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Banking on Innovation? the challange of retail banks


Banking on Innovation? the challange of retail banks

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									F I N A N C I A L S E RV I C E S

Banking on Innovation?
The challenge for retail banks

“We are always saying to
ourselves... we have to
innovate. We’ve got to come
up with that breakthrough.
Bill Gates, Chairman, Microsoft Corporation
                                                    Banking on innovation? 1

Foreword                                       3

The real challenge facing retail banking       5

Innovation in retail banking                   9

    Payment systems: innovation in practice    1

The inside view: could do better              13

    Self-assessment                           13

    Attitudes to the role of innovation       13

    Innovation expenditure and evaluation     14

    Innovation portfolio                      14

    Organisation and process                  15

    Barriers to innovation                    15

Rising to the challenge                       17

    Recognising the need to improve           17

    Key innovation capabilities               17

    Learning how to innovate better           19

Appendix 1                                    22

Appendix 2                                    24

2 Banking on innovation?

                           “Innovation is the central
                           issue in economic prosperity.
                           Michael Porter, Bishop William Lawrence University
                           Professor, Harvard Business School
                                                                                                             Banking on innovation? 3


Retail banking is under increasing pressure. Competition is tough, margins are being
squeezed, new entrants and new business models are threatening established providers,
and regulatory requirements continue to grow. The banks which grow and prosper will be
those that can profitably develop new products, services and channels to market. Innovation
will increasingly be the key to success.

It is commonly said that retail banks                  Innovaro Ltd1 undertook a joint review   What is very clear is that retail banks
are poor at innovation. This is not                    to assess the state of innovation in     are, in the main, well behind the game
entirely fair. A lot of innovation does                retail banking and its potential to      in the way they manage the innovation
occur in the sector. But much of it is                 enable the sector to rise to the         process. Other industry sectors have a
not classified as such, and is hidden                  challenges of the future. This report    great deal to teach them about how to
from view; and much of it focuses on                   represents a synthesis of conclusions    implement a structured innovation
new processes and ways of doing                        from day-to-day external client          management and delivery process.
business, rather than on the classical                 experiences and KPMG and Innovaro
development of new technology and                      insights in this area.
products. KPMG LLP (UK) and

     We believe that the most successful retail banks of the future will
     be those which take these lessons to heart and act on them.

1 Innovaro Ltd is a leading innovation consulting and research firm
4 Banking on innovation?
                                                                                                   Banking on innovation? 5

The real challenge facing retail banking

Most, if not all, senior executives in retail banking would probably claim that they understood
the challenges facing the industry. In a sense, they would be right. The challenges of structural
change, increasing regulation, tough competition and more demanding customer expectations
are routinely expounded (see Appendix 1). But in a more profound sense, these executives
would be wrong. They do not — and cannot — understand the most significant challenges
facing their business, because the genuinely threatening developments are those which are
unexpected and unpredictable.

The lesson from a wide range of             •	 Within little more than five years,       management technology, complex
industries and markets is that the truly       digital photography has largely           variable pricing models and
threatening challenges — those which           destroyed the mass market for             direct-sales channels to become a
have the potential to destroy existing         traditional film; it is likely that use   major competitor to traditional
businesses — are those which result            of film will shortly become limited       airlines in little over five years.
from disruptive innovations, whether           to a tiny minority of professionals,      The airline’s holding company,
these focus on new technology, new             specialists and diehards. In 2004,        easyGroup, has extended similar
business processes or completely new           Kodak effectively withdrew from           business models into markets such
business models. These challenges fall         the film camera market. Nikon has         as car rental, cinemas and hotels.
outside the boundaries of familiar,            ceased production of all but one or
incremental change, and are often              two models of film camera. Konica
impossible to foresee until it is too          Minolta has withdrawn from the
late. The victims are those who never          film market completely. AgfaPhoto
saw it coming.                                 went into liquidation in 2005. High
                                               street photo-processors are
Three recent examples are:                     struggling to offset the collapse in
•	 The traditional recorded music              film sales by providing digital
   industry has been turned upside             processing and printing services.
   down by the consequences of              •	 The passenger airline industry has
   digital downloading. Sales of CDs           been transformed by the rise of
   are declining precipitously. In July        ‘low-cost’ carriers such as
   2007 the American artist Prince             Southwest Airlines in the US and
   actually gave away a million copies         Ryanair in Europe: Southwest is
   of his latest recording in association      now the largest airline in the
   with a British Sunday newspaper.            country in terms of passenger
   In September 2007 the British               numbers carried, while Ryanair is
   band Radiohead announced that               the third largest European carrier
   they were making their latest               on the same basis. Alongside
   album available for download on             conventional strict cost control and
   the basis that fans could decide            ‘no-frills’ service, Ryanair has
   how much to pay for it — or                 pioneered an innovative business
   alternatively download it free of           model of virtually giving tickets
   charge. The conventional business           away and making money from
   model, where live performance               in-flight sales and extra charges,
   served to promote album sales,              and from subsidies from airports
   has been reversed, with musicians           the company agrees to fly into.
   having to revert increasingly to            Its rival low-cost carrier, easyJet,
   touring to generate revenue.                has exploited sophisticated yield
6 Banking on innovation?

