The Future of Banking
 
It wasn’t long ago that it would have been nearly impossible to drive down a major street in any American city, town, or suburb without passing several video stores, bookstores, and music stores. Today, nearly all of those bricks-and-mortar businesses are gone, having been obliterated by online disrupters like Netflix, Amazon, and Pandora.

What has taken the place of all that vacant real estate? Bank branches. There are now 94,752 bank branches in the United States, and based on the U.S. population of 318.9 million, there is a bank branch for every 3,366 people.

However, within ten years - and perhaps even sooner - 80 percent of those branches will disappear.

That’s because - just like books, music, movies, and retail of all kinds - bricks-and-mortar banking is about to be vaporized, transformed from a transaction performed in the physical world to one that is accomplished with a swipe on a smartphone.

The crucial point to realize is that financial transactions are no longer about dollars. They’re about bits.

Depositing a paycheck in a savings account, withdrawing money from a checking account, making a mortgage payment, or paying off a business loan no longer requires pushing piles of cash across a counter. Instead, bits of information are exchanged, and those bits can be swapped just as easily - in fact, much easier - when a customer uses a mobile app on a smartphone to connect to a server in a remote facility, versus sliding pieces of paper across a teller’s window.

Those bits can also be transmitted a lot cheaper over the app: In a Wall Street Journal article, William Demchak, president of PNC Financial Services Group, which has 2,900 bank branches, revealed that every time a PNC customer deposits a check by taking a picture on her smartphone instead of going to a teller, the bank saves $3.88.1 Multiply that by millions of transactions per bank per year, and the size of the opportunity becomes clear.

Despite the fact that the thirty largest U.S. banks spend $50 billion per year to keep their branches open and fully staffed, according to research by AlixPartners only 14 percent of U.S. banking transactions are now conducted at branches, while the rest are completed through Internet banking or mobile banking.

What this means is that the American banking industry no longer needs - and certainly cannot afford - nearly 100,000 branches. Over the past two years, according to CNBC.com, despite thousands of new branch openings per year, banks have closed nearly 3,000 more branches in the U.S. than they have opened.2

More importantly, it also means that business models that are based on serving banking customers virtually (with no branches at all) enjoy a competitive advantage. Without the high overhead costs of real estate and personnel to meet customers in person, their cost structure is 90 percent less than established banks.

For that reason, upstarts are attracting a growing amount of venture capital. Such firms - called Fintech businesses, because they merge finance and technology - received $13.2 billion in VC investments in 2014, up from $4 billion in 2013, and less than $1 billion in 2012, according to banking industry expert Chris Skinner.3

Asked by Emerging Markets Review why VCs would invest so much capital, Skinner replied, “Because they can see the returns. In 2014, there were 36 new Fintech startups like Lending Club, Stripe, Funding Circle, and Square, with over a billion dollar valuations. The year before, there were only twelve, and next year, there will probably be over 100.  These new companies are using the mobile Internet to create new peer-to-peer connections for crowdfunding and lending and new payments systems. . . . In fact, a third of the Fintech firms are focused upon P2P value connections like Zopa and TransferWise, while a third are focused upon payments like Klarna and Traxpay.  These firms are really changing the game, and the result is that banks will lose money.”4

How much money?

According to a Goldman Sachs report, banks are expected to lose more than $10 billion of profitability, or roughly one-fifth of the total market, in the credit line of business alone by the end of the decade, as customers opt to borrow from peer-to-peer lenders rather than banks.5

What can you expect as this trend unfolds?

First, just as in previous digital disruptions, established businesses will not survive if they pretend the revolution isn’t happening.

Traditional banks will need to overcome their resistance to change in order to survive the reality of the digital future. According to Skinner, too many bank executives consider digital just another channel, like call centers, Internet channels, bank branches, and so on. Instead, they have to realize that a single electronic channel is the foundation for all of the ways in which it communicates with customers.

Second, the ubiquitous bank branch, which now seems to loom over every street corner in the U.S., will soon become as scarce as a bookstore or record shop.

According to Skinner’s book, Digital Bank: Strategies to Launch or Become a Digital Bank, it’s already happening in Europe, where over the past four years the number of branches has fallen by 33 percent in Denmark, 25 percent in the Netherlands, 17 percent in Spain, 8 percent in Germany, 5 percent in the UK, and 3 percent in France.6 In his book, Skinner quotes a Motley Fool article that reports that traffic in U.S. bank branches has been going down by 4 percent per year over the past sixteen years.7 And, unlike the neighborhood bookstore or record shop, no one is going to complain about the closing of a bank branch. According to Thomas Frey, author of Communicating With the Future, a recent Viacom Media poll of 10,000 Americans found that 71 percent would rather go to the dentist instead of talking to a banker.8 Skinner predicts that 80 percent of today’s U.S. bank branches will close. They will be replaced by self-service satellite stations, where customers can use ATMs or connect to a human advisor via a remote video terminal. The other 20 percent of branches will be turned into sleek stores modeled after Apple Stores with Genius Bars, where customers can get in-person banking advice from people who really understand finance.
 
Third, only a few businesses are currently set up to reap the benefits of digital banking and lending, but this number will rapidly increase.

