Finding the Next Wave to Ride

Hey, welcome back to another episode of the What's Going On in Banking podcast, the first one for 2024. I thought, what better way to start the new year than with a discussion of the What's Going On in Banking report for 2024?

I'm Ron Shevlin, chief research officer at Cornerstone Advisors, author of the FinTech Snark Tank blog on Forbes, and author of Cornerstone's What's Going On in Banking report.

With me today is really the only person I'd want to have on the show to talk about the report: Steve Williams, president, partner, and co-founder of Cornerstone. Steve, welcome.

Hey, Ron. How are you doing? I was waiting for someone more special when you said I was the only person you'd have, but thanks for having me on. I'm ready to riff on some good discussion.

You are number one on the list, Steve. Absolutely. I value your input more than anybody's.

The theme for the 2024 What's Going On in Banking report is “finding the next wave to ride.” I pulled that theme partly from the 2023 report, where the theme was “facing the headwinds, riding the tailwinds.” That report used the image of an executive sitting out at sea in a small boat, waiting to see what the economy and the world would deliver.

This year, there are certainly still headwinds, but I envisioned banks and credit unions sitting in a windless cove, waiting to see what begins to bubble up and what might carry them forward. We'll come back to the theme later, but first, let's get into the outlook.

This is the ninth year we've done the report. Every year, we ask senior executives about their expectations for the industry. This year, we had more than 350 respondents, split almost evenly between banks and credit unions. About 90% were vice president level or higher, and a significant share were CEOs.

We ask how optimistic or pessimistic they are about the prospects for the industry in the coming year. This year, 60% said they were somewhat or very optimistic, while 38% said they were somewhat or very pessimistic. Most of those responses were in the “somewhat” categories.

That 60% optimism figure is up five percentage points from last year, so the outlook going into 2024 is clearly rosier than it was going into 2023.

At the same time, just over half of respondents, 52%, said they anticipate a recession or economic downturn. Clearly, that expectation is not eliminating their optimism. What do you make of that?

Go back to late 2022, when we surveyed for last year's report. Everybody seemed to be trying to schedule the recession and get it over with. We had almost accepted that there would be a recession.

I used to joke that people wanted to get it done like a four o'clock Pilates class so they could get ready for dinner. Let's get it done, make it short, and move on.

It didn't happen. I think getting through 2023 made people a little more optimistic, especially considering how strange the year was. We started with bank failures, then had a liquidity crisis and a lot of uncertainty.

The question is whether weakness is still lurking out there. What's unusual is the level of anxiety we're seeing alongside very low unemployment and a consumer who is still in fairly good shape.

The negative side is that we've been sitting with much higher interest rates. That means higher borrowing costs for the federal government, businesses, investors, commercial real estate, and consumers.

The question is whether those higher costs finally start to drag on the economy enough to create a recession. What I don't see is the deep, doom-and-gloom recession some people like to predict. Other than people trying to sell gold investments, I'm not seeing much of that for 2024.

We had some interesting comments in the survey, too. We try to capture qualitative responses in addition to the numbers.

One of my favorite comments came from a respondent who was somewhat pessimistic. They said personal saving rates are falling while spending continues, housing affordability is at historic lows, credit card debt is at record highs, delinquencies and bankruptcies are rising, and increases in 401(k) hardship withdrawals and buy now, pay later usage are troubling.

Other than that, everything looks good.

They didn't actually say that last part. I added it.

We also got a comment from Jill Castilla, CEO of Citizens Bank of Edmond, on liquidity. She said extending the Fed's Bank Term Funding Program is imperative to ensure continued liquidity. With recent inflation, GDP, and unemployment data looking favorable, recession may be less likely, but that could also mean rate cuts are less likely.

Another respondent commented on industry dynamics and said the steps banks took to shore up deposit outflows by locking in very high term-deposit rates may outlast the period of high rates on loans, squeezing margins even further as those loans reprice or refinance lower.

So there are both positive and negative factors, which is probably true every year.

