The valuation of banks in a more fragmented market

The valuation of banks in a more fragmented market

This is the first in a series of blogs looking at the top 10 banking trends highlighted by Accenture for
2019. Building on their predictions, I plan to explore some of the themes raised, starting with the topics of fragmentation of the market and bank valuation.

Banking – unlike manufacturing, for example – has been built as a vertically integrated business. This means that banks have been responsible for producing a full portfolio of financial products, servicing those products and retailing those products to their
customers. An industry like manufacturing, on the other hand – which depends on maximum efficiency – has long relied on a diverse supply chain of specialist component providers. With new entrants coming to the banking market specialising in specific horizontal
niches, we’re now seeing this transformation affecting banking. The traditional banking model is starting to break down – and as the move to digital accelerates, we’re also seeing an impact on bank valuation. 

It’s essential for banks in 2019 to ask serious questions about which parts of the value chain they’re best placed to focus on. They need to play to their strengths and open up to increased collaboration. If they wish to retain the relationship with the
customer, they need to recognize that they won’t always be best placed to provide and service every product themselves, but may need to bring in other providers to help them offer the very best service to customers.

What’s behind this fragmentation? 

Government initiatives to stimulate greater competition in banking are a key driver. Open Banking means banks are mandated to open up their business and to work with third parties and other banks in a way that they never have before. This change in regulation,
coupled with changing customer requirements in the digital age, is allowing new entrants to gain a foothold in the market and to start building a customer base. At the start of 2019, some 62 companies had registered under the Open Banking initiative as third-party
providers in the UK alone.

It’s becoming much easier for customers to cherry pick the services that best meet their financial needs from a range of best-in-class suppliers. With customers visiting bank branches less often and more accustomed to doing their banking online, there is
less reason to remain loyal to a single bank. This is a wake-up call for large established players. Concentrating on one area of the market allows the new horizontal players to do that one thing very well, and to stay laser-focused on customer needs and preferences.
In contrast, while traditional banks can boast a full-service offering, some would say that in many cases the services being offered are pretty average, with no single offering that stands out from the crowd.

Impact on bank valuation 

The valuation of traditional businesses, including banks, is failing to keep up with the rising valuation of successful tech companies that are better able to tell a compelling story about the future. According to Accenture, those companies that can build
confidence in the evolution of their business model can command a ‘future-premium’ that is often more than 50 percent of their valuation. Accenture has also identified a similar trend among traditional banks, whereby banks that are digital leaders are starting
to command a future premium of around 25 percent.  

The key is whether those so-called digital banking leaders can translate their premium valuations into increased profitability and tangible financial results. With banks such as Singapore’s DBS Bank revealing they
can generate double the income from digital customers compared to traditional customers, it’s more important than ever for banks to move in this direction and show that their digital investments are paying off. 

So what lies ahead in 2019? Fragmentation is likely to continue, though we’ll also see an increase in traditional banks acquiring niche players and challengers to strengthen their offering in particular areas. At the same time we’ll also see banks attempting
to re-bundle new components into holistic customer propositions. One thing’s for sure: it will be interesting to see how things develop.


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via Finextra Research Headlines
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