The Path to Profitable Growth in Retail Lending

Narendra Kumar

11 Dec, 2020

Despite the significant recovery from the global financial crisis, the retail banking industry is witnessing significant pressure on margins due to stringent regulations, frequent changes in customer behavior and a vast increase in competitive threat from FinTechs.

As per one of the studies, it has been found that the profit-growth of Asia-Pacific lenders may slow to below 4% annually between 2017-2021 if banks do not take action to address the threat of slowing economic growth, technology disruption, and weaker balance sheets.

Review of global banking which reveals that as much as 40% of revenues and up to 60% of the profits in retail banking businesses – consumer finance, mortgages, small-business lending, retail payments and wealth management are at risk from fin-tech start-ups. Retail lending which has historically been a profit driver for banks is deemed the most at-risk with the increase of peer-to-peer (P2P) and online lenders. The business model used by different traditional retail banks is under threat.

Without the burden of regulations, the limitations created by inflexible legacy IT systems or the huge cost of Bank branches, many online lenders are able to operate business models that are much more efficient and cost-effective than the traditional bank model that is the reason why FinTechs are scoring over the banks.

To bridge the profitability gap with Fintechs, banks must aggressively drive a step-change improvement in all aspects of lending efficiency. Banks must be ruthless in finding and eliminating unnecessary costs. While cutting costs is easy, driving cost reduction in a way that is both sustainable and supportive of the bank’s future growth opportunities is much more challenging. It requires an approach that can enable the bank to optimize operations while delivering enhanced customer experiences rather than just trimming operations.

Latest technology now provides an opportunity to achieve digitally-enabled simplicity coupled with high operational efficiency. Digitizing lending operations involves rightsizing product portfolios, redesigning customer journeys to create seamless interaction across channels, replacing the complexity of the multitude of systems with just a couple of platforms that can handle variety while industrializing and automating core processes from end to end.

Digital investments are best placed in back-office automation, automation had the highest correlation with profitability. Apart from that, when it comes to offering customized products or launching any new products quickly, legacy systems at traditional banks generally have hard-coded rules for every product feature, such as interest rate structures, term lengths, up-front fees, etc. Such inflexible hardcoding does not allow banks to develop or modify products quickly. Capabilities such as paperless loan origination and self-servicing can be extremely difficult to achieve using these systems. Legacy systems, therefore, limit the bank’s ability to roll out new competitive features or service offerings, in addition to restricting their ability to compete on cost, speed or convenience.

Research shows that it is possible to build a new digital bank at a substantially lower cost per customer as compared to traditional banks. While the elimination of costly physical branches has a role to play here, it is mostly due to simplified product offerings and streamlined processes which eliminate the challenges caused by expensive legacy systems. Replacing legacy lending applications with modern third-party systems is, therefore, a key in transforming lending operations.

While many banks have not made much headway in terms of digitization, BCG’s Global Retail-Banking Excellence benchmarking shows that banks leading in measures of operational and digital excellence are seeing significant results in both customer experience and operational efficiency. They are reducing cycle times for core processes while achieving higher rates of straight-through-processing and improving productivity.

As the top-performing retail banks in the world continue to extend their lead over the rest, banks will need to kick-start their digital transformation now. Banks with an overly cautious approach, banks that simply try to wait out the storm will probably find themselves struggling for survival, but those that take action can uncover growth opportunities that could help regain their momentum.

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