To date, retail banking has avoided                 To be sure, the substantial and             Sustainable competitive advantage
such disruptive shocks. But online                  increasing regulatory burden on the         depends on a number of factors.
banking has already transformed                     retail banking sector constitutes a         But one of the clearest conclusions
customer channels. Non-traditional                  significant barrier to entry. Companies     to be drawn from studying the most
banking providers such as large                     unwilling to submit to the necessary        successful companies is that those
retailers or utility companies are taking           scrutiny, or unable to implement            which sustain the highest share price
a growing share of the market. New                  cost-effective compliance systems,          are those which are the most
payment technologies threaten                       will be deterred from entering the          consistently innovative3. In a virtuous
conventional cash transactions.                     market, especially in an environment        circle, innovation underpins success
                                                    of soft margins and cost pressures.         and success generates innovation.
A more radical entrant to the UK                    Both large multinational banks and          In retail banking, as in other sectors,
market, Zopa, offers a new business                 specialist niche providers are likely       meeting the real challenges of the
model based on peer-to-peer ‘social                 to continue to dominate the market.         future will depend on constant and
lending’, where an online marketplace                                                           intensive innovation in products,
allows lenders and borrowers to be                  But who dares bet against a truly           services and processes.
matched, by-passing banks completely.               disruptive new technology or business
As yet, the sums involved are small.                model? Customer inertia is perhaps          Most banks are currently striving to
But already the model is being copied               the only significant constraint on retail   achieve operational excellence and
internationally, for example by Prosper             banks losing their grip on their            improved efficiency. Hence sustained
in the US, Smava in Germany and                     markets, so the potential for dramatic      competitive positioning will be attained
Boober in the Netherlands. Whether                  change is ever-present.                     by those which secure long term
social lending has the potential to pose            Disintermediation between lenders           customer loyalty by delivering
a serious challenge to the conventional             and borrowers, dynamically-variable         attractive and compelling products
retail banking sector is unclear. But as            loan pricing, real-time clearance…          and services tailored to the
What Investment commented: ‘No                      who can predict what might be over          customers needs.
banks in the middle, no huge                        the horizon? Some idea of the wide
overheads, no unethical investments                 potential for such disruption can be
— Zopa could permanently change                     gained from reviewing the range of
the way people save and invest                      current issues and trends in the
their money.’2                                      industry (see Appendix 2).

2 What Investment, Product of the month, August 2006
3 Innovation Leaders,
“No banks in the middle, no huge
overheads, no unethical investments
– Zopa could permanently change
the way people save and invest
their money.
What Investment, Product of the month, August 2006
8 Banking on innovation?
                                                                                                                            Banking on innovation? 9

Innovation in retail banking

It is commonly said, both within and outside the sector, that retail banks are especially poor
at innovation. A typical comment is from The Banker: “Banks are abysmal at innovation. 4  ”
Similarly, Kathleen Khirallah, Director at Tower Group says: “Retail banking has traditionally
been a place where the road to innovation is blocked by numerous barriers. 5 Banks rarely
feature in league tables of the most innovative companies.