One quote that stuck with me came from Steve Stapp at Unitus Credit Union. He said conditions for inflation are not being moderated and government spending will drive higher inflation.

He's one of the people saying: don't build your entire plan around rate cuts. I agree with him. We could get rate cuts, or we could have stubborn inflation all year. I'm a big fan of scenario planning right now.

The stock market has already priced in rate cuts and a return to a more accommodative Fed. I think stock prices may be running ahead of reality, and I don't like building a financial institution's strategy on that assumption.

Steve, guess what? I've got 10 bank accounts plus a main account with insane amounts, and every bank and credit union wants to get their hands on it.

By the way, that's the only line from that Lil Wayne song I can say publicly or privately.

Deposit gathering is at the top of the list. You and I had a conversation with a group of executives about a month ago. What strategies do you think will be successful for deposit gathering in 2024?

Congratulations, Ron. You've created a more youthful version of yourself by quoting Lil Wayne.

What happened is that everybody got shocked when consumers and small businesses suddenly woke up to pricing in April, right after the SVB, First Republic, and Signature failures.

The good news is that banks priced up. It hurt margins, but it stabilized deposits.

The first thing we should stop and acknowledge is that the country still wants banks. Their cost of funds remains a good 250 to 300 basis points below Fed funds or what someone could get today in Treasuries. A large portion of deposits in America is still uninsured, especially business deposits, yet those customers continue banking with banks.

So people still want this system to work.

That said, I don't think this liquidity challenge is temporary. It's going to be systemic because of embedded finance, challenger banks, banking as a service, and all the places people can move money today.

We need to treat deposit competition as a long-term business-model issue.

Where I don't think we're operating at full tilt yet is in combining marketing, digital delivery, and data analysis around deposits. Take your marketing leader, your head of digital delivery, and your head of analytics, put them together, and start developing intelligent deposit strategies.

What is unique about high-balance baby boomers? Where can you drive more core deposits from younger generations?

You've done a lot of research showing very little innovation in micro-business banking, especially for businesses with under $2 million in revenue. There is an opportunity to package better, digital-first services for that segment.

To me, the answer is segmentation and connecting your delivery system to the data you already have.

One of the things we asked specifically in the report was which strategies institutions plan to use. Two of the most popular line up exactly with what you're describing.

Number one was targeted pricing strategies to retain specific clients. Number two, which was more popular with credit unions than banks, was introducing new deposit products tied to pricing.

Your point about bringing retail, digital delivery, and analytics together highlights something important: organizational agility matters just as much as technology capability.

My concern is that some banks and credit unions may take six to nine months, or even longer, to develop and launch a new product. Speed matters. And if they're building on weak analytics, that's another problem.

We've been telling banks and credit unions for 10 years that they need to improve their analytics. Now it's coming home to roost.

One thing an executive told me this year really stuck. Instead of saying “product,” I now use the term “product experience.”

It's not only the price and terms. It's how you access it, how you move money, what other features it includes, and how you open the account.

Traditional banks tend to think in terms of static products. App developers think in terms of a continuous flow of new features and experiences.

If I had to grade the banking industry on how mature it is at delivering product experiences in a digital-first way, I'd give it a straight C.

I couldn't agree more. I often rant about the fact that this is not only about customer experience. It's also about product design.

A couple of years ago, I participated in a study of product design and development capabilities at financial institutions. Those capabilities generally aren't there because many institutions rely heavily on vendors.

That's going to have to change.

You did a lot of consumer research this year, and one thing you proved me wrong about was the value of features added to payment accounts.

I had a bias that things such as subscription management, cell phone protection, and similar features were just bells and whistles that overcomplicated the product. I assumed consumers mostly wanted a good old checking account.

Your research showed otherwise. Consumers do find value in those features.

This started for me about a year and a half or two years ago when someone we both know called and said they had done consumer research showing that the typical consumer had six to eight financial relationships.

I told him not to publish that because he was off by an order of magnitude.

