No Bank Is an Island

1. No Bank Is an Island FelabanPanama City, September 10, 2014 Daniel W. Latimore, CFA Senior Vice President, Banking

2. Institutions must adjust their business models to adapt to a changed banking ecosystem Drastically changing external forces… …exacerbate ongoing pressures and change the Ecosystem… …necessitating changes in the business model New Business Model Changing Ecosystem Consumer Pressure on revenue Technology Channels Economic Innovation Architecture Regulatory Pressure on costs Competition

3. Banks are part of a complex ecosystem that they have traditionallytried to keep at as much of a distance as possible Customers Commentators Suppliers / Vendors Bank Competitors Regulators Counterparties

4. Core Security ATM BranchAutomation Call Center Core ATM Cloud Analytics Call Center Social BranchAutomation Security Mobile Risk The bank ecosystem, even among suppliers, is becoming more complicated Vendor ecosystem used to be relatively straightforward It is now much more complicated

5. Consumers are changing the ways in which they interact with banks; banks are paying more attention than ever before • Other industries and experiences are shaping expectations • Shopping and socializing have changed radically • Retail-oriented technology now often outpaces what individuals experience at work – “consumerization” • User Experience is becoming more important, with simplicity being a core component • Information is becoming more transparent • Consumers find it easier to compare • Consumers are better informed • Switching banks has become simultaneously easier and more difficult • Expressed intent has increased… • …but inertia is a powerful force • Millenials bringing new world view to financial services; banks view them with fascination and puzzlement

6. Naïve customers ask: As a flier, I can pull up real time seat assignments on my phone; why can’t my bank let me do cool and convenient stuff, too? It sure would be nice to be able to add payees from my phone… Source: iPhone apps for Delta and Bank of America, June 12, 2014

7. Technologyis advancing rapidly and is often outpacing banks’ capacity to adapt as fast as other industries Security Social Mobile Cloud Big Data / Analytics

8. Mobile banking adoption continues to outpace predictions and gain immense traction • Current mobile evolution

9. Banks require a concrete and structured social media strategy; most aren’t there yet Banks are starting to define social media strategy Financial institutions should start building social features into online banking Most banks don’t know understand how they can take advantage of social media to realize business goals Social media is about much more than building a Facebook fan page, creating a Twitter handle, publishing a blog, or building a private community Banks need to focus on business goals and incorporate social media into the process. Social media activities need to be blended into a bank’s sales, marketing, and customer service activities Source: Celent

10. Banks are willing to use cloudto reduce costs; security concerns often make bigger banks reluctant to cede control Bank willingness to adopt cloud • Cloud computing enables ubiquitous, convenient, on-demand network access to a shared pool of computing resources that can be rapidly provisioned and released with minimal management effort or service provider interaction • Service models • SaaS: Software as a Service • PaaS: Platform as a Service • IaaS: Infrastructure as a Service • Deployment models • Private Cloud • Community Cloud • Public Cloud • Hybrid Cloud • On/Off premise an important distinction Larger Banks Smaller Banks Source: National Institute of Standards and Technology; Celent Analysis

11. Big Data and Analytics hold great promise, but banks have some basic work to do before taking on next-generation ambitions • Big Data is trendy and ill-defined • Celent defines it on three dimensions • Volume: Large amounts of data, now in terabytes, some in petabytes, exabytes coming • Velocity: Near real time collection and analysis of data • Variety: Internal and external; structured and unstructured; includes social media • 60% of firms we surveyed said that “information” holds the key to competitive advantage • Only 24% of surveyed banks have hands-on experience with Big Data in production • 70% of big data projects have met or exceeded business case expectations • Deriving compelling value from Big Data requires deliberate and sustained effort • Analytics has four main goals • Increase customer centricity • Improve customer engagement • Improve marketing effectiveness • Combat fraud

12. Securitycontinues to be an ongoing and significant concern for banks • Corporate Security • Institutions continue to be bombarded by hackers intent on penetrating their defenses • Multi-layered, multi-level approach is best practice • Consumer Security • The most significant barrier to increased consumer mobile adoption is security • Banks must balance the tradeoff between security and ease-of-use (simplicity) • Biometric startups abound, but none have yet cracked the code that has led to adoption by major banks