In many ways this is to be expected.                 customer interactions and in facilitating            more efficiently, designing new
Banks’ traditional, and appropriate,                 outsourcing, off-shoring and similar                 financial instruments and new trading
prudence can easily be expressed as                  cost management strategies.                          programmes” are not innovation, he
conservatism. Stringent regulation                                                                        says. Naturally the bankers disagree.’6
militates against risk-taking and                    Balancing the innovation mix
imposes caution in the process of
developing and implementing new
ideas. Softer pressure from regulators,                               Business Model Innovation                   Management Innovation
such as the Financial Services
Authority’s Treating Customers Fairly

principle, discourages the launch of
radical new products and drives
convergence to a norm.
But it’s not as simple as that. To begin
with, some banking sectors, at least,
are characterised by constant, creative
product innovation: witness the
proliferation of derivatives and
structured finance products in
investment banking in recent years.
And in retail banking itself, consumer
channels have been revolutionised in

recent years by the internet, both in
terms of on-line banking with
traditional banks and through the                                   Future Growth
launch of internet-only banks such as
Smile (a division of the Co-operative
Bank) and Egg (formerly a division of
Prudential and now part of Citigroup)                On the other side of the argument,                   To some extent, it’s simply a matter of
in the UK.                                           Eric von Hippel, Head of the Innovation              definition. Innovation is a particularly
                                                     and Entrepreneurship Group at MIT                    slippery concept. What to one
Systems and process innovations have                 Sloan School of Management                           observer may look radical and new
been equally important over recent                   ‘disparages what investment bankers                  may to another seem simply an
years in transforming banks’ back                    applaud as innovation: “automating                   incremental development of existing
office functions, in streamlining                    systems they’ve got, processing loans                products or processes. There are

4 The Banker, 5 February 2007
5 “Opening the Flood Gates of Retail Bank Product Innovation: Technology Drivers to Realize the Future” Tower Group, June 2005
6 The Banker, ibid
10 Banking on innovation?

structural difficulties too. The traditional          An innovative organisation requires knowledgeable, empowered teams to
paradigm of innovation is that it is                  drive idea progression, supported by appropriate metrics
product- or technology-focused, and
emerges from a dedicated group doing
what is termed research and
development. But research and                                                                 De                       Le
development (R&D), as formally                                                           tion                            ad

defined, often excludes the kind of


software and process development on

which banking innovation frequently
depends: ‘The Frascati Manual only                                                             Structure     Ambition
acknowledges software development                                                               Culture     Governance
that represents a “scientific and
technological advance” as R&D and
hence as innovation.’ So much
innovation in retail banking is ‘hidden
innovation’.7 The use of existing                                                              Metrics      Resource
software for a new application or                                                              Rewards      Learning

purpose, for example, is not

considered to be an investment in


innovation — despite the central role                                               eM


that this software might play in                                                          an
                                                                                               age                       Ca
providing an innovative new service                                                               m   ent
such as internet banking.

7 Hidden Innovation: How innovation happens in six ‘low innovation’ sectors,
NESTA (the National Endowment for Science, Technology and the Arts), June 2007
                                                                                                      Banking on innovation? 11

