Do Business Banks Need to Worry About Digital Transformation?

I recently met the Chief Risk Officer of a $25+ billion bank at a conference I was attending. During our lunch break, I asked him how his bank was viewing strategic risk in the context of the digital transformation and the ever-increasing competition from tech-savvy major banks and FinTech companies. He replied that his bank was really a business bank, and because of that didn’t believe they were too affected. He did allow that they would continue to monitor developments and act if or when they perceive any real threat to their business model.

This isn’t the first time that I’ve encountered this attitude. Leaders of predominantly business-oriented banks often have the view that digital transformation is a ‘retail’ thing. They view most of the innovation in banking and rising FinTech competition as being focused on the consumer market. The commercial business (in which their focus is often on the commercial lending side) continues pretty much the same as it always has.

I think this is a seriously short-sighted perspective. The effects of the digital transformation on business bank operations may be masked somewhat by current levels of profitability in a strong economy, but they will be having an ever-growing impact on operations and the long-term viability of the business model. Consider the following:

• Funding. A problem many business banks have is that they are much more successful in generating commercial and CRE loan growth than they are in attracting deposits to fund those assets. Commercial relationships are typically credit-driven and don’t yield much in the way of deposit funding. Because of this most of the business banks I’ve worked with are forced to get a substantial amount of their deposits from the consumer market. This makes it hard to argue that they are immune from issues affecting the consumer institutions that they are forced to compete with for consumer deposits.
• Margin compression. To attract consumer deposits these banks usually have to rely on offering high-interest rates since they don’t otherwise have much of a value proposition for retail customers otherwise. When that still isn’t enough to plug the funding gap, then they turn to wholesale sources such as brokered deposits, listing service deposits, or FHLB advances. They may also court high cost/high-risk deposit sources such as MSB accounts, EB-5 deposits, escrow deposits, etc.

Aside from the challenges of maintaining regulator-friendly liquidity ratios, this also can lead to serious margin compression given the higher funding costs. This is certainly the case for the CRO’s bank which has been experiencing slowly declining asset yields and sharply rising funding costs. This doesn’t bode well for the long-term success of their business model.

• Processes. Many business banks continue to rely on legacy, paper-based processes. Investment decisions for new technology often target the needs of a particular business silo, with little thought to how it may impact other aspects of the customer’s overall journey as they move from identifying a need to securing an appropriate solution. This lack of a holistic view of the customer often leads to poor customer service experiences, not to mention internal complications with hand-offs from one department to another.

One bank that I worked with had such an archaic commercial loan origination process that their internal service level agreements for the underwriting of new loans called for time frames of anywhere between 6 weeks and 3+ months. All of the commercial lenders that I spoke with at the bank told me that their underwriting/approval/funding process took so long that they were at a serious disadvantage compared to their more nimble and efficient competitors. Commercial loan origination should be the bread and butter of business banks. Failure to invest in systems and process transformation is not a viable strategy going forward.

Deposit account opening is another good example of an area where attention often needs to be focused on enhanced technology and customer-centric process improvement. One mid-sized business bank that I assisted had a legacy process in which it could take up to 3 hours to open a new business deposit account. Their ‘online’ new account application could take up to 10 days before an account was available for use. And their mobile app did not support account opening for either new or existing customers. The problem was that the bank was still using the same paper-based processes that they’d been using for the past 30 years. Not to mention the fact that their onboarding system lacked the ability to integrate with external APIs to be able to take advantage of current technology that could greatly aid things such as customer identification for KYC purposes.

The bar has been significantly raised in the consumer world for basic processes such as this, and that’s quickly crossing over into the business realm. Customers – whether they be consumers or businesses – expect simple, friction-free experiences that are conducted in real-time.

• Ancillary services. Business banks generally view treasury management services as a key product to complement their deposit products and help them both attract and retain business customers. This is one area in which I’ve found bank executives the most willing to discuss improving existing services and offering new ones.

The problem, though, is that they usually want something that can simply be bolted onto their existing mobile/online/core system infrastructure. Sometimes that can work, but it’s often the case that they’re running ‘closed’ legacy systems that lack open APIs to integrate with other platforms and solutions. So they simply run with what their existing vendors can provide and call it ‘good enough’. But this is a highly competitive area, and ‘good enough’ may not cut it with many customers or prospects.

I recently worked with a smaller business bank that had hired a few new account officers from larger competitors. In talking with these folks, I learned that they considered the bank’s treasury management services to be so inferior to what they were used to that they refused to encourage some of their old clients to follow them to the new bank. They felt that to do so would jeopardize their relationship with their former clients.

• Fintech competition. Financial technology companies are not just targeting the consumer market, some are vigorously coming after small businesses as well, and are poised to continue to work their way up to address the needs of larger business customers. Try googling “small business loans” and see what appears on the first page of the search results. You’ll likely not see any banks, but you will see a host of non-bank competitors.

Business banks should be focusing attention on how the digital transformation is exposing deficiencies in their current business model, and then work aggressively to implement transformative change in technology, processes, and staff skills. Here are a few questions that could be researched to help highlight the challenges and obtain needed resources from your Board and executive management:

1. How much of existing deposits come from consumers? Small businesses? Do you even have the analytics in place that will allow you to easily answer those questions?
2. How long does it take to move new requests for different loan types from initial application, through underwriting and approval, and on to funding? How does that compare with bank and FinTech competitors?
3. How many different software systems are currently being used in the loan origination process? Where do bottlenecks seem to form?
4. How long does it take to open new consumer or business deposit accounts in the branch? How about via online/mobile channels? Do you even have a digital account opening system that supports the process end-to-end?
5. What products and services would you like to be able to offer your customers but cannot today because of systems limitations?
6. How much of this year’s technology budget is focused on maintenance activities and regulatory compliance, and how much is devoted to installing new systems to improve the customer experience or streamline internal processes?
7. Are there key areas where the bank lacks employees with advanced and technical skills needed to drive meaningful change?

A ‘wait and see’ approach to digital transformation is an incredibly high-risk strategy. Once it becomes crystal clear that changes to your business model are needed, it’s likely to be too late. It may take years to transform legacy processes and systems – can’t just buy and install some off-the-shelf software that will magically solve all your problems.

The time to act is now!