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Banks have limited window to decide how to respond to threat of digital disruption, says McKinsey

Out-Law News | 01 Oct 2015 | 10:19 am | 2 min. read

Banks have a limited window of probably no more than three years in which to decide how to respond to the threat of digital disruption, according to a new report by McKinsey.

The market analysts and consultancy business said retail banks could lose up to 40% of their revenues and 60% of their profits by 2025 as a result of competition from financial technology companies and other new entrants to the consumer finance, mortgages, SME lending, retail payments and wealth management markets.

"Attackers will likely capture only a small portion of these businesses; most of banks’ losses will come from margin compression as attackers force prices lower," McKinsey's Global Banking Annual Review 2015 said. "Corporate and investment banking will be much less affected."

"Many banks will have to reset their strategic direction. They have two choices. They can take the battle for the customer – the defining dynamic of the next 10 years – to the upstarts, by mastering the customer relationship, creating an emotional connection and leveraging their data treasure to deliver a superior customer experience. Or they can retreat, excelling at the basic business of financing and providing their balance sheet to others for resale – another option, but one that requires substantial simplification and cost-cutting. The window for making this choice is narrowing; banks must decide soon, probably within three years, or the choice will be made for them," it said.

Banking law expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, said, though, that high street banks have some advantages over new entrants to the market which can help them win and retain business in an increasingly competitive digital environment.

"As the McKinsey report highlights, the potential increase in regulation facing non-banks entering banking markets could shift the competitive balance in favour of incumbents," Anderson said. "New entrants to the market currently operate outside many of the regulatory restrictions which traditional banks are bound by."

"Should a major cyber fraud take place then it might also persuade consumers and companies to take their banking business back to brands that they perceive offer quality and safety in that respect. The major high street banks would fare well in that regard.  In addition, other factors weigh in favour of banks, including the fact that financial technology companies are untested in a recession, whilst there is also a feeling in the market that some of the prices being offered by new challenger banks may be unsustainable when quantitative easing comes to an end," Anderson said.

McKinsey said that the banking market will change over the next decade and impact on banking economics and business models in a "much more substantial" way than the financial crisis did. A "digital revolution" together with increased regulation will be behind these changes, it said.

McKinsey said that "dramatic" changes could affect banks' "core business of deposit-taking, lending and current/checking accounts for retail customers" in particular.

"The substantial value that banks generate from distribution may be captured by others," it said. "Margins will come under pressure, and the customer relationship, a platform from which banks sell other, higher margin, fee-based products, will be weakened or might even disappear."

The SME banking market could also move away from banks that do not have "a good digital banking platform", whilst banks' share of the payments market is also at risk as a result of technological changes in the market and impending new EU rules on payment services, McKinsey said.

"New services will likely increase the size of the payments market, as cash usage declines and cross-selling opportunities arise from better use of data," McKinsey said. "But banks may struggle to capture this growth. Margins may fade as payments bypass banks or credit cards. Regulations like the European Union’s Payments Services Directive may be a catalyst for further disruption."