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Reshaping retail banks: Enhancing banking for the next digital age

The most direct path to success is to target profit pools in specific businesses of the universal banking model—daily banking (deposit accounts, payments, and credit cards), navigating life events (with complex lending products), or building and protecting wealth—where the bank can define and deliver a value proposition that can win in our new digital age. While much has been made of the threat from fintechs and Big Tech, we believe incumbent banks will continue to lead in retail banking. Banks running the old playbook, however, will not survive; the new winners will operate like tech companies, with advanced data capabilities, a cutting-edge tech stack, and an agile operating model.

Banking faces severe challenges

About the authors.

This article is a collaborative effort by Ashwin Adarkar , Stefano Cantù, Klaus Dallerup , Vito Giudici, Enrico Lucchinetti, and Zaccaria Orlando, representing views from McKinsey’s Financial Services Practice.

Differences in the profitability of key retail banking businesses have always existed to some extent, depending on the market, and daily banking has often served as the foundation for building lifetime client relationships.

However, to succeed in today’s fast-evolving market, which leaves little margin for underperformance, it is imperative for banks everywhere to know where they make a profit and where they don’t (Exhibit 1), and to protect and expand their most strategic revenue streams. While the need for closer examination of profitability is global, the severity of the challenges to the traditional model of universal banking and the implied strategic imperatives generally vary by region:

• In Europe, North America, and developed Asia, the imperative for retail banks is to embrace new technology—including a digital-first business model and hybrid-cloud core technology stack—to move to a fundamentally lower cost curve, fight attackers on innovation, and identify new sources of revenue in complex lending and wealth/protection via end-to-end journeys and personalization.
• Banks in China and emerging Asia should fight for share of wallet while also focusing on increasing the penetration of higher-value businesses, especially complex lending; they should improve the economics for complex lending and wealth/protection through product innovation and segmentation.
• In Latin America, the Middle East, and North Africa, banks need to leverage current profits from daily banking to defend market share against digital attackers and avoid the economic challenges to daily banking seen, for example, in North America. This could be done either by diversifying the source of profitability within daily banking or deepening relationships with daily banking customers by cross-selling complex lending or wealth and protection services.

The vulnerabilities inherent in the universal banking model are becoming more severe as three key trends continue to reshape the competitive environment:

• shifting in scale advantages from branches to innovation
• digital attackers taking the first significant bites out of traditional banks’ revenue streams
• consumers wanting more digital offerings and superior experiences

The fight for customer relationships has moved to new terrain unfamiliar to banks, and many incumbents are ill-equipped to defend market share on the digital battlefield. This is a battle banks cannot afford to lose, and they will need to fortify themselves with new, reimagined, fit-for-purpose value propositions and business models.

How customers will engage with the retail bank of the future

To thrive in the new digital environment, banks will need to rearticulate their value proposition, bearing in mind the power of simultaneously simplifying and upgrading the customer experience and creating value through data. Each bank should prioritize a retail business—or, depending on capital resources and competitive strengths, multiple businesses—and develop a digital platform that supports the full search-shop-manage value chain of the priority businesses (Exhibit 2):

• The daily banking platform would focus on simplifying daily shopping activities by embedding transactions seamlessly (and often invisibly) within customer journeys and giving customers fast, convenient access to diverse retailers and service providers.
• The home and life events (or complex lending) platform would increase customer value through ecosystem partnerships supporting end-to-end journeys for major life undertakings, from search and selection to financing and ongoing management and maintenance.
• The platform for wealth and protection services would compete on the appropriate use of customer data to deliver hyperpersonalized advisory support, enabling investors to make well-informed decisions about increasing and protecting wealth over decades.

