Retail Banking 2010

Financial Services Practice
The Future of Retail Banking

The Future of Retail Banking
Contents
Introduction 1
Deposit Profits: New Approaches for an Old Standby 8
U.S. Credit Cards: Looking at the Business Through a 16

Long-Term Lens
New Market Realities for Mortgage Lenders 23
Rebounding in Small Business Banking 36
Stepping Into the Breach: How to Build Profitable 46

Middle Market Share
Back to the Future: Rediscovering Relationship 56

Banking
Big Fish in Small Ponds: Why Regional Banks Need 66

Critical Mass
Improving Branch Performance in Retail Banking 78
Banking on Multichannel 85
The Evolving Consumer: Implications for Retail Banks 93
Profiting Through Simplification 101

Introduction 1
Introduction
Retail banking has historically been a large and stable business. In

2007, the U.S. retail banking profit pool was $363 billion. However,
over the past two years, a perfect storm of headwinds and cross-cur-
rents have changed the landscape for banks. Massive losses across a
range of consumer credit products, reduced spending and transactions
in debit and cards, and increased competition for deposits are among
the forces pressuring bank margins. New regulations will also be drag
on profitability, to the tune of roughly $16 billion to $26 billion in 2010.
Overdraft regulation alone will likely reduce deposit revenues by $6 bil-
lion to $10 billion in 2010. The CARD Act could cost banks $10 billion,
and mortgage lending regulation another $10 billion of origination and
servicing profitability. The Durbin amendment on interchange fees and
the repeal of Regulation Q will also have an impact, although the extent
is unclear as we go to press.
The credit industry has been drastically reshaped, with the disappear-
ance or acquisition of specialty finance and monoline players. Mort-
gage lenders are facing a near-term market decline, low building
activity and a lack of non-agency secondary markets. Card players are
struggling with slow growth, regulatory scrutiny, credit losses and
changing customer behaviors.
These challenges would be formidable enough, if banks could simply

resort to the approaches that worked in the past. But this will not suf-
fice. Consumers emerged from the financial crisis with altered behav-
iors and attitudes. They are paying down debt, favoring debit and
charge cards over credit, and showing increased interest in more se-
cure, lower-margin products. At the same time, technology and social
media are giving consumers tools and access to information that em-
power them to take more control over their financial lives.
To lead now, U.S. retail banks must not only correct past mistakes, re-
build broken models and operate in a more difficult regulatory environ-
ment, they must also serve the needs of a dynamically changing
consumer base.
2 The Future of Retail Banking
Specifically, winning banks will make progress on five broad imperatives:
• Focus on relationship banking
• Rethink distribution across channels
• Develop new value propositions that capitalize on evolving customer be-

haviors
• Reinvent underwriting models
• Ensure flawless sales and service execution
Focus on relationship banking

In the new retail banking environment, in which overall profitability has dra-
matically decreased, successful banks will excel at building and leveraging
customer relationships. This relationship banking approach has implications
for the entire organization, across marketing and sales, underwriting, fulfill-
ment and collections. It is a proactive stance supported by research on con-
sumer profitability and risk. Relationship banking has three hallmarks. First,
customers have an integrated sales and service experience. They see the in-
stitution as “one bank” across multiple channels. Second, the bank orients
itself to the customer, rather than its own preferences. Lastly, relationship
banking entails building the right capabilities to enable cross-product deci-
sion-making. These features will enhance a bank’s success with both con-
sumers and small and medium-size business clients, which represent a
growing source of revenue and profits.
The rewards are significant. Deepening relationships with existing cus-

