There is no respite in banking. With profits starting to recover after the financial crisis, the regulatory and compliance overhaul largely completed and costs slashed, bankers could be forgiven for wanting to go slow on further disruptive change. 

But two recent reports suggest that no such luxury can be afforded. In its annual banking review, McKinsey claims that on the retail side in five major businesses – consumer finance, mortgages, SME lending, retail payment and wealth management – 10% to 40% of revenues and 20% to 60% of profits will be at risk by 2025 due to the market impact of fintech firms. 

The greatest impact will not come because the fintech firms will steal large parts of the business, but more because their efforts will result in margin compression across the entire business, according to McKinsey. 

The industry fear for some time has been that the banks could lose the valuable customer relationship to more tech-savvy competitors and end up as payments utilities. But, according to a report from Deloitte called ‘Payments disrupted – the emerging challenge for European retail banks’, they cannot rely on even that rather unsatisfactory outcome. “Deloitte expects the status quo, in which payment systems continue to be run by and for the major banks, will not survive as EU regulations will not permit it,” says the report. 

So what is to be done? Most large banks now have innovation centres and are busy exploring everything digital from mobile apps to blockchain. All the same, innovating in a large, highly regulated organisation such as a bank presents challenges in pushing ideas through the bureaucracy. What’s more, banks don’t seem to be spending sufficiently. Deloitte estimates that banks only accounted for 19% of an estimated $10bn in overall fintech investment in 2014, while non-banks accounted for 62%, with the rest coming from collaborations. 

The accepted wisdom was that the banks would eventually buy the fintech companies and so leverage off their innovations. McKinsey disputes this idea. “We do not think the answer is simply to acquire great fintechs and integrate them into the business,” says a McKinsey consultant. “For one thing, valuations are high. We may be at, or near the top, of the latest Silicon Valley cycle.”

So this means banks can either wait until the cycle turns and hope to pick up assets on the cheap, or start to invest even more in their own transformations. It may be a hard sell to boards and shareholders at a time when return on equity in many banks is not much greater than the cost of equity. 

Furthermore, some banks will get it wrong and make bad acquisitions or poor transformations, so costing shareholders even more money. But doing nothing isn’t really an alternative in a market where all yesterday’s assumptions are being challenged. Banks will just have to get used to living in a world of perpetual change.

Source : Brian Caplen is the editor of The Banker.