Digital transactions won’t save banks’ profits, warn finance experts

Retail banks should not rely on digital channels alone to increase flagging profit margins, experts at audit and consultancy firm Ernst & Young will warn bank chiefs at tomorrow's European Retail Banking Summit in London.

The warning comes as retail banks across Europe are struggling with the euro crisis and the impact of increased capitalisation regulations on profitability.

"Being solely digital is currently not a viable option for a scale retail bank," said Omar Ali, head of Ernst & Young's European retail banking advisory team.

Research by the consultancy among 298 European bank heads, ahead of tomorrow's summit, reveals falling margins as the biggest challenge facing retail banks across Europe in the next five years, closely followed by the cost of regulatory compliance and increased competition.

"With increased pressure on banks to meet their return on equity targets while facing higher costs of capital and funding, generating returns in a highly regulated environment is the industry's major concern," said Ali.

"The immediate response is to cut costs, with 58 per cent of banks looking to reduce the cost of serving their customers."

However, customer churn is also high on the bankers' list of concerns, so they are looking to digital channels to cut costs while keeping service levels high.

The profitability of retail banking – largely dominated by the economics of in-branch transactions 20 years ago – increased enormously before the financial crisis of 2007 with the successive development of ATM, telephone, online and most recently mobile services.

Consequently, nearly three-quarters (72 per cent) of bankers surveyed by Earnst & Young believe new technology is a key factor in attracting and serving customers.

But Ali warned that digital channels cannot replace all face-to-face contact, especially when it comes to selling complex financial products, such as mortgages and pensions, for which he said the branch network will remain as the main sales conduit.

"One channel of communications with customers will not win out over the others as this would not suit the banks' customers," he said. "The majority of consumers still look for face-to-face advice when buying complex products such as mortgages or pensions.

"These products hold some of the largest margins for banks and, in order to differentiate their offer and preserve their margins, banks will need to work their branch networks harder in the future."

Digital-only banking could work "for a new entrant without the legacy customer base", commented Ali.

Bank chiefs and investors have to recognise that the 20 per cent return on equity (ROE) rates they achieved before the 2007 banking crisis have gone for good, Ernst & Young will tell the summit's delegates.

They should now plan for a future where the industry average is 10 - 12 per cent, and look to push ROE to 15 per cent by paying attention to "the transactions that matter most to customers".