The trick, then, is to identify and           shop online, most using their online       now be used at a wide range of
assess innovation in retail banking on        bank account to make payments or           stores, restaurants and other retail
its own terms, unencumbered by                transfers. For the first time, the         outlets. Since the launch of London
semantic or definitional distortion.          number of adults using internet            Underground’s similar Oyster card in
One fundamental characteristic                banking exceeds those using                2003, over 10 million have been
emerges: retail banking innovation            telephone banking.                         issued, and 5 million are in regular
is as much about process as about                                                        use.9 Contactless payment technology
product, although where the                   Other process innovations have had         is now being extended to regular
product is as intangible as most              a more mixed reception. The                payment cards for small retail
financial services, the distinction           development of new, automated,             transactions of £10 or less, with Visa’s
between product and process can               integrated back-office systems has         ‘payWave’ system in Europe;
be quite blurred.                             allowed banks to outsource and             customers will simply hold their
                                              offshore routine administration and        contactless card up to a secure reader
Nevertheless, it is fair to say that retail   customer service functions. At the         to make their payment. In the UK,
banking innovation mainly focuses on          same time, centralisation of               Barclays Bank’s OnePulse card,
how products and services are                 transaction processing — and of such                                   ,
                                                                                         launched in autumn 2007 combines
delivered to the customer, how the            core operations as credit risk             a credit card, cashless payment and
customer interaction is managed and           assessment and sanctioning — has           Oyster travel card in one product.
how back-office operations are carried        reduced the role of the local branch       Payment by mobile phone using similar
out, rather than on the development of        and led to a raft of branch closures.      near-field communication technology
radically new retail financial products.      There are now clear signs that the         is already entering the market,
Most new products are incremental             consumer resents the consequent            and is likely to take off rapidly in
developments of a small range of              adverse impact on service, with            the near future.
fundamental offerings: loans,                 leading retail banks now stressing local
mortgages, savings etc.                       accessibility and re-focusing on the       Other payment system innovations
                                              branch network.                            with significant potential include:
As far as the consumer is concerned,                                                     •	 The VeriChip Corporation has
the most visible process innovations          Payment systems: innovation
                                              in practice                                   developed the first human-
of recent years have been those                                                             implantable RFID microchip to be
exploiting internet technology to allow                                                     licensed by the US Food and Drug
a rapid increase in on-line banking           Most examples of retail banking
                                              innovation occupy the blurred region                                      ,
                                                                                            Administration. In May 2007 the
transactions. In the UK, recent figures                                                     Financial Times reported that a
from APACS, the UK payments                   between process and product. An area
                                              where process and product                     group of clubbers in Barcelona had
association,8 show that:                                                                    opted to have VeriChip implants.
                                              developments have combined to
                                              produce genuine innovation in retail          ‘When they want to buy a drink,
•	 almost half (48 per cent) of internet      banking is that of payment methods.           they simply wave their techno-
   users now bank online                      From cheques to credit cards,                 enabled arms across the counter.’10
•	 online banking users have almost           debit cards, chip-and-pin and now          •	 The Vodafone-Citigroup joint
   doubled since 2002                         contactless payment systems,                  venture offering a global money
                                              how consumers transact purchases              transfer service using SMS text
•	 younger age groups make up the
                                              is being revolutionised. Cash is              messaging won the Banker
   greatest proportion of new users
                                              increasingly marginalised. particularly       magazine’s New Payment Systems
                                              as many retailers are now beginning           Innovation award in July 2007.
The figures show that 16.9 million
                                              to refuse to accept cheques.
adults — over a third of the adult
population — now bank online, with                                                       But beyond such examples, where is
                                              It is already ten years since Hong Kong    sustained innovation in retail banking
two-thirds of online current account
                                              introduced the Octopus card, a             coming from? How do bankers
holders now going online at least once
                                              contactless stored value smart card.       themselves rate their innovation
a week. The great majority — 90 per
                                              Originally designed for payment on the     performance? How great is the
cent — of internet banking users also
                                              city’s public transport system, it can     challenge they face?

8 APACS, Press release, 28 December 2006
9 The Guardian, 13 March 2006
10 Financial Times, 18 May 2007
12 Banking on innovation?
                                                                                                 Banking on innovation? 13

The inside view: could do better

In order to research the views of retail bankers on innovation in their companies, and to
assess how their innovation performance measured up against the best-performing companies,
KPMG and Innovaro mounted a joint review. This involved structured face-to-face interviews
with senior executives — CEOs, and CXOs in Strategy, Marketing and Innovation roles — of
UK, American, Dutch and Irish banks.

