In the years following the global financial crisis (“GFC”), the banking industry experienced a paradigm shift in the regulatory environment, with regulators across the world shifting from what was widely perceived as a relatively relaxed stance to an overtly vigilant one. The imposition and enforcement of stricter risk management requirements have not only increased compliance costs for banks, but also led to larger and more frequent fines and penalties, weighing considerably on industry profitability.
In response to the new regulatory climate, global banks made a seemingly unanimous decision to off-board their “tail clients” – namely, clients with low existing revenues and / or high associated compliance risks. Much of this was driven by the view that the profits generated by such clients did not justify the costs (and risks) of servicing them. The scale of this coverage optimisation / de-risking exercise has been far from trivial; we estimate that over USD 13 billion in revenues has been off-boarded by the top 15 global banks alone since 2014. Several global tier-2 and regional players have been actively targeting these revenue pools.
While we recognise the short-term rationale behind a renewed focus on larger accounts, especially in a cost-conscious and resource- constrained environment, we believe this strategy is both short-sighted and economically sub-optimal over the medium-to- long-term. Banks have not only failed to create a compelling service proposition for their tail clients over the years, but the move by many firms to focus on their key accounts is weighing considerably on margins and wallet share. Moreover, the future growth potential for a large number of these “key clients” remains much more subdued than many up- and-coming tail accounts.
We believe that a renewed focus on tail clients remains an attractive long-term strategic proposition for global and regional banks alike, given lower barriers to entry, less competition, and the strong future growth potential of banking successful (albeit smaller) high- growth accounts. However, to capture this opportunity in a profitable manner, a robust, end-to-end digital strategy is needed. At its core, this will necessitate a low-cost, low-touch approach across the entire client service value chain. Whilst we recognise that this has been done with varying degrees of success in retail banking, digital transformation in the wholesale banking space lags significantly behind.
We see a number of regional banks in Asia Pacific (“APAC”) being well-positioned to capitalise on this opportunity, especially those with greater management and operational flexibility, including a willingness to invest and innovate – in other words, those with the appetite to change. Additionally, given the rich, burgeoning FinTech landscape in the region, we also see a sizeable ecosystem of existing FinTech firms which regional banks can partner with (or potentially acquire) to supercharge their digitalisation efforts.
While the digital transformation journey will take considerable time, effort, and investment, we believe the off-boarded tail represents a USD 25 billion revenue opportunity. Overall, we estimate that digitalisation has the potential to deliver a 10-15% increase in top-line revenues and a 30% reduction in operating costs for successful players. With incumbents being rapidly disrupted by a plethora of FinTech firms, digitalisation is fast moving from a strategic priority to an operational necessity for banks that want to stay relevant in today’s market and capture new revenue pools offered by chasing the tail.