How Banks Can Extend Their Digital Relevance

This article originally appeared on Forbes.com.

As technology giants such as Alibaba and smaller specialists such as Mint continue to encroach on traditional retail banking markets, most banks’ business models are not well-equipped to deal with the disruption. The traditional model of providing a full suite of standard products and services through legacy organizations and proprietary channels—branches, call centers, website—does not have enough flexibility and speed to adapt.

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Bain & Company anticipates that the total profit pool for US retail banking will hold roughly steady by 2025 at between $70 billion and $80 billion, but the composition of the pool will look very different. New profit pools such as customer acquisition, customer advice and technology services will grow faster than the traditional banking book and yield higher margins than holding loans and deposits on the balance sheet. They will also secure higher multiples from investors, mainly because these businesses grow faster and require less capital than credit and less operational intensity than deposits.

As profit pools shift, banks will need to increase their reach and relevance by using third-party or cobranded digital distribution. Their viability will hinge on finding new business models, and we expect four models to dominate banking markets:

Infrastructure. Open-banking regulations will require banks to share data and ultimately banking services with other providers. Anticipating this shift, some banks have chosen to extend their core banking infrastructure to other banks or institutions. Bradesco, for example, has given other companies access to some of its core services through open application programming interfaces (APIs). Instead of a bank needing its own infrastructure for transaction accounts in, say, Brazil, the bank can use Bradesco’s balance sheet, regulatory compliance function and other services.

Many banks could be pushed into infrastructure. But forward-looking banks recognize that three other models exist to retain the customer relationship.

Aggregation. This option aggregates in one place a customer’s interactions across multiple financial institutions, to make doing business easier and more convenient. Many online companies now aggregate data across multiple banks and provide customers with some limited insight. One can imagine customers getting greater insight into managing their money, then making payments, investments and borrowing money based on this insight across several financial institutions. They might also have access to an ecosystem of benefits, such as home-buying services and access to special retailing offers. HSBC, for instance, started a mobile app that gives its own customers access to accounts they have with other banks.

Digital pure play. Many fully digital banks such as Atom in the UK and N26 in Germany try to attract new customers, particularly younger ones. These customers tend to want simple service, at competitive prices, often engineered around an innovative proposition. For example, Fidor offers an online community in which customers can turn to their peers for tips and advice and to an ecosystem of services outside basic banking.

The economics of a digital pure play look like a traditional bank, except the business runs off a lower cost base, since it has little or no physical distribution, and collects fees from the providers who fill out the growing ecosystem of services.

Embedded component experiences. A number of banks and fintech firms have set up a branded experience that’s embedded in other companies’ online platforms, complete with a link to customer data and automated decision logic, for transactions such as a credit authorization or identity verification. For example, the Swedish bank Klarna offers online payments and easy collection of payments for merchants. Customers benefit by having their personal details prepopulated for a retail transaction, and getting an easy, secure payment experience.

Banks that offer a strong embedded experience can extend it across business lines and distribution channels, and thus extend their reach and relevance. The economic model here revolves around transaction fees from the retailer or other company running the online platform.

These models are not mutually exclusive. Within a large bank, one business unit could take a utility role providing core infrastructure, while another unit could concentrate on developing stronger customer relationships through one of the other three models.

Banks should not slow down their ongoing transformation of leaning out branches, digitalizing and automating processes, and otherwise removing friction and cost from the business. At the same time, they will want to extend their reach and relevance by exploring the new models. They will likely have to accelerate partnerships with fintechs, retailers or large technology firms. They will also need to invest in customer experience design, cloud infrastructure, APIs or other capabilities that underpin the new models. Turning the flurry of disruption to advantage will not be easy, but banks have no choice but to adapt or become less relevant to ever-more-discriminating customers.

Richard Fleming, Joe Fielding and Eduardo Roma are partners with Bain & Company’s Financial Services practice.