US Banking: 30 by 2030 — Strategies for Banks & Financial Institutions

The current Fintech and Banking landscape in US contains about 5000 FDIC registered banks (Top 100 Banks 82% market share), 5100 Credit Unions and over 8000 VC funded Fintech’s.

As posited in our previous article, we strongly believe that the banking industry will undergo a round of consolidation driven by focus on scale, and FinTech disruption leading to 30 dominant banking services providers by 2030. Based on the consolidation trend, the options available for banks are centered around a combination of (1) Focus on Scale; (2) Transform to Fintech & (3) Harvest and Exit.

Each bank will choose its own path, based on the time horizon that each bank defines for itself, geographic focus, current positioning, organizational capabilities long with available resources such as capital, talent etc. The greatest influencer of choices the banks make will be the current leadership teams’ mindset and ability to lead disruptive change.

To enable us to understand the strategic options identified below, we decided to explore a parallel or two that could provide an analogous glimpse into the future of banking and make it easier for banking leaders to adapt and leverage those options.

The $ 5T US Retail industry is a poster child for technology driven disruption coupled with consolidation. An initial review of the retailers in US revealed that each of the Top 5 retailers each are built at a national scale and differentiated to dominate a different retail vertical.

Walgreens, Kroger, Target, Lowes and Albertsons round out the list of Top 10 US retailers and together the Top 10 retailers own over 41% of US retail.

With the initial retail insight into scale and differentiated vertical we identified Grocery as a common sub segment of offering among the Top 10 retailers (Walmart, Amazon, Costco, Kroger, Target, Albertsons, Lowes). Hence, we took a deeper dive into the $600 B US Grocery industry.

The Top 7 Grocers, operating under multiple brands own over 82% market share. Walmart alone owns over 40% market share. A clear scale and national/regional dominance theme emerged. The Top 7 Grocers have benefited from economies of scale, pooled demand to reduce costs, acquired and/or merged as necessary and invested heavily in technology solutions to establish their dominance. The numbers from the high-level analysis of the Grocery industry reveal a market share story very similar to banks (Top 4 banks 42% market share, Top 100 banks 82% market share with a bias towards further consolidation)

A handful of grocers have followed a regional domination strategy. Publix, a regional grocer (~20% FY 20 growth rate), is getting close in size to the 4th largest national grocer Ahold Delhaize (~12% FY 20 growth rate). When looked at carefully, the regional grocers’ strategy and tactics are very similar to the one followed by the national grocers, just on a smaller scale.

The key takeaways from Retail and Grocery industry review were

1. Focus on an industry vertical and build scale to dominate,
2. Define a regional (if not national) geographic focus to dominate but compete with national players
3. Invest in technology on an ongoing basis

A review of additional industries such as PC manufacturers, Cloud Technology providers, US Browser, Telecom Mobile Providers to Global Container Shipping, Smartphone manufacturers, Global Aircraft manufacturers, US Railroad transportation companies, US Meat Processing companies et al. reaffirms the strategy of scaled industry vertical focus as well as the differentiated regional dominance strategy. The market share dominance by a handful of players is very notable in each of those industries.

Given the regulatory constraints imposed on the Banking Industry to ensure competition and access in the marketplace, we do not believe that just a handful of players will achieve similar dominance as that in the US Grocery Industry. However, the regional and differentiated offering template is a key tactic for banks to follow.

Strategies for banks and financial institutions

The Top 10 banks, having already embarked on the journey, have achieved the necessary scale and have been focused on Fintech and differentiation strategies by creating, acquiring, or strengthening their new age ecosystems.

The broader set of strategies in this article are primarily targeted for banks that fall outside of the Top 10. A handful of the Top 11–100 banks have also started on some scale and differentiation initiatives. However, the Top 11–100 banks need to start executing faster on a larger set of scale and differentiation initiatives e.g regional acquisitions without diluting their brand and creating their own ecosystems or partnering in the established banking ecosystems.

Banks outside of the Top 100 will need to focus on building scale (several multiples of current size) while laying the foundation for Fintech acquisitions. Banks in the bottom 50% (ranked by assets) will need to focus on balance sheet cleanup (for increased valuations) and partnering initiatives with Fintech (Bancorp and Chime partnership) for survival and/or prepare to be acquired.

The common set of key strategies for US banks to follow are -

1. Merger & Acquisition: for scale (nationally, regionally, geographic) or for increased breadth or focus on segments — Retail, Commercial, Wealth, Investments, Infrastructure leasing/lending, PE, VC etc.
2. Operational excellence with ongoing focus on Continuous improvement
3. Build, Buy, Partner for Fintech Innovation
4. Digital Business model transformation (Customer Experience, Value Chain Differentiated, Technology and Data Driven)
5. Crypto and DeFi based banking

The strategy formulation and decision-making will be difficult and require leadership that has the appropriate growth mindset and the intestinal fortitude to lead and drive the change.

