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Banks will need to respond to disruption to survive a possible recession.
- A recent McKinsey report calls for bold moves from banks as they prepare for a possible economic downturn.
- For 35% of banks, it's a "do or die moment," to reinvent their business models if they want to survive the next recession, the consulting firm said.
- The report identifies 5 disruptive trends that will make this late cycle period challenging for banks.
- Disruptions include a more digitally-focused customer, regulators smoothing the way for new players, and outdated tech at big banks hindering their ability to innovate.
- To survive, banks have both in-house options, like cost-cutting through process efficiencies, and outside options, like strategic acquisitions to broaden their service offerings
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For more than a third of banks, it's a "do or die moment," according to a new report from consulting firm McKinsey & Company.
This group of banks, which McKinsey calls "challenged," is most vulnerable to the disruptive forces of technology, and the pressures of a slow-growth market environment.
"Their business models are flawed, and the sense of urgency is acute. To survive a downturn, merging with similar banks may be the only option if a full reinvention is not feasible," the report said.
According to McKinsey, the current economic environment suggests that we are entering a late cycle phase of recovery from the 2008 Global Financial Crisis. Late cycles are typically marked by slowed growth and rising inflation. A recession typically follows the late cycle period.
Here are the five key themes of disruption at play in the late cycle environment.
Customers want digital solutions
According to the report, the rate of online banking usage increased globally on average by 13 percentage points from 2013 to 2018. In retail banking and asset management, consumers are accustomed to digital solutions, and expect real-time and personalized services on these platforms.
It's not just consumers that have an interest in digital banking - companies are also eager to get in on the action. For example, they may want the ability to link their business bank account to their accounting software. Big banks need to offer these kinds of integrations to stay competitive with neobanks that already offer this to their customers.
Fintechs have raised the bar
New entrants to financial services have raised the bar on user experience. Neobanks offer intuitive apps and websites, so as customers get used to a digital-focused experience, big banks will need to offer the same.
Fintechs are also focused on offering price transparency, looking to provide cheaper services than the big banks. Big banks need to keep their tech on par with the neobanks, and ensure they offer as competitive a price for services like money transfers, the report said.
Regulators are welcoming competition
Regulators around the globe are taking steps to increase transparency and lower the barriers to entry for challenger fintechs. One of the key regulatory shifts McKinsey noted is that non-bank companies have more access to consumer financial data, which can help them access the market.
The advent of open banking has helped neobanks gain market share. "In the UK, where open banking is being rapidly rolled out, the number of new entrants in the market has increased by 65% in the past year alone," the report said.
Read more: How open banking and bank APIs are boosting fintech growth.
Banks should act before it's the obvious thing to do
In retail banking, asset management, and especially commercial banking, fintechs and big tech firms aren't yet operating at the same level as the big banks. That said, the report suggests that across all industries, the legacy players that survive disruption tend to be those who can identify the trend and act before it's obvious to do so.
So big banks shouldn't ignore the threat of fintechs just because they're still in early stages of growth. A July McKinsey survey found that two thirds of respondents would trust Amazon with their financial needs -- a hint that big tech could make moves into traditional banking.
Fintechs outspend banks on innovation
Outdated technology is a major pain point for big banks. "While fintechs devote more than 70 percent of their budget to launching and scaling up innovative solutions, banks end up spending just 35 percent of their budget on innovation with the rest spent on legacy architecture," the report said.
What's more, operating in a late cycle environment with a decline in profits and slowed growth, big banks may struggle to come up with the money needed to truly invest in innovation.
Read more: Retail banks could see big tech move in on their turf. Here's what they need to do to stay ahead.
Bold moves are needed
There has been no shortage of recession talk over the past year or so. If a downturn comes, it may be the most predicted yet. Given this, shouldn't the big banks be ready?
"Unfortunately, not," the report said, at least as compared to the state of the banks prior to the 2008 financial crisis. "Not only has growth over the past decade been slower than the decade preceding the global financial crisis, but most banks have not regained their pre-crisis level of profitability."
McKinsey identified three things banks should do within their own companies to prepare themselves for a possible downturn. First, build resilience with strong risk management. Second, reduce costs by focusing on productivity and efficiency initiatives. Third, increase revenue by attracting more customers with a better user experience.
Additionally, banks should consider mergers & acquisitions, or partnerships to stay competitive with disruptive fintechs.