Especially among consumers under 45, people are using a huge number of digital tools to manage their financial lives, and in many cases, they're paying for those tools.

We've run this survey five or six years in a row now, and consumers consistently tell us they would rather get many of those capabilities from one place, ideally bundled with their checking account, even if they have to pay for it.

That creates a potential win-win for both the financial institution and the consumer.

Speaking of fintech competitors, for the past couple of years we've asked about competitive threats. We ask how significant a threat respondents consider big tech, mega banks, large fintechs, and challenger banks.

This year, the numbers jumped sharply. The percentage saying big tech companies were a significant threat rose from 39% to 57%. Mega banks went from 38% to 56%. Large fintechs such as PayPal and Square rose from 47% to 60%. Challenger banks also jumped significantly.

What do you make of those increases?

I thought the jumps were fascinating, but I think they're happening for different reasons.

For big tech, I think it's the march of embedded finance. Look at Apple Savings, Amazon small-business lending, and similar efforts. Finance is increasingly moving into ecosystems rather than remaining tied to individual institutions.

For mega banks, I think the concern came from the flight to safety. After institutions such as SVB failed, customers started thinking, “Maybe I should move funds to a bank the government won't let fail.”

With large fintechs, we've seen a shakeout, but big companies such as PayPal are still operating at scale, making money, and making acquisitions even after huge stock-price declines.

And with challenger banks, rising rates allow them to press their cost advantage.

So a traditional institution now sees four different categories of competitors surrounding it for different reasons. The threat feels very real.

It also connects to something you talk about often: how do banks adopt some of the value these players create? That's your concept of embedded fintech.

One thing that may also explain the jump in concern about challenger banks is the recognition that niche strategy is not dead.

I don't care what happened with Silicon Valley Bank or the argument that it was too concentrated in technology companies. I think more midsized financial institutions are recognizing that a targeted niche strategy can work.

And there's another factor: the normalization of fast money movement. People believe in it now. Moving money no longer scares consumers the way it once did.

Today, opening a challenger-bank account and moving half your money can take 20 minutes. That's a very different competitive environment.

I added a new item to the competitive-threat question this year. I asked respondents to what extent they consider the U.S. government a significant threat.

Overall, 25% of bank respondents said the government was a significant threat. One out of five credit union respondents said the same. But among bank CEOs, the figure was nearly four out of 10.

There's room for interpretation. Some may have been thinking about faster payments displacing traditional banks. I was thinking more about the regulatory environment and whether an anti-bank regulatory posture itself poses a threat.

Still, I was struck that nearly four out of 10 bank CEOs considered the U.S. government a significant threat to the industry.

The bigger a bank gets, the more brutal the regulatory environment becomes.

I think many banks now look at the $100 billion threshold and say they may not want to cross it. There's also the $10 billion threshold, which brings in CFPB supervision and other regulatory requirements.

And there's an interesting contradiction. Janet Yellen has said we need to consolidate the banking industry to make it stronger. Most people agree we probably don't need 4,700 banks, although we certainly don't want only 10.

Consolidation has to happen, but at the same time, the government is slowing merger approvals and creating additional requirements.

It's as if the message is: consolidate and become stronger, but we're going to make common-sense mergers harder to complete.

In the community-bank space, you also have things such as Regulation II, Senator Durbin's proposals around credit-card pricing, and the CFPB's push on overdraft fees.

Banks are asking how they're supposed to provide all this infrastructure, safety, and soundness to consumers while still making money.

That's the regulatory threat: you want us to be strong and vibrant, but every time we turn around, you're trying to weaken us.

Agreed.

One of the big developments in 2023 that will affect 2024 was the launch of FedNow and real-time payments.

We had already been seeing growing interest before the launch, and not surprisingly, the report shows a healthy increase in institutions planning to launch real-time payments this year.

One thing I think banks and credit unions may be missing is the opportunity to use faster payments as a revenue generator.