The current leaders include Alibaba, TenCent, mBank in Poland, Commonwealth Bank of Australia, and ICICI Bank in India. But even these businesses, according to Skinner, are not what he considers truly digital - that is, they still do not have the Internet-enabled core systems that are enterprise-wide and can provide a single view of the customer that allows them to provide the one-to-one personalized digital service they have come to expect.

According to the interview with Skinner, “Personalization is all about making sure you remember what the individual did last time to make it easier for them to do the next time and, for the data intermediary, that’s easy as they’ve got the data.9  Airbnb, Facebook, [or] Google know where you stayed, what you posted or searched for last time, and therefore they make it easier and easier each time you touch their service by simplifying that process on a personalized basis.  That’s what banks and insurers need to do: Connect, simplify, and repeat, by making it personal.  These are the basics of attracting and retaining the customer in the digital age.” In his book, Skinner elaborates that the goal is to use exabytes of customer data to identify what banking services customers may need in real time.10 As long as customers opt-in to the service, a digital bank could monitor their posts on social media and respond with private messages. If a customer Tweets that he is shopping for an expensive new luxury car, it can remind him that his credit score and the balance in his savings account advise against it. If a customer posts on Facebook or Square that she has just landed in Rome on a vacation, the digital bank can send a message detailing its exchange rate, along with a map of the closest ATMs to her hotel.

Fourth, just as mobile phone technology penetrated developing economies more rapidly because they lacked the landline infrastructure that slowed adoption in the developed world, digital banking will be embraced even more swiftly in China, Eastern Europe, and Africa than it will in the U.S.

In the past, banks didn’t bother to build branches in impoverished areas where the potential for profit was low. But now that billions of people are connected to each around the world via smartphones, everyone will be able to communicate - and sell to, or borrow from - everyone else.

As Skinner puts it, “Goat farmers in Ethiopia will be able to sell goat products - leather hides or crafts made from goat hide - to Korean buyers via QQ pages, Wechat photos, text-messaged payments, and Alipay logistics.  That is an amazing new world and amazing new concept.  Everyone on this planet can buy and sell anything with anyone, anywhere.”

Fifth, as in the early stages of any industry disruption, it is too early to predict which new businesses will triumph in ten years, but a few companies seem particularly promising at this point.

Among them are Square, Klarna, Stripe, Currency Cloud, and TransferWise in transferring payments. In lending, the preliminary leaders are Lending Club, Prosper, Kabbage, Zopa, and Funding Circle.  It is worth noting that venture capital firms are pursuing lending and payments investments more aggressively than any other aspect of digital banking, representing two-thirds of the $13.2 billion that they invested in Fintech startups in 2014.

References
1. The Wall Street Journal, March 31, 2013, “After Years of Growth, Banks Are Pruning Their Branches,” by Robin Sidel. ⓒ 2013 Dow Jones & Company, Inc. All rights reserved.

http://www.wsj.com/articles/SB10001424127887323699704578326894146325274

2. CNBC News, November 2014, “Bank Branches Slowly Fading Away in Neighborhoods,” by Jeff Cox. ⓒ 2014 CNBC LLC. All rights reserved

http://www.cnbc.com/2014/11/13/bank-branches-slowly-fading-away-in-neighborhoods.html

3. The Finanser, September 1, 2015, “The State of Digital, Fintech and the Future Bank,” by Chris Skinner. ⓒ 2015 Financial Services Club. All rights reserved.

http://thefinanser.co.uk/fsclub/2015/09/the-state-of-digital-fintech-and-the-future-bank.html

4. Ibid.

5. The Finanser, May 13, 2015, “Goldman Sachs Estimate 20% of Bank Lending Will Move to Alternative Finance ($12bn of Profits Lost),” by Chris Skinner. ⓒ 2015 Financial Services Club. All rights reserved.

http://thefinanser.co.uk/fsclub/2015/05/goldman-sachs-estimate-20-of-bank-lending-will-move-to-alternative-finance-12bn-of-profits-lost.html

6. Digital Bank: Strategies to Launch or Become a Digital Bank by Chris Skinner is published by Marshall Cavendish Business, an Imprint of Marshall Cavendish International. ⓒ 2014 Chris Skinner. All rights reserved.

7. Stock Gumshoe, June 19, 2013, “‘Big Banking’s $20.8 Trillion Secret’ Pick from David Gardner,” by Travis Johnson. ⓒ 2013 Stock Gumshoe, Inc. All rights reserved.

http://www.stockgumshoe.com/reviews/motley-fool-rule-breakers/big-bankings-20-8-trillion-secret-pick-from-david-gardner/

8. Communicating with the Future: How Re-engineering Intentions Will Alter the Master Code of Our Future by Thomas Frey is published by DaVinci Institute. ⓒ 2011 Thomas J. Frey. All rights reserved.

9. The Finanser, September 1, 2015, “The State of Digital, Fintech and the Future Bank,” by Chris Skinner. ⓒ 2015 Financial Services Club. All rights reserved.

http://thefinanser.co.uk/fsclub/2015/09/the-state-of-digital-fintech-and-the-future-bank.html

10. Communicating with the Future: How Re-engineering Intentions Will Alter the Master Code of Our Future by Thomas Frey is published by DaVinci Institute. ⓒ 2011 Thomas J. Frey. All rights reserved.