Six strategic levers to optimize long-term cost transformation

Achieving long-term, sustainable progress in cost transformation requires a strategic approach applying six potential levers.

It is widely accepted that banks’ profitability is under pressure from increased competition and regulation, as well as macroeconomic downturns. The COVID-19 pandemic has only exacerbated the situation. Across the banking sector as a whole, investors are now looking for cost transformation strategies that move beyond incremental improvement. Although tactical and incremental cost reduction still has its place in a bank’s armory, now is the time to step back and truly envisage what a future highly efficient, flexible and scalable enterprise-wide operating model and cost base might look like, and architect plans to achieve them. It will be exciting to see which banks feel ready to start painting this picture in Q1 2021 in their annual reports and investor roadshows, shifting focus away from the financial resilience stories presented during 2020.

Set the strategy now for why, where and how costs will be incurred in future

The ability to select the right strategic positioning is now, more than ever, key to building a resilient and sustainable business that can navigate the ups and downs of uncertainty. We see six strategic cost levers available to banks, relating to clients, markets, products, channels, joint ventures and partnerships, and acquisitions and disposals. Although unlikely to generate near-term savings, applying these levers is essential for reframing why, where and how costs should be incurred by the bank in the future, and so enable the right decisions to be made now on initiatives that will create long-term value.

Client and market strategy

The ability to correctly select “who to serve” and “where to play” is vital for building a resilient and sustainable business. Therefore, the first step is to look at the sectors and client segments the bank is serving and in which jurisdictions. The financial crisis of 2008 led to a wave of divestments as banks radically challenged themselves on the sectors they were operating in (e.g., selling off insurance arms) and the jurisdictions in which they operated. That same challenge must now be revisited.

Banks need to question the business and financial attractiveness of specific markets (size of the prize) and their ability to competitively play in such markets (probability of success). The question of whether to continue serving specific client segments in particular sectors and markets isn’t a binary one; it’s also a matter of assessing how best to do so. Decision makers also need to consider whether current sectors, client segments and markets are fully aligned to the bank’s purpose. This is particularly important, given that many banks globally have either recently redefined their purpose or are planning to do so. 

Product strategy

A bank’s product strategy defines “how to play” in relation to product mix, differentiators, features, pricing and marketing. The extent to which product decisions can impact cost is often overlooked. For example, product variants may be introduced to address client feedback or complaints, accommodate relationship managers who want tailored solutions for their clients, or to minimize the impact on new clients acquired through an acquisition. Over time, this can lead to significant complexity within core product platforms, making maintenance and application development more costly and materially reducing process efficiency for customer service and operations teams.

Major banks are already taking action to rationalize their product offerings, as illustrated recently by ABN AMRO’s announcement² that trade and commodity finance activities will be discontinued completely.

When considering cost impacts, decisions need to be taken not only about which products to offer to chosen client segments in chosen markets, but also about how best to do so. For example, making it easier for customers to purchase products can improve scalability and cost-income performance.

For any bank considering its product strategy from a cost-lever perspective, these are the types of question we envisage being asked: Do we have the right product mix to meet current and future client and market requirements? Which products should we distribute and manufacture to our chosen client segments in our chosen markets — and which should we just distribute? How can we reduce new business leakage e.g., by ensuring customers complete product application processes? Could we white label selected products and realize greater economies of scale from our systems and processes? Which products need to be better marketed, packaged, repriced, standardized or removed from the portfolio? How and where does our current product mix drive cost elsewhere in the bank?

Channel strategy

Channel strategy aims to maximize internal and customer benefits through effective channel management. This involves reshaping customer interactions, reducing operating costs and improving omni-channel experience by reducing call demand, migrating activities to lower cost channels and optimizing the remaining work and required workforce.

This is one of the areas where the COVID-19 pandemic has most profoundly impacted banks to date, with enforced branch closures and operating changes due to government restrictions and social distancing. It’s also led to a significant uplift in the volumes of customers using digital channels as well as a dramatic shift to contactless payment, enabled by increases in card payment limits and driven by concerns over cash handling.

Channel strategy has a material influence on a bank’s cost efficiency. For example, costs increase if a customer’s needs are not met by phone, leading to a branch visit. Similarly, additional costs are incurred if a customer feels insufficiently confident with digital channels and wants to speak to someone in person or over the phone instead. Costs increase again if incomplete data online results in manual intervention being required before a customer request can be processed.

Banks may want to work together to achieve a cost-effective channel strategy. For example, Belgium’s four big banks (Belfius, BNP Paribas Fortis, ING and KBC) have announced they are joining forces to set up an integrated, optimized network of ATMs³ – responding to the systematic decline in cash withdrawals from ATMs since 2012. 