13. Economictrends have been difficult, although the federal safety net has allowed banks to prosper, at least superficially • Hangover from Great Recession has depressed lending activity • Persistently low interest rates have decreased net interest income and lowered bank top lines • Fee income has decreased as a result of Dodd-Frank • Smaller banks have suffered much more than their larger brethren Decreasing provisions have contributed heavily to earnings Source: FDIC; Celent Analysis

14. Regulationaffects investment priorities and requires an inordinate amount of compliance effort • Compliance activities are taking a huge portion of IT spend and management time • A host of new regulations are in various stages of implementation, both domestically and internationally • Dodd-Frank • Basel III • FATCA • OFAC • FCRA • AML • Increased and changing capital requirements continue to change bank economics • Too Big to Fail (TBTF) issue concerns largest institutions (SIFIs: Systematically Important Financial Institutions)

15. Competitionis tough; banks are being attacked from all sides

16. Some companies use a two pronged approach to attack incumbentsEnabling other start-ups/firms and developers 1 2 • Consumers and/or Merchants Other Start-ups/Firms Other examples:

17. Uber is exploiting market inefficiencies to offer a valuable serviceThe payment has been reduced to a commodity

18. Another two pronged approach works with incumbents to reach consumersEnabling financial institutions 1 2 • Consumers and/or Merchants Financial Institutions Other examples:

19. The two pronged approach with a kickEnabling consumers/merchants, other startups/firms, and financial institutions 1 2 3 • Consumers and/or Merchants Other Start-ups/Firms Financial Institutions Other examples:

20. Technology breeds choice…US centric view of the landscape supporting mobile commerce Source: LUMA partners

21. Square is letting customers into the formerly exclusive club of card acceptors; other competitors are entering the fray Square’s challenge questions to set up an account Babysitters are now pulling out their square dongle to accept payment for taking care of the kids! Square was the first to enter the space; others, like Fiserv, are mounting fast-follower challenges

22. Banks’s revenuesources are under immense and continuing pressure FDIC-insured commercial banks and savings institutions Source: FDIC, Celent analysis

23. Marginal expenseimprovements that might improve the efficiency ratio by a point or two are no longer sufficient • Tinkering at the edges won’t cut it; many banks are facing existential decisions • Fundamental changes in major expense categories are critical • Branch network: types and number of branches • Core replacement • Turning “capex into opex” / making fixed expenses variable • Outsourcing certain functions is now up for discussion

24. Many retail categories have witnessed an erosion of brick-and-mortar in response to changing consumer demand and online growth US Retail banking has been an anomaly; branch densities have grown alongside usage of digital channels -1.0% CAGR -1.8% Decline in video and music has been most dramatic 1.6% -3.1% -9.5% Source: Celent, Branch Boom Gone Bust, May 2013

25. Banks want to increase revenue, better serve customers, and reduce costs Q: What are your institution's top retail banking priorities? • Improving sales results a clear #1 strategic priority overall • Followed closely by improving customer relationships and service results • Cost reduction is imperative, but “can’t cut your way to prosperity” • Cost reduction grows in importance with asset size Source: Celent July 2012 Survey of 132 FIs

26. The business model of abundant income from net interest and high fees, generated as independently as possible, may never return • The traditional retail bank business model – taking deposits, making loans, and earning fee income – is no longer a path to prosperity • Banks have done themselves a fundamental disservice over generations by teaching customers that banking should be “free” • Loans have often been made with little competition • Much fee income has been punitive • Banks must reconstruct their business models around three areas, recognizing that they are part of a financial ecosystem • Channels: How the bank serves customers • Architecture: How the bank organizes to deliver value • Innovation: How the bank delivers new ideas, products and services around both channels and architecture

27. The online channelwas the top funding priorityBut mobile has suddenly overtaken it Q: Given limited resources, indicate the relative priority among your delivery channels based on what gets funded in your organization • Mobile is a top investment priority; 24% of banks ranked the mobile channel #1 priority compared to just 5% in 2010 • Branch is not dead, but its role is changing; for the first time, more FIs say online banking channel is #1 in importance, overtaking the branch channel’s historic spot • Developing an integrated omni-channel experience is the next imperative • User interface and customer experience are areas of focus for certain forward-looking institutions • All retail channels are key and FIs must be competitive across all of them Delivery channel funding priority – all FIs1 • Because mobile has been changing so fast, this information is dated, even though it’s only a year old Source: Celent Analysis; Celent Surveys