All were global companies, with a          or the sector as a whole, very highly.    Attitudes to the role of innovation
global perspective being obtained on a     Outside financial services, companies
broad range of topics:                     such as Apple were seen as exemplars      Attitudes to the role of innovation
•	 assessment of current capability        of product innovation; Toyota was seen    varied between companies. Some saw
                                           as a leading process innovator; and       it clearly, and simply, as implementing
•	 the role of innovation                  Ryanair was picked out for its business   new ideas to generate growth and
•	 levels of investment and evaluation     model innovation. In FMCG and             profits. Others, explicitly focused on
   of results                              retailing, Unilever and Tesco were        putting the customer at the heart of
                                           mentioned as having a good grasp of       the business, were principally
•	 innovation portfolio
                                           customer needs.                           concerned about customer
•	 innovation structure and process                                                  relationships, and saw innovation as
•	 barriers to innovation                  Overall, the banks surveyed rated         producing new or better ways to
                                           themselves only between average and       satisfy customer needs in detailed
                                           good on the innovation scale. Some        aspects of product, process and
In summary, respondents recognised         felt they were at the leading edge in     service, rather than searching for a
the importance of innovation to their      individual areas, with pockets of         radically new ‘silver bullet’.
future business development, while         innovation; others that they were only
acknowledging their comparatively          average or worse. Specific examples of    All interviewees considered that they
poor innovation performance at             innovation identified elsewhere in the    were using customer insight to make
the moment.                                financial services sector included new    better business decisions. Most had a
                                           payment methods such as contactless       Customer Insight team in place or
                                           payment (discussed above) and             used insight systematically to develop
                                           internet/telephone banks such as          new product and service offers,
All interviewees rated their strategic
                                           First Direct and Egg. A significant       through techniques such as focus
focus on innovation from medium to
                                           feature was that US companies (Bank       groups, data mining, customer tests,
high, with most of the banks stating
                                           of America, Washington Mutual, Wells      lead user panels.
that it was firmly on senior executives’
                                           Fargo, Wachovia etc) were in general
agendas. There has been an increased
                                           seen as more innovative than              Some interviewees took a broader
focus recently on innovation and the
                                           British ones.                             view, regarding innovation as
part it can play. For some, clear
                                                                                     developing combinations of new
themes were being used to drive
                                           The banks are starting to use a number    systems, processes and
innovation such as simplicity and
                                           of ways to ‘import’ better innovation     communications, and business
accessibility. But some questioned
                                           thinking into their businesses – they     model innovations, as well as tools
whether the message had yet been
                                           are using external consultants;           to help staff find solutions to
heard by all employees, and whether
                                           benchmarking performance against          customer problems.
they knew how to contribute.
                                           other sectors; formally exchanging
                                           learnings with exemplar organisations;
By contrast, retail banking executives
                                           and actively recruiting talent from
did not rate the innovation
                                           outside of the sector.
performance of their own business,
14 Banking on innovation?

Innovation expenditure and               there was a clear expectation of a       Innovation portfolio
evaluation                               return on investment for the new
                                         business ventures.                       Interviewees were asked where their
There was an overwhelming view that                                               main current innovation focus lay,
spend on innovation was increasing,      Very few were using formal innovation    whether on product/service (ie visible
although few accounted for innovation    metrics to measure value/return.         to the consumer) or on process (ie
spend separately (see the discussion     Some were incorporating innovation       largely invisible), and whether
about definition earlier). Spend on      metrics in a balanced scorecard (e.g.    incremental or fundamental change
insight and product development were     percentage of business from products     was the target. Although it was
generally categorised as marketing,      launched within last three years).       difficult to derive specific figures,
and spend on process improvements        Others were using operational metrics    there was a general view (see
generally came under the heading of      to gauge the success of some             diagram) that the focus had shifted
IT. Those that did account separately    innovation initiatives (e.g. what        away from cost-driven process
did this in the form of a venture fund   percentage of customers feel valued at   improvement to improving the
with a specific investment capacity.     the counter, what percentage would       customer experience; albeit that the
                                         make a repeat purchase, what             majority of effort was focused on
Expenditure on innovation was not        percentage would recommend us to a       incremental improvement.
usually linked to any form of growth     friend). However compared to best-in­
target, although in some cases           class innovators, the use of metrics
                                         was limited.
                                                                                                            Banking on innovation? 15

