The impact of Digital Banking in the traditional consumer & community banking industry
I spent most of my pre-MBA career in J.P. Morgan Chase, the first couple of years in its Buenos Aires, Argentina office, and then in the New York Headquarters. J. P. Morgan hardly needs an introduction, but on a quick note, as one of the largest investment banks in the world in terms of assets, it covers the four traditional legs of banking — consumer & community, investment, commercial, and private banking (see chart below).
Source: J.P. Morgan Chase Annual Report
We will be focusing on the consumer & community banking sector (the “Chase” brand in the case of J.P. Morgan Chase) in the North America market.
The digitalization of consumer banking has become increasingly relevant within the industry, where customers are becoming more and more aware of the amount of things they can now do online or from their smartphones versus having to physically go to a branch to perform transactions — especially day-to-day, standard things like transfers, payments, investments, and even check deposits, to name a few.
The introduction of ATM machines in 1969, although they were not widely utilized until the late 1980s, revolutionized the banking industry, but digitalization completely changed it. We are not talking about the fact that you can extract cash practically anywhere in the world (which is quite amazing), but the fact that nowadays you can virtually operate and manage your bank account from your phone, no matter where you are, or when. Very few processes require a person’s physical presence in the bank anymore, if at all. Some banks, which will be the main focus of this analysis, are nowadays 100% digital, meaning they don’t even have a physical branch. Some examples of these (in the US) are Discover, GoBank, Moven, USAA, Ally, and Chime, to name a few[1].
Just as an anecdote, upon arriving to Milan on my last vacation, I opened a bank account with the German digital bank N26 in a matter of minutes and received my debit card by mail in just a few days. The process was incredibly seamless, and not limited to EU citizens — I just had to show a picture of my Argentina Passport. N26 is now working on entering the US market.
The benefits of digital banking, both for the customers and the actual bank, are evident. On the customer side, it is clear that this type of banking is targeting younger, generation Y-type of customers, which have grown up in a digital world. Eventually, all customers will be inclined towards this type of banking. The processes and transactions are not only faster, but more convenient and seamless. I literally opened my bank account at N26 from my smartphone, and after receiving a transfer, I can now withdraw cash from any ATM when needed, without a fee.
However, the true competitive advantage and benefits of digital banking come for the banks themselves — and are mostly around a significant reduction in overhead costs. No branches, reduced personnel, and automated customer service systems mean that banks can reduce their spending to levels that traditional banks only dreamed of. This allows the digital banks not only to realize higher profits on standard operations, but also to offer an increasing amount of free services which customers love — checking accounts, debit/credit cards, transfers, and deposits (to name a few) are usually free of charge, something unheard of from banking services just a few years ago.
Nevertheless, there are several things to consider regarding this aspect. As significant as the cost savings may be, there is no evident reason as to why eventually big banks (or even small community banks) cannot adopt the same type of business model. It will take time, money, and an effort to “convince” their current customers to move to digital, especially if they are predominantly older, but eventually everything will tend to that.
Second, there are virtually no significant barriers to entry to this market. Eventually, more and more digital banks will flood the industry. Perhaps some government regulation will limit the number of banks, yes, but in todays increasingly globalized world, there is no reason as to why a bank cannot be based in one country, and have customers from another. So although my scope here is limited to the US, this is really a global trend and issue for traditional banks.
On a similar note, even the popular so-called “roboadvisors” like Wealthfront (an automated investment platform) are offering high-interest checking accounts for free. There is no reason as to why other firms who have nothing to do with the industry, such as Facebook, Google, or Amazon, cannot join this trend as well. Hence, I would not be surprised to see a “Google Checking account” in the near future. And the secondary benefits of doing so are also noteworthy — knowing a customer’s spending habits gives room to more targeted advertising, and hence increased spending for specific retailers (who I assume would be willing to pay a significant amount of money for that information).
The nature of this innovation, in relation to Chase’s traditional banking, can be classified as an incremental disruption in the overall banking service with regards to the way in which it is provided. Moreover, I would classify this as a modular-type of innovation — since the underlying service provided is virtually the same, it is now just simpler to bank than before. Therefore, I would then classify this phenomenon as a competence destroying innovation in the sense that existing players need to re-adapt their service to now provide digital means of offering their products and services.
