We’ve met the enemy. Is it us?

19. October 2017.

Almost since the arrival of the internet, community bankers have been hearing “the sky is falling.” If they didn’t change their ways they would face obsolescence. The emergence of fintech players and such technologies as artificial intelligence (AI) and machine learning (ML), has only heightened the rhetoric.

Despite these claims, and the negative trends over the past 30-pus years stemming from what we call the Five Future Forces (changes in regulation, the economy, competition, shifting customer needs, and technology), most community institutions continue to do the business of banking much the same way as their predecessors did, focusing on relationships and personal service, while updating their technology periodically as their core processor contracts came up for renewal.

This is not to suggest these future forces haven’t been impactful. Indeed, the number of financial institutions have dropped dramatically over time: currently there are 5,779 banks, and 5,857 credit unions in the U.S.; those numbers topped 14,000+ for banks in the early 1980s, and 23,866 credit unions in 1969.

Is gradual change giving way to something more?

Do the newer trends in AI, fintech competition, and shifts in customer and member expectations—mostly centered around the digitization of banking—represent some sort of new order?

Will the transition from physical to digital banking remain limited in scope like now, with adoption of online and mobile banking and some new niche competitors?

Or will it represent a true paradigm shift in banking, permeating most of what we do in getting and serving customers?

And if the digital transition is to become truly significant in impact and likely to become commonplace, when and how must community institutions plan and adopt new ways of doing business? Further, what role will relationships and personal service play in this new environment for community institutions?

Slow change won’t continue

Bankers don’t appear to be significantly affected … yet. In a survey we conducted with Florida’s CenterState Bank, only 17% of institutions reported losing real business to non-traditional digital lenders. However, those same bankers acknowledge the threat is real, with 81% of bankers expecting to lose significant or some business to them over the next five years.

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The reality is that digitization has already reinvented many industries, most notably retailers, media and entertainment, and the taxi business. Significance to the banking industry will likely be as profound, albeit slower in coming, given customers’ and institutions’ hesitancy to adopt change when it comes to matters of money, finance, and risk.

Although slow in adoption to date, performance gains stemming from the digitization of banking are powerful and irrefutable.

For example, Rocket Mortgage by Quicken has grown to be the third-largest mortgage originator, and the highest in customer satisfaction (as measured by JD Powers), by digitizing the entire mortgage process and thereby improving approval times from an industry average of 26 days to only 18 days.

Live Oak Bank (North Carolina-based, but operating nationally) and Seacoast Commerce Bank (San Diego-based and operating regionally) have transformed SBA lending, with Seacoast now able to fund SBA 7A loans in 30-45 days, versus 90 days common at other major SBA lenders. They’ve done so by digitizing the entire lending platform.

USAA, the ninth-largest US bank and a perennial member satisfaction award winner, has benefitted from digitizing the entire retail banking process and delivering it exclusively on a remote basis.

Moreover, Univest Corp. of Pennsylvania has trimmed small business lending decisions and funding from weeks to days, while also dramatically cutting expenses.

This time is different

As a result of these and other significant performance gains, there can be little doubt about the likelihood that these shifts will become permanent and omnipresent sometime in the future. But when?

Nearly all major banks, along with some regional players and a few progressive community institutions, are currently testing digital technologies such as AI and ML. Some are already deployed, especially in fraud detection. (An excellent overview of AI and ML can be found in the article “The Business of Artificial Intelligence,” in the July 2017 online issue of Harvard Business Review. Many articles on AI and ML have also appeared on BankingExchange.com)

Many observers, including some bankers, expect broad rollout within two or three years. At that point, when combined with other digital tools and workflow improvements, customer acquisition becomes more targeted and effective; underwriting, processing, and funding all become safer, faster, easier and at a lower cost. Digitization will also bring enhancements to risk management.

As a result, banking will be forever changed.

Competing institutions will be forced to adopt digitization and other processes in order to compete against more agile, lower-cost, and more effective competitors—or risk irrelevancy and lost earnings. Customers will come to expect faster, easier, and cheaper as a minimum requirement for doing business in the banking space.

As a consequence, relationships will matter far less as a value proposition. That may sound like heresy, but how valuable will relationships be if the institution is slower, more difficult to work with, and more expensive?

This time is indeed, different.

Most community bankers are unaware of how soon this seminal change will be here. Chris Nichols, CenterState Bank’s chief strategy officer, predicts online lending will comprise 50% of loan production in three short years. Making the threat even greater is the fact that online platforms can originate loans at a 15% efficiency ratio, as opposed to a more typical 75% efficiency ratio with non-digital originations.

As for timing, this quote from “How to Make Sure Your Digital Transformation Succeeds,” in the August 2017 issue of Digital McKinsey, sums it up:

“… If you don’t act now, it might be too late a year from now. It will definitely be too late two years from now, and you might not have a right to play three years from now.”

[Also read: “Farmer Jones wants mobile banking,” in BE’s Next Voices blog]

Four steps to thrive amid the change

Community institutions will be able to compete, but only if they recognize in time the need to take action, and then take the proper strategic steps to ensure their viability. In fact, “the most nimble and adaptable companies and executives will thrive,” as stated in the HBR article.

In order to play and thrive in the coming years, community bankers should be developing and implementing the following strategies now in their current strategic plans:

Prepare and activate a clear technology plan to transition platforms and workflows from physical to digital, with an emphasis on making customer-facing and internal operations faster, easier, more accurate, and more cost efficient.

Form cross-functional teams, including outside of IT, to oversee the transformation to digital, and provide them with the resources to succeed. Make successful implementation a strategic necessity. Leverage the latest tools, including AI and ML; they are currently available at a reasonable cost.

Seek top-of-peer performance, to ensure covering your cost of capital and keeping stakeholders happy, by finding and executing a sustainable business model. For community institutions, that typically means finding and being the best in a particular niche line of business or developing a strong affinity and emotional connection with your customers or members.

Create a goal of driving down your efficiency ratio into the lower 50s (where the large banks are currently), 40s, and eventually the 30s, by reducing costs through the use of technology and greatly curtailing physical branch building, and also by increasing yields by adding and realizing value in your business-line offerings and delivery.

Look in your mirror to see Problem #1

Acquiring the technology is not the biggest challenge for community and regional institutions. Nor is competing effectively against others in this digitized environment, or meeting customer expectations. Rather, the biggest challenge for community bankers is themselves.

With digitized competitors yet to take a significant chunk of banks’ business away, the threat seems all too distant. For community institutions who are typically risk adverse, compliance focused, and hesitant to change, “business as usual” seems to be the easier, safest and less costly choice for now.

Unfortunately, the most likely responses to the digitization of banking over the short term by community bankers will be “we’re monitoring it,” or “we’ll work on it in the future,” or worse, “this too shall pass.”

Yet, as discussed here, the digitization of banking is right at our doorstep. The impacts are significant. The consequences of inactivity are real. The time to act is now.

So ask yourself: We have met the enemy. … Is it us?

About the author

Joseph H. Cady, a Certified Management Consultant, is the Managing Partner of CS Consulting Group LLC, a San Diego-based strategy consultancy specializing in financial institutions. He is a frequent national speaker and contributor to banking publications. His observations are based upon nearly three decades of strategy formulation and implementation experience with managements and boards from financial institutions of all sizes. Cady can be contacted at (858) 530-8250, or via email at [email protected]

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