Among banks, only about one in five said they think commercial B2B real-time payments are very likely to become a profit center within three years. On the retail side, that falls to about one in 10.

Only 7% of credit unions saw either commercial or retail real-time payments becoming a profit center.

I think they're missing the boat. Do you disagree?

I think it's nuanced. Let me give you my view, then tell me why you think they're missing out.

Commercial banks make a lot of money sending wires, so real-time payments could cannibalize wire revenue.

On the consumer side, institutions may assume that fintechs, Chime, and challenger banks will use faster payments to gain market share. That makes it hard to charge a premium because competitors will offer it as a customer benefit.

I do think there's revenue to be made by using this capability within specific niches. If a bank gets very good at serving restaurants, homeowners, medical-claims processing, or another vertical, the broader relationship can become a source of revenue growth.

That's where banks need to go deeper.

I'm with you 100% on the B2B side. I don't think retail faster payments are necessarily a major revenue opportunity.

But on the commercial side, I think banks are at risk of looking at FedNow and real-time payments as products themselves. I don't think they are products. They're capabilities around which you build solutions.

That goes back to our earlier discussion about product design and development.

If a bank is not building industry-specific solutions and instead is simply saying, “If someone wants real-time payments, we'll give it to them and charge 15 cents a transaction,” then it's missing the opportunity.

I give the government some credit here. It has created common infrastructure for people to use.

What may surprise us is how quickly fintech engineers and entrepreneurs build intelligence, workflows, and niche offerings on top of that infrastructure.

They're going to move faster than banks, which is why banks need to keep partnering with and investing in fintechs. Fintechs will use FedNow as common infrastructure and innovate on top of it.

All right, next topic. We'd probably take a lot of grief if we didn't talk about artificial intelligence.

Doesn't ring a bell. Is something going on there?

Yeah, after about 60 years, it's finally becoming a reality in banking. Things don't move quickly.

The report includes some useful charts showing year-over-year adoption levels. We're seeing real growth in robotic process automation, machine learning, and chatbots. Chatbots are now used by more than a third of credit unions and about one in five banks.

But the biggest area of interest since late 2022 has been generative AI.

Looking into 2024, 14% of banks say they plan to invest in or implement generative AI. Among credit unions, that figure is 24%.

What do you think 2024 will look like from a generative-AI perspective?

Some of the smart people at our firm talk about machine learning as the older cousin. It's been around for a long time and already has useful applications in cybersecurity, fraud, and alternative credit underwriting.

I think that part of AI will continue moving quickly.

With generative AI and large language models, though, I think the real value comes when they're used to enhance smart knowledge workers.

If people use these tools just to produce empty content, I think it will eventually sound dated in the same way so many songs from the late 1980s are immediately identifiable because of those terrible keyboards.

Content generated by ChatGPT without meaningful human enhancement is going to start feeling like that.

So as institutions use large language models for marketing, policies, procedures, and training, they also need to enrich the roles of the knowledge workers using those tools.

Otherwise, we're going to end up with a lot of late-80s keyboard content.

I agree. I like to think my BS radar is pretty good, and I'm starting to develop a ChatGPT radar too. There is a certain feeling and flow to text that was clearly generated rather than originally written by a person.

But I also think we have a terminology problem.

Until around 2022, people used “AI” very broadly to refer to a lot of different technologies. Then ChatGPT launched, and generative AI became the umbrella term, even though it actually refers to a fairly specific set of technologies.

In the report, I wrote that I think we're going to simultaneously overestimate and underestimate generative-AI usage.

We'll overestimate it because people will label things “GenAI” that really aren't. We'll underestimate it because senior executives often don't know how much people in marketing, legal, and other support functions are already using these tools.

These aren't necessarily enterprise applications. They're individual productivity tools.

That's why I've liked saying that ChatGPT was to 2023 what Lotus 1-2-3 was to 1983.

Good knowledge workers are going to be incredibly productive with tools such as Copilot and the hundreds of other applications being built around these models.