Each of the three business models—daily banking, navigating life events, and building and protecting wealth—if executed successfully, could provide a much-needed boost in profitability for retail banks, with target cost-to-income ratios between 40 and 50 percent. Cost-reduction levers would differ for each model but would include optimization of branch networks and maximum automation of customer acquisition/onboarding, credit underwriting, servicing, and more. In addition to increased product penetration across the customer base, income levers include new revenue streams with ecosystem partners (Exhibit 3).

The adoption of platform-based business models will unleash a kind of internal disruption, requiring banks to give up revenue in some areas (for example, net interest margins, transaction fees, and commissions on securities trading) as they position themselves for fast growth in the target business.

Operate like a tech company

To deliver a market-leading platform-based value proposition, banks will need to work like a tech company. Leaders should act promptly to take advantage of strong financials and double down on three key capabilities essential to a platform-based business model: data analytics, a cutting-edge technology stack, and an agile operating model.

Leveraging data for personalization and stronger customer engagement

Crucially, banks have real advantages against Big Tech regarding customer engagement and data, but they have yet to extract the full value of these assets. To compete for data on an equal footing with technology companies, banks will need a comprehensive data infrastructure to support data collection, storage, and advanced analytics, as well as a digital marketing engine to translate analytical insights into personalized messages that anticipate individual customer needs and intentions.

A cutting-edge technology stack to reduce costs and speed up innovation

Each of the main retail banking business models requires an IT infrastructure that is capable of handling significant variations in demand for streaming and processing capacity and delivering new solutions through fast innovation cycles.

The main challenge in designing the new architecture is deciding which components should be developed in-house to strengthen competitive differentiation and which elements of the infrastructure can and should be outsourced to reduce the cost and the risk of service interruptions attendant to updates and upgrades. In addition, the cloud services available today have reached a level of maturity and accessibility that affords banks diverse options (including in-house development and various partnership models) for meeting the requirements of a maximally automated, digital-first business.

An agile operating model to respond to fast-changing markets

Winning banks will develop speed as a core competitive advantage, and they can do this through two main avenues: an agile operating model and building the right mix of talent and skills.

Banks must push ahead with their transition to an agile culture, removing barriers to cross-functional collaboration and creating semiautonomous teams that can deliver solutions quickly in alignment with enterprise strategy. Consistency in roles, communication, and work patterns across teams enables an organization to reallocate funding and form new teams quickly as new opportunities arise and priorities change. 1 “ The five trademarks of agile organizations ,” McKinsey, January 22, 2018; Andrea Alexander, Aaron De Smet, Sarah Kleinman, and Marino Mugayar-Baldocchi, “ To weather a crisis, build a network of teams ,” McKinsey, April 8, 2020.

Sustaining this more dynamic operating model while adapting to a new, more digital environment will require a dramatic shift in skill profiles. For example, the primary role of branch professionals will shift from teller to universal banker, and with an agile tech organization, a bank may see its ratio of developers to tech operations and infrastructure specialists flip from 1:2 to 1.5:1 (Exhibit 4).

Managing this shift in the mix of talent and skills will be a central challenge for banks. Training existing employees to become proficient in higher-value activities is a crucial lever, and our experience and research show that reskilling can be 20 to 30 percent more cost-efficient than recruiting new talent. It also strengthens employee engagement, measured in higher employee retention and higher customer satisfaction, which also contributes to financial performance. 2 “ Enterprise agility: Buzz or business impact? ,” McKinsey, March 20, 2020.

Today’s retail banking market is vastly different in shape and structure from the old environment, in which the traditional model of universal banking was economically sound. In the new world, the winning banks will be those that carefully choose the businesses in which they can lead and commit to building a value proposition, core technology, and operating model fit to win on the digital battlefield.

Ashwin Adarkar is a senior partner in McKinsey’s Southern California office; Stefano Cantù is a partner in the Milan office, where Enrico Lucchinetti is a senior partner and Zaccaria Orlando is an associate partner; Klaus Dallerup is a senior partner in the Copenhagen office; and Vito Giudici is a senior partner emeritus in the Hong Kong office.

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