The Art of Banking Wars


This is an article published in November when RBI deregulated the savings bank rate in India. This piece looked at the implications of this move, beyond increase in cost of borrowing as was being touted by all analysts. 

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RBI’s saving rate deregulation move has the potential to change the competition leader board across various product categories. Rather than viewing this as a run of the mill cost of funds increase issue banks need to take a holistic view of their entire product portfolio vis-a-vis competition in light of this change.

Savings accounts with their lower interest outflows have provided large banks with a rate cushion to price their lending products more competitively than their savings account poorer banks. But all this is about to change and how. What was till now a relatively passively consumed and marketed product has the potential to become an extremely actively competed for product. And the timing and scale of the competition this time will not be decided only by the larger banks. If the smaller banks play their cards well and aggressively, they will be able to pull in the larger banks into the competition to the smaller bank’s benefit.

Some banks have been quick to jump onto this bandwagon and have already raised their savings rates while other are playing the wait and watch game. Yes Bank raised its savings rate by 200 basis points within hours of the RBI move. Kotak and Indus Ind followed suit a couple of days later. The larger banks have clearly stated that they will adopt a wait and watch policy and respond only if the situation demands it. We have also seen most brokerage houses giving their views on this and most have been dead right in their calculations of the impact on the NIMs of various banks. But what has been missed is the opportunity this deregulation would provide to various banks to improve their lending business and the resultant NIM increase from there.

Scenarios

There are three most probable scenarios at each bank post this:

Scenario 1 – Savings deposits reduce (as a percentage of total deposits) and are replaced by higher cost term deposits (This is when customers are weaned away to other banks)

Scenario 2 – Savings deposits remain the same but now cost higher (This is when banks need to increase rates just to maintain status quo)

Scenario 3 – Savings deposits increase and term deposits reduce (This will happen under two conditions – a) With the differential between them now lower some customers may be more willing to forego slightly higher interest for liquidity. This is a desirable scenario and banks need to use data analytics to identify their customers most likely to fit this profile.     b) This will also happen because new customers would be acquired from lower interest paying banks. Though interest rate is not the only criteria while customers choose a savings bank, there will still be customers, more so the higher balance customers who could be enticed.)

Banks would therefore do well to take a holistic view of these scenarios not only for themselves but for their competition too, as scenario building in the true sense always encompasses the competition landscape. There are a couple of scenario building and war room planning tools available which banks could use.

Model

Below we see a sample scenario model, which demonstrates the use of scenario building for ‘Cost of deposit’. We have used Cost of deposit as a proxy for Cost of funds. We have used two banks here to build scenarios – the larger bank being the defender and the smaller bank being the challenger. The contribution column shows the percentage composition of each type of deposit to the total. (Average term deposit rates have been assumed at 9%. From a

cost of deposit perspective demand deposits have zero direct cost, though they have a higher intermediation cost, which is not accounted in cost of deposit)

These scenarios have been built with certain assumptions primary amongst those being that quite a few banks will come forward and increase their savings rates across the board. This has actually already taken place.

Originally there was a 122 basis point difference in the cost of deposits between the two banks. In the first scenario where the defender loses savings deposits and the challenger improves its savings contribution, we see the difference in COD being whittled down to 57 basis points. The point to note here is that the COD improved for the Challenger bank by only 23 basis points but its competitiveness on COD against the Defender improved by 65 basis points. A 50 basis points gap is a competitive advantage in many keenly fought consumer lending products!

Similarly in the second scenario even though the Challenger bank’s COD increased by 17 basis points, its competitiveness against the Defender improved by 28 basis points. This is classic Sun-Tzu!

What this whittling down of the COD gap does is that in certain highly rate sensitive products (from the customer’s point of view) the Challenger bank can now think of mounting a serious challenge. Earlier the Challenger may have been lying low as the gap of 1.22% was too large to make up in rate sensitive products (like in housing loans, car loans), but now is in a better position to mount a challenge. The Challenger may now revisit its entire customer proposition as it is no longer fighting in the market from a position of lending rate weakness. Challenger banks which thrived on catering to a slightly riskier customer profile in the race to get a higher yield will now use that risk expertise to move into the hitherto prime customer space occupied by the large banks.