                                   Offset mortgage

                                                             Next Generation Platforms
  Product Changes

                       Improved                                                  Ave 30%

                                         Hybrids & Derivatives

                    Modification   Ave 70%

                                                                                         On-line banking
                                           Small                        Improved           Fundamental
                                         Modification                  Production            Change
                                                            Process Changes

Organisation and process                                     Barriers to innovation

Three main models for managing                               All interviewees identified barriers to
innovation were apparent:                                    effective innovation in their companies.
•	 small, central innovation team
   with a clear brief to work with                           Three in particular were often
   business units                                            mentioned:

•	 innovation clearly part of the                            •	 regulatory and compliance
   ‘day job’                                                    constraints

•	 innovation activities vested in                           •	 cultural constraints: silo mentality,
   the marketing/insight/new                                    cautiousness and bureaucracy
   product development teams                                 •	 short-termism.

Innovation processes used by the                             Nevertheless, there was a clear view
different companies varied from being                        that innovation would be a major
‘quite loose’ to ‘a formal stage gate                        contributor to business performance in
process’. Idea generation tended not                         future, especially in the areas of new
to be formalised, and was heavily                            products and new business models.
‘product owner’ based, Unsurprisingly,                       Given the generally lukewarm
the result is a focus on short-term                          assessments of current performance,
incremental innovation.                                      there is an obvious corollary that retail
                                                             banks need to raise their game — and
All respondents were struggling with                         recognise this.
the question of how to (whether to)
‘roll out’ innovation and make it part of
the corporate culture or DNA.
16 Banking on innovation?
                                                                                                  Banking on innovation? 17

Rising to the challenge

Recognising the need to improve

We have seen that some innovation is taking place in the retail banking sector, whether or not
it is explicitly recognised as such. But we have also seen that senior banking executives judge
themselves as lagging behind industry leaders in other sectors, and that the lack of systematic
innovation processes is particularly marked in retail banking compared with other sectors.
Set against this, it is clear that more effective, rapid and productive innovation strategies will
be key to banks’ survival and prosperity as the industry evolves over the next decade.

There is evidently a strong desire         Key innovation capabilities               Collaboration – The most effective
among companies in the sector to                                                     innovators have a clear understanding
improve their innovation performance.      From previous Innovaro research it is     of their core capabilities, and of their
Several banks point to legal and           evident that, across multiple sectors,    partners, and work together to deliver
compliance constraints. However,           there are five common capabilities that   innovative products and services.
these have not been a barrier to           innovation leaders clearly possess and    They adopt formal open innovation
innovation in other heavily regulated      exploit:                                  approaches and exploit technology
sectors, such as pharmaceuticals,                                                    scouting.
airlines and the food industry.            Strategic Focus – The most successful
They should not represent                  and innovative companies in other         Process – They use simple,
insurmountable obstacles to                sectors have a clear focus on the role    yet effective, pipeline/portfolio
implementing a more effective              of innovation within their markets and    approaches to conceiving, qualifying,
innovation strategy.                       the contribution that innovation makes    developing and then quickly launching
                                           to the business. They clearly recognise   new products and services.
The senior executives interviewed          the need to define innovation strategy
recognise their companies’                 in such a way that it becomes an          Organisation – In the most successful
shortcomings, especially in the light of   integral part of business strategy,       companies, roles, responsibilities and
increasing challenges facing them in       and is understandable and                 culture all support innovation,
the future. But they are less clear on     implementable by all in the business.     while appropriate metrics are used
how to overcome them. This is where                                                  to measure and reward successful
an appreciation of best practice in        Insight – Innovation leaders              innovation.
other sectors, supplemented by the         demonstrate an excellent
lessons of successful implementation       understanding of their marketplace        It is clear from the conclusions
of innovation strategies elsewhere,        and customers, and an ability to          outlined earlier, that retails banks have
can be most valuable.                      configure products and services           quite a way to go to match the best
                                           around emerging needs. They have          examples in other industries.
                                           access to a full range of insight
                                           techniques, including not just
                                           quantitative and data-orientated
                                           methodology but also qualitative
                                           approaches such as ethnography,
                                           personas, semiotics etc.
18 Banking on innovation?

