This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on April 18 - 24, 2016.

Bank branches will focus more on advisory and consultation services than on transactions in the future, according to the Citi Global Perspectives & Solutions report, released by Citigroup Global Markets Inc last month.

This is because the returns from having a physical network are diminishing as the cost of bank branches and associated staff — which make up about 65% of the total retail cost — can be reduced by automation.

Citi’s global head of retail and mortgage Jonathan Larsen says there were confident predictions 15 years ago that bank branches would lose their function and disappear. However, this did not happen. Instead, there has been a consolidation of existing branch networks, he adds.

“Today, with the ever-increasing adoption of mobile banking, we have incremental additional channels rather than the replacement of the branch channel,” says Larsen in the report.

He adds that even though there is an increasing adoption of mobile banking, there are still functions that cannot be done via mobile channels, such as password reset, high-value payments and change of address. Also, many customers still value the consultative experience.

“The human interaction component won’t go away. The branches may not look like what we see today. Instead, there will be premises and hubs where customers can meet advisers. That is why we still have branches around,” says Larsen. 

Virgin Money plc in the UK, for example, has transformed its branches into “lounges” where consumers can meet, relax and have coffee. Other banks in the country, meanwhile, have installed self-service machines to handle transaction-related services.

Banking consumer behaviour has fundamentally shifted with the adoption of smartphones and other mobile devices, according to the Accenture Banking Customer Survey 2015 cited in the report. By studying retail banking consumers in 12 key markets, including Indonesia and China, it found that a customer interacts with his main bank about 17 times a month on average across multiple channels. Of that number, 15 are of the non-human-contact kind, such as internet and mobile banking, ATMs and social media. 

Due to this shift, Citi says banks are rethinking their channel strategy. The report says as customers interact with their main bank via multiple channels rather than a single channel, the omni-channel strategy will be the winning solution in the next decade. 

Larsen says the segmentation of customers is also important. This is because mass-market customers generally contribute lower profitability relative to the affluent and emerging affluent segments. Thus, mass-market customers are more efficiently served through channels such as digital and mobile. 

“Moreover, clients’ profitability increases as they increase the number of products held with the institution. There should be increased focus on client depth,” says Larsen.

Recent financial innovations promote a cashless society and eliminate customer frictions. In developing markets, digital money manifests itself in the form of mobile money, that is, transactions executed via mobile phone. 

The report says mobile money, however, is somewhat of a conundrum within the broad financial technology and banking spaces owing to the uneven usage rates in different parts of the world. High-income Organization for Economic Cooperation and Development (OECD) countries, for example, have relatively low mobile banking usage. 

The low usage is said to be linked to bank access. Consumers in high-income OECD countries have ample access to traditional banking channels, thus giving them little incentive to set up and use the mobile money channel. Simply put, the traditional way of paying with credit or debit cards is not considered a problem that needs “fixing”. 

As banks capture the wealthier segments of the population, mobile payment can help the poor gain access to basic financial services. Kenya, which has an unbanked population of 45%, has been using the mobile-based payment service M-PESA. Since its launch in 2007, the service has seen great success with 23 million active customers in 11 countries currently.

Although some mobile payment products have been introduced in the Philippines since 2007, Citi’s managing director of global digital strategy Aditya Menon says they have not seen the same success as M-PESA, due to the number of agents per capita being far lower. “Transposing this theme on to Indonesia, we can observe that the country has regulatory barriers that require every agent to obtain a money transmitter licence to cash out, whereas cash in is permitted without this licensing,” he adds.

He says this has been a barrier to the creation of a distribution network, even for established m-wallet players. It will require the growth of interoperable networks for mobile money to flourish in Indonesia and the Philippines — a role that their central banks can facilitate with the implementation of a real-time 24/7 cross-bank or cross-payment provider network.

With regard to the emerging markets, Citi — in partnership with the Imperial College London — examined the space and found that a 10% increase in digital money adoption would see 220 million people participate in the formal financial sector. This, in turn, will result in US$1 trillion in new net flows in the formal economy, US$100 billion in increased tax collections, a reduction of US$120 billion in lower costs of cash handling at retail, and US$185 billion in benefits from digitising government services, among others. 

