After the Pandemic – What?

Thursday, February 3, 2022  |  Bill Handel

While it may feel premature to talk about life after the pandemic while we remain in the midst of it, it is also important to look forward and to plan with an eye to the future. Despite the concerns many may currently harbor, the pandemic will end. There will be a point when life returns to “normal.”

But what will be “normal” in the post-pandemic age? This is not an article that will touch on issues of vaccinations or masks. Rather, I would like to think more broadly about the socioeconomic impacts of COVID-19 and, more specifically, about the impact on the financial services industry.

Without a doubt, COVID-19 has been one of the more seminal events in our lives. Most of us experienced significant disruption in how we live, work, shop, learn and socialize. This also extends to how we bank. I would argue that the best description of the impact of the pandemic is not disruption but acceleration. Nascent trends emerging prior to COVID-19 were accelerated, in many cases at an unprecedented pace, due to the pandemic. As a result, the socioeconomic long tail of COVID-19 could be more impactful than the virus itself.

Consider several examples:

  • Since the fourth quarter of 2019, the investment in nonresidential real estate has declined by over 20%. In contrast, investment in residential real estate has grown by 13%. While the growth in residential real estate investment is due heavily to the millennial focus on home ownership as well as a low-rate environment, it is also a reflection of “cocooning,” the tendency for people to focus on places of perceived security (such as home) in times of uncertainty. On the other hand, the decline in nonresidential real estate is at least in part a reflection of the change in working and shopping patterns. Both these patterns existed prior to the pandemic; both clearly accelerated during the pandemic
  • COVID significantly impacted how we shop. The chart illustrates the percentage of retail sales that are made online. While there has been a degree of pullback following the sharp acceleration in the second quarter of 2020, COVID-19 clearly has had an impact on how we shop. Expect this trend to continue
  • College enrollment continued to decline in 2021. According to the National Student Clearinghouse Research Center, undergraduate enrollment fell by 3.2% in fall of 2021, which followed a decline of 3.4% in 2020. Unlike previous recessions, during which we typically experience an upsurge in college enrollment, this recession saw a sustained downturn in college enrollment. Without a doubt, the virtual learning environment played a role in this enrollment decline in 2020. To see this trend continue into 2021 suggests a longer-term shift in behavior
  • Are movie theaters going the way of video arcades? Evidence suggests that this is the case. In fact, movie attendance has been down since the 1960s, and the pandemic clearly accelerated this trend. We have become much more comfortable in a streaming world, and movies are increasingly released initially through streaming services. This is not to suggest that we won’t go to movie theaters. We just won’t go as frequently as we did. Sound familiar? Same message applies to financial institution branches
  • We’ve also seen significant trend acceleration in the financial services space. Digital adoption – especially mobile services – was happening at a rapid pace prior to the pandemic, but the pace of adoption has accelerated, especially among the older demographics. As the chart below illustrates, the largest percentage gain in usage of mobile banking between 2016 and 2021 occurred among traditionalists – those over the age of 72! This makes sense; the necessity to use tools such as mobile banking in the pandemic spurred adoption which, in turn, spurred acceptance

Similarly, the number of bank and credit union combined branches has been in decline since 2009, but we anticipate this decline may accelerate over the coming years. Since 2012, the “Big Three” (Bank of America, Chase and Wells Fargo) have shed almost one in five of their branches in the U.S.

Is the Industry in Decline?

What has also been apparent is the decline in the number of banks and credit unions. This trend is not short-term by any stretch of the imagination, as the accompanying chart illustrates.

What factors are behind this decline? The fact that this reduction has been consistent across a long horizon – 2% to 3% per year – suggests that systemic factors are at play. The decline in industry counts is markedly among smaller institutions. Simply, it is increasingly difficult to compete as a smaller financial institution, and this is due to economies of scale. What are those areas in which economies of scale are most impactful? We suggest four areas, but there may be others as well.

  • Technology – It is much easier for large financial institutions to implement effective technology solutions – either accountholder-facing or back office – than is true for small institutions. Large organizations can spread technology costs over a larger base of clients, resulting in lower technology costs per customer or member
  • Compliance – Compliance costs are a very real and significant expense for financial institutions. Even with the $10 billion CFPB hurdle that large banks and credit unions face, it is clear that dealing with compliance is easier for large institutions. Many large organizations have entire teams whose sole responsibility is compliance; small institutions cannot afford this luxury
  • Marketing – There are also economies of scale in marketing. The ability of the largest banks to use the national airwaves to tout their capabilities is something not available to smaller organizations, and the largest banks are increasingly effective at it
  • Talent – The most recent issue to emerge – and one that will be a catchphrase for 2022 – is talent. Is your organization able to attract and retain talent commensurate with the goals of your organization? Can you compete with the largest banks for the best talent?

