exact status of our packages 24 hours a day and the cab-hailing app, uber, has taken this one step further by letting consumers view their cab’s progress toward them in real time. consumers will now have these kinds of expectations when interacting with a mortgage lender. lenders must make the process easy, be responsive to questions and get borrowers to the closing table promptly. Those who fail to meet these new standards will find purchase money even harder to attract than in the past.

The combined effect of these three factors is a compelling catalyst for lenders to re-think mortgage operations with the objectives of remaining operationally compliant with ever-changing regulations, raising the level of customer care as will be required to compete in the coming environment and improving operational productivity to minimize impacts on per-unit costs. The last of these becomes important because the first two, if undertaken without efficiency and cost discipline in mind, would naturally otherwise be likely to lead to an unacceptable escalation of operating costs.

re-THinkinG mOrTGAGe OPerATiOnS

With these objectives in mind, leading players are beginning to innovate and re-envision their operations around three elements: creating an assembly-line approach to mortgage operations, building cross-channel and self-service capabilities and industrializing miS.

A. creATinG An ASSemblY-line APPrOAcH

leading lenders are creating a new, consistently speedy, scalable, and reliable end-to-end process, from application to closing. Possibly the greatest lesson of the past four years has been that lenders need a production process that is more adaptable to huge

swings in workload. This means establishing a more variabilized expense structure, but it also means having the capability to promptly enact this variabilization to keep cycle times within an acceptable range.

Over time, lenders have worked to improve cycle times and scalability through better use of technology and process redesign at the margin. However, lenders are now re-thinking operations from the bottom up using an assembly-line principle of breaking work down into its base component parts. This approach is well-established in manufacturing, pioneered in auto assembly and now prevalent across industries from technology to retailing. Disparate/non-dependent tasks should be conducted in parallel where possible and like tasks should be clustered for efficiency where possible.

This change in mindset, when applied to loan origination and fulfillment processes, requires lenders to fundamentally redesign business processes, roles, tasks and technology in mortgage operations. For example, mortgage fulfillment has traditionally been conducted by a loan processor who serves as the point person for fielding customer questions, collecting required documents, verifying information, coordinating with third parties and preparing the underwriting package – essentially playing the role of quarterback. The bottleneck for completing fulfillment work is often this mortgage processor who is typically handling up to 30 other loan files simultaneously. in the assembly-line view of the world most of these activities can be conducted by members of specialized teams, focusing on a particular sub-set of component activities, many of which can run in parallel; the processor then effectively becomes a “loan coordinator” who focuses primarily on customer contact. At scale, our experience has identified 10+ component activities in mortgage fulfillment, each of which can be conducted in parallel by specialized teams. This approach reduces application cycle time considerably while improving fulfillment productivity by 30-40%.

redesigning mortgage operations as an assembly-line also helps address scalability challenges. Traditional mortgage operations have tried to variabilize their expense structure by laying off and re-hiring employees. Scaling operations to meet demand this way is crude but effective. However, the combination of lagging indicators and lead time in hiring and training resources creates a substantial time delay before lenders are able


to flex their workforce. This effect was compounded after the SAFe Act, which forced lenders to specifically search for licensed personnel or spend time training and certifying unlicensed individuals.

The shift towards “componentized” processes greatly improves lenders’ ability to enact expense variabilization and reduce the time delay in flexing capacity. This is achieved by narrowing the criteria for training and hiring required for both the loan coordinator and members of the componentized teams. For example, whereas the traditional loan processor needs a broad range of both technical and soft skills, the assembly-line approach separates the roles requiring soft skills (loan coordinator) from the technical skills (component teams). This reduces the typical training time for a new employee from a few months to a few weeks.

While the operational upside to cycle time and scalability is substantial, realizing this model requires significant investment and technology prowess. The “brain” of the assembly-line approach is the workflow engine that drives the process and coordinates work. Processes need to be fully standardized with clear service level agreements and turn times. Detailed business rules

need to be defined for treatment of most possible outcomes. exceptions and escalation need to be routed and managed separately. Full transparency is required on both a loan level and process view to identify choke points and manage adherence to service levels. Some new vendor platforms are now specifically designed to enable the assembly-line approach, but lenders will remain responsible for redesigning operations in the manner most suited to their individual needs and objectives.

b. builDinG crOSS-cHAnnel AnD SelF-Serve cAPAbiliTieS

A universal need for all mortgage applicants is to have flexible and responsive interactions with the lender. The quickest way for lenders to frustrate their customers is to make it difficult for those customers to get in touch with the right representative to discuss their loan application. The fallback to any interaction has always been the phone channel, where a customer can dial an 800 number and eventually get someone to answer his/her question. While this fallback will always continue to exist, the expectations of the next generation of home buyers include the ability

exHibiT 2: TYPicAl inDuSTrY inTerAcTiOn mODelS FOr mOrTGAGe OriGinATiOnS

TYPICAL DIRECT MODELDISTINCT ORIGINATIONS ANDPROCESSING

Originator

Customer Customer

Hand-off

TYPICAL RETAIL MODELLOAN OFFICER WITH PROCESSORSUPPORT

POTENTIAL ASSEMBLY-LINE MODELORIGINATOR WITHCOMPONENTIZED FULFILLMENT

Processor

Underwriting

Closing

3rd parties

Originator Loan coordinator

Origination

Title

Certification

Underwriting

Closing

Fulfillment

Hand-off

Underwriting

Closing

3rd parties

Loan Officer

Customer Customer

Loan Officer

Processor VoD

Appraisal

Credit and ID

VoE & VoI

Origination Fulfillment

CustomerCustomer

Origination

Componentized fulfillment teams

Fulfillment


to interact with their lender in the manner of their convenience, be it in person or via mobile, internet, phone, online chat or even video telephony. This means building out cross-channel capabilities with seamless integration into lender processes and systems.

in a few years, these capabilities will likely be considered table stakes, but for now they can differentiate a lender and the experience it provides the customer. The best example in this context is quickenloans and its innovative online and mobile features. Their myql® platform provides a single customer-facing portal that translates the loan process into a simple to-do list for the customer, with clear real-time status updates and integration with their myql® iOS and Android apps. While quickenloans is one of the few lenders with live instances of tools of this nature, development of similar mobile and tablet features are among the top priorities at many large lenders, with some anticipating further developments into home-search, advice, location-based services, and application taking.