tomers makes for attractive economics. Customer retention increases with
stronger relationships. The relationship multiplier – driven by higher bal-
ances and usage – can increase profits by up to 25 percent compared to
profits from products sold individually. Risk benefits also accrue from rela-
tionship banking. Our analysis has shown a 10 to 25 percent lower risk
from clients with deeper relationships with the bank. Integrating operations
can also result in 5 to 15 percent cost savings in the relevant areas.
The shift from product to customer focus triggers implications for banks’
operating models, organization and product development, as well as a tran-
sition toward simplification in processes and structure. The challenges as-
sociated with these changes are not minimal, but there are several points
where banks can begin to shift focus.
Introduction 3
The first is the redesign of important touch points from the customer point of
view. Account opening is a perfect example. This crucial interaction is an op-
portune moment for relationship-building that is often squandered because
banks approach clients in a siloed manner.
The shift from product to customer Branch bankers are frequently not fully versed in
focus triggers implications for the product range, or are operationally unable to
offer the entire product set. A redesign of the ac-
banks’ operational models, count opening process could have an enormous
organization and product impact. Mortgage origination is another often un-
tapped moment for making deeper inroads with
development, as well as a
attractive customers. Mortgage customers tend
transition toward simplification in to have higher deposit balances and longer tenure
processes and structure. with their bank. With targeted cross-selling, and
the development of teams to focus on migrating
these applicants to other financial relationships, banks stand to build more
lasting, profitable connections.
The second relationship banking leverage point is the silo: breaking down
unnecessary and cumbersome divisions within banks is imperative if banks
are to truly reap the rewards of deeper customer relationships. In practical
terms, this means consolidating organizational ownership of product group-
ings that customers purchase jointly, along with marketing analytics and risk.
The third leverage point centers on building capabilities to support cross-

product decision-making; for example, taking a horizontal view of risk and
approving customers upfront for multiple lending products.
Rethink distribution across channels

Across a range of retail markets, consumers increasingly expect to be
able to conduct transactions in the channel of their choice and to seam-
lessly cross those channels. To meet these demands, banks need to re-
duce their dependence on branches by thinking of them in strategic terms
as a core element in their broader multichannel distribution. This may not
be a new idea, but few banks have made it a reality. To do so, they must
allow customers to self-select their preferred channel. They need to re-
duce broken transactions by linking across channels to improve conver-
sion rates, selectively move service and low-value transactions from
branch to lower-cost channels, and, conversely, push higher-value trans-
actions to branch and phone channels to improve conversion rates.
Technology is of course an important part of this work. For example, banks

must offer secure and dependable mobile banking for services such as bill
payment and balance inquiries; and mobile transaction execution, such as
card payment via phone.
However, in the drive toward multichannel distribution, banks must not rel-
egate the branch to afterthought status. The branch is still a vital piece of
the distribution matrix. What is required is a more thoughtful approach to
branch density, especially for regional banks
with smaller resources than their giant peers.
Crisis-driven acquisitions
Crisis-driven acquisitions have led to a top-
have led to a top-heavy heavy concentration in the U.S. retail banking in-
concentration in the U.S. retail dustry, with four megabanks accounting for
almost 60 percent of assets. These Goliaths will
banking industry, with four
clearly have advantages. But regional banks can
megabanks accounting for embrace and develop what makes them unique:
almost 60 percent of assets. their local scale. They must become super-effi-
cient in designing their branch footprint, with a
These Goliaths will clearly sharp focus on building critical mass in their
have advantages. But regional home markets, as opposed to trying to “out-
banks can embrace and branch” megabanks in markets where the re-
turns are suboptimal. Our work has shown that
develop what makes them unique: when regional players have branch share that is
their local scale. at or above the saturation point for a market,
they outperform the megabanks by 5 percent-
age points in terms of deposit share, even when megabank itself was also
at saturation point. These regional banks are outcompeting theoretically
more efficient rivals.
Develop new value propositions