At a tactical level increase in business will come from reaching out to the right channels and clients. Business verticals with rate sensitive customers should be involved in this scenario planning exercise to understand the role which each vertical will play. Business verticals should also have their plans ready for the different played out scenarios. Each vertical will need to list their competitors and their prevalent lending rates and basis the different probable scenarios, their competitors’ probable lending rates by product. Basis inputs from all a grid mapping competitors and products with the new rates for all customer rate sensitive products should be drawn out. This grid should be used to target the distribution channels and clients of competitors who now seem weaker or within striking distance. The challengers need to have their plans in place before the events occur to be the first to take advantage of the changes in the market place. Similarly the Defender banks will be able to identify the potential challengers across their product suite and be able to build defences accordingly in advance. 

One of the powerful tools used in such scenario building exercise is an Advanced Solution Centre, a proprietary tool of Ernst and Young.

This exercise is played out in an event based setup over 2-3 days. The spade work is done prior to the event by collating all possible data that will be required during the event. The participants in the event are not just the senior management but also a sprinkling of the ground forces to bring a more ground level feel to the exercise. During the event the participants are exposed to various tools including rich pictures, thinkshop, metaphors and stories. The participant groups are assisted in formulating scenarios and in repeatedly defending them. This helps create a list of possible scenarios with robust response plans.

Scenario building is a powerful tool and the savings rate deregulation offers a good opportunity to the Indian banks to embrace it like their global counterparts. We are heading into exciting times for the market.

MSME Assess – Complete diagnosis before treatment


There are five key blocks which are critical in delivering value in the consumer and MSME banking space.Image I have placed these blocks purposely in a pyramid to signify the order of intervention, i.e. interventions along Structure and People take precedence over those along Technology.  This pyramid is the pictorial depiction of the proprietary diagnostic tool ‘MSME Assess’, but can be used with minor tweaks for consumer banking too.

Diagnostic tool – Any bank embarking on a major project in the MSME space would do well to employ a diagnostic tool at the outset. The diagnostic tool will analyze and help lay out the strengths and weaknesses in the current system across all these blocks. A good diagnostic tool will go further and do some sort of a benchmark of the bank’s capabilities against hypothetical or existing leading practices. A great diagnostic tool though would be interactive and provide a list of possible interventions for each level of capability across these banking blocks. The bank can then decide the order of implementation and be in a position to appreciate that getting desired outcomes within one block will more often than not demand interventions across other blocks too. According to me this is the biggest benefit of an advanced diagnostic tool. It can help in laying out starkly the linkages between the various components of the banking blocks. MSME Assess maps out the maturity level of each of the criteria measured within the blocks. These maturity levels are denoted as – emerging, developing, developed and advanced. Trained practitioners can use the tool to map each of the 32 criteria of the banking blocks to their maturity levels. Banks then take a call on the implementation priority based on the maturity levels and resource commitment based on the possible required interventions as shown by the tool.   

MSME Assess – A brief elaboration of these blocks and the components they measure is in order here to give you a flavor of what is on offer:

Structure and People- A bank can have the best technology, best products and infrastructure but without the appropriate organization structure and the right quality of people, the bank will always struggle. This is the reason that this block sits on top of our SME Assess pyramid. Leading banks in the MSME space all have the ability to measure the profitability of the MSME business. The majority of these banks have MSME as a separate division within the bank, thus providing the necessary resources and appreciating that the MSME culture is distinct from their retail and large corporate counterparts. This block describes the required core competencies as:

  • Organization and reporting structure,
  • HR practices including performance management and people development practices.
  • These core competencies are further decomposed to the next measureable level of criteria, for eg-

HR Practices:

  • Hiring
  • Training
  • Performance measurement
  • Incentives
  • Career path development

The tool further describes for each of these criteria their state when found across the four maturity levels as mentioned earlier.  

 Credit and Risk – This block describes the capabilities of the bank in across its risk measurement and monitoring systems and its ability to provide credit underwriting capabilities in line with the requirements for the MSME segment. The aim of the MSME credit function is to provide consistent cost effective credit underwriting without over reliance on collateral. Banks which are able to employ lending technologies which can thrive without full coverage of collateral are poised to do well in a scenario where the MSME market is still largely untapped. The ability of banks to identify risks and monitor and resolve them well in advance is of paramount importance in this portfolio, where the slide into NPAs can be fast and the furious.