Digital is indeed a new world for traditional banks, and one that they need to enter if they want to survive. Nowadays, a bank without a website, application, or a way to operate online is unthinkable. Nobody would open an account in a bank with no digital service, whereas an increasing amount of consumers are opening accounts in banks which do not even possess a physical branch.
It is the classical “innovate or die” scenario for traditional banks, and hence my “competence destroying” classification. Arguments can be made in favor of competence enhancing too, but given the nature of Digital banking, I believe this classification is more appropriate.
The enabling technology for this type of innovation is evident: the increasing processing capacity of both hardware and software elements in the tech sector. Just five years ago, there barely existed smartphone applications that allowed to bank digitally. Nowadays, it’s the norm. This is not only because banks became smarter, but mainly because technology made it possible for them to offer this type of service. More and more, as technology and devices continue to evolve, banks will be able to offer an increasing amount of products and services (think of mobile wallets and digital payment platforms).
All of these contribute to a cashless world as well, where banks won’t even need to offer an ATM machine service in the future. It is hard to envision a 100% cashless world, but more and more, especially in the US, carrying cash around is becoming increasingly rare — you can even perform a $0.50 payment using a credit card, and where in the past the cashier would usually complain, nowadays digital payment is welcomed.
In the US, Chase, like many other banks, has become increasingly aware and devoted an insane amount of resources on the digitalization of its services. Three out of four “town hall” type of conferences by J.P. Morgan Chase CEO Jamie Dimon were about digital banking while I was there. And its efforts to become increasingly digital have paid off — as a Chase customer, I have seen significant improvements in their service since I first opened my account with them on 2014 upon moving to NYC. They streamlined their app, are offering more and more services online, have included automatic tellers at branches, and more recently they are even closing big branches around Manhattan (in what I assume is an effort to lower overhead costs).
This all tends to my previous hypothesis that there is no evident reason as to why traditional banks wont eventually become digital themselves. Yes, they would still need to offer some branch services, especially for the late adopting Generation X customers. Now, big banks like Chase can afford this because of their size — they are literally Too Big to Fail. The most affected players in this industry, at least in the US, are the traditional community, local banks. They probably don’t have either the network or the resources to sustain an increasing amount of flocking customers, and therefore I would not be surprised to see more and more of these type of banks disappear — their customers either going to a big bank or to a digital one.
As mentioned earlier, the digitalization of banking has led existing players to increasingly adopt digital practices among their products and services, due to an increasingly digitalized customer base. New players in the industry have thus pressured traditional banks into these type of offerings, at a pace which they were probably not expecting. There is, however, no clear key differentiators among digital banks.
Since there are no clear barriers to entry to this industry, customers usually choose their digital bank by either word of mouth or a given promotion/discount. For example, Discover periodically offers a $100 bonus to those who open a checking account with an $X amount of deposit. Or by providing a free service (which usually comes at a cost to the bank) like free ATM withdrawals anywhere in the US.
The future potential impact of digitalization in banking is evident. All major consulting firms, for instance, are now focusing on this trend and are increasingly “helping” (they charge. A lot.) banks to become increasingly digitalized. Those banks that are foolish enough to chose not to do so, will inevitably perish, like Blockbuster. Or those that fail to do it in a timely and adequate manner will perish as well, like Kodak. As mentioned earlier, digital banking will eventually become the norm, especially in todays inter-connected, global world where virtually everybody carries a smartphone.
My personal recommendation for big banks like Chase would be to continue to invest their time and resources in digitalization, because it not only attracts Generation Y or Millenial customers, but also, by teaching older generations how to bank digitally, they will save a significant amount of resources due to branch closures, and subsequent lower personnel costs, among other benefits.
It was long ago stated that digitalization and technology would eventually impact the robust financial services industry — that time has now come and, like in other areas such as traditional retail, it is an “adapt or die” type of world, where some players will inevitably perish — small, local community banks in this case.
[1] https://thefinancialbrand.com/69560/25-direct-online-digital-banks/
The impact of Digital Banking in the traditional consumer & community banking industry
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