28. ABN AMRO has seen mobile logins exceed online logins Source: Presentation by ABN AMRO: Integrated Channel Transformation at EFMA, Brussels, May 2013

29. Architecturesare coming under increased scrutiny for agility, cost and simplicity • Core architectures may finally start seeing significant activity; the discussion has certainly become more persistent • Agility requirements • Cost imperatives • Simplicity: Increased interest in “process orchestration” technologies to change customer experience without replacing core • Banks increasingly willing to work within a partner ecosystem to deliver value to customers • Increasing use of on-demand computing • Selective outsourcing / partnerships to get more value out of existing assets • Specific contracting arrangements to achieve specific tasks requiring specialized expertise • Some have always been outsourced, at least partially, e.g., advertising, creative and legal • Some have more recently been outsourced, e.g., call centers • Some are now on the table • Cloud • Marketing services • Analytics • Innovation

30. Innovationis a keen interest of a subset of bankers we speak toBanking innovation is not a paradox Illustrative payment innovations Channel innovations Ecosystem innovations Architectural innovations • New payment products, like mobile ticketing and mobile wallets • New payment-enabling technologies, like near field communication (NFC) • New payment platforms, like mobile banking applications or on-line social networking platforms, make payments easier • New promotion programs, like incentives offers for customers and sales promotion tools for merchants • New partnership models, like banks and telcosto offer mobile payment services, often to new markets (i.e. unbanked population) • New entrants to the market, offering bank-like products like P2P payments and lending, or financial planning, like PayPal and Mint • New product distribution models, like Apple’s “AppStore” • New organisational and structural designs, like shared services both internally and externally • New process design methodologies, like “lean manufacturing” • New architectural concepts, like Payment Services Hubs • New technological applications and capabilities, e.g. cloud Source: Oliver Wyman, Celent

31. Uncertainty around customer uptake is one of the key reasons why retail banks are struggling with innovation Other comments/findings Why do banks reject innovative ideas? • The inability to guarantee customer uptake was the chief reason for innovative ideas to be rejected by organisations. Banks want “proven innovation” – a contradiction in terms • “Opportunities are often over-analysed. With many innovations you just cannot predict how customers will react, so you have to make the developments and then hope for the best; that just isn’t how banks work” • Third-party innovators or developers have the greatest influence over innovation. In-house teams are said generally to be a ‘tick box’ for senior management rather than bringing true innovation Degree of Success: 5 = High, 1 = Low Who is best at driving innovation? Source: Payments Innovation 2011 – The Global Jury Decides, a report based on a poll of 22 payments experts representing 15 countries across 5 continents sponsored by Ixaris, released February 2011

32. Some should be building capabilities to execute a fast follower strategy: close monitoring to identify winners and potential partners at an early stage “The emerging ideas pipeline” Best applicable when Commoditize (join utilities, outsource) • Likely to become “table stakes” • Very expensive to develop in‑house Research and monitor Test and learn Develop strategic options Acquire and make proprietary • Potential for IP protection and a distinctive proposition • Prize is worth the price • Pilot selective ideas to test for • Business model and economics • Customer/ merchant adoption • IP protection not available, but vendor offerings vary in quality • Lock up the best partner before others can Partner • Engage potential partners • Seek to influence regulation or technical standards • Cast a wide net, e.g. • Mobile payments • Social networking • Web 2.0 All the time When a winner is emerging At execution readiness Source: Oliver Wyman analysis, Celent

33. Banks and their ecosystem partners must answer certain fundamental questions in this rapidly changing environment Banks Differentiate the value proposition Non-bank ecosystem participants Partner with banks Why do customers use me instead of another bank? What non-commodity offerings can banks provide their customers? What are current unmet consumer finance needs? What am I uniquely – or at least well – positioned to do? Where do banks need help? What should I partner with others to do? On which dimension do I excel when I provide that help? • I have more expertise What must I do myself? • I reduce risk • I’m cheaper • I do it more quickly • I do it uniquely well • I aggregate data from multiple banks • Risks of not doing it myself are too high • Margins too attractive to give up

34. Thank You Daniel W. Latimore, CFA Senior Vice President, Banking dlatimore@celent.com Twitter: @danlatimore • Blog: http://bankingblog.celent.com/ • Celent.com