Tuesday 15 October 2019

The rise of the banking machines will dispense with cash, branches and humans

Irish banking is changing rapidly and now Bank of Ireland CEO Francesca McDonagh may have to follow rivals and wield the axe

'The day of the cashless bank branch, which once seemed about as likely as a pub with no beer, is rapidly dawning.'
'The day of the cashless bank branch, which once seemed about as likely as a pub with no beer, is rapidly dawning.'

Dan White

After six months as Bank of Ireland boss Francesca McDonagh is preparing to wield the axe. The bank has refused to comment on reports that it is getting ready to part company with up to 200 senior managers. "We will not be commenting on staffing matters," says a spokesman.

If the reports are correct, and McDonagh has already told analysts that Bank of Ireland (BofI) "can't simply wait" for its near €1bn IT upgrade to deliver cost savings, then the bank will be showing the door to almost a sixth of its senior managers in Ireland and the UK.

Bank of Ireland's 2017 full-year results, which were published at the end of February, show why it needs to tackle its costs aggressively.

Last year BofI's costs were the equivalent of 62pc of its total income. While BofI's costs were artificially boosted by a number of one-off factors, mainly IT-related, its underlying cost/income ratio was still a vertiginous 59pc.

By comparison, AIB's 2017 cost/income ratio was a much more respectable 48pc. Even when loan write-backs are stripped out, AIB's underlying cost/income ratio was 53pc, a full 6pc lower than Bank of Ireland's.

Faced with such a wide cost gap between BofI and its major domestic competitor, the pressure on McDonagh to act has been intense.

Uniquely among the banks operating in Ireland, Bank of Ireland has largely refrained from closing branches in recent years (see panel).

Its 250-strong branch network is easily the largest of any bank operating in the Republic

This means that BofI has managed to avoid the storm of controversy other banks have endured from politicians and local communities when they have sought to close branches.

Read more: Richard Curran: The traditional bank manager has become an endangered species

But is this about to change?

McDonagh, in her previous job as head of HSBC's UK retail operations, shut 40pc of its British retail branches. A repeat performance on this side of the Irish Sea could translate into up to 100 Bank of Ireland branch closures.

Closures of this order of magnitude, even from a bank that had previously largely avoided shutting branches, would unleash a political and media firestorm - Bank of Ireland is still 14pc state-owned. By culling the ranks of her senior managers first, is McDonagh buying "cover" for when the inevitable branch closures begin, by being then able to argue that she is merely "spreading the pain"?

What the latest reports of job losses at Bank of Ireland demonstrate yet again is that the old banking model is irretrievably broken.

Back in the day, banking could be characterised as a 3-6-3 business - take in deposits at 3pc, lend them out again at 6pc and be on the golf course at 3 o'clock. It may be not much consolation for McDonagh, but Bank of Ireland's plight is not unique. Technology, financial crises and increased regulation have combined to utterly transform how banks must do business.

"Banks have been through the perfect storm over the past decade," says Tom Conlon, associate professor of banking and finance at UCD Business School. "They have an undiversified business model. They have been hit by changing technology, newcomers to the marketplace and demographics."

The days when customers conducted most of their banking transactions at the counter of their local branch are long gone. In 2017, 95pc of AIB's customer transactions were automated. The proportion was even higher at Bank of Ireland with 98pc of customer interactions being through ATMs, self-service or direct channels. BofI claims to have one million digital customers and 720,000 active mobile users.

At the same time as technology is pushing their customers out of the branches, newcomers are nibbling away at what were once considered core banking functions.

These newcomers include payment systems such as PayPal, Apple Pay and Payzone as well as peer-to-peer lenders, where the depositor lends directly to the borrower, and crowd funding.

Changes in the regulatory environment since the crash mean that banks are now much more tightly regulated than they were before the crash.

The main change is that the banks must now hold much more capital on their balance sheets. At the end of 2017, AIB had a common equity tier one (CET 1) ratio of 17.5pc while Bank of Ireland's CET I ratio was 13.8pc.

While the requirement to hold more capital makes it less likely that banks will go bust, the downside is that their lending capacity, and thus their profitability, is also greatly reduced as banks must set now aside a higher amount of capital against each loan.

"The banks have gone from where they were earning 20pc ROE [return on equity] to 10pc ROE or even lower. They are now more like utilities," says Tom Conlon.

So is it all over for branches and perhaps even for the banks themselves? Is the banks' business model, which developed over more than half a millennium, about to be swept away by a tide of economic, technological and regulatory change?

While the banks are certainly facing unprecedented problems, reports of their imminent demise are almost certainly greatly exaggerated.

Newcomers such as crowd funders and peer-to-peer lenders certainly have the ability to capture some of the traditional lending business but they are unlikely to run the banks out of town. This is because banks only have to hold back a small portion of their deposits to meet withdrawals and can lend the rest, a practice know as fractional reserve banking.

By comparison, the crowd funders and peer-to-peer lenders directly match depositors and borrowers. This ability to leverage their assets means that the traditional banks will almost always have more lending capacity at their disposal than the newcomers.

"In the current regulatory framework, banks are irreplaceable. Peer-to-peer lenders can't perform the same function", says Conlon.

Likewise, the bank branch may not be about to disappear any time soon. Instead, we may be about witness a transformation in its role, with a smaller number of branches surviving to cater to customers' big-ticket financial needs, mortgages, pensions, investments, etc, rather than, as was the case in the past, facilitating basic financial transactions such as cash deposits and withdrawals.

"A certain demographic is always going to want branches. There may not be as many of them, but that demographic is living longer. Bank branches are going to have to change the services they provide. The future of the branch lies in providing financial planning and problem solving for customers, creating added value for the banks. This is going to require staff who are very highly qualified," forecasts Conlon.

So where does all of this leave the Irish banks? What can the customer of 2023 or 2028 expect? Five or 10 years hence all routine banking transactions will be digital.

Even the days of the ATM, the original "hole in the wall" that first introduced most of us to the joys of automated banking, are numbered as the increased use of debit cards cuts down on the use of cash in small retail transactions.

The ATM Industry in Europe, the organisation which represents European ATM operators, forecasts that 25,000-30,000 ATMs across Europe could either disappear altogether or start charging customers for cash withdrawals over the next few years.

At the same time as cards reduce the need for cash in small transactions, governments everywhere are seeking to reduce the volume of high-denomination banknotes in circulation in order to make life more difficult for drug traffickers, tax dodgers and other miscreants.

The highest-value US banknote issued is now the $100 bill while the Bank of England's most valuable note is for £50. Even the ECB, traditionally a laggard in this field, has stopped printing new €500 banknotes.

The day of the cashless bank branch, which once seemed about as likely as a pub with no beer, is rapidly dawning.

Future bank customers will visit these cashless branches by appointment only when they need to meet a human being before buying a pension or homeloan.

With Francesca McDonagh committed to reducing Bank of Ireland's cost/income ratio to below 50pc, which implies a €275m reduction in costs from their 2017 level, that future could come sooner rather than later.

Sunday Indo Business

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