Operationalizing these capabilities requires not just building out the cross-channel platforms, but also integrating information from lender systems in

real-time and re-engineering processes to account for new or changed processes. For example, mobile and tablet platforms will need to pull loan and status data not only from originations, servicing and workflow systems, but also other bank systems housing customer data (e.g., deposits, cards). chat functionality will require a dedicated component team equipped to handle questions on any loan file. Settings for customer preference on form of contact need to be customizable and lender agents should honor those preferences, for example by emailing if the customer prefers email or calling if the customer prefers to be called.

While the customer experience benefit of building user-friendly cross-channel platforms is game-changing by itself, migrating customer interactions to alternative channels is also a boon to operationally scaling capacity at times of surges or troughs. integrating self-service capabilities into these platforms reduces the number of phone calls or office visits for basic functions (e.g., inquiring about status, handing in documents) and, therefore, flattens the relationship curve between loan volume and number of resources required to handle that volume.

exHibiT 3: exAmPle cuSTOmer PATHS AcrOSS mulTiPle cHAnnelS

HOME & MORTGAGESHOPPING

APPLICATIONTAKING

CLOSING AND POST-CLOSINGFULFILLMENT

PHONE

CHANNEL

Bob uses mobile app while looking for houses to get home-buying tips

WEB

MOBILE

IN-PERSON

Susan goes through the entire loan process exclusively over the phone, just as she could have done for any channel

Bob meets in person with rep to begin loan app; rep sees Bob’s online quote and mobile history, which inform his discussion and advice

Bob goes online at home to do more research – gets an online quote

Bob returns home, tracks down some missing information, and picks up loan app online right where he left off at his in-person meeting

Bob receives a call updating him on the status of his loan

Bob checks in on his loan status on the mobile app

Bob goes to online portal to verify closing details

BOB

SUSAN


c. inDuSTriAlizinG miS AnD DATA

Operational excellence is an important driver of economics and competitive success, yet mortgage leadership teams are being challenged to make the right operational decisions with insufficient information. Good miS has always been important to managing the business in a controlled way, but now lenders have elevated its significance to “mission critical” status as both an early warning indicator of changing market conditions and a tool to manage operational risk. At the same time, the metrics that must be tracked are more in number and more complex than they were in the old-fashioned world, where one processor saw a loan all the way through from application to underwriting. in that world, productivity metrics rarely drilled down to the individual level and floor managers had difficulty knowing who was getting the work done efficiently and who was lagging.

in the assembly-line approach, as processes are componentized across disparate teams (some located at third parties and each responsible for only one step in a complicated process), accountability is dispersed and nuanced reporting is essential to know what is working

well and what requires improvement. At the same time, new-form operational reporting also provides a “heat map” of where work is flowing versus bottlenecking, enabling managers to dynamically reallocate resources before backlogs can emerge at any given step in the process.

Anticipating when to reallocate resources and having the confidence to do so decisively cannot be underestimated in importance. For a recent client, we explored scenarios where a particular operational lever was either pulled on time or delayed and we found that in the scenario where the decision was delayed even slightly, performance was never able to recover to the level where it could have been had decisive action been taken (even a year past the initial delay).

miS needs are not just limited to the operationally-oriented and should not even be exclusively inward-looking. instead, we see five key dimensions to robust future-state mortgage miS and believe that these should be assembled and tracked dynamically so that management has a real-time view across all five dimensions at its fingertips in making key operational decisions. These five dimensions are as show in exhibit 4.

exHibiT 4: Five DimenSiOnS OF A rObuST FuTure-STATe mOrTGAGe miS

• Volume trends e.g., by product, geography, segment

• Productivity and utilization

• Quality

• Drill-downs e.g., by location, team, process, etc.

• Industry originations trends

• Macroeconomic indicators e.g., interest rate, unemployment

• Other market events that drive volume changes

• Call quality and service levels

• End of call feedback

• Regular surveys

• Regular focus groups to understand big pain points

• Industry satisfaction rankingse.g., JD Power & Associates

• Forums and messaging boards

• CFPB consumer complaints database

• Employee satisfaction surveys

• Attrition rate by role, geography, etc.

• Peer attrition rates

• Compensation benchmarkingacross roles

• Cost per loan

• Profit per loan

• “Shock” scenarios

• Volume surge/ trough

• Margin sensitivity

• Interest rate sensitivity

• Other economic indicators

• Peer cost and profit per loan

• Peer margins

• Market share

• Penetration in core customer segments

• Comparison against peer institutions OPERATIONAL

FINA

NC

IAL

EMPLOYEESATISFACTION

CU

STO

MER

SATI

SFA

CTI

ON

STRATEGIC

T Example of internal metricsExample of external metrics T


Synthesizing across these various dimensions is critical to making accurate and timely management decisions in a business that is both operationally-intensive, highly market-driven and subject to intense regulatory scrutiny. While many will be making investments during the coming “refi bust” (as often happens), the players who currently excel in this area devote considerable resources to the miS that supports the business and have fully routinized, and in parts even automated, its impact on decision making.

cOncluSiOn

We believe the current environment is opportune for lenders to prepare for this new normal. competition for purchase money will create a more challenging

market for lenders, with the keys to success being an operational ability to meet customer expectations on the experience, and building a model that is both practically and economically scalable. To realize this end-state, lenders need to define the ideal set of interactions between the customer and lender and derive the operational, technological and organizational capabilities required to effect that vision. Achieving this re-envisioned state requires time, resources, investment, and above all, a commitment by the lender to the strategy in order to reap the benefits.

Samrat Kansara is a Senior manager at Oliver Wyman.

Narayan Nallicheri is a Partner at Oliver Wyman.

Lucia Uribe is a Partner at Oliver Wyman.


JPmorgan chase has taken a first step towards creating a new 3-party network similar to American express and Discover. The new entity, chase merchant Services, will leverage the visa infrastructure, but won’t be subject to visa rule sets or pricing terms. it will allow chase to self-settle any transactions executed at chase Paymentech merchants using chase credit or signature debit cards – while leaving the visa network to process transactions at merchants who have not signed onto the new mini-network.

This move has been a long time coming. The payment card market today consists of six mega-issuers ( JPm, bAc, citi, cOF, AxP, DFS) processing on four major networks (visa, mastercard, AxP, DFS).

Since visa and mastercard went public in the early 2000s, issuers have gradually lost influence over the payment card system. The networks have much higher valuations than the issuers, are less exposed to regulation and credit conditions, and have global growth opportunities that the issuers lack.