   Issues for the innovation leader
   Do we have a clear focus on the role innovation can play in retail banking and
   the contribution that innovation can make to our company?
   How well do we understand our marketplace and customers, and how well are
   we able to configure products and services around emerging needs?
   Do we have a clear understanding of our core capabilities and those of our
   partners, and how well do we work together to deliver innovative products
   and services?
   Is our process for developing and launching new products and services simple
   and effective?
   Do roles, responsibilities and culture in the company all support innovation;
   do we have effective metrics to measure and reward successful innovation?
                                                                                                                        Banking on innovation? 19

Learning how to innovate better                                    The most enlightened retail banks
                                                                   recognise that other industry sectors
In many other sectors, there is a                                  have a great deal to teach them about
growing trend towards a more open                                  how to implement a structured
style of learning, with the concept of                             innovation management and delivery
‘innovation discovery’ becoming                                    process. We believe that the most
commonplace — where those                                          successful retail banks of the future
companies starting their innovation                                will be those which take these lessons
journey target specific leaders from                               to heart and act on them. For the rest,
which to learn and use various                                     there will be a risk of succumbing to
mechanisms to stimulate innovation                                 the profound and unexpected
within their own organisation. Some of                             challenges we have seen hit
the banks in our survey are also doing                             other industries.
this, particularly focusing on the
general retail and hotel sectors, which
clearly suggests a focus on service
innovation. And as we have seen,
some banks are deliberately looking to
external recruitment, consultants and
the use of their own non-executive
directors to stimulate more effective
innovation processes.

Effective innovation processes systematically identify, develop and
progress ideas from both inside and outside the orgnisation

                    Stimulus                                 Ideation             Development                Delivery          Impact


                                      (5 to 10 yrs)
                            (3 to 5 yrs)

                   (1 to 2 yrs)


                                                                            Innovation Partnerships

                                                                               Innovation Toolkit

                                                                              Innovation Metrics
20 Banking on innovation?


Banking on innovation? 21
22 Banking on innovation?

Appendix 1: There are familiar

challenges in retail banking…

The retail banking sector is under increasing pressure, from regulators, competition,
cost pressures and shrinking margins.

Structural change: rationalisation        Increasing regulation                     Technology
and consolidation
                                          Regulation is a major factor in driving   The growth in banks’ dependence on
Retail banks’ organisational model is     both priorities and market trends.        IT systems is constant and relentless.
undergoing continual change. The last     The FSA, Ombudsman, Office of Fair        Compliance and core processing have
two decades have seen continuous          Trading, US Regulators and Banking        to take priority, since without these the
evolution to segmented distribution by    Code Standards Board impose a range       bank cannot survive. The challenge will
customer type and through multiple        of onerous requirements, from Treating    increasingly be to maintain and
channels, central design of products      Customers Fairly to effective business    develop alongside these core systems
and determination of credit, and          controls and prudent balance sheet        applications which can add real
efficient operations serving a range of   management. The regulators are            commercial benefit: systems which
frontline businesses. Globalisation and   themselves scrutinised by consumer        provide better information, faster to
internationalisation continue to reduce   bodies, the Government and by an          allow smarter business decisions to be
the number of separate banks.             often hostile media. The                  taken; systems which facilitate
Middle-ranking banks, in particular,      responsibilities of regulators            interaction with the customer and the
lacking economies of scale, are likely    sometimes overlap, and it is at times     creation of products for which there is
to be squeezed by the large               unclear which has jurisdiction. In the    unmet demand.
multinationals on one side and by         major banking centres of the world,
small niche providers on the other.       regulators are pursuing parallel
                                          agendas aimed at improving
                                          transparency in financial reporting,
                                          preventing money laundering and
                                          improving consumer protection.
                                                                                       Banking on innovation? 23

Change in customer behaviour                Competition and the rise of
and expectations                            non-traditional banks