When developing a cost-effective channel strategy, the types of question we envisage banks evaluating include: Should we be leveraging alternative distribution models to reach specific customer demographics? How can we sustain the heightened digital adoption levels driven by the COVID-19 pandemic? What is the cost efficiency of each of our channels? Could our digital user experience deliver a more seamless and intuitive customer experience? How do we influence customer behavior to redirect it to our more cost-efficient channels? How do we address critical failure demand in our branches and call centers?

Acquisitions and disposals

When seeking to optimize costs, acquisitions and disposals are well-established strategic moves. Banks typically rely on acquisitions to improve the scalability of their cost base fast, as well as accessing specialist resources. Meanwhile, disposals can maximize shareholder value by divesting non-core or under-performing assets. The proceeds from divestment and any surplus capital can be reinvested into core business activities and potential acquisitions aligned to client, market, product and channel strategies – where these support enhanced cost-income ratios.

The banking sector is likely to see substantial M&A activity in the near future. According to our EY 2020 Global Corporate Divestment Study, 87% of banks surveyed plan to undertake divestments within two years, for reasons that include revamping operations to improve profitability in a post-pandemic environment. 

Deals are already being done. For example, the merger of CaixaBank and Bankia⁴ will create the biggest banking and insurance group in Spain — giving both parties greater scale, financial strength and profitability. From a disposal perspective, in mid-November, Spanish banking group BBVA announced⁵ that it would exit the US market through a sale to PNC for $11.6 billion. 

When considering acquisitions and disposals from a strategic cost perspective, banks might evaluate questions such as the following: Which business units are underperforming or operating at sub-scale? Which divisions or products are not aligned with the business purpose or overall strategy of the bank? What opportunities exist for regulatory capital arbitrage? In which business line(s) could an acquisition help generate greater economies of scale from existing infrastructure? Where could an acquisition of capability help address cost inefficiency or scalability issues? 

Joint ventures and partnerships

Financial institutions use joint ventures and partnerships to gain access to critical markets and resources, and to benefit from economies of scale; and they can do so while maintaining their individual company identities, including their brand, balance sheet and corporate strategy. When banks team up with FinTechs or mobile disruptors, they can also gain access to new platforms and technologies — as well as new customers — in a cost-efficient way.

In periods of market or operational uncertainty, joint ventures and partnerships provide a particularly effective alternative to both M&A and organic growth — helping banks to increase scale while minimizing risk levels. Open banking is also acting as a catalyst for further collaboration between key players within financial services.

New relationships are already being developed. For example, in Europe we see the strategic partnership formed between Belgian bank-insurer Belfius and Belgian telecoms company Proximus to market an exclusive, digitally integrated offer for their respective customers from 2021 onwards via a disruptive ecosystem. Proximus customers will have access to a digital banking offer, while Belfius customers will be able to subscribe through Belfius sales channels to a specific offer developed by Proximus⁶. 

When considering the potential for joint ventures and partnerships to improve cost performance, the types of question we envisage banks evaluating include: How can existing product and capability gaps be addressed through strategic partnerships and joint ventures? How important is the bank’s brand to its customers? Where does product manufacturing no longer help the bank differentiate itself in the market? Is there an existing ecosystem of partners that would be beneficial to the bank? What is the cost-benefit of designing and building products in-house versus outsourcing them to third-party partners? What is the best model for the bank to capitalize on ever-increasing product and technology capabilities among FinTechs?

Pulling levers in parallel 

There are a number of areas where strategic decisions should be made to ensure that investments into structural and operational cost levers are not rendered redundant once the strategic changes are implemented. Some clients, markets, products and channels may be so core that their ongoing status is never in doubt. For these, banks should immediately consider what structural and operational improvements could be made to optimize costs as soon as possible, in parallel to the evaluation of the strategic levers available.

Structurally, for example, a bank might improve its cost-income ratio by simplifying its legal entity structure, transforming its organization design, driving greater consolidation of activities into onshore, nearshore or offshore centers of excellence or enabling increased cloud adoption. Operationally, for example, greater cost efficiency and scalability can be driven through process simplification, intelligent automation, advanced analytics or process digitization.

Strategic cost levers are powerful, but generally deliver results over the medium to long term. Analysis of them therefore needs to be progressed now, so that options can be evaluated and decisions made with a view to giving early guidance to investors on implementation plans for 2021—2022, and in order for the cost reduction to be generated and improvements in cost flexibility, scalability and transparency to be realized in the future.