5. cHASe mercHAnT ServiceSHOW Will iT DiSruPT THe cArD PAYmenTS bAlAnce OF POWer?by Andy Dresner

exHibiT 1: TOP iSSuerS AnD neTWOrkS relATive vOlume Size, AFFiliATiOn

VisaMastercard

Citi

Capital One

JPMorganChase

AmericanExpress

Discover

3-PARTY NETWORKS

Bank ofAmerica

Wells Fargo

US Bank

PNC Credit volume

Total volume (credit & debit)

Credit volume –Top 7 issuers

Total volume –Top 7 issuers(credit & debit)

Total volume –all issuers(credit & debit)

Note: volumes represent consumer credit and debit as of 2011 year endSource: The nilson report


The networks also have pricing power with both issuers and merchants. And when merchants pushed back in court, it is not network fees that were reduced, but interchange – merchants can now deploy surcharges, discounts and product discrimination to influence card choice. Furthermore, the networks continually commoditize the market by providing Tier ii & iii issuers with functionality that approaches what the mega-issuers spent millions to pioneer.

much of this came to a head during Durbin implementation. issuers expected the networks to share the Durbin pain in two ways:

1. Accept that it was in the issuers’ interest to drop the networks’ “affiliated” Pin brands (interlink, maestro) to avoid network-on-network interchange competition

2. reduce issuer-side processing fees to reflect the new economic reality

Yet the networks dug their heels in to protect their own revenue streams and, in the case of visa, introduced a new “stealth” debit network (PAvD) that issuers could not opt out of even though it would be more costly to them than “unaffiliated” Pin debit. This was a wake-up call for the mega-issuers that the power balance had shifted to the networks. The only way to gain back leverage is to shift volume to the other network. This is expensive and disruptive for customers and only a handful of issuers took that route.

enter JPm. Of the major mc/visa issuers, only chase is both a scale issuer and a scale acquirer. most other banks have either small issuing scale or Jv acquiring structures that limit their flexibility. uS bank has large issuing and acquiring businesses, but at only one-fourth JPm’s issuing scale and one half its acquiring scale.

note that FDc, with its alliances, has over 50% share in acquiring and its alliance partners collectively have a big position in issuing. While FDc could form a club of these Jv partners to negotiate a similar deal, this would be complex, given the different equity shares in each Jv, and the different mix of visa/mc affiliations among its partners. Such a club would remain a 4-party network, but with fewer parties on each side – it would lack the nimbleness of a 3-party design.

The press release announcing the deal suggests that chase aims to improve its positioning with both cardholders and merchants:

• For merchants, chase can be more flexible in interchange terms and rules sets – at least as it relates to the volume from chase-branded cards. chase can also develop proprietary data sharing protocols that provide the merchants with more customer insights than is possible via a standard network

• For cardholders, chase may offer proprietary deals from its merchants. For example, by using chase data to target offers to narrow segments, a merchant may be willing to offer better deals than it does to the general public

The question that arises is how this will impact chase’s competitors and its customers (merchants and cardholders), as well as the networks themselves.

exHibiT 2: SPenD SHAre OF mAJOr cArD iSSuerS (viSA/mc OnlY)

iSSuinG SHAre

AcquirinG SHAre*creDiT DebiT TOTAl

JPm 25% 8% 15% 13%Paymentech (Wholly owned)

bAc 16% 13% 14% 18%Jv with FDc (minority stake)

Wells 4% 11% 8% 4%Jv with FDc (minority stake)

citi 13% 1% 6% 4%Jv with FDc (minority stake)

cOF 8% 0.6% 4% <1%cOmS (Wholly owned)

uSb 6% 2% 4% 6%elavon (Wholly owned)

Pnc 0.5% 2% 1% 1%Jv with FDc (majority stake)

* Some large acquirers are not issuers (e.g., vantiv, Heartland and GPS). First Data also acquires under its own brand

Source: The nilson report


AcquirinG imPAcT

The clearest advantage from this deal accrues to Paymentech, chase’s merchant acquiring arm. To the degree that chase is able to offer a lower total cost to the merchant than another acquirer, it will generally win the contract. Paymentech already has competitive scale and services, but this is a unique differentiator.

in the POS world, Paymentech could simply charge a lower network fee than visa does and outperform all other competitors. large merchants typically face three major components of card acceptance costs: the acquirer fee of 0.2-1¢, the interchange fee that goes to the issuer and the network fee that goes to visa or mastercard. The network fee is typically 11bp plus 1.5-2.5¢ which works out to 5-6¢ on the average debit transaction and 10-11¢ on the average credit transaction. if Paymentech simply undercuts the network fee by a penny on chase card volume, their average acquiring fee per transaction would be substantially lower than the market level charge. This leaves interchange unchanged.

Paymentech can also offer this deal on a partial basis. A merchant could use Paymentech to process its chase cards while leaving all other volume to the incumbent acquirer (similar to how merchants operate with AxP and Discover). in this case, chase reduces its competitors’ volumes and revenues even without winning the entire contract (most merchant acquiring contracts have a carve-out for 3-party networks). Furthermore, Paymentech gets to integrate with these merchants, making it easier to displace the incumbent the next time the contract comes up for bid – such transition costs are one reason large merchants rarely leave their incumbent acquirer.

This will have different appeal to different merchant segments depending on their payment mix and geography. Debit-centric verticals, like supermarkets and gas stations, will have a smaller share of their volume from chase cards than credit-centric verticals such as airlines, hotels and department stores. Further, low-average ticket verticals, like fast food, already pay low absolute network fees that would be harder to undercut. Finally, chase’s branch footprint is concentrated in certain metro areas, giving stores in those cities a much bigger debit impact.

The network fee advantage doesn’t help directly with smaller merchants who pay via a merchant discount. For

these Sme merchants, a penny per transaction reduction would not be noticeable. Further, selling acquiring to small merchants is as much a function of distribution as it is of price. instead, Paymentech might invest its network fee savings to pay iSOs an improved “buy rate” and grab the lion’s share of their sales without any particular differentiation to the merchant.

Paymentech could also use its new freedom to offer superior rule sets and pricing policies. One example is ecommerce, where card not Present (cnP) interchange is substantially higher than POS interchange – even for merchants with very strong fraud monitoring and prevention programs. Paymentech specializes in ecommerce and must be very aware of this. A deal that offers lower interchange on chase volume to reward higher levels of card security would reinforce Paymentech’s position as the acquirer of choice for cnP and put pressure on the legacy networks to reexamine cnP policies. While this would reduce interchange revenue to the issuing side, ecommerce is still a small enough portion of total spend that the tradeoff may be worth it. At “bricks and clicks” retailers, such a concession on the “clicks” side may be enough to win the larger “bricks” business. There may also be areas like “friendly fraud” where closer collaboration might result in material reductions in merchant costs without reducing interchange at all.