The core competencies benchmarked in this block are:

  • Credit Structure
  • Credit Underwriting
  • Risk Monitoring
  • Delinquency Management

 For example within Risk Monitoring the criteria are:

  • Risk modeling
  • Early warning systems
  • Risk segmentation
  • Risk processes

 Market Segments and Products – Identifying and defining the market segments that a bank wishes to compete in is very critical. Building expertise and knowledge of particular segments and sectors has been proven time and again to be a successful way of building a profitable MSME book. Over time, the superior knowledge leads to the raising of welcome entry barriers for others wishing for a share of that market. Shriram Transport, is one name that easily comes to mind in the pre-owned commercial vehicle Indian market, which has followed a similar strategy to build a profitable business. This block measures how well the bank is able to segment the market and deliver products as per the needs of the identified segments. The core competencies benchmarked in this block are:

  • Product Development
  • Market Segmentation

 For example within Product Development the criteria are:

  • Development process
  • Pricing
  • Competitive relevance

 Product Distribution Channels – Branch based distribution systems are the traditional distribution channels, but have now outlived their relevance by over a decade. In this age a multi channel approach leveraging on the existing branch is more prevalent amongst leading banks. The ability of a bank to build a mass market relationship based selling model drawing on leading practices from both retail and corporate banking is critical here. The core competencies benchmarked in this block are:

  • Sales structure and strategy
  • Sales process and systems
  • Use of Business intelligence
  • Channel network usage

 For example within Sales structure and strategy the criteria are:

  • Sales organization
  • Sales culture
  • Role of relationship managers
  • Skill training

 Technology – With the dual aim of providing efficient cost effective acquisition and service, and maintain a profitable portfolio, the use of technology plays a crucial part in the quest to build a successful MSME portfolio. Technology is used to automate to cut costs and reduce response times, and to capture and churn data to build a data centric organization. The core competencies benchmarked in this block are:

  • Analytical capabilities
  • MIS capabilities

 For example with Analytical capabilities the criteria are:

  • Data capture
  • Data storage

 Using diagnostic tools like MSME Assess increase the chances that banks do not work on only the easiest and the most visible criterion, but get a bang for their buck when spent after a holistic analysis of the tool’s output.

Not all Kings are equal – An intro to customer lifetime profitability


The myth

All of us are familiar with the mantra “Customer is the King”, which conveys that we satisfy the needs of all our customers. At first glance, this concept makes sense. After all, more the happy customers, more the profit, right? But is it possible to make all our customers happy? Or is it even necessary? It is a utopian thought with no resource constraints and shareholders to answer to.

Where most banks go wrong is in assuming that they can/should treat each customer like a King. Even in the courts of Emperors, all kings had a clear hierarchy of privileges and seating around the throne. With millions of customers to serve, each one though a king deserves differentiated levels of privileges. This differentiation needs to be done like the Emperors did not only on the king’s current army strength (in our case current relationship value), but also on the kings’ ability to influence other aligned and non-aligned kings (ability of customers to be promoters) and future earning/tax potential of the kings’ lands (future growth potential of customers’ wealth). Banks currently accord privileges to majority of ‘kings’ primarily basis their current relationship value. Banks, who wish to become Emperors, will need to like Emperors calculate the King Relationship Value or the Customer Relationship Value.

 

Measuring CLV

CLV is the net present value of the current and potential profits from the customer. Without a strong theoretical framework, it is difficult to link current revenues and costs to customers, and even more onerous to predict potential revenue and costs. Currently majority of Indian banks primarily use heuristics based current relationship value as an indicator of CLV. These methods are satisfactory in predicting the CLVs of the premium customers, but fall woefully short while predicting for the mid market customers who generally form the bulk of the customer base at most banks.

The CLV theoretical framework has three components of profitability derived from:

  • Current relationship value
  • Potential relationship value based on attitudes/behavior/wealth/income over time
  • In the age of the social media the customer’s influencing ability.

Note that CLV is ideally based on profitability and not revenue and requires the ability to have a single view of the customer across all relationships. CLV basis revenue is lower on maturity.

To build the framework banks first need to understand the costs incurred to service each customer. In my discussions with banks, the absence of a cost capture framework has been observed time and again. Customer costs flow through various departments and cost centers across the bank though have yet to see a Customer cost center, which captures costs incurred on the customer across the bank. Banks could do well to start building a cost framework, as herein lies, huge amounts of cost savings waiting to be released primarily through removal of duplication and process streamlining.

Most banks have done some work on the current revenue framework but still rarely at the customer level. These frameworks are robust for the premium customers and can be extended across segments.  The next milestone will then be in building a framework to capture potential revenues and costs over the lifetime; a lifetime is generally defined as a cycle of seven years. There are various intelligent IT tools, which can be used as a base to customize this framework for each bank.