The reality is that the industry is not in decline; industry assets continue to grow. But assets are concentrated in an increasingly smaller number of institutions that are increasingly larger in size. We have shown in many Raddon blog posts the growing strength of the largest banks in primary financial institution (PFI) status, especially among younger consumers. This is a very real issue, and if you are not one of the largest organizations, it is imperative that you take appropriate steps. Survival is at stake – maybe not today or tomorrow, but certainly for the long term.

The challenges financial institutions face fall into three areas:

  • Generating sustainable growth – As noted, smaller organizations are generally having more difficulty attracting younger individuals. This doesn’t bode well for the future. Moreover, new trends are emerging in the lending arena that threaten the traditional ways in which we generate consumer loan volume, especially trends such as point-of-sale lending, commonly termed buy now, pay later (BNPL)
  • Earnings – We have seen a systematic decline in net interest margins in the industry for decades, correlating to the long-term decline in interest rates since the 1980s. Our earnings models have not evolved sufficiently to account for this fundamental change
  • Relevancy – In the world of fintech, many smaller financial institutions appear to the average consumer (or potential employee) as outdated relics of the past

What You Need to Do

With these challenges in mind, how should a financial institution think about the areas of focus for 2022 and beyond? In our view, there are three critical areas of focus.

Address Your Growth Model

The growth strategies that have been used for years may not be sufficient in today’s environment. Many small- to medium-size institutions continue to use traditional growth strategies such as indirect lending to fuel growth. Large banks have built growth strategies highly dependent on digital and cards. Major bank credit card offers are potentially a Trojan horse into a smaller institution’s customer or member base, especially for younger consumers. Get the card in the consumer’s wallet, and then cross-sell other services. In turn, BNPL is a potential Trojan horse into the credit card base.

Every financial institution should understand its basis for competition. Traditionally these are convenience, service quality and price. Convenience is not just location but can also be digital. Service quality is today called customer or member experience. Price is interest rates and fees.

Financial wellness can be a fourth vector upon which a financial institution competes. The younger segments of the market are more in tune with this and looking for tools and support to help them manage their finances in an increasingly complex world. However, recognize that financial wellness is not simply seminars and workshops; it is increasingly delivered digitally and uses artificial intelligence capabilities to drive value.

Modernize Delivery

The second major focus should be creating an integrated delivery ecosystem. Raddon research has consistently shown that most consumers want both high-tech and high-touch. Perhaps surprisingly to many, this is true even of the younger consumer segments. What this means is that while digital grows in importance, traditional delivery points such as the branch will continue to play a vital role in how value is delivered to the consumer. Maximizing customer or member experience means that experience across all channels must be consistent and integrated.

Equally important is reducing friction in engagement with customers and members. This is the major lesson to be learned from the success of fintechs. Very rarely have fintechs created new products; their major value-add is reduction in friction and perhaps a reduction in price. Put a high priority on evaluating process – both consumer-facing as well as back office – as this both improves the experience of the customer or member and makes for a more attractive and enjoyable workplace for employees.

If you haven’t heard of robotic process automation (RPA), you will in 2022. With the labor market challenges all financial institutions – and all employers generally – will face, we need to examine ways in which to be more efficient and effective in how we get things done.

Update the Business Model

The historical business model of financial institutions places heavy focus on net interest margins. Non-interest income is a minor contributor for most institutions, and the basic tradeoff that is made is between margin income and operating expense. As margin income has systemically come under pressure over the past 20 to 30 years, the industry has looked for new sources of non-interest income and sought ways to reduce operating expenses to meet financial objectives.

Unfortunately, some of those sources of non-interest income are no longer sustainable long term. One example is nonsufficient funds (NSF) and overdraft income. Every senior management team should be discussing “life after NSF” as part of the evolution of their business strategy – not that this income source goes away in 2022, but that its decline is inevitable due to consumer perspective, regulatory oversight and competitive pressures. In the Raddon Performance Analytics program, the average institution has seen NSF income per checking household decline by 50% since 2006. The same is true for debit card income, especially as an institution approaches $10 billion in assets. Many large organizations have seen significant earnings pressure emerge due to these issues alone.

Two truisms to recognize:

  • Sustainable sources of non-interest income are those that both leverage competencies you have as an organization and are non-zero sum in nature. That means that it fits with what you already do as an organization and provides value to both the institution and the customer or member. Wealth management and insurance services are two very good examples of this
  • Household balances, both deposit and loans, are a significant leverage point for an organization. In response to a decline in margins, you can either grow household balances or reduce household operating expenses. The required change in either is the same. In other words, with increasing margin pressure, your strategic options are to grow average household balances by some percentage or reduce operating expenses by that same percentage. For myriad reasons, most organizations will find that the growth in relationship balances is the preferable option

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