Finally, by working directly with merchants in a closed loop, chase can develop analytics that provide merchants with greater insights into customer behavior. issuers like chase have data on customer spend and demographic profiles that merchants lack. using these data, merchants can target offers to niches of chase cardholders. AxP has exploited analytics of this kind historically to justify premium discount rates from merchants and there is no reason chase couldn’t do the same thing.

The net result could be a large increase in Paymentech share at both large and small merchants. At large merchants they could win more contracts outright or take a share of volume at the expense of the incumbents. At small merchants they will appeal to the best iSOs because they can pay more without undermining core economics. These share increases could be highest in verticals with high credit spend and average ticket as well as debit-centric verticals that are in-footprint for the chase branch network.


iSSuinG imPAcT

The impact on chase issuing share is much more speculative.

1. chase and its merchants need to find a proposition that leverages cardholder spend and demographics data to make proprietary, targeted offers to their joint customers

2. The offers have to be differentiated enough – either from a value or exclusivity perspective – to differentiate chase cards from other cards

3. The offers have to be rich enough so that cardholders use them more than they have used other, less targeted and differentiated offers from specialists like Groupon or cardlytics. visa and mastercard are also moving into this space

chase was clearly thinking along these lines when it purchased bloomspot recently. bloomspot specializes in daily deals in upscale venues like restaurants, spas and hotels. This gives chase an engine for capturing merchant offers and distributing them to cardholders – and it focuses on just the kinds of merchants that the acquiring proposition will most appeal to.

However, it is not clear how important merchant offers are to either merchants or cardholders. AxP has done this for a long time, but it is not clear how much of its market position among affluent cardholders is due to this rather than its service quality, rewards proposition and product differentiation (no pre-set spending limit). The effort required to craft and target offers is non-trivial and many merchants lack the sophistication to take advantage of the rich data that chase might put at their disposal. chase could develop advisory services to work with merchants on this opportunity, but these would only be affordable in collaboration with the very largest merchants.

The other advantage for cardholders is the availability of reward redemption at the point of sale. chase cardholders would be able to “pay with points” at selected merchants; this may be combined with targeted offers or it may be a routine payment option.

redemption at the POS offers liquidity to the cardholder, but the actual value depends on how many merchants choose to adopt the mechanism and what exchange rate chase adopts for these redemptions. Historically, points redeemed this way have a lower exchange rate than those redeemed using the standard menu of redemption options – and low exchange rates discourage usage. chase may also need to restrict the universe of merchants allowed to participate – there simply isn’t enough redemption volume to make it material to any merchant if it is deployed too broadly.

in short, the impact on chase issuing fortunes is highly contingent on getting enthusiastic merchant participation. This will take time and investment by both the merchants and chase. it also requires merchants to adopt unique processes to make offers to chase cardholders who might account for only 20% of so of their overall customer base. This is a tall order.

neTWOrk imPAcT

While chase is a winner in this deal, the impact on the networks is clearly negative.

visa will lose the network fees that merchants would ordinarily pay on chase volume. chase will likely pay some fee to visa for the use of visanet, but this will no doubt be much lower than the typical 11bp + 1.5-2.5¢. On the other hand, chase has committed to migrating more of its volume from mastercard to visa – this will backfill some of visa’s lost revenues at mastercard’s expense. So mastercard may be the biggest short term loser here.

To the degree that chase succeeds in growing issuing share, both networks will see an absolute reduction in volume over the longer term. Furthermore, there may be merchant pressure to match any interchange or network fee reductions that chase merchant Services might offer. To the degree that any other banks form similar mini-networks, the losses will be compounded.


imPAcT On OTHer lArGe bAnkS

bAc is potentially large enough to cut a similar deal with the networks. but first, they may need to claw back controlling share in their acquiring Jv, so they are at least a year behind chase in getting there. collectively, bAc and JPm account for 41% of visa debit and credit spend, so moving this volume to private mini-networks would vastly reduce aggregate network revenues and scale.

no other issuer is positioned to cut a similar deal without further m&A. citi, uS bank, Pnc and Wells all have much smaller issuing and acquiring businesses and would have difficulty monetizing their volumes even if they could cut similar deals. While they might club together to do this, it is hard to see how they could deliver the shared network from multiple acquiring arms – and even then, would operate on a 4-party model which undermines some of the advantages of such a move. capital One is particularly challenged as they have material issuing share but almost no acquiring volume. A logical move could be to align with vantiv to gain acquiring scale.

cOncluSiOn

if the leading issuers do all move to mini-networks, it is hard to see how Tier ii/iii issuers and acquirers stay relevant. Pure-play acquirers will lose to large merchants on cost and to smaller merchants on distribution. mastercard and visa will have fewer funds to promote their acceptance brands and build out their services which are disproportionately used by Tier ii/iii issuers. Additionally, these issuers will lack the differentiation that comes from ads, offers and POS redemption. This could lead to another round of consolidation on both sides of the cards business.

Andy Dresner is a Partner at Oliver Wyman

exHibiT 3: creDiT cArD mArkeT

Visa

MC

Consortium

BoA

Chase

Amex

Discover

40%

JP M

org

anC

has

e

Ban

k of

Am

eric

a

60%

20%

80%

Pot

enti

alfu

ture

Tod

ay

Con

sort

ium

(oth

er to

p is

suer

s)

100%

0%

Note: Assuming the top 7 issuers break away to set up their own networks

Source: The nilson report


Significantly reduced profitability and changing customer behavior have created a clear imperative for uS banks to change how they approach retail distribution. charting a new course will be challenging: the new model must confer the same competitive advantage that local branch density has provided, drive a mix of traffic that can be converted into new and deeper relationships and deliver a superior customer experience – all while meaningfully reducing cost to serve. So, what might the future look like? With high mobile and internet banking adoption, low branch traffic and heavy use of electronic payments, we believe Sweden and its banks provide a beacon. in this paper we will profile the characteristics of retail distribution in Sweden, explore the factors that enabled banks there to accelerate evolution, and evaluate what we can learn about the future of uS retail distribution.

uS reTAil DiSTribuTiOn: An imPerATive TO cHAnGe

The impact of the financial crisis and its aftermath on retail banking economics is, by now, well-understood. According to our estimates, between 2007 and 2012, as much as $50 bn in annual revenues evaporated due to fee regulation, deleveraging and low interest rates. As a result, the branch banking business lines at most large banks are operating at efficiency ratios in the 65-75% range and producing equity returns in the mid-to-high single digits. neither outcome is sustainable.

