By: Ted Moynihan and Dan Rosenbaum
This article first appeared in American Banker on February 5, 2020.
Banks are betting billions of dollars on digital transformations they hope will catapult them to higher growth rates in the 2020s.
Investors, however, generally aren’t impressed. If anything, value-minded shareholders in the coming years are likely to grow more skeptical of banks’ digital spending, not less.
Banks are caught in a digital-technology trap. They feel compelled to spend vast sums of money to compete over the long term, not only with large tech firms such as Google and Amazon, but also the fast-growing fintechs encroaching on all sides. Yet investors have been severely discounting digital efforts for years.
The only way out is to persuade shareholders a bank’s digital investments are worthy. It will require much convincing.
While banks bounced back from the financial crisis, their stocks have severely lagged the broader market. The KBW Bank Index trailed the S&P 500-stock index by 31 percentage points over the decade, ending in 2019.
The gap with tech is especially stark: The 20 largest tech companies increased their market values by $3.8 trillion during the 2010s, compared with just $410 billion for the 20 largest banks.
Within the financial services industry itself, tech-oriented companies are widening their lead.
The average price-to-earnings multiple for publicly traded fintech companies jumped from 39 in 2010 to 49 in 2018, yet the multiple dropped from 14 to 11 for the industry overall, according to an Oliver Wyman analysis of data from Refinitiv.
The message from investors: they love digital. They just don’t think most banks can pull it off.
Just 25% of investors polled recently by Oliver Wyman are confident that banks’ digital transformation strategies will be effective. And less than 1% believe plans are well articulated
Shareholders are likely to become even less forgiving in coming years as the economy begins its inevitable decline after 10-plus years of expansion. Investors and analysts during the past year have become increasingly concerned about banks’ tech spending, and are asking difficult questions about investment portfolios and the likelihood of delivering value.
How skeptical are investors? Just 25% of investors polled recently by Oliver Wyman are confident that banks’ digital transformation strategies will be effective. And less than 1% believe plans are well articulated.
However, 80% of investors still say digital transformation is critical or important in their investment appetite. Yet 43% say digital investments will negatively affect banks’ profitability over time. In short, investors are deeply ambivalent about bank technology.
Part of the problem is that banks track their technology investment poorly. Many firms don’t know how well their investment dollars are being spent, and the returns these dollars are delivering.
The tools used to measure the return on investment of digital initiatives are lacking. For many banks, the act of investing in technology requires nothing less than a leap of faith.
Investors, for their part, don’t feel they understand what banks are investing in or why. They often don’t know what the endgame looks like. Investors don’t see any useful metrics on progress and they are largely distrustful of the cost-benefit argument of significant technology investments.
To be sure, retail banks are achieving some tech breakthroughs. They have massively improved the customer experience in recent years, with tremendous uptake of mobile banking services and new payments offerings that have allowed some banks to reduce their branch networks.
But these advances haven’t transformed the value of the overall customer base to the bank. The cost to serve customers has generally increased, not decreased, over time. And many institutions haven’t been able to generate savings from cuts to the physical network.
At the dawn of this new decade, pressure on banks is increasing on both sides of the ledger.
On the revenue side, competition is heating up. Major tech companies are positioning themselves in financial services, starting in payments and moving to consumer finance (PayPal Credit); business financing (Amazon Lending); banking-like relationships (Libra) and asset management (China’s flagship Ant Financial). Banks that don’t innovate will be left behind.
Yet on the cost side, the economic cycle is forcing many banks to better explain to investors their technology investments and to produce meaningful results to the bottom line. Banks that can’t show quantifiable progress on tech initiatives are likely to be scrutinized heavily by shareholders.
How can banks tell their story better to shareholders and avoid the technology trap? The investors surveyed said they like value-oriented metrics such as return on investment because they can understand it and feed it into their projection models.
Vision, on the other hand, depends on a coherent supporting narrative: the “why we need to build this” in order to persuade investors to buy in.
Banks that are clear on their big growth initiatives, concrete on what they are investing in and why, and can quantify their progress stand the best chance of selling their story to investors in the coming decade. Banks that don’t are likely to remain stuck in a technology trap for the foreseeable future, even as tech rivals feast all around them.