The U-shaped retail banking economic model – in which the majority of
revenues are generated by low-deposit customers who incur significant
fees and high-balance customers – is under pressure. Heightened compe-
tition for growth and increased regulation on profit drivers are only two of
the profit headwinds. Banks must develop new, profitable but customer-
friendly value propositions that are less dependent on penalty fees; gener-
ate profitable revenues for the majority of customers that do not currently
contribute meaningfully to bank economics; and encourage higher bal-
ances and use of services from high-value segments.
Introduction 5
For example, overdraft regulations mean that banks must now convince cus-
tomers to opt in to the service. To do so, they need a better understanding of
the preferences and behaviors of each customer segment. Banks will also need
to create a suite of overdraft products with different credit standards and pricing
and move away from free checking to annual and
To create successful new quarterly fees with low overdraft/ATM propositions.
For high-value segments, banks should develop in-
value propositions, banks
novative offerings that leverage the full relationship;
need a clear picture of consumers’ for instance, deposit insurance above FDIC limits
changing spending and saving for affluent customers, or tools that help customers
manage their near-term cash flow. The need for in-
behaviors, and of their evolving
novation in products and services is particularly
views toward investments and risk. pressing today, with non-traditional players increas-
ingly competing in the retail banking space. Banks
need to offer packages that customers are willing to pay for, taking into account
the utility of different deposit features to different segments.
To create successful new value propositions, banks need a clear picture of

consumers’ changing spending and saving behaviors and of their evolving
views toward investments and risk. That picture has some obvious broad
strokes – consumers are saving and paying down debt – but banks need to
more finely stratify customer segments. In some cases, this will be the only
way to fully profit from the bank-customer relationship.
Changes in consumer behavior are challenging, but also offer opportunity.

Consumer deleveraging has indeed led to a dramatic shift to debit. But
while banks stand to lose profits from penalty and interchange fees, there
are opportunities for innovation on the product side: cards that are more
tightly integrated into demand deposit accounts or cash flow management
tools that integrate transaction data with debit and bill pay for sophisti-
cated spend analysis.
Reinvent underwriting models

Emerging from the painful readjustment of the financial crisis, underwriting
is in need of an overhaul. Getting the underwriting model right – improving
predictive power across the broader set of lending products – must be a
priority for all lenders.
Banks must rethink the mortgage lending model. To succeed in a difficult

environment, lenders must make critical decisions on origination capacity,
and on the optimal mix of whole loans to servicing assets on their bal-
ance sheets.
In the small business market, underwriting models had been primarily

derived from consumer credit, a mismatch that resulted in poor predic-
tive power. Banks were using quick scoring models that relied heavily on
limited and low-quality underlying data, and portfolio monitoring was a
low priority. Unsurprisingly, a tail of unprofitable accounts developed. In
response, banks have swung to the opposite
Banks should bear in mind costly and unsustainable extreme, manually
that excellence in execution will underwriting all sizes of loans. Now, banks
must redefine the underwriting model in order
always be a necessary to restore confidence and grow. They need to
underpinning of success. define boundaries between credit processes,
weigh the trade-offs between efficiency and
risk, improve scoring and score-plus models with better data and rigor-
ous testing, integrate relationship information in enhanced credit deci-
sion processes, and build improved portfolio management capabilities
with clear triggers, processes and responsibilities.
Underwriting in middle market also needs an end-to-end makeover. This

can begin with refining and enhancing inputs and recalibrating models to
reflect recent loss exposure, while fixing outputs and reducing cycle
time by improving information flow across relationship managers, credit
officers and portfolio managers.
Ensure flawless sales and service execution

As banks make progress on these initiatives, they should also bear in
mind that excellence in execution will always be a necessary underpin-
ning of success. Branch sales are one example where many banks are
operating well below potential. While the expansion of non-branch chan-
nels will continue to change distribution dynamics, the branch is still the
heart of retail banking – and the asset of greatest. Banks cannot afford
less than optimal performance. But there is a huge variability in perform-
ance between the best players and the laggards. For example, our re-
search reveals that in the typical urban market, the average bank sells 96
non-free-checking accounts per branch per year, while the lowest per-
formers sell 65. Best-in-class banks sell 143 accounts per branch per
year. The primary driver of this disparity is execution. To rise to the
Introduction 7
higher-performing level, banks must not only pursue optimal density in

promising markets, but also strengthen sales and service capabilities and
structure metrics and incentives to produce performance aligned with each
market’s opportunity.
***
The future of retail banking will belong to those institutions that not only
address the shortcomings of the past, but also meet the raft of current
challenges by building stronger, nimbler and more resilient models. The
following articles provide both food for thought and guidelines for action
as this journey begins.
Deposit Profits: New

