Making change

Creating the financial institution of the future

Canada’s financial services sector has earned widespread admiration in recent years for its prudent management, solid performance and ability to weather the heaviest economic storms. Canada’s financial institutions will continue to rely on these qualities in the years to come—but will they be enough?

Record profits suggest that all is rosy among Canada’s banks—and compared to many peers elsewhere, it is. But these profit announcements mask an unavoidable fact: Unless banks make some major shifts, it will be impossible to achieve similar returns in the future. Consider:

Economic growth remains stubbornly low.
The cost of capital and regulatory compliance continues to rise.
Household debt levels are reaching historic highs, prompting some to rein in spending.
Moves to tighten mortgage lending rules are making it harder for many to get into Canada’s sky-high housing market, suggesting that mortgage lending will no longer be the lucrative growth driver it has been.

Meanwhile, the financial landscape itself is changing. New players are entering the market—retailers, telecom firms and technology companies chief among them. They’re bringing innovative, disruptive products, services and thinking and are determined to capture market share in niche and underserved markets—especially in the emerging mobile payments arena.

For traditional financial institutions, the risk is not simply that these new entrants will take away profitable market share but that they will do so in a way that cuts traditional institutions out entirely. In this environment, Canada’s banks and other financial institutions can no longer be complacent. The caution that has sustained the sector for so long won’t meet the demands of a rapidly changing market.

To succeed, Canadian financial institutions need to find ways to work with new and non-traditional partners. They also need to allow themselves to take risks, act fast—and even make the occasional mistake. In other words, the very qualities that have sustained banks in the past are likely to hurt their ability to compete in this newly disruptive landscape.

The new normal for financial services
Consumer behaviour has undergone a tremendous shift, driven in part by rapid advances in digital and mobile technology. The expectations of today’s financial services customers are shaped by their experience with companies outside of financial services, especially retailers. Customers want:

Personalized attention and service.
The ability to conduct business quickly and easily.
The flexibility to choose when, where and how they interact with service providers.

These changes in consumer behaviour have encouraged retailers, technology companies and telecom firms to expand their customer relationships by moving into financial services. But that’s not all. The main reason these new players are entering the market is much simpler: there’s money to be made.

These firms often face thin margins and the challenges of business-cycle ups and downs in their own industries. In contrast, financial services offer a large profit pool, better margins—far better, in many cases—and a business that is comparatively immune to ebbs and flows.

Some contend that these new market entrants, unconstrained by the same regulatory restrictions, will overwhelm and usurp traditional financial services firms. Others believe traditional firms have little to fear. A middle ground between these two extremes is much more likely, but one thing is certain: the new entrants will disrupt the status quo—and make it harder for banks to grow unless they take swift decisive action.

How will the new entrants do this? By delivering a better customer experience—and seizing the most promising growth opportunities before banks and other traditional firms can get there.

The battleground
This new competitive dynamic will play out on several fronts in the years to come. Often, firms will clash at the edges of the traditional financial services business—in overlooked, underserved or niche markets, such as specialized lending or insurance.

However, competition will be fiercest in the payments space, as new players race to seize market share and traditional firms strive to protect their long held territory. The stakes are high: payments, especially credit cards, account for roughly one-third of banks’ profitability.

Also at risk in the battle for payments market share is data. Why?

Customer data, and the insights gleaned from it, is essential to delivering the targeted, tailored, 24/7 experience today’s consumers demand.
Losing market share to new players and the new payment tools they offer means banks could lose access to crucial data about their very own customers.
This will hinder banks’ efforts to better understand and serve their customers—and drive profitable revenue growth from doing so.

Responding to the challenge
We believe Canada’s traditional players should focus on the following strategies:

Embrace uncertainty
Prudence and caution have served Canada’s financial services industry very well over the years, delivering security and stability in good times and bad. However, these same qualities are inhibiting firms’ efforts to innovate in a rapidly shifting market. A change in mindset is needed—one that allows for taking smart risks and failing occasionally.

Innovate faster—and with help
Canada’s financial services firms have traditionally built things themselves, maintaining control of projects and products from start to finish. But this approach has often led to very lengthy development cycles and products that are out of date by the time they are launched.

Firms need to embrace a new approach to innovation that allows them to:

Develop, test, modify and launch new products and services much faster.
Become more comfortable with letting go and allowing outsiders to take the lead on developing products and services on the firm’s behalf.

Think like a venture capitalist
It’s virtually impossible to predict which new tool or product will win out in the end. We believe that rather than making one big bet, banks and other firms should instead place several smaller bets—spreading out their risk and increasing the odds that they’ll land on a winner in the end. Not every company will necessarily succeed, but some will win BIG.

Build alliances with the new players
Partnerships will be a vital part of operating in the new financial services environment—and both traditional players and new entrants bring something important to the table.

New entrants bring fresh thinking and new technologies and aren’t subject to the same regulatory restrictions as traditional firms.
Traditional firms, on the other hand, boast an enormous existing customer base, a deep understanding of those customers—and Canadians still trust them.

Working with non-traditional partners, of course, requires traditional firms to relinquish some of the control they’re used to having. To make these partnerships work effectively, it’s important that both parties are very clear about their goals and requirements. These can then be used to set the boundaries for any product or service development.