And the last but not least job will be of building the Influencer profitability model. Identifying and nurturing this segment of customers is something which the banks need to learn from other industries. For eg – Mattel, the toy manufacturer has a list of 400 blogger moms in the US, who the manufacturer actively engages with while designing and promoting their toys. The company has shifted its promotion budgets from giving out free toys in stores to sharing their toys with the blogger moms to get their buy-in. Many banks have customer contact programs where they engage with customers and use their insights in building/improving their products and services. But none of them know the promoter scores of this set of customers and none flag these customers off on their internal systems as an influencer who needs to be accorded special privileges.

CLV in action

With a CLV deployment banks will know the CLV of a customer on the day he is on-boarded. This is possible through the use of tried and tested customer frameworks. Just imagine, if we were to know the profitability of our current and new customers on day one? Customers could then be accorded privileges basis CLV and not just their current relationship value. Banks could define the overall customer CLV segmentation that all departments should aim for, as the ultimate aim would be- meeting CLV potential, driven through cross-sell. The CLV framework when combined with event based marketing (EVM) is a potent tool to increase cross sell revenues.

Most customers have multiple banking relationships but one/two primary bank(s). The secondary banks because of the low relationship value of this same customer do not accord it the privileges that a customer of his stature (CLV) deserves. So this customer, used to higher privileges at his primary bank, is never enticed to make one of his secondary banks as his primary. With older banks saddled with hundreds of thousands of dormant/low value accounts, we will never know how many of those dormant accounts are highly profitable accounts, at their primary banks.

CLV would be used to offer truly differentiated service to customers across products. Imagine a high CLV customer with only a credit card relationship. When this customer goes to the bank to open a vanilla savings account he could be offered free platinum services on his vanilla account for a look-in period of (six) months. He would be referred to other product groups depending on his CLV matrix and if his promoter score is high, the bank would engage with him on a different level. The probability of building a stronger/wider relationship with the bank is evident. The additional cost spent on the customer over and above his current entitlement is an issue, which requires the cost framework to incorporate an apportionment model across various potential verticals. This kind of accounting necessitates banks to view themselves as a single entity rather than as a federation of products, as banks currently do. CLV as a concept therefore needs buy-in and drive right from the C-suite. Businesses can focus more on customers with high CLVs. Customers who increase the overall CLV of the bank rather than just of individual products will be sought. Only with use will CLV models become more robust.

In the developed markets with already high banking product penetrations, banks and insurance firms have deploying CLV. This is to optimize their operations and improve profitability in a scenario where fresh customer additions are low. We in India do not have the same challenge. CLV in India is important as, rather than only acquiring large customer numbers, banks need to focus on juicing the CLV of every customer who the bank comes in contact with. The days of 30% dormant accounts and low products per customer would then be a matter of the past.

Idea Markets – The Power in numbers


Dattaram had just taken over as the branch manager of the SME branch of this large PSU bank since the last six months but had spent over 20 years at the bank. One of his biggest challenges was in providing as fast a turnaround on credit proposals as the new age private sector bank next door. He discussed with another SME branch BM in Delhi and designed a new process for credit appraisals which would improve the TAT by 25% for all SME branches across the bank. With a lot of excitement he presented this proposal to his Regional Head, Mr. Prabhu. Mr. Prabhu though had his hands full with the launch of ten new branches in the next quarter and did not wish to be bothered with Dattaram’s new project at that time. He told Datta that they would discuss the project after the branch openings and pushed the project onto the pending list. The branch inauguration next quarter was a grand success. Another ten branches were to be commissioned within the next two quarters, and thus Dattaram’s TAT improvement project went onto the perpetual pending list which most Regional head’s like Prabhu have. Dattaram too got used to operating with the sub-optimal process and life continued at the bank. Dattaram never again bothered to think of a better way to perform his job as getting Prabhu’s mindshare was too daunting. We will never know if Dattaram’s TAT idea was worth pursuing by the bank. We will never know if that change could have increased PAT by those millions by which the bank missed its year-end PAT estimate!

Every organization has its fair share of Dattaram’s and Prabhu’s.  Idea markets is about giving a voice to all the Dattaram’s and making redundant all the Prabhu’s in our system.

The banking industry has one of the most educated and largest employee bases. But the majority of this base is conditioned to think as workers rather than as intrapreneurs (entrepreneurial thinking employees). While comparing banks most ranking methodologies give weightage to the financial parameters but none take into account the size and quality of the workforce. In my mind, quality of workforce being equal, a bank with a hundred thousand strong employee force should have five times the intellectual capital as one with twenty thousand employees and this should give the larger bank intrinsic strength. But this arithmetic does not hold true as organizations have by and large not built systems to harness the true intellectual capabilities of their entire worksforce. I see Idea markets as an interesting concept to right this wrong.