Approaches for an Old Standby
Retail banking deposit-gathering is encountering a wave of pressures. Low

interest rates have dramatically reduced spreads. Customers are moving their
money out of lower-interest savings and checking products and into higher-
yielding money markets and CDs. Established attackers and potential new
entrants are threatening to ratchet up yields, adding even more competitive
pressure.
Regulation is also generating headwinds. Overdraft fees, which have ac-

counted for a growing percentage of revenues, are now subject to strict
rules, while the Durbin amendment on interchange fees will also have an im-
pact, although the extent is not yet clear.
There is no single silver-bullet solution to this array of challenges, but banks

can begin to compensate for the seismic shifts in the deposits landscape in
three ways:
• Rethink deposit fees. Banks must embrace more transparency in fees to

better serve customers, restore trust and respond directly to regulatory
change.
• Revise check and deposit pricing. Banks should balance household mar-
gins, household growth and funding requirements to bring a measure of
sanity back to pricing strategies.
• Put the customer first. Banks must break down silos to present value
propositions that are integrated and tailored to serve high-priority cus-
tomer segments.
The deposit landscape

Overdraft fees grew by 28 percent from 2006 to 2009 and accounted for
more than 40 percent of total deposit fee revenue in 2009 (Exhibit 1). Cour-
tesy overdraft fees comprised the majority of the $26 billion in 2009 penalty
fees, or more than one-quarter of consumer checking revenues. A sizable
portion of these fees were paid by the relatively small group of customers
who make a large number of overdrafts per day. Many banks also increased
overdraft profits by adjusting the transaction posting order.
Federal Reserve rules will likely make a large dent in these fees. The rules
prohibit banks from charging fees for overdrafts from one-time debit card
and ATM transactions, unless a customer has opted in to the service. Many
– possibly most – will not do so. These customers will have unfunded trans-
actions denied, resulting in fewer overdrafts and a drop in bank fees. Regu-
lators may yet dictate posting order. We estimate that these and other
changes will result in a 20 to 40 percent reduction in overdraft fees for a
typical bank.
In light of these developments, banks need to find ways to replace lost rev-
enue, but they must do so in transparent ways that provide value for cus-
tomers and not fodder for regulators.
Rethink deposit fees

Increased transparency is an important priority for regulators in drafting rules
governing overdraft fees. An amendment to Regulation DD mandates the dis-
Exhibit 1
In 2009, penalty fees accounted for 38 percent of DDA account

revenues
2009 consumer DDA revenue by source
Percent
Transaction
30
38 Penalty
30
Net interest
income 2
Maintenance
Source: McKinsey U.S. Payments Map 2009-2014
closure of fees on statements. Rules requiring opt-in for courtesy overdraft

will make consumers much more conscious of the cost of the services.
Banks should embrace rather than resist the trend toward transparency and
develop a marketing-based approach that tailors overdraft services to cus-
tomer segments and aligns fees to usage levels.
• Customer-driven approach. Our research shows that customers are by

no means uniform in their needs and attitudes related to overdrafts (Ex-
hibit 2). Some resent the fees and blame the bank. These customers
are, of course, least likely to opt in, but may be open to some form of
overdraft protection services. Other customers – “dice rollers” – pay little
attention to their finances and acknowledge they occasionally run the
risk of needing overdraft protection. They are likely to desire some over-
draft services, at least for their most important bills. They may also value
notification services that let them know when they run the risk of over-
drafting. Finally, some customers use overdraft deliberately, value the
ability to pay bills when their deposits are low, and thus are most likely
to be satisfied with the status quo.
Exhibit 2
Not all overdraft customer segments are alike