Customers, as in many other                 Competition is increasing as the
consumer sectors, are becoming              internet provides ready price
increasingly discriminating. The internet   comparison, driving margins down;
gives them access to vast amounts of        the development of efficient third party
comparative information, helpfully          suppliers enables relatively small
consolidated for them by price              players to operate efficiently through
comparison websites. Customer               pooling operations or outsourcing
attitudes are fragmenting, with             distribution. Securitisation has enabled
individual preferences generating           businesses to compete with lower
scores of niche interest markets.           capital requirements. The relatively
The ease of price comparison and            small number of large banks means
simple transfer processes between           that decisions on pricing have to be
suppliers, reinforced by intense            made with a very close assessment
competition, means both that brand          of the timing and nature of
loyalty is declining rapidly and that       competitor response.
inertia is becoming a much less
significant factor in customer retention.

      …but what about the unfamiliar challenges?

24	 Banking on innovation?

Appendix 2: Issues and trends in the
retail banking industry

    Issues	                               •   Widespread liquidity crisis          •   EU Directives on Consumer
    Accountability	                       •   Rising interest rates and                Credit, Payments and MIFID
                                              personal debt levels                 Increasingly consumer driven
    •	 Corporate social responsibility                                             industry
       and environment	                   •   Real questions on whether free
                                              in-credit banking will end and the   •   Internet allows price comparison
    •	 Good corporate governance                                                       and execution
                                              major implications for
    •   Financial transparency                competition in banking with          •   Increasing demand for lower
    State of the industry                     Payments increasing in                   prices and higher quality
                                              importance as a source of            •   Growing long term saving
    •	 Very profitable BUT
                                              revenue                                  vehicle demand and tax break
    •   Major regulatory challenges to	
                                          Increasing regulatory environment            investments
        current model for pricing and
        cross selling                     •	 Greater legislation and cost          Public image/reputation
                                             transparency requirements             •   Customer demands lower prices
    •	 Competition Commission
       PPI Review                         •   Treating Customers Fairly and            for better service
                                              Principles Based Regulation          •   Reduced loyalty
    •	 OFT bank charge review
                                          •   Increasing risk management           •   Negative public image resulting
    •   Lower margins and increased	
                                              regulation — specifically Basel II       from adverse media

    Trends                                Retail Banking channel growth            Growth of retail strategic alliances
    Cost Control                          •	 Continued diversification of          •	 Banks choose whether they
    •	 Outsourcing and off shoring           channels available to                    focus on all aspects of
       of processing                         customers – PDA, Online,                 Distribution, Product
                                             Phone and Branch                         manufacture or IT and Ops
    •	 Lean manufacturing and STP
                                          •	 Security issues, anti-money           •	 Some choose to distribute
    Enhanced customer focus and              laundering and instances                 through IFAs, others to
    differentiation                          of fraud                                 outsource aspects of IT
    •	 Constant imperative to improve     •	 On demand banking available              and Operations
       customer service and retain           when and where the                    Growth areas
       client base                           customer wants                        •	 Wealth management is a fast
    •	 Development of internet and        •	 New channels lower the barriers          growing market as is Premier
       ease of transfer has resulted in      to entry for niche providers             for the next tier of customers
       reduced client loyalty
                                          Consumer finance                         •	 Savings and Bancassurance
    •	 Particular emphasis on service                                                 markets are showing
       through retail branch networks     •	 Low margins due to competition
                                                                                      strong growth
       and 24-hour customer support       •	 Compensating revenues
                                             from cross-sale under                 •	 Islamic Finance is a fast growing
    •	 Resurgence in focus on face-to­                                                sub-segment serving affluent
       face and personal touch               regulatory challenge
                                                                                      Muslim populations
       customer care                      •	 ‘Sub-prime’ borrowers and
                                             resulting higher degree of
                                             credit risk


Michael Robinson
Financial Services
Tel: 020 7694 2904

David Sayer
Financial Services
Tel: 020 7311 5404

Ian Pallister
Innovaro Limited
Tel: 020 7866 6184

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