Would you much rather self disrupt or self destruct?

To those who reckon banks are going to keel over and die in the face of disruption from non-traditional contenders, I have a piece of advice. Hang on. It isn't going to happen so fast

K Ramkumar

[Photograph by Richard Tanzer under Creative Commons]

Yes. I am aware. Obituaries are being written on how banks are going to implode in the face of disruption. For instance, even as I write this piece, media reports are exploding with stories of how non-traditional players can now be a part of the financial services business using wallets on electronic devices. As developments go, it is an interesting one. But I have only one submission to make. It is a little too early in the day to write obituaries for all of us who have been around for as long as we have. Allow me articulate why.

The real threat, not just to those in the financial services business like banks, but to any industry, is not a competitor that threatens to disrupt. It is the inability of established players to play the game right. Most lack the foresight and risk appetite to embrace technology and shut newcomers out.

The way I see it, newcomers into the business are under constant pressure to deliver profits. Their honeymoon periods with investors wane. And when the money they’ve burnt fails to deliver returns, things begin to get horribly uncomfortable. On their part, established players can force this to happen. But to do that, they must demonstrate the courage and wisdom to shed baggage from the past and create a war chest to make life difficult for cash burning, fresh off-the-block, so-called disruptors.

Leaders who hesitate, or worse still continue to burn money by clinging to old notions like fully manned bank branches, do not need these external disruptors to make life difficult for themselves. They will kill themselves.

To put this into perspective, some understanding of how banking evolved over a few hundred years is pertinent.

When the barter system gave way to value denominated coins, what we now call the financial services business was born. The need for intermediation came alive. The earliest formal institution, which we now identify as a “bank”, emerged out of Venice and was promoted by the Medici family. For 500 years now, their purpose has remained much the same.

  • Move money from one person or entity to another and from one place to another, safely and credibly.
  • Stand as a guarantor in trade-related transactions between two or more parties.
  • Aggregate idle money and make it productive.
  • Deploy idle money to where there is a requirement, beyond the capital markets.
  • Function as settlers for the capital markets.
  • Function as capital raisers and distributors of capital market products.
  • Broker consolidation through mergers and acquisitions, to make capital more efficient.
  • Deploy money in the most efficient manner for wealth creation at all levels—whether it be for governments, enterprises or individuals.

But the structure and process by which the financial services industry has stayed true to this purpose, has periodically undergone changes. In fact, banks were the first formal structural entities that emerged to deliver financial services. Along with banks, many non-banking financial service delivering entities have competitively co-existed. Each time a non-banking industry identified a new need of the society and walked into the space to take charge of it, panicky pundits predicted the death of banks.

Cases in point? The informal, sometimes even illegal, parallel banking system, which has prospered for centuries. It has successfully kept away a large revenue and profit pool from the formal financial services system. This suggests customers find value, no matter what the structure of the entity, which delivers them a financial service. Every structure has its core, loyal customer segments.

The single biggest disruptor, not to the industry, but to the structure of the industry, has been technology. In fact, technology has even influenced and shaped regulation. The advent of Morse code created huge arbitrage opportunities for trans-Atlantic movement of money even as it created value for the customers.

Innovation in communication technology has been the biggest disruptor thus far. But the banking business has assimilated all of these threats into its fold.

When credit cards made their appearance, an epitaph was written for the banks. How many pure card companies have survived? And what part of the total revenue pool have they managed to take out of banks? On the contrary, every innovation has expanded the revenue and profit pool of banks.

The beauty of technology is that it gets commoditised within months. The question is, what share of the revenue and profit pool will current and potential cede? That depends on how much headway banks give disruptors. Let us take for example payment disruptors of the kind I had alluded to earlier. They are deploying mobile technologies to create virtual wallets and everybody is gung ho about them. But let us look at the facts.

The total share of payments-driven, fee-based income is a fraction of the universe of revenue and profits for the financial service industry. Players who are getting in now are focused mainly on the retail segment. But the share from the retail segment in payments is even smaller.

Bear in mind, banks and non-banking financial service players make the major share of their revenue and profits through the net interest income (NII) and income from investments. The largest share of income even in the payments segment comes from entities, private and government; and not retail. The payment industry has to make its revenue largely from the fee. To that extent, the float is likely to be wafer thin and transient.

