The Future of Financial Services in 2021 and Beyond
Eleven months into the COVID-19 crisis, vaccines are finally being rolled out across the US. However, experts estimate that normalcy will be 9 to 12 months in the future. In the present, however, many nations such as the UK, Italy, and the US are grappling with a second or even third wave of infections. Thus, slowing down the much- needed recovery offset by the Pfizer BioNTech vaccine’s overwhelmingly positive efficacy rates last November.
As discussed in our previous article, the financial services industry has been hit particularly hard, with the XLF lagging behind the SPY by 20% YoY. A McKinsey report expects banks will suffer a two-part problem. The first being severe credit losses, lasting till late 2021. The report then goes on to state that banks will face ongoing operations challenges through 2024 and it’s estimated that this will cost the industry $3.7 trillion.
The Future of Banking
A traditional bank’s performance is closely tied to that of the economy and due to record unemployment and the slowdown of many businesses, banks have fewer customers. NIM (Net-Interest Margin) is expected to drop too due to the prolonged low-interest-rate environment.
Banking is, therefore, no longer an attractive investment opportunity and this is clearly evident. For instance, the market cap of the 200 largest banks is smaller than that of the seven largest tech companies. Furthermore, most big investment has in recent been directed in way of technology companies.
If financial firms want to avoid getting fazed out in the modern era, they need to pivot, and once again play a meaningful role in the emerging digital ecosystem, catering to the needs of a changing demographic. This brings us to what the future holds for financial firms - banks and insurance firms in particular.
Firstly, banks should shift towards digital banking. Today, less than half of American’s carry cash, cheque-related transactions have also been dramatically cut down, and thus, it makes much sense to cut down physical branches. Doing so, whilst investing in consumer education and self-service stations can significantly reduce operational expenses and preserve a bank’s existing customer base.
Sweeden’s Handelsbanken (SHBA:SS) and Singapore’s DBS (SGX: MU7) are examples of retail banks that have leveraged their brand equity to promote their digital banking divisions. Handelsbanken, for example, plans to close another 180 branches by 2021 as it focuses on digital and private banking. Similarly, DBS’s PayLah! program handles some S$1.5 billion annually in P2P and P2B transactions according to a 2019 report. Early self-disruption by DBS ensured that they saturated the market. They currently handle around 65% of all online transactions, with users expected to double by 2023, and are labeled the ‘Best Digital Bank in the World’ by Forbes. In America, Bank of America (NYSE: BAC) and JP Morgan (NYSE: JPM), are also leading the way in digital banking and are poised to capitalize on these new opportunities.
Banks should also expand participation in ESG (environmental sustainability). A KPMG Report has found that increased participation in ESG has led to higher equity returns. Given that ‘green’ businesses (solar panels, wind farms, EVs) seem to be our future, given a more environmentally conscious generation, banks will need to transition sooner or later. Over the past year, SolarRun, America’s largest solar panel installer is up 330%. This trend is not exclusive to SolarRun, but rather a trend seen across the ESG industry as a whole with ESG index returns dwarfing that of the S&P.
The Future of Insurance
Similar to banking, online insurance providers have been entering the market. In the UK for example, 55% of insurance is purchased directly. Comparable numbers can be seen in Italy and Germany. Online insurance providers have multiple advantages. For instance, they can quickly scale, launch products and plans at a whim whilst making use Big Data for optimization.
US incumbents (Berkshire Hathaway, State Farm & Chubb) must build up their digital businesses lest they get wiped out by the ‘new generation’ of Direct Purchase Insurance (DPI). Building up a digital business can be challenging, however, as online insurance is considerably different from ‘regular’ insurance. Furthermore, integrating legacy systems will prove difficult. Incumbents will also be required to terminate or significantly reduce their sales & marketing teams, focusing funds on digital channels that will support the acquisition of customers.
Online insurance providers, present investors with a huge opportunity in that they do not have enough capital to sustain ‘black swan’ events and thus, pay premiums to reinsurers. Swiss Re (SWX: SREN), is one of many reinsurance companies deeply invested in both DPI and in providing reinsurances to DPI providers.
Drawing a parallel to banking, incumbent insurers should leverage brand equity; Something that takes online providers millions to develop. They should also consider expanding into cross-industry services in ecosystems. Examples include, Etiqa Insurance partnering with IKEA to provide coverage for furniture.
In conclusion, incumbent insurance providers and banks need to constantly self-disrupt and meet ever-changing consumer needs in the digital world or risk being left behind.