Dice Rollers Deliberates Blindsiders
Characteristics Low credit card Like to “balance hop” Highest credit card
penetration on credit cards penetration
Typically no mortgage Roughly one third have Around half have a mortgage
a mortgage
Minimal investment Roughly one third have a
products Some use payday car loan
lending
Attitudes Spenders who do not Consider themselves Comfortable with overall

toward like to stick to a good money managers financial situation
finances budget
Pay close attention to Pay fairly close attention to
Don’t pay close account and are aware account, but often surprised
attention to balances when they overdraft when they overdraft
Willing to have higher Take personal Typically upset with the
levels of debt responsibility for bank when overdraft occurs
overdrafts
Likely More likely to opt in to More likely to opt in to Less likely to opt in to
response courtesy overdraft courtesy overdraft courtesy overdraft
to regulations
May be more interested in
overdraft protection products
Source: GCI/McKinsey Consumer Financial Life Survey, July 2009

• Tailored overdraft offerings. As overdraft policies become more transpar-

ent, banks should tailor these offerings to customer segments as they do
other products. Customers could choose from a suite of overdraft serv-
ices, based on their individual preferences and risk profile. For instance,
overdraft protection (as opposed to courtesy overdraft) typically has an
annual fee and modest charges per overdraft. We expect overdraft pro-
tection to become a more prevalent alternative, particularly for lower-risk
customers. Another option likely to grow is overdraft protection tied to an-
other of the customer’s accounts, such as credit or savings.
• Other fee changes. Free checking has been subsidized in large part by
overdraft fees. This model has now run its course. More banks will revise
this fee structure, considering other “pay for services” models that align
fees to usage levels.
To do this successfully, banks need a more sophisticated understanding

of the costs of particular checking services and of the value customers
place on them. As an example, our research indicates that checking ac-
count holders fall into four different groups we label: brick and mortar in-
tensive, fee averse, online intensive and interest sensitive (Exhibit 3, page
12). Customers in each segment are willing to pay more for the services
that they value most. As banks migrate away from free checking, they will
need to develop checking products that meet the needs of these specific
segments.
Revise check deposit pricing

In the low interest rate environment, banks have struggled to define their
pricing strategy. Broadly, banks need to bring more sophistication to the
task of synchronizing deposit and lending volumes and to understanding
all the profit drivers underlying pricing.
• Coordinated target-setting. Over the past several years, as other funding

sources rose to prominence, deposit funding was de-coupled from the
funding requirements for lending. Now deposits are once again the critical
funding source, but banks lack the coordination to synchronize deposit
volumes with lending volumes. As a result, deposit growth targets must
be more frequently and systematically reviewed in conjunction with lend-
ing, given the recent volatility in lending volumes.
We also find that there must be a commonly accepted picture of deposit

profitability to generate agreement among treasury, finance, marketing
and product managers. This is not as simple as it may seem, particularly

in a low-rate environment where current deposit spreads may even be
negative. To succeed, banks need an end-to-end present value view of
product profitability, which incorporates several factors: current and future
interest margins based on yield curves and expected future repricing;
benefits of cross-sell for new-to-bank customers; operating and acquisi-
tion expenses; and attrition rates.
• Sophisticated relationship pricing. Many banks take a siloed approach to

pricing which results in policies that do not place sufficient value on the
customer relationship. For instance, profits from cross-sell should be
quantified and factored into overall pricing strategy. However, because
rate deposit product managers often have difficulty accessing product
sales and profitability data tied to their account holders, this critical analy-
sis is frequently not performed.
Exhibit 3
DDA account holders fall into four needs-based segments

Segment membership
is driven by a singular
priority
1 Highly fee averse

These core categories are
38% of population important to all segments
2
Fraud protection/ Maintenance/ 3
bricks & mortar usage fees
intensive Online intensive
Online access 20% of population
27% of population
Interest
Fraud protection
Bricks & mortar
4 Highly interest sensitive

