The KISS principle in banking

Two key issues emerged from the recently wrapped major Australian bank reporting season: growth and costs. But there is a third, actually more-entrenched issue: simplification.

The era of the ‘universal bank’, where one institution offered consumers and business endless choice, has passed. 

That trend, at various times and in various guises called allfinanz, bancassurance, the supermarket of banking or holistic banking, really started to ebb as institutions worked through the financial crisis.

But in recent years the retreat to simplicity has gathered pace with the more-rigorous drive to cost containment and digital amplifying it. Given the focus on costs and revenue, this tide won’t be coming back in for the foreseeable future.

" The era of the ‘universal bank’, where one institution offered consumers and business endless choice, has passed."

No easy answer

Investors and analysts, both at the results announcements and in meetings afterwards, pressed bank management on where they were seeing growth coming from in the year ahead and beyond.

Given there was no easy answer to that question, the magnifying glass was then trained on the expense line.

Neither issue is easy. Revenue growth essentially comes from two places: growth in the broader economy or winning market share from rivals.

While macro-economic conditions globally are looking better, that is yet to translate to solid growth in business investment while policy makers remain concerned about too much growth in housing and household debt.

Cost reduction then is imperative but potentially politically damaging – as the splashback to National Australia Bank’s announcement it would cut 6,000 jobs across the bank from traditional roles while adding 2,000 in new technologies showed.

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But the underlying current of simplification is easy to overlook and underestimate. The common narrative is new technologies – be that blockchain, artificial intelligence, smart phones, the cloud – are costing human jobs. We in the banking industry are being replaced by robots.

While it is certainly true new technologies will reduce the human intervention required for a lot of processes that assumes banks will continue to do the same things. Existing processes will be done more efficiently.

Simplification though means institutions will not just perform existing functions more efficiently, they will stop doing a vast array altogether. Fewer business lines, fewer product lines, less vertical integration of product manufacture.

Announcing the result for this bank, ANZ, chief executive Shayne Elliott emphasised “our simplification is real”.

“We have closed more than 200 products across the organisation, decommissioned around 100 systems and removed 70 tonnes of hardware (since Elliott took over just under two years ago),” he said.

“In just two years we've announced the sale of 14 businesses. This has simplified our portfolio, reduced our operating risk, freed up investments and strengthened our capital position by around 100 basis points.”

He is not alone. 

Not alone

Commonwealth Bank, Westpac Banking Corp and NAB have all sold major business, particularly on the wealth management side. Banks like ANZ no longer own their own stock broking operations.

NAB highlighted its divestment of low returning businesses including Great Western Bank, Clydesdale Bank and life insurance.

Indeed, with hindsight, the “one-stop-shop” banking model, where the bank built and operated almost all the financial products a consumer or business could want, peaked with the financial crisis.

In Australia, the major banks all bought or expanded their wealth-management businesses around the turn of the century, driven by the basic idea that growth in such businesses would be at least double that of traditional banking.

In aggregate, that strategic shift has not delivered and it is being unwound – superannuation and adviser networks are being sold, life insurance is on the blocks or sold.

The new model is for banks to continue to sell these products – because consumers do want them – but not manufacture those products themselves.

Or take something as simple as credit cards. For a couple of decades now the major Australian banks not only offered a choice of the two main schemes, Visa and MasterCard, but multiple products of each and also, often, American Express.

Today all banks are shifting towards far fewer variations and only one scheme.

Nor is this trend to simplification an Australian anomaly. If anything large foreign banks have been far more aggressive in pruning their operating models. Global banks like Deutsche Bank, Citigroup, HSBC, Barclays and JP Morgan have all vastly reduced their business units in recent years.

To the extent the ‘universal banking’ model is still in favour, the brands at the top of such structures are far more likely to outsource product manufacture or buy in new capability by acquiring financial technology start-ups.

This tidal current towards less complexity of course has its own implications for staffing levels.

In a new paper from the Peterson Institute for International Economics, “Recent US Manufacturing Employment: The Exception that Proves the Rule”, Robert Lawrence analyses the relationship between productivity and employment.

His analysis finds “a trade-off between the ability of the manufacturing sector to contribute to productivity growth and its ability to provide employment opportunities”.

“Spending patterns in the United States and elsewhere suggest that the productivity slowdown is real and that thus far fears about robots and other technological advances in manufacturing displacing large numbers of jobs appear misplaced,” he writes.

Of course that’s not necessarily re-assuring for the job market because it implies if productivity improvement does occur – whether via new technologies or removing duplication in roles and processes – then employment is likely to come under pressure.

In financial services, history tells us expansion in operating units (and complexity) occurs when revenue growth is strong, allowing investment (even speculation) in mergers and acquisitions and new capacity with increased costs outweighed by higher income.

With structurally weaker income, management focus will continue to be on absolute costs and simplification. As ANZ’s Elliott puts it: “doing fewer things better”. This was illustrated by the below slide from the ANZ Full-Year Result investor pack.

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This week in Westpac’s result there was also a focus on productivity. The bank primarily drew attention to its cost to income but throughout its investor presentation there was frequent reference to simplifying processes – such as reducing 25 pages of application down to 1 page.

Multiple costs

Complexity has multiple costs. Not only does it require more resources, it dilutes management focus and leads to much higher operational risk.

Former Reserve Bank governor Glenn Stevens emphasised this risk in his 2010 Shann Memorial Lecture: "The finance industry, certainly at the level of the very large internationally active institutions, needs to seek to be less exciting, less ambitious for growth, less complex, more conscious of risk and more responsible about where those risks end up than we saw for the past decade or two."

They need to be simpler.

In the academic literature, complexity has three broad categories of cost – the resources expended are not rewarded by the market; the dilution of focus on growth opportunities; the misallocation of resources to lower growth (or even value destroying) areas.

In a recent report, Escaping the commodity trap: The future of banking in Australia, PwC’s consulting arm, Strategy& argues successful banks in the future will need to be “simpler, smaller, and more deeply connected to their customers”.

Without simplification, even large scale automation or the adoption of ground breaking artificial intelligence won’t deliver cost savings or revenue in the long term.

In another new report, The transformative power of automation in banking, McKinsey & Co listed the opportunity for failure: “Some have installed hundreds of bots - software programs that automate repeated tasks - with very little to show in terms of efficiency and effectiveness.

Some have launched numerous tactical pilots without a long-range plan, resulting in confusion and challenges in scaling. Other banks have trained developers but have been unable to move solutions into production.

 Still more have begun the automation process only to find they lack the capabilities required to move the work forward, much less transform the bank in any comprehensive fashion.”

Success won’t come from technology nor cost reduction; both are necessary but not sufficient. The same can be said of simplification – but it is necessary.

Andrew Cornell is managing editor at bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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