Idea Markets

Idea markets use ‘crowdsourcing’ as its primary building block. Crowdsourcing, at its most basic level, is about collaborative thinking towards a common goal. It is when a business or organization takes a task usually performed by a designated internal team or individual and outsources it to an undefined group of people in the form of an open call. The concept has been present and has been used knowingly or unknowingly since ages. It is based on the belief that a diverse collection of independently-deciding individuals is likely to make decisions and predictions better than experts. Spurred by the benefits offered by web 2.0 technologies and the increasing acceptance of technology as a platform, all industries, including BFSI, are trying to use it to the fullest. Stock markets its functioning is the most common example of crowdsourcing. The premise which forms the basis of Idea markets as an application of crowdsourcing is the fact that stock markets essentially evaluate the stocks of companies based on the “crowd’s” perception on how good a stock is. Applying the same idea within an organization, we have a collaborative innovation platform.

There are many instances of crowdsourcing, which have been deployed:

  • The first prediction markets namely Iowa Electronic Markets (IEM) predictions for presidential elections have been continuously more accurate than exit polls
  • HP’s internal prediction market outperformed HP’s official printer sales forecasts 75% of the time over 3 years. Intel established a prediction market to allocate manufacturing capacity, which yielded a 100% efficiency improvement
  • Walmart, Southwest Airlines, Google and Microsoft have all deployed different forms of Idea markets
  • Closer home Infosys has implemented its own Idea market within the company

How it works?

A perfect crowdsourcing application should have four characteristics that ensure a success story – diversity of opinion about the said idea, independence in formation of thoughts & opinion, decentralization of sources of information, and a platform to quantitatively aggregate the information held by the crowd.

The objective of idea markets is to create a virtual market where all participants can suggest new product ideas and collectively evaluate those ideas through a market mechanism. Idea markets use idea stocks to represent new product ideas, let participants trade the stocks on a virtual market place, and use the resulting stock prices as indicators for the possible success of the different new product ideas.

The Idea markets implementation is a six-step process starting from generation of ideas based on an open-ended or closed ended question by the management team. The questions can be as specific as improvements on a feature of a service, or as open as invitation on ideas on a new product, or product category. Dattaram’s TAT improvement project would have been an idea which he could have listed (without requiring Prabhu’s approval) on the idea market at his bank.

All collected ideas are evaluated by the employees. Employees in the SME department would have been interested to evaluate Dattaram’s idea. The basic principle behind using the market mechanism for idea generation is to exploit the power of markets to efficiently evaluate a large number of stocks, as the market mechanism stands out for its ability to aggregate dispersed opinions. There would be other ideas too which would be traded. At the end of the period the aggregating mechanism of the platform would highlight the idea stocks with the highest market capitalization. Dattaram’s idea would now float up to be noticed by the SME Head who can then start a pilot implementation of the idea. There could be other ideas which may not be as easy to implement and may require further resources in terms of time and money which can be sanctioned by the senior management who play the role of venture capitalists within the bank.

In conjunction to Idea markets, banks would also want to look at Idea management systems which allows them to collect, track, and manage ideas. Selected ideas are taken in for further analysis, implementation and more. It also allows those participating in the project to volunteer to work on particular projects and vote on which ideas should be considered for investment and developed to the proof-of-concept phase. An idea markets implementation along with an idea management system forms the ideal combination for the innovation program in a bank to analyze the potential benefits of all incoming ideas and insights, product management, strategic planning, sales, and processes improvements, and others.

Why Bother?

Enough said, but why should any organization, be it in BFSI or any other industry, bother to setup a collaborative interaction platform within its intranet. Truth being told, there are benefits for both the company and the employees from such a platform

For the organization, constructive employee engagement through a game-like environment for fostering participation, strengthened intrapreneurial culture, a feedback and employee pulse detection channel and identification of opinion makers are some key benefits. However, the key benefit is to be able to ask its employees key questions and solicit ideas and answers from them.

Employees too reap benefits by getting reward and recognition opportunities, and greater job satisfaction through a say in the decision making process of the company. More Dattaram’s will be unearthed and Prabhu’s made redundant.

If Idea markets are deployed well large banks could start enjoying the fruits of owning a large employee base and increase the performance gap with the smaller banks.