2023 Banking Outlook: Mid-Year Update

In our 2023 Outlook: The Future of the Banking Industry, we anticipated murky waters and a rising need for the use of digital solutions to better evaluate profitability, identify key customer touchpoints, and work to prevent deposit outflows and overconcentration. 

Banks have had to make swift pivots in the first half of 2023 to maintain stability and deliver top-tier customer experiences amid ongoing uncertainty, inflationary pressures, and rising interest rates. The mid-market is the center of discussion across the industry as volatility and deposit outflows heighten following the fallout of Silicon Valley Bank and First Republic. Discussion around uncertainty and the continued looming of a recession or banking crisis only grows as banks are forced to reassess how they are avoiding the threats of defaults, credit quality, and deposit runoff.  

We emphasized that it was imperative for banks to home in on where and how to best meet customers where they are, with the urgency of today’s climate requiring a greater sense of efficiency in meeting these customer needs—while also managing risk accordingly.

The future of banking—this year and beyond—hinges on understanding customers, building seamless experiences both digital and interpersonal, and evolving multi-channel strategies to meet needs and navigate a turbulent economy; this only matters more at the mid-year point of the year. Weaving in data, automation, and customer segmenting effectively can drive deposits and build trust amid uncertainty, providing tangible shifts to reduce risk and increase net income.

This mid-year update provides quick hits on ongoing trends, new challenges, and key focus areas looking toward the back half of the year.

Bank lending teams are being tasked to balance growth while also having a much tighter leash on lending activity, emphasizing the need to know your customers and the ability to predict their needs in an even greater way. With the generational wealth transfer as an additional factor, the ability to segment and identify your most valuable customers is essential for any bank seeking to outperform competitors and serve both their clients and stakeholders. 

In the wake of recent turmoil spurred by deposit concentration, banks are facing amplified threats and increased scrutiny of their financial stability. 

Targeted data insights will enable banks to proactively identify potential weaknesses, withstand uncertain market conditions, and capitalize on opportunities for expansion.   

Amid increasing interest rates, economic uncertainty, and heightened public concerns, banks must also answer the following: 

• Who are my stickiest and most loyal customers?  
• Are there early warning cues to signal attrition or runoff?  
• Is our portfolio exposed to concentration risks?  
• Are there channels more optimized to bringing in stickiest deposits?  
• Do we have an overconcentration of customer base in a given vertical industry segment?  

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• Focus on treasury management: An often overlooked by source of stable deposits is treasury management: having consistent, repeatable processes that identify risks and opportunities can equip banks with the right momentum as they seek additional paths toward growth.  
• Small business comes into sharper focus: Digitizing small businesses can boost features, efficiency, and profit margins while reducing risk through increased granular deposits.

We’re living through the peril of a fragmented industry as we speak. The pace at which money moved out of SVB and into Fintechs is dizzying. How will banks bring these deposits back? The question of relationship primacy remains an opportunity for banks—and is turning more into a mandate—as banks consider how they can bring customers back in (and keep them.) 

Given the sheer volume of non-traditional challengers to banks, the question of relationship primacy is top of mind for executives. The number of banking relationships per customer has increased exponentially and the downstream impacts are starting to be acutely felt on bank balance sheets, with customers divvying up their deposits between traditional banks, digital currencies and wallets, and even retailers.  

The need for investment in technology to create customer-centric experiences and embrace new models like banking-as-a-service will better enable this relationship management is perhaps even more punctuated. The ease with which customers can move money—and know it will be safe—cannot be underscored.  

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Now is the time to identify fragments, centralize opportunities and value, and double down on digitally driven solutions to help manage, target, segment, and capitalize on areas of growth. Whether there’s a budget set aside or room to dig internally to reallocate, the shift to customer centricity will prove a strong ROI in today’s market.  

Leverage distributed banking as a growth method. With growth as a goal for every bank, a diversified strategy to expand customer bases and cash flows will help weather economic uncertainty and rising interest rates. Entering new areas such as lending through buy-now-pay-later, crediting via co-branded credit and debit cards, and serving as a financial partner with other companies can broaden the landscape and create unique revenue streams that meet new, unique customer needs—even if indirectly.  

Turn to spend management as a source for innovation funding. Among the ways to find funds, banks should consider evaluating their existing third-party spend. It’s often fragmented, undermanaged, and ripe with opportunities to identify and drive value and cost savings—which can in turn be reinvested in other areas, including digital capabilities. While financial services organizations generally understand the need to enhance digital capabilities, the current market isn’t lending itself toward increased budgets. But finding existing funds to repurpose can present the opportunity to build digital capabilities which create greater efficiencies, reduce costs, and increase growth over time. 

Spend management in practice. How much is potentially up for grabs will vary by institution. But when employing this approach at multiple financial services clients, we’ve identified and captured savings of 15% on $300-400 million in contingent labor spend, and savings of upwards of 20% on more than $10 million of print-related spend. With the demand for innovation dollars only intensifying, the potential bottom-line savings cannot not be overlooked. 