We repeat, each bank will need to formulate its own strategy, make its own choices, set its own goals, and chart a path based on a realistic self-assessment — capabilities, strengths, weaknesses et al. all with the focus on where the bank sees itself or wants to be in 2030.

Based on its strategy formulation and a longer-term target, each Bank will need to identify a set of 3–4 Priorities to be executed in 3-year increments (Now, Next, After Next). Strategy is game of choices and the set of strategic choices at the start of each such increment will be influenced by each banks’ execution and the position in the ecosystem. Over the longer term the strategy choice themes will end up being Scale, Transform, Exit.

1. M&A for Growth and Transformation

Banks will have to pursue M&A as a key part of their growth strategy. M&A will be characterized by the need for scale, acquiring regional market share, increase breadth of products/offering capabilities and technology capabilities.

Identify a vertical and dominate nationally –Focus on an industry vertical that the bank wishes to excel at (believes it has a ‘Right to Win’) and take necessary actions to dominate that vertical.

Regional focus, Geographic dominance — Focus on establishing dominance within a region

Diverse Product and services offering — Focus on adding a core competency vertical to increase the overall breadth of product and services offering.

As a starting point each bank should identify a core competency vertical but also target building a diverse product offering portfolio like a national player just at a smaller scale. E.g., Verizon in NY, Meijer in MI, HEB in TX.

2. Operational Efficiency and Effectiveness

Banks will need to develop data driven, AI/ML enabled operational efficiency and effectiveness models. Business processes and operational playbooks will need to be accordingly aligned to drive sustained value creation at an accelerated pace.

Investments in Data analytics, AI and Blockchain are no longer growth plays, but an operational effectiveness need. The data driven, AI augmented decision making is a journey and banks will see enhanced benefits by placing data analytics and AI/ML at the heart of all functions and operations of the bank.

Enterprise risk models will need to increase the weightage assigned to customer insight.

3. Build, Buy, Partner for Fintech Transformation

Larger financial institutions such as JP Morgan, Goldman Sachs, Bank of America, Fidelity, Vanguard all have active and thriving investments in FinTech and created ecosystems, having executed the entire Build, Buy, Partner playbook.

Mid-tier and regional banks such as State Street (Technology Innovation in Blockchain), PNC Bank (Industrial Private Equity), Schwab (Intelligent Investor Portfolio) have been equally active and executed smaller initiatives based on geographic, personnel capabilities and business need.

The smaller banks will need to assess their technology capabilities vis-à-vis the available ecosystems and place bets accordingly, in terms of joining existing one or more of the ecosystems — a win-win scenario. Chime, a VC/Wall Street favorite, is a financial technology company that offers fee-free mobile banking services provided by The BanCorp Bank/Stride Bank. Chime is valued at $14.5B, while market cap of BanCorp is $1.3B.

Goldman, JP Morgan, Citi Fintech Bets

Goldman Sachs, JP Morgan, Citibank, Bank of America already have established positions in terms of scale and have been focused on Fintech enabled transformation through Build, Buy, Partner as evidenced by the chart as well as by more than 130 post Series A fintech bets by these organizations in the last 3 years.

Marcus, by Goldman Sachs, with ~ $100B deposits, aspires to be the leading digital consumer bank and has been active in partnering with well-established brands such as Apple and Amazon.

Vanguard robo advisory has $231B in Assets Under Management (AUM) in 2020 vs $17B in 2015 and $65B in 2017. Vanguard competitors in the robo advisory business include Schwab Intelligent Advisors ~$61 B, Betterment ~$27 B and Wealthfront ~$25B in AUM.

Fintech focus areas by Banks in 2020

Fintech’s typically focus on addressing a customer need, opportunity and then scale up to own a large percentage of market share in that segment.

Here is a breakdown of key areas that FinTech’s are working in. Banks need to consider one or more of these when thinking about Build, Buy or Partner initiatives.

4. Digital Business Model Transformation

Operational model transitions are the most challenging, risky and need to be executed gradually. Banks will need to embark on a journey of transformation of knowledge base, cultural mindset, view of risk, and the entire operational value delivery model from the lens of customer value delivery, customer journey mapping, speed of customer outcome, customer retention and scale.

True digital transformation is about transforming business models/processes rather than just mere digitization or platform replacement. Establishing the modified operational model and reimagining the enterprise-wide value chain with a ‘customer first’ mindset will ensure success of the digital transformation

People/Mindset/Culture

Digitally transformed banks will need to rebuild teams and culture with an Innovation mindset. Traditional silos of IT, Sales and Operations will need to be broken down. Scaled and agile team’s organization structures aligned to delivering customer value will need to be built. Banks should strive to invest in people and operations with innovation and growth mindsets or will find themselves making sub-optimal return on their technology and operational investments.

