It’s hardly breaking news that the banking industry has evolved beyond its historical boundaries of branch networks, mortgages, and commercial lending. What is less clear, though, is what banking will look like in the future.
In our view, banks will have to choose among several business models to compete and differentiate themselves. Winners will be the best providers of banking services—and not those aiming to be the best bank.
Strategy matters more.
Banking models and strategies used to be fairly homogenous, with performance typically in tight ranges. Competition was within groups of like institutions, such as globals versus globals, regionals versus other regionals, etc. Execution excellence was the key differentiator.
More recently, rapid changes in technology and customer behaviors have fostered a broader variety of strategies with a wider dispersion of potential returns. Customers can get their banking services from a bigger range of competitors, meaning that the threat of substitution is higher than ever.
Banks must decide whether they want to embrace the possibilities of the service- provider construct, or maintain business as historical—i.e., whether they want to be in the top or bottom performance tiers. Put simply, strategy matters more now than in the past.
Which model? We see a number of business models for the provision of banking services:
- Banks (traditional banks, digitalized traditionals, digital native banks, partners that provide access to fintechs, banking-as-a-service[BaaS]/embedded finance providers, and third-party consumer products and services platforms)
- Nonbank financial institutions (e.g., Fundbox, OnDeck)
- Corporate providers (e.g., Walmart)
- Fintech enablers, which provide banking infrastructure, automation, etc., to banks
- Fintech providers of banking tools to customers (e.g., Mint)
- Big tech (e.g., Apple, Google, Amazon)
BaaS and embedded finance.
Two emerging approaches generating considerable buzz are BaaS and embedded finance, both of which feature banks as back-end utilities rather than as customer-facing service providers.
BaaS allows nonbanks to offer standard financial products manufactured by banks, while embedded finance integrates FS such as payments and lending into the infrastructures of nonfinancial businesses. By assuming the distribution function and simplifying the customer experience, each can significantly reduce banks’ costs and enable the distributors to attract customers they might not have otherwise.
Banks need to choose a model that can position them for long-term competitiveness and outperformance. Their choices will have direct implications for M&A activity.
The more aggressive players will look to be buyers or position themselves for eventual acquisition, while traditional banks—especially smaller and midsize institutions—should consider selling.
The weak economic environment will likely force some sellers to act sooner than they’d prefer.
Note: KPMG will discuss the future of banking at greater length in a series of articles during 2023.