“Therefore, it is imperative to understand the role of governments and industry in growing digital money adoption in emerging markets, starting with need and then rapidly transitioning the support to value and experience, each of which requires the growth of the overall ecosystem,” says Aditya.

Blockchain the next big thing

The report also says the blockchain technology may be the next big thing to disrupt the banking industry. Even if it does not end up replacing the core financial infrastructure, the technology may be a catalyst for financial institutions to rethink and reengineer legacy systems to make them work more efficiently.

With the blockchain technology, clearing house revenue may modestly suffer, according to the report. As the characteristics of blockchain compete with the clearing house’s function, it is possible that blockchain will allow two counterparties to settle trades with each other directly, bypassing the need for a clearing house. But the report also states that even though this may be technologically feasible, it would require a network of counterparties to belong to the same blockchain. Thus, regulators would need to be involved to monitor trades.

With the way custodian banks operate, it was initially expected to benefit from operational efficiencies of the technology. This is because the systems are already designed for quicker settlement times and the market is expected to adjust to the shorter clearing cycle. Custodians will have the ability to expediently reclaim securities that have been lent out. 

In the much longer term, however, custody banks could see a reduced role as custody and back-office services become outdated with the new technology. Investment banks, on the other hand, are expected to derive several benefits from the adoption of the blockchain technology. These include potentially lower costs, as the technology can conceptually allow banks to settle transactions without having to go through exchanges or central counterparties. 

As the blockchain technology can be used to shorten settlement cycles, it is also able to potentially free up capital by reducing the size of the balance sheet. Citi sees a potential reduction in some brokerage, clearance and exchange fees expense for investment banks as well. 

While peer-to-peer (P2P) lending was introduced more than a decade ago, it has only taken off in the last few years. The total amount of loans lent by such platforms is less than 1% of the total loans outstanding. With cumulative lending of US$66.9 billion, China is the largest P2P market in the world. The amount is almost four times that of the US (US$16.6 billion) and more than 10 times that of the UK (US$5.4 billion). 

The P2P cumulative lending in China currently amounts to about 3% of system retail loans. Extrapolating the recent growth rate out to end of 2018, the P2P market will be about 9% of total retail loans. 

P2P lending is relatively new and small across Asia, excluding China. Start-up lenders are mostly in developed Asia, where the digital infrastructure is more mature, consumers are better banked and credit information is more readily available. 

While most of the lenders are focused on unsecured consumer lending, a handful of P2P lenders, such as MicroGraam in India and MEKAR in Indonesia, are engaged in socially responsible lending to the unbanked, which is aimed at increasing financial inclusion.

The report says that in the coming years, P2P lending will disintermediate a portion of the existing consumer credit and small business lending in Asia. It estimates US$6.8 trillion of consumer credit in Asia ex-Japan, which overall accounts for 38% of gross domestic product and 32% of total loans in the banking system.

The potential addressable market in underbanked countries could be significantly larger than the figures given by the report. A leading non-bank financial institution in China estimates that there is a potential RMB20 trillion market for unsecured small business lending — larger than the existing size of consumer lending in the country at RMB16 trillion. This potential, says the report, is just as enormous in countries where the official penetration rate of consumer credit is very low (10% to 15% of GDP) like the Philippines, India and Indonesia. 

McKinsey’s Economic Conditions Snapshot report, released in June 2015, estimated the potential value of personal financial assets that could be served by virtual advice at US$13.5 trillion — US$6.4 trillion in North America, US$3.4 trillion in Asia, US$3.3 trillion in Europe, US$0.4 trillion in Australia and US$0.1 trillion in Latin America. 

One of the more prominent virtual advice services available is robo-advisory. In Citi’s GPS report, it states that while robo-advisers are improving the productivity of traditional investment advisers, it does not cause significant risk of job substitution. Sophisticated investors, it adds, will always demand face-to-face advice instead of relying solely on virtual advice.

However, the services offered by personal financial advisers have the potential to be augmented by the virtual and robo-advisory tools, it adds, thus increasing individual adviser productivity and the ability to service more clients in more sophisticated ways. 

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