Building an Innovation mindset is a journey and needs sustained focus and significant investment. Banks may choose to launch large-scale initiatives to start transforming themselves into Technology First/Fintech organizations but such initiatives are inherently high-risk/high-reward.

Customer Based Value Model

The traditional bank mindset and measures of valuation such as Market Value/Book value will need to evolve. Traditional operating metrics that bank leaders focus on are Efficiency ratio, Loan to Deposit Ratio, Capital Ratio.

These ratios, vital for Wall Street and Investor Relations purposes, will be augmented with relatively newer metrics such as Customer Acquisition Cost (CAC), Customer Retention Rate (CRR), Annual Recurring Revenue (ARR), Lifetime Value (LTV) of a customer as key success/valuation metrics. This customer-based model will become the norm for valuing technology companies offering banking services.

5. Crypto and DeFi based banking

Crypto and Defi based banking threatens to upend the current US banking system from the following perspectives

Money outside traditional banking system

Crypto became mainstream in FY 2021. Crypto topped $2 T in market value in April 2021 and is a $1.6 T market even after the recent pullback. Crypto market represents the money outside the traditional US banking system such as bank accounts, ETF’s mutual funds etc. This chunk, growing at a rate greater than 10% per year is taking away money from US banking. Banks need to join the the revolution and enable Crypto in traditional banking.

Disruption by Decentralized P2P approach

Beyond the money outside the traditional system, Crypto has given birth to protocols such as Ethereum, Cardano etc. and the peer-to-peer approach of Crypto threatens the centralized nature of US banking. With the security provided by blockchain the traditional role of banks as trusted intermediaries is threatened.

Ethereum 2.0 to be released in late FY 2021 with its current support of smart contracts, DApps etc. will start support transaction rate scalability (15–17 K transactions per second) that might be acceptable for some banking systems. Blockchain provides all banks an opportunity to rethink their IT approach from a scalability, agility perspective.

International trade finance settlement

Countries such as India, China are actively executing e-currencies pilots. Countries such as El Salvador whose traditional currency is devalued against the US Dollar, Euro, Yen now accepts Bitcoin as legal transaction tender. Similar efforts for currency, smart contracts etc. are active in Africa and Middle East. The traditional role of US Banks in trade and settlements as well as the role of reserve currencies will be threatened in 5–10 years.

US Banks and Crypto efforts

A handful of US banks such as JP Morgan, Goldman Sachs, State Street, BNY Mellon etc. initiated a dedicated focus on Blockchain/Crypto 5–6 years back. US Bank started on their Crypto/Blockchain initiative in 2015. In April 2021, US Bank was named as the custodian for the NYDIG platform, an institutional grade platform for Crypto based asset management, derivatives, financing, insurance etc.

NYDIG through Open API’s is open to Fintech’s, Banks and other FI’s and has already announced partnerships with FIS, Fiserv, Allied Network etc. within the last 3 months. As of June 23, 2021 NCR with its relationship with NYDIG will be offering Crypto access to over 650 credit unions. State Street built and launched a Crypto exchange in FY 21. BNY Mellon, Bank of America etc. joined as participants in the exchange in July 2021.

In short, Blockchain and Crypto are mainstream in FY 2021. Banks need to initiate appropriate Build, Buy, Partner efforts to provide expected and appropriate Crypto based services to the customers in the short term while preparing for the Blockchain/DApps led disruption in 2–3 years.

Recommendation for Bank Leaders

US banks are in a strong balance sheet position at this time and have benefited from the policy decisions and actions taken by the Federal Reserve to promote economic and financial stability and ensure liquidity in the markets.

Most banks are faced with continued pressures of operating and growing through the current business model and mindsets that have served them well over decades of their existence. However, that heritage will no longer suffice. The interplay between scale and technology capabilities in ensuring sustained growth and profitability is now very clear.

In conclusion, US Banking is on the cusp of disruptive transformation. It is up to executives to make a directional call towards Scale and Transform or Exit.

Postscript

This article, is the second article in our series of the future of US banking. The next article in the series will cover Digital Transformation approaches and models. As before we will be happy to hear more views and collaborate on some of the upcoming topics.

• Practical approach to Digital Transformation
• A comparison of Valuation traditional banks v/s Neo banks
• US Banking: AI, Machine Learning, Data Analytics, Behavior Analytics

Gautam Gole

gautam.gole@gmail.com

Makarand Kelkar

mak.kelkar@icloud.com