15% of population
Source: GCI/McKinsey Customer DDA research

• Cross-region pricing optimization. Many banks have sophisticated regional

pricing models. However, these models can turn into black boxes that do
little to inform the intuition of the product managers and marketing, fi-
nance and sales leaders who must ultimately make the pricing call. Addi-
tionally, these models often compute elasticity but do not incorporate the
other factors that ultimately drive profitability and optimal pricing decisions
(e.g., absolute price by market, local marketing spend, cross-sell and at-
trition rates). An approach that transparently and simply lays out the criti-
cal components of the pricing decision by region would drive more
profitable decisions (Exhibit 4).
• Coordinating marketing, sales and pricing. Many banks continue to strug-

gle with the link between marketing spend, pricing and sales incentives.
As a result, the sales force may be rewarded for an increase in sales, even
when more aggressive pricing and higher marketing spend were the real
Exhibit 4
Regional pricing models should transparently display multiple

factors to help management determine the optimal price
Normalized elasticity Average market Optimal price by region

by region price by region Percent relative to
Percent balance increase Percent average market
per 10% change in price
Region 1 30 1.20 1.70
Region 2 30 1.10 1.70
Region 3 20 1.30 1.20
Region 4 20 1.30 1.20
Region 5 15 1.25 1.00
Region 6 10 1.40 1.00
Region 7 10 1.35 1.00
1.50 0.90 In this example,

Region 8 15
combination of
price elasticity and
Region 9 10 1.60 0.90 absolute price by
region drives
optimal price
Region 10 5 1.55 0.70
recommendation
Source: McKinsey analysis

drivers. Further, the sales force may be generating low-quality churn as

opposed to high-quality new-to-bank sales. Banks can no longer afford
these inefficiencies and must have systems to solve them.
The first step is to put in place the factors discussed above to make the
drivers of profitable pricing more transparent. Then, a deeper understand-
ing of the relationship between marketing spend and rate deposit prof-
itability should be used to determine the level of sales opportunity. Only
with this understanding can a bank reward its sales force appropriately for
opportunity-adjusted performance.
Put the customer first

Deposit products are fairly commoditized in the United States, which means
that competition is based primarily on price and convenience. To break out of
this constraint, banks must develop more innovative propositions, based on
customer needs and desires. There are three areas where we see opportunity
for this kind of innovation:
• First, banks are increasingly considering integration of products across

silos. This idea goes beyond mere bundling. An example might be a ho-
listic rewards program that offers benefits for total deposit and lending
volumes with the institution. Banks can offer creative account transfer
features, such as free checking overdraft tied to the credit card, or auto-
matic transfers from checking into savings for specific goals, such as
saving for a car. Another example, Bank of America’s “Keep the Change”
program, generated more than 1 million new current accounts in its first
year. This was a clear case of product development from a customer-
value standpoint.
• Second, banks can better target value propositions for specific segments.
For instance, older affluent customers are driving most deposit growth.
These customers are likely to be interested in guaranteed income solu-
tions, such as ING’s Orange CD ladder, which provides an online option
that allows the customer to put dollar amounts into different CD terms to
receive separate interest disbursements. Younger customers might prefer
a CD that pays out interest immediately, rather than at the end of the
term. For customers who have difficulty saving, banks can offer progres-
sive rates that reward them for meeting savings goals.
• A third area ripe for innovation is individual customization. When Com-

pass Bank introduced its “Pick Your Own Features” checking account, it
received credit from consumers for providing a fully customizable de-

posit product and it also implicitly received permission to provide each
free feature only to a subset of customers. Customers who opt for free
ATM usage are implicitly accepting that they will pay for other services
(e.g., overdraft protection). By embracing the concept of choice, Com-
pass also created a mechanism for maintaining and improving the prof-
itability of new deposit accounts.
***
Banks cannot rely on their old models to compensate for profits lost to com-
petitive or regulatory pressures. Instead, they should take this opportunity to
rethink value propositions, fee structures, pricing and distribution to create a
more sustainable – and profitable – deposit model.
U.S. Credit Cards:

Looking at the Business
Through a Long-Term Lens
The U.S. credit card industry has a long history of strong growth, prof-
itability and innovation. From the early days when cards were a conven-
ient payment device, through their role as an easy borrowing vehicle, to
the more recent incarnation as a reward-based loyalty tool, the sector
has proven consistently resilient. This was a business, after all, that ac-
tually grew revenues and profits through the recession of 2001-02, as
higher charge-offs were more than offset by the lower cost of funds. We
believe the latest economic downturn presents a very different chal-
lenge: the sector can no longer rely on its traditional strengths, it must
reinvent its business model.
Credit card issuers are operating in a maturing industry in which growth is

slowing and credit losses are rising. They face increasing regulatory scrutiny
and consumers who are deleveraging and favoring their debit cards.
The traditional tactical responses to these macroeconomic challenges –

repricing, cost-cutting, etc. – will not be enough. The direct-mail domi-
nated, balance-transfer driven business model that has served the sector
so well for so long is unlikely to suffice. Players must take a “through-the-
cycle” view with an eye toward long-term sustainability.
The end of business as usual

Over the past 20 years, the industry’s return on assets (ROA) has held
relatively steady at between 2.5 and 4.6 percent, driven by net credit
margins (gross revenue minus cost of funds) rarely falling outside 8.5 to
10.5 percent of receivables. However, charge-offs rose dramatically be-
tween June 2007 and June 2010, from approximately 4.6 percent to
10.3 percent. For the first time, structural changes in the funding mar-
kets mean that the traditional buffer to rising charge-offs – falling cost of
funds – is not materializing.
U.S. Credit Cards: Looking at the Business Through a Long-Term Lens 17
Issuers responded quickly and dramatically to the deteriorating economy –

but also predictably. Most have undertaken a strategic review of their port-
folios and are abandoning unprofitable products, cutting credit lines and
revamping credit standards and models. They are also aggressively cutting
costs across the board and improving reward scheme cost structures.
Even formerly taboo topics, such as off-shoring or IT platform in-sourc-
ing/out-sourcing, are being openly discussed. We estimate that in 2008
these cost-cutting measures generated industry-wide savings of more than
$3.6 billion and that the industry likely stripped out another $2 billion or
possibly even more in 2009.
All this is necessary, but insufficient. Issuers need to understand how to com-
pete in the shifting landscape rather than merely react to immediate shocks.
To survive in the long run, players must adapt to changing consumer atti-
tudes and the rapidly evolving regulatory environment.
Consumer attitudes have changed forever

Between 2000 and 2007, U.S. household debt grew 18 percent faster than
income. Since then, consumer confidence in the use of credit and in the
economy more broadly, has been shattered (Exhibit 1). Americans are now
Exhibit 1
Concerns about the economy and its long-term effects are felt by
cardholders across the credit spectrum
Percent of respondents who strongly agree
On track to meet long term Have cut back

financial goals on spending
Economy will be much Concerned about income
better in 6 months during retirement
9 65
Subprime Subprime
20 71
Prime 24 Prime 61
revolver 24 revolver 68
Prime 25 Prime 48
transactor 26 transactor 63
37 40
Superprime Superprime
23 53
Source: McKinsey Consumer Financial Life Survey, March 2009

saving more. The average consumer saved 1.8 percent of discretionary

spending in 2008, triple the 0.6 percent in 2007. We expect that number to
nearly triple again in 2010 and to remain high for the foreseeable future.
Cardholders are also voluntarily paying off balances and closing accounts:
voluntary attrition in December 2009 was 9.3 percent, an increase of 30 per-
cent over the average for 2008. Finally, the use of revolving debt was down
by 13.3 percent in September 2009, the largest drop since December 1976.
Furthermore, consumers are leaving their credit cards at home in favor of