At the same time, customer preferences and channel usage have reached an inflection point. After years of uninterrupted growth, same-branch teller transaction volumes are declining steadily for most banks. At the same time, card-based and other electronic payment methods are supplanting cash and checks, obviating the need for a weekly visit. Simple branch service requests have declined similarly, as customers make use of increased internet and other remote service functionalities to resolve their own needs. Finally, recent

6. THe FuTure “Ar nu”WHAT We cAn leArn FrOm SWeDen AbOuT THe FuTure OF reTAil DiSTribuTiOnby Siddhesh karmali and Tim Spence

exHibiT 1: Online/DirecT cHAnnelS Will cOnTinue TO GrOW in THe uS AnnuAl TrAnSAcTiOn vOlume bY cHAnnel (DiSGuiSeD clienT exAmPle)

2008 2009 2010 2011 2012

NUMBER OF TRANSACTIONS

CAGR

Online/Mobile 13%

Branch -4%

ATM -6%

CallCenter

7%



Oliver Wyman research confirms that most customers now conduct their pre-purchase research outside the branch as well – only 14% of a consumer survey’s respondents indicated the branch was their preferred research channel, as compared to 61% for the web.

Against this backdrop, there is no question that uS banks must evolve their retail distribution strategies. recent Oliver Wyman research and analysis suggests the rewards of doing so are great: most banks could at least double their branch banking business line profitability and increase equity returns to above 15%.

And yet this change will not come without significant risk. branches (specifically, locational convenience) are still the most important driver of primary bank selection (as shown in exhibit 2), and they generate the vast majority of profitable cross-sales.

Those banks that historically maintained good network planning and expense discipline simply will not be able to prune their networks significantly without putting future sales opportunity at risk. in addition, there will be no “silver bullet” solution – winning strategies will need to address network structure, retail format, process, technology, staffing model and cross-channel integration, and must be flexible enough to adapt to different customer segment and local market

preferences. Finally, there is no beacon of success to emulate in the uS market. Although most of the largest banks are experimenting with new approaches, none has yet completed a network-wide transformation.

So, where can executives contemplating their retail distribution strategies look for inspiration? We believe Sweden provides a glimpse of at least a decade into the future of retail and offers important lessons on how to complete the transition.

reTAil bAnkinG in SWeDen: A DecADe AHeAD Or An AlTernATe reAliTY?To the eyes of a uS banker, retail banking in Sweden seems a world apart. internet and mobile banking are nearly ubiquitous – more than 85% of Swedes are active users of one or both – and have long since become the primary method for interfacing with your bank. Swedes log in more than ten times as frequently as they use any other retail channel. Advanced user-friendly “app” functionality available in Sweden enables consumers to complete a much wider range of financial management, information-gathering and payments activities than is possible in the uS. in payments, electronic methods

exHibiT 2: level OF HiGH imPOrTAnce OF keY FAcTOrS WHen SelecTinG PrimArY bAnk

FOR INDIVIDUAL SWITCHERS* FOR SMALL BUSINESS SWITCHERS†

LOCATION :the new bank’s

branch(es) are very convenient

TECHNOLOGY :impressive online or

mobile capabilities

ACCESS TO CREDIT :the new bank is

willing to lend me money

PRODUCT :the product has good

features and pricing

Branches nearwhere I live or work

High quality service

Fee level and structure

Low minimum balance requirement

100% 80% 60% 40% 20% 0 100% 80% 60% 40% 20% 0

* Defined as consumers who switched their primary checking account bank within the last 18 months; consumers are not counted as a “switcher” if their new bank was acquired by their old bank and they did not actively switch banks

† Switched primary banks within the last 18 months

Source: Oliver Wyman Survey of consumers (q1 2012), Oliver Wyman new-Form lending Survey of Small businesses (q1 2013)


dominate paper alternatives. cards are broadly accepted and heavily utilized – cash represents only 20% of retail transactions1 – and paper checks have disappeared entirely from Swedish consumer households in favor of simple-to-use AcH and P2P transfers2.

bank branches form a much less prominent part of the street-level retail landscape in Sweden – there are 35% fewer per capita, as compared to the uS – and customer traffic is significantly lower. Over 80% of customers at one Swedish bank have not visited a branch in the last six months3. in this environment, most Swedish banks employ retail formats and operating models that differ materially from the traditional uS approach. branches are significantly smaller, many less than 1,500 square feet, and utilize an open floor-plan to encourage casual banker-customer interaction. Traditional teller zones are uncommon: in fact, the largest Swedish banks have eliminated manual cash-handling from 65-75% of their

1 Swedish Trade Federation.2 Sveriges riksbank.3 Oliver Wyman analysis; excludes visits to on-site ATms.

branches4 due to rapidly declining customer demand (as mentioned previously, check-related transactions are non-existent). Staffing levels are generally lower and roles more fluid. most bankers are “universal” – they switch seamlessly between sales and service – but dedicated to a specific segment. customer-facing technologies, including self-service terminals, internet and mobile banking demo stations, video teleconferencing and digital merchandising are much more prevalent. A significant portion of branches serve only small-to-mid-sized businesses or mass affluent customers.

So, is Sweden an alternate reality, or does it provide a glimpse into the future of uS retail banking? Probably a bit of both, but we believe primarily in the latter for two reasons. First, the profile of demand for consumer financial services in the uS and Sweden is sufficiently similar to suggest that they should evolve toward similar end-states:

4 bloomberg.com “Swedish Banks Make Money by Saying No to Cash”, April 11, 2013.

exHibiT 3: cOmPAriSOn OF keY mArkeT STATiSTicS beTWeen THe uS AnD SWeDen

+

MIX OF CONSUMER PAYMENTSSWEDEN CUSTOMERS HAVE REPLACED CONVENTIONAL PAPER-BASED METHODS WITH ELECTRONIC TRANSACTIONS

BRANCHES PER CAPITAWIDTH INDICATES AVERAGE BRANCH SIZE

REMOTE CHANNEL USAGEMOBILE AND ONLINE BANKING IS TWICE AS WIDESPREAD IN SWEDEN AS IT IS IN THE US

YEARLY BRANCH VISITSSWEDEN CONSUMERS VISIT BRANCHES LESS THAN 5%AS FREQUENTLY AS US CONSUMERS

Sweden today US today

Sweden today

Electronic

Mobile &Online

Online only

Neither

Paper-based

Card-based

US today



+ 40 2044 4016 40

29 651 5220 42

%

%

%

%

%

%

%

%

%

%

%

%

BANK

1000-1500 sq. ft 2000-3500 sq. ft

BANK

Source: Swedish Trade Federation, Swedish bankers’ Association, 2012 American bankers Association Guide , FDic, OecD, nilson report, internetstatistik.se, cisco ibSG Global research


• Demographics – The Swedish population is substantially smaller than the uS (~3%), but the countries have similar population age pyramids and average life expectancies. Average household size in Sweden is 2.0 versus 2.6 in the uS. immigrants are 12-14% of the total population in both countries. levels of urbanization are also similar (80%+)

• use of financial services – According to recent studies, 99% of the Swedish population participates in the banking system (i.e., owns at least one financial account), relative to 91% in the uS5. The 8 percentage point difference is meaningful when scaled to the full uS population, but both countries are among the most highly banked, globally. The growth in uS general purpose reloadable prepaid cards – nearly one in five unbanked customers used one in 2011 – will continue to erode this gap

• Household balance sheets – in both countries, total household debt-to-income ratios are at or above 100%. Thanks to recent deleveraging in the uS, DTis are actually higher in Sweden. Homeownership rates are 60-65% in both countries

5 Demirgüç-kunt, Asli, Thorsten beck, and Patrick Honohan. 2008. Finance for All? Policies and Pitfalls in Expanding Access. Washington, Dc: World bank.

• long-term savings needs – Structural reforms to the Swedish public pension scheme have given rise to the same personal savings requirements that exist in the uS. Today, a 40 year-old Swede can expect to collect a pension benefit equivalent to 40% of his/her salary, starting at age 65; the equivalent calculation for Social Security is 30-35%

Second, the developments that enabled the retail transformation in Sweden – the secular shift toward electronic payments and access to/adoption of internet banking being the most critical – are already underway in the uS; structural advantages merely allowed the Swedish banks to accelerate them. For example, internet access is now near-universal in the uS and the gap in online banking adoption – 84% of Swedes use it, versus 60% of uS consumers – is closing quickly. Similarly, the voluntary shift from paper to electronic payments is well underway. While over 40% of uS consumer payments are paper-based (compared to just 20% in Sweden), they have been declining at 2-3% YoY in the uS for the past 5 years. At the current pace, the uS would reach parity with Sweden within a decade.

exHibiT 4: SAmPle brAncH lAYOuTS OF TWO bAnkS in SWeDen


What structural advantages enabled Swedish banks to accelerate these trends? We see three:

• Favorable competitive market structure – Following a wave of consolidation in the 1990s, there are only 36 chartered commercial banks in Sweden (versus more than 6,000 in the uS), and the four biggest banks dominate the retail banking market. As a result, Swedish banks were able to operate in concert to accelerate changes in customer behavior (i.e., eliminating paper checks and, now, cash)

• Government infrastructure investments – Sweden has made a number of significant public investments to spur internet access and personal computing availability. The government adopted a formal “broadband policy” in the 1990s and has since aggressively subsidized broadband deployment. Similarly, until 2009, the “home-Pc” policy enabled employees to lease and/or purchase computers from their employers on a pre-tax basis, substantially lowering the cost of home computers6. As a result, computing and high-speed internet connectivity was available to the majority of the Swedish population at a significantly earlier date

6 The subsidy was a concept called “home-pc” where employees could rent a computer from the employer with the cost deducted from the gross salary (rather than net), typically over a 3 year period. This was phased out over 2007-2009.

• cultural dynamics – While harder to pinpoint, recent studies by the World economic Forum identify Swedes as being among the earliest adopters of new technologies, globally, which would suggest that the population may generally have been more willing to try out new remote/self-service banking options. The legacy of socialism may also have contributed indirectly to the willingness to accept institution-led change

WHAT cAn SWeDen TeAcH uS AbOuT THe FuTure OF uS reTAil DiSTribuTiOn?So, what can the Swedish paradigm teach us about the future of retail distribution? We see five lessons, which we will explore in more detail below.

1. TrAnSFOrmATiOn Will nOT meAn cOmmODiTizATiOn

The Swedish market suggests that competitive diversity will survive, and even thrive, as the retail model evolves. universal banks, traditional community banks, small-to-medium enterprise and affluent segment-focused banks, internet-only banks, consumer finance specialists and

exHibiT 5: SWeDen’S TOP bAnkS DOminATe THe reTAil bAnkinG mArkeT

Swed

ban

k

Han

del

sban

ken

Nor

dea

Spar

ban

kern

a

SEB

All

oth

er b

anks

20%

15%

10%

5%

25%

MARKET SHARE

PRIVATE MARKET DEPOSITSTOP FIVE PLAYERS CONTROL OVER 80% OF CONSUMER MARKET DEPOSITS

Swed

ban

k

Han

del

sban

ken

Nor

dea

SEB

SBA

B

All

oth

er b

anks

20%

15%

10%

5%

25%

MARKET SHARE

PRIVATE MARKET LENDINGTOP SIX PLAYERS CONTROL OVER 80% OF CONSUMER MARKET LENDING

Spar

ban

kern

a

0% 0%

Source: Swedbank Annual report 2012


non-bank alternatives all exist, and have proven capable of delivering above-hurdle returns. Given its sheer size of the uS, we believe the uS market may support even greater strategic diversity.

2. TrAnSFOrmATiOn Will meAn (limiTeD) brAncH cOnSOliDATiOn

From 2008-2011, after a decade where the number of branches per capita in Sweden was relatively stable, all but one of the largest Swedish banks meaningfully reduced their branch networks. Overall, branches per capita declined by 8%. To put this in context, a proportional effort in the uS would result in more than 9,000 branch consolidations and closures.

Speaking with the executives who oversaw the network reduction for one of the earliest movers, it is clear that the process was challenging. 2-for-1 consolidations (i.e., shuttering two locations in favor of a new, centrally located branch) proved much more successful than outright closures, which resulted in attrition as high as 70-90% in instances where only one bank closed its branch in a local market. Overall, however, the programs delivered meaningful channel profitability improvements and Swedish retail efficiency ratios were already envy-inducing.

could large uS banks undertake similar consolidation programs? Although many metro markets may be as much as 20% over-branched7, we believe the organic consolidation opportunities are limited for most banks.

7 baird equity research, D. George, “Is It Time to Rethink Branch Banking Strategies?”, Sept 2012.

exHibiT 6: TrAnSFOrmATiOn DOeS nOT meAn cOmmODizATiOn SWeDen STill mAinTAinS A DiverSiTY OF brAncH mODelS

Vir

tual

Seg

men

t foc

use

dC

omm

un

ity

Mass market Subset

CUSTOMER FOCUS

MO

DEL

S

Niche (HNW)

SkandiaDirect bank

Ikano BankDirect bank

Avanza BankDirect bank

NordnetDirect bank

JAK28 branches

S|E|B170 branches59% cashless

Nordea304 branches47% cashless

Swedbank317 branches30% cashless

Handelsbanken461 branches2% cashless

Sparbanken 182620 branches

Sparbanken Nord16 branches

REMOTE BANKING SPECIALIZED SELF-SERVICE

TRADITIONAL BANKING RELATIONSHIP BANKINGCo-operative bank

Savings bank

Commercial bank

Note: Data from 2011Source: Swedish bankers’ Association

exHibiT 7: FOr SWeDen, TrAnSFOrmATiOn meAnT cOnSOliDATiOn SWeDiSH brAncH neTWOrkS cOnTrAcTeD mATeriAllY (2004-2011)

2004 2005 2006 2007 2008 2009 2010 2011

NUMBER OF BRANCHES PER 100K ADULTS

8% drop in branchesin 7 years

21.1

21.7

22.2

23.123.0 22.822.922.9

Source: Swedish bankers’ Association


For example, in two recent research examples, potential branch consolidation candidates totaled no more than 5-10% of bank networks. To start with, to maintain satisfactory crA ratings, most banks must exempt a material share of their least profitable branches from any optimization program. in addition, branch real estate ownership rates are significantly higher in the uS than they are in Sweden (where the large banks lease the majority of their retail square footage), limiting the banks’ flexibility to execute 2-for-1 consolidations or at least delaying the ability to realize fixed cost savings. most importantly, given the number of competitors in most metro areas who meet the minimum “locational convenience” threshold, it is a virtual certainty that at least one competitor will maintain or expand its presence in an effort to capture market share from those who contract. That leaves in-footprint, merger-related consolidation and outright market exit as the most viable levers to eliminate the remaining 10-15% of excess branch capacity. We expect to see a good deal of both in the coming years.

3. TrAnSFOrmATiOn Will meAn reTAil FOrmAT AnD OPerATinG mODel innOvATiOn

Whereas we expect the decline of total uS branch counts to occur more slowly than many have forecast, as simple teller transaction volumes continue to decline, the Swedish experience suggests that branch formats and operating models will evolve radically. many of the changes will be instantly visible:

• branch network designs will become less monolithic and more tailored – most banks will move away from the traditional, homogenous “model branch” network model toward a more tailored, site-specific structure. individual locations will receive different treatments and staffing levels based on the local market opportunity, mix of customer segments they serve, and proximity to other, larger locations. more segment-specific branches – or “branches within branches” – will be built to serve only small businesses or affluent customers (at one leading bank in Sweden, 15% of branches serve only small-to-medium businesses and another 30% serve only the affluent)

• branches in general will become much smaller and more flexible – We expect the average branch footprint to fall by as much as 50% (from 3,000 ft2 to closer to 1,500 ft2) as there is less (or no) need for a large (or any) teller zone, lower staffing levels and more cash handling automation reducing back-office space needs. Floor plans will need to become more open and flexible to encourage more non-transactional banker-customer interactions and to allow for more site-specific staffing. Specific tactics that are commonplace in Sweden: 24-hour access ATm vestibules at the entrance, larger windows and limited architectural space dividers (a less material security risk if manual cash handling is automated or eliminated), open pods and private meeting rooms in place of assigned offices and dedicated demo-stations to showcase internet, tablet and mobile app functionality

exHibiT 8: A TYPicAl lAYOuT FOr SWeDiSH univerSAl brAncHeS

Self service machines(e.g., deposits)

Greeter

Servicepods

Waitingarea

Meeting room

Internet accessterminals

Open office

Entr

ance


• customer-facing technologies will become much more prevalent – in high-transaction locations ATms and assisted self-service technologies will replace tellers to handle the majority of simple transactions. video teleconferencing will provide on-demand access to mortgage, small business and investment sales specialists in locations that could not support such expertise otherwise. video-tellers will provide human support outside open hours. in Sweden, some locations have been replaced entirely by ATm and self-service only technologies

• branch staffing levels will decline and the use of “hybrid” or “universal” job families will increase – As overall transaction volumes decline and an increasing share are fulfilled via self-service technologies, required branch staffing levels will fall significantly. To enable smaller numbers of staff to handle peak-volume sales and service times, more banks will design and deploy hybrid “teller-seller” or “universal banker” job families. Any remaining non-customer facing activities will be shifted to lower-cost back-office resources. Some of the capacity freed up will be reinvested in resources focused on high value segments, or other specialists

in total, we estimate that adopting a Sweden-like branch operating model could produce run-rate savings of 25-30% of retail operating expenses. effecting this transformation across a large legacy network will not be easy, but our experience suggests it can be achieved in time – and be accretive in each period. in cases where leases expire or real-estate can be sold, outmoded legacy branches can be replaced entirely with the new format(s). For branches where neither exit option is possible, or where a superior new location is not available, traditional teller zones can be retrofitted with new technology, and low-cost environmental elements can be deployed to repurpose or conceal unneeded floor-space. new roles and staffing levels can be introduced in almost any circumstance, and Oliver Wyman experience suggests that in most cases the headcount-related savings are sufficient to self-finance critical, related capital investments. in some cases, there may even be opportunities to monetize excess square-footage by sub-leasing it to other financially-oriented firms (e.g., insurance brokers, local title agents, accountants) or making it available to customers or community groups.