We're running out of time, but I want to squeeze in two more topics.

For the past couple of years, we've asked respondents about satisfaction with their core providers and digital-platform providers.

One of bankers' favorite sports is complaining about their core providers. That said, satisfaction among bank respondents actually increased from 2023 to 2024 across several attributes. Among credit unions, satisfaction declined somewhat.

Any thoughts on why?

I don't think it happened because the core providers suddenly received Ritz-Carlton service training.

I think other technology priorities began consuming more attention. Institutions are asking: where do we go with AI? Is our digital transformation really working, especially around customer acquisition and cross-selling? Have we used platform automation effectively in lending, fraud, and relationship management?

The core is still frustrating, but the priority has shifted somewhat.

The bigger issue I'm watching is that many technology companies want to become providers of cloud technology. Their attitude is essentially: here's our cloud system, now go use it.

Community banks, credit unions, and regional banks want service providers. They need help integrating systems, deploying new technologies, and understanding how everything fits together.

That service layer is not being provided consistently. In fact, there is a real brain drain in operations and product knowledge across some of the conglomerates that own the major technology platforms.

I think that's a risk to the industry.

Over the next five to 10 years, I expect to see a new fintech ecosystem develop around the cores, providing integration, development, middleware, and custom services.

Two quick reactions.

First, there's a quote in the report from one of our survey respondents that perfectly captures the resource issues at the major providers.

Second, when I'm talking with financial institutions in board and strategy meetings, I'm telling them they have to build integration capability as a core competency.

Absolutely.

You may not have to build everything yourself, but you do have to know how to integrate it.

I always ask whether an institution has a SWAT team that combines enterprise architecture, integration, data, customer experience, and development.

You can work with partners, but you have to take control of your own destiny.

Let's wrap up by going back to the report's theme: finding the next wave to ride.

One reason I selected that theme is the strategy analogy behind it.

I often see financial institutions at opposite ends of a spectrum. At one end is the “set it and forget it” strategy: we compete on service, and every year strategic planning becomes little more than project planning.

At the other end are institutions that essentially rewrite their strategy every year.

The sweet spot is somewhere in the middle. You need a clearly defined strategy that lasts at least two years, and ideally three to five years.

That strategy is the wave.

Maybe the wave is a product strategy, such as optimizing revenue around real-time payments. Maybe it's building new capabilities through AI. Maybe it's moving toward banking as a service.

The wave carries you for several years, and then eventually it fades. Technology changes, the industry changes, society changes, and you have to find the next wave.

That's what was driving the theme for me.

I couldn't agree more.

When there's uncertainty about what will create the next source of momentum, you have to build optionality. And to build optionality, you have to be doing things. You have to be trying things.

Banks often confuse the need to be risk-averse with their balance sheet and finances, capital, liquidity, credit risk, with the idea that they should be equally risk-averse about experimentation.

Those are different things.

Partner with a fintech. Try a new marketing strategy. Build a small niche line of business and see whether you can expand it nationally.

That's the creative element.

You and I both read Rick Rubin's book on creativity in 2023. Financial institutions need to think about their comeback album. What's their U2 moment? What's their Foo Fighters after Nirvana?

The only way you find that is by going out, trying things, talking to people, and seeing what works.

Stay conservative on safety and soundness, but take some creative risk around where the business can go, where you should market, and how you can use data.

I'm not seeing enough of that, and institutions need to stop confusing those two kinds of risk appetite.

Steve, I've been working with you for eight and a half years, and I'm going to do something right now that I've never done in all that time.

Ready?

What?

I'm going to give you the last word.

Steve Williams, president and partner at Cornerstone Advisors, thanks a lot for joining me.

And to everybody listening, thanks for joining the inaugural 2024 edition of the What's Going On in Banking podcast. If you already subscribe, thank you. If not, please do.

We look forward to seeing you on another episode.

Thanks, Ron. Really great stuff. I hope everybody reads the report because there's great input in there from hundreds of executives.