their debit cards. Visa and MasterCard’s second quarter 2010 credit charge
volumes were down 4 and 15 percent, respectively, compared to the second
quarter of 2008, while debit volumes rose 26 and 4 percent, respectively.
Visa reported that total dollar volumes of purchases made with its branded
debit cards exceeded credit card purchases for the first time ever in the
fourth quarter of 2008.
We expect this reduction in consumer debt and shift in spending behavior to

last, with enormous consequences for the card industry. Issuers are going to
be forced to think beyond their traditional notion of growth in outstanding
balances if they are to attract this new breed of debt-averse consumer.
Exhibit 2
Direct mail credit card solicitations fell 67% in 2009

Mail solicitations
U.S.$ billions
8.3 8.3
7.4
5.4
-67%
1.8
2005 2006 2007 2008 2009
Source: Mintel Comperemedia

Evolving regulatory environment

Regulators have been seeking to protect consumers through measures that
will have a significant impact on the industry, especially the move to limit
risk-based repricing. The Durbin interchange amendment will further de-
press industry revenues. These new regulations will either prompt financial
institutions to find new sources of income by pricing differently (e.g., more
upfront balance-transfer fees), reducing fee waivers or steering customers
to more profitable products; or they will force them to reinvent the business
model. The industry may even have to take a new perspective on revolving
credit: instead of having the freedom to manage risk and return throughout
the life of the product, issuers will need to think about cards as a series of
installment loans, where each change in terms will lock in future balances
to that return.
Winning through the cycle

Direct mail has been slowly declining as a source of new accounts, and the
structural changes to the industry are turning this gradual slippage into a
steep decline. Mail volumes were down a staggering 67 percent in 2009
and are likely to fall further in 2010 (Exhibit 2). While issuers will continue to
use direct mail, it is unlikely to be the engine of industry growth and prof-
itability it once was.
We believe three new business models are likely to emerge over the next few
years as issuers rethink both the product and the channel interactions with
customers. Issuers will need to rediscover rela-
Maximizing existing customer tionship-based sales through traditional channels,
as well as to develop new and cheaper forms of
relationships allows banks to target
direct marketing. Relationships will be increasingly
products more effectively, reduce important to acquiring new customers, as will de-
churn and improve profitability. veloping new value propositions and delivering
experiential benefits. Specifically, the emerging
models we see are a) relationship-based bank sales, b) partnership relation-
ship sales and c) reinvention of the product for the digital world.
Relationship sales: Going multichannel

Maximizing existing customer relationships allows banks to target products
more effectively, reduce churn and improve profitability. Issuers with large
customer bases and branch footprints will enjoy a natural advantage as
they can focus on cross-selling with deposit accounts and other products.
On average, U.S. banks have sold credit cards to 20 to 22 percent of their

retail banking customers, with leading institutions reaching penetration
rates of 35 to 40 percent. These numbers leave a great deal of room for
growth: outside the U.S., some banks have achieved penetration rates of
more than 50 percent despite operating in less
To improve cross-selling rates developed credit card markets.
in the new environment, bank To improve cross-selling rates in the new envi-
issuers need to understand which ronment, bank issuers need to understand which
channels to emphasize, improve the marketing
channels to emphasize, improve infrastructure, and ensure the products are suit-
the marketing infrastructure, ably integrated.
and ensure the products are Multichannel: Although some institutions today
suitably integrated. generate nearly 30 new accounts per branch
each month, the branch alone will not be
enough. Issuers will also need to use their online, call center and even ATM
channels to push acquisition rates higher.
Marketing infrastructure: Issuers must do a better job of using the relation-

ship data and information they have on customers to tailor and target prod-
ucts and offers and evaluate credit. For example, bank issuers could
pre-qualify their entire retail customer base for credit cards so