Virtually every analyst and reporter following the financial services industry appropriately predicts a tougher operating environment for 2007. Most of you know the reasons, among them: flat yield curve, “normal” credit environment, tougher competitors, and more demanding customers.
Some banks immediately focused on expense reduction as an initiative to address the rougher climate and increase the bottom line. In past crunches, many banks have viewed reducing costs as an easier and more certain path to bolstering the bottom line versus increasing revenues.
A few banks, the ones we think will ultimately be the most successful, are trying a different tact; they are going where the growth is in the foreseeable future. For these players, banking small businesses and the wealthy offer as close to a sure thing as exists in the current banking environment.
Why focus on these segments?
1. Growth. Small business and the wealthy are growing segments. For example, top banks, such as Wachovia and Wells Fargo, reported double-digit revenue increases from both small business and wealth management in the third quarter. In addition, both Merrill Lynch and UBS expect the number of wealthy households in the U.S. to growth between five and eight percent annually through 2010.
2. Strong returns. Both can generate outsized returns; ROEs of 30 percent or more are not unusual. Further, much of the income is fee-based rather than relying on loans.
3. Relatively low risk. Both offer strong risk performance. In recent years, the loss numbers generated by small businesses have been in the low double digits. While the basis points are likely to rise this year, the erosion in risk quality will be limited. Neither segment is riskless, but both small business and the wealthy will continue to turn in strong credit numbers.
4. Bank friendly segments. Depending upon how a bank defines small business and the wealthy, they remain segments that continue to rely on banks for much of their financial services needs. Of course, even the smallest businesses have significant financing and investment options, whether from an American Express line of credit, a business credit card provided by a national player, or a non-bank player like Fidelity for investment and retirement needs. Similarly, “the wealthy” can be an intensely competitive segment, particularly as assets available for investment increase.
Within both segments, banks need to “pick” their targeted clients based upon as objective an evaluation as possible of their capabilities and aspirations as well as a frank assessment of the competition and customer preferences.
One of the elements that often get in the way of a bank succeeding in small business or with the wealthy is that it targets an inappropriate customer set. Frequently, banks aim too high in the wealth management arena, stretching their internal resources and credibility with targeted clients. One indication: up to this point in our consulting work, we have always found a significant gap between a bank’s stated minimum threshold for a wealth management client and its actual client base.
The small business situation may be even more complex. Too often, banks simply do not really know enough about their current small business customers and their potential; insights and opinions rely on anecdote and folklore rather than quantitatively-based analysis. What we find most frequently is that a misalignment exists between a bank’s customer base and its delivery approach. For example, a bank may emphasize an expensive relationship manager model aimed at a small business client set whose economics cannot justify that investment or wealth managers offer too much hand holding to smaller investors. By the way, this delivery misalignment also occurs with many segments outside of small business and wealth management. We have found that better aligning sales and service channels with customer segments provides a major productivity and sales opportunity to many banks.
We can continue to build this list with other elements such as cross-sell opportunities, deposit levels, and linkages between the two businesses. More than one client bank has used its small business group as a feeder for its wealth management efforts and vice versa.
Key Barriers To Success
Despite the attractiveness of these segments and their demonstrated past performance, we believe that top management at many banks has failed to commit sufficient resources to these segments, particularly small business. Why? Small business is quasi-retail, quasi-commercial; individual customer revenue numbers are low compared to other commercial business; given the nature of the segment, it seems risky (in reality, it is not). Note that we think most barriers are internal and not related to market fundamentals or attractiveness.
Final Thought
Obviously “easy money” is meant to be a relative term. These segments are large, growing, and attractive with strong risk profiles. Banks need to agree on their optimal strategic focus (what makes practical sense for them) and, then, get out of their own way organizationally in order to generate the level of revenues these segments can provide.