While interest rates are rising, the market continues to be volatile and inflation is squeezing consumers and businesses alike—putting pressure on traditional sources of banking profitability. The threat of deposit runoff remains top of mind. There’s a continued lack of efficiency among banks’ current operating models; ROI on the status quo is shrinking, and 2023 presents the opportunity to build more digital and AI-optimization into your organization. 

With banking becoming increasingly fragmented—and the rise of Fintechs and acquisitions—banks must lean into automation, AI, and data analytics to build a digitally driven operating environment and digital mindset among employees. It won’t be an all-at-once overhaul but rather a step-by-step journey toward a zero-waste operations model that reduces costs to be reallocated toward innovation and/or trimmed to help margins. 

Just 44% of leaders gave themselves an “A” grade when asked about the maturity of their access to and use of data. Though banks have done a better job of gathering data and improving quality, a disconnect remains in terms of how data is used—and there continues to be room to enhance the efficiency ratio and reduce overall portfolio risk along the way.

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Instead of sporadically cutting costs, implementing an efficient operations goal and the right technologies can significantly reduce operations overhead, shift and enhance productivity, and potentially alleviate tight margins. If done properly, this becomes a scalable digital foundation that empowers human capital more effectively, facilitates growth, and positions the organization for success through economic uncertainty and the modern day’s increasingly digital approach.

The need for banks to attract and retain new customers must be balanced with the need to keep highly profitable current clients who often prefer in-person, traditional banking experiences tied to digital banking solutions. While the notion of “omnichannel” is still evolving, it implies that banks can and should be on every platform—when the reality is that they should be evaluating and determining the strongest solutions and intersections between digital and in-person, and ultimately converting branches into revenue centers from cost centers through investments in these intersections. 

It isn’t just about the role of the branch or the role of digital, but rather how those channels interact to engage employees and customers most effectively and efficiently, when and where they want it most—rather than trying to do it all in both digital and physical means. Mobile and online-first banking is popular across generations—but the need for efficient, in-person interactions remains.

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The relentless challenge posed by Fintech and non-traditional banking services only underlines the need for banks to establish relationship primacy with their customers.  

Intersecting physical branches with digital delivery to outperform competition. Leveraging data and technology centered around human guidance and judgment will provide customers with a strong, evolving digital experience with the benefits of expert interactions through hybrid platforms. 

Tightening traditional in-person processes and expand on digital offerings. By leveraging strong digital tools and enabling carefully curated experiences to reduce unnecessary friction from customer interactions and follow-ups, banks free their employees to focus on driving value and deepening relationships with customers in person, on the phone, and over video channels—with streamlined or automated processes to address the low revenue-generating areas and open time to greater value activities.

With the industry’s eyes on mid-market banks, the question in many peoples’ minds is: How are the regulators going to respond and what is this going to mean for banks going forward? From what we’ve seen historically and what we are hearing, the following outlines what we believe is headed banks’ way—and fast:

1. A push to repeal the 2018 Senate Bill which eased several regulatory requirements for banks with less than $250 billion of assets 
   
   
2. Heightened requirements and stress testing—specifically around liquidity   
   
   
3. A more sophisticated and modeled approach to a run-off of deposits and interest rate sensitivity of HQLA (high quality liquid assets) 
   
   
4. Tighter capital requirements or further disclosure around capital against long-term assets like U.S. Treasury bonds   
   
   
5. More thorough exams and less tolerance from regulators

What can banks do to prepare for new regulations? 

Even if only a few of the suspected changes are implemented, midsize banks still need to be preparing for a different regulatory environment in the near future and should be taking the following actions, among others, to prepare:

• Ensure your data is accessible. Banks need to proactively identify potential weaknesses or runoffs while also responding to regulatory inquiries and exams faster than expected in today’s environment. Speed, in addition to accuracy, will be key.  
• Evaluate existing practices and methodologies in place for liquidity testing and balance sheet forecasting. Are these in line with best and leading practices? Are they scalable?  
• Prepare for Dodd-Frank Act Stress Testing. Given the push to repeal the 2018 Senate Bill, it’s all but assumed annual stress testing will yet again become a requirement for midsize banks. Start planning today. 
• Ensure your modeling capabilities are ready for robust requirements. What’s more, do you have the talent and team behind the models who understand them?   
• Assess your firm’s exposure to non-traditional financial products. Does your firm service the crypto industry and, if so, to what extent? What portion of your customer base is made up of non-traditional financial products?  

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Only 53% of companies feel their program management is strategic and nimble enough to adopt risk-related improvements, leaving room for many to differentiate and add value through technology risk management as it becomes table stakes for banks. With regulatory shifts on the horizon, embracing nimbler working models and the right digital solutions can help streamline efforts and mitigate risk more effectively—an area where many banks need additional support right now.

The relentless challenge posed by the macroenvironment and Fintech and non-traditional banking services only underlines the need for banks to establish relationship primacy with their customers. Banks must find ways to meet their customers where they are, with precisely what they need, and at the right time—all while managing risk and driving efficiency, with the right digital solutions in place. 

It’s no small feat. In 2023, banks will need to embrace a mindset shift from the traditional bank-centric approach into a multi-channel customer-centric approach, powered by data and digital solutions.