In every industry where a proposition has been made for decades that if you get market share and volume first, pricing power will follow has been proven wrong. I think this will hold true for the payments segment as well.

The banks may appear tardy now. But anyone counting them out will do so at their own peril. Sure, a share of the new expanding market will be taken away by the disruptors. But this will not be a share out of the current pool of banks. Banks will join in and grow this market and take a healthy share for themselves. The new non-banking financial disruptors will at best be new and additional competition to established players—not the ones who extinguish them.

The real risk lies in that banks are blind to the revenue and profits staring them in the face. Technology is making heavily manned bank branches redundant. Almost two-thirds of the cost of banks are locked in the operating expenses of the branches. Less than 10 percent of customers ever visit a bank branch; the more profitable ones almost never. Even the first-time-to-banking customers do not come to a branch to open a bank account.

More than 75 percent of the banking products are sold outside the branch. Even the 25 percent is merely booked into a branch, but rarely sold inside its precincts. Almost 80 percent of customer servicing happens on alternate channels.

The fully automated branches and the automatic cash acceptance machines are shrinking the space requirement of a branch and the number of people who need to be stationed inside a branch. The profit pool to be harvested from this is many times more than the profit pool that any payment disruptor can take away.

My argument is not that we need to ignore one for the other. Branch automation and cost rationalisation in my estimate has a minimum 25 percent to offer to profit accretion of the banks’ retail segments. In less than 10 years, bank branches will be similar to landline phones; a supplementary channel and not the main channel.

So long as traditional players don’t lose sight of facts like these and stay open to embracing disruptions, there is no need to lose sleep yet.

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Srikanth Rajagopalan on Aug 21, 2015 3:23 p.m. said

It's interesting to note that you see the biggest benefits of technology for a bank to be lower costs and the reduced need for human service delivery. This argument has two flaws:

(1) By making a service impersonal, you commoditize it. The application that delivers the best value and experience creates a sticky customer relationship and monetizes that relationship, reducing the service provider to a dumb pipe. Think of telcos and OTT services such as WhatsApp and Skype. Show me one service provider in an open market (i.e., customers have choices of equal quality and low switching costs) that has built a sticky customer relationship. The best such example, mPesa, is not a banking service :-)
(2) The value of technology innovation is in its interoperability and scalability. I'm yet to meet a banker who can think of a payments product that does not begin and end with the bank's own customer, and imposes all manner of needless friction in adoption and usage in the name of security.

The best play for a bank is to go back to its roots - of being a guarantor and custodian - an intermediary that enjoys its trusted status by sovereign fiat ... until cryptocurrencies make even this role redundant.

About the author

K Ramkumar
K Ramkumar

Founder and CEO

Leadership Centre

K. Ramkumar is the founder and CEO of Leadership Centre, an institution dedicated to building world-class thought and practice in the domain of leadership consulting, research and development.

He is a retired executive director of ICICI Bank and retired president of ICICI Foundation. He has completed his Post Graduate Diploma in Personnel Management from Madras School of Social Work in 1984. He joined the Board of Directors with effect from February 1, 2009.

Prior to joining ICICI Bank in 2001, Ramkumar served companies such as Hindustan Aeronautics, Brookebond Lipton India Limited (now Hindustan Unilever Limited) and ICI India Ltd. His work in these companies has mainly been in the areas of Human Resources Management and Manufacturing.

While at ICICI Bank, he was passionately devoted to Leadership Development, Succession Management, building a supply chain for the Bank’s human resources requirements, leveraging technology to innovate, and driving operational excellence for world class service quality.

Institute for Finance, Banking & Insurance and ICICI Manipal Academy for Banking & Insurance were conceived and nurtured by him. The partnership Initiatives with SEBI – National Institute for securities management and with NIIT - the NIIT University, were also nurtured by him. He led the CSR project of ICICI Foundation on skilling youth and promoting livelihood. This is done under the ICICI Academy for Skills, which has 21 centers offering 13 skills to 25,000 youth per year.

He writes extensively on a range of topics on his blog www.theotherview.in. He invites you all to be active contributing members of this blog.

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