4. TrAnSFOrmATiOn Will require A neW SAleS PArADiGm

retail sales models employed by the largest Swedish banks share three common characteristics which differ materially from their uS counterparts:

• Swedish branches originate a much more balanced mix of deposits, lending, payments and investments product sales, where uS branches tend to be much more deposit-centric

• Swedish banks employ far more dedicated affluent and small business sales forces, where these are served primarily by personal bankers in many uS banks

• Swedish banks have moved toward a more integrated, outbound sales model, where the majority of uS branch sales arise from in-bound foot traffic (e.g., teller referrals, lobby intercepts, in-branch merchandising and other related programs)

On the first two of these, the transition is already well underway inside most of the largest uS banks; the third may be more disruptive. At many uS banks, in-bound traffic constitutes more than 95% of branch sales, new relationships and cross-sales. As branch traffic declined in Sweden, the banks there experienced first-hand that this model simply could not create enough activity at the “top of the sales funnel” to perpetuate their historical growth. now, according to one of the largest Swedish banks, well over 75% of new sales are initiated through outbound activity.

To prepare for this paradigm shift, uS banks will need to invest in building more integrated, information-driven, outbound sales capabilities, in parallel with any efforts to reduce branch traffic. using Sweden as a guide, such capabilities would include:

• Advanced customer segmentation and targeting – moving from simple wealth or demographic segmentation to incorporate current profitability, preferences and potential lifetime value; developing predictive analytics to identify profitable cross-selling opportunities and changes in attrition risk


• better integration between sales and marketing – more direct-response and internet as a percentage of total marketing spend, integrated campaigns that include marketing (e.g., media buy, direct mail) and sales (e.g., a follow-up call) components and more consistency of message across service channels

• Phone-based meeting booking support for branch sellers – e.g., dedicated contact center teams to pre-qualify leads and set appointments, which the local branch sales personnel can fulfill

5. TrAnSFOrmATiOn Will require SubSTAnTiAl inveSTmenTS in inTerneT AnD mObile bAnkinG

compared to their American counterparts, Swedish banks possess significantly more advanced internet and mobile banking capabilities. each of the largest Swedish banks offer dedicated “apps” for mobile and tablet formats and support all of the most prominent operating systems. in general, the breadth of functionality is much greater than what any individual uS bank offers today and Swedish banks have invested significantly to ensure

that the experience design for each task is intuitive and user-friendly. examples of advanced mobile functionality in Sweden include:

exHibiT 9: TrAnSFOrmATiOn meAnS mArkeTinG AnD SAleS evOluTiOn

US TODAY SWEDEN TODAY – FUTURE US

Bookedmeetings

Walk-in Sales Service-to-sales hand-offs

Bookedmeetings

Walk-in Sales Service-to-sales hand-offs

GENERAL SALES REPRESENTATIVES

REMOTE SALESSUPPORT

SPECIALIZEDBRANCH BANKERS

REMOTE SALESREPRESENTATIVE

exHibiT 10: TrAnSFOrmATiOn meAnS mulTi-cHAnnel exPerience innOvATiOn

GPS AUGMENTEDREALITY

P2PPAYMENTS

NFCPAYMENTS

PFM INVOICE/BILL PAY

MOBILEWALLET

ONLINEMEETINGS

$

$

$20SEND

$20RECEIVED

Thai restaurant

Gallery QCafe

Taphere

PAID


While some of this functionality may not prove essential, the lesson for uS banks is clear: if the goal is to migrate low-value activities to lower-cost channels, the perception of capabilities, and especially ease-of-use, will be critical to increasing adoption.

6. TrAnSFOrmATiOn Will require An inTeGrATeD eFFOrT, neW TAlenT, AnD SubSTAnTiAl cuSTOmer cOmmunicATiOn

When reflecting on the factors that influenced the success (or failure) of their transformation initiatives, executives at Swedish banks highlighted four critical success factors:

• Approaching the transformation as an integrated change effort – Since the key elements of the retail transformation were all heavily inter-related, the banks that approached transformation as an integrated program enjoyed substantially better results than banks who attempted to make changes piece-meal

8 The way invoice payments work is through a combination of a standard identifier (known as the Ocr number) and a company routing number tied to the company’s banking account (known as a giro transfer number). Through the mobile app, the customer scans a long line of text containing the Ocr number, amount and giro transfer number which auto-populates all payment information.

• new talent to fit new roles/capabilities – Strong branch and regional leadership were the key catalysts for change, and not all of the legacy leaders were a good fit for their roles. One of the largest banks actually “re-appointed” all branch and regional manager positions as part of the transformation. ~60% of legacy branch managers were re-hired, but the majority of those were placed in new branches. The remainder of positions were either promoted or hired from the outside

• customer communication – executives identified proactive communication and education as the factors that most strongly influenced customer acceptance of the new model. Having branch staff assist customers in navigating new branch technologies and demonstrate internet/mobile capabilities was particularly important in changing customer behavior

• Strong top-down support and dedicated project leadership – banks with the most successful experiences heavily engaged the executive team in shaping the strategy, structure, business and people decisions; they also established a small, dedicated project team with clear governance and decision rights

iF THiS iS THe FuTure, WHen Will iT Arrive AnD WHAT iS iT WOrTH?

While it is highly unlikely that the uS market will follow the same development curve, or arrive at precisely the same end-point, Sweden provides interesting insights into the future of retail banking and important lessons on making the transformation smooth. Further, given the pace of change in the market, the economic imperatives and long lead-times associated with a change of this magnitude, we do not believe banks can afford to wait to set their strategies once a “future standard” emerges in the uS.

While the transformation may be challenging, the prize is certainly attractive: on a run-rate basis, we believe most banks could double the profitability of their retail franchises, return efficiency ratios to their historical levels and boost returns-on-equity to more than 15%.

Siddhesh Karmali is a Senior manager at Oliver Wyman.

Tim Spence is a Partner at Oliver Wyman.

exHibiT 11: mObile TecHnOlOGY in SWeDen OuTPAceS THe uS

FiNANCiAL/ ACCoUNT MANAgEMENT

balance checks Shake your phone to get balance information

Personal Financial management (PFm)

Single view of all financial holdings, whether with the bank or another provider

Standard functionality

Device-specific rendering (e.g., schedule bills, make transfers, execute trades)

PAyMENTS P2P transfers The six largest banks formed a joint-venture, Swish, to offer real-time P2P funds transfers

AcH/bill pay Take a picture of a bill, and the app pre-populates payment information and remits funds8

mobile payments at the point-of-sale

The largest banks have been piloting qr-based technology in conjunction with Seamless, a Stockholm-based mobile payments firm (a number of major merchants, including mcDonalds, have recently signed on)

iNFoRMATioN gATHERiNg

“Augmented reality” branch locator

Point your phone camera in any direction and the mobile app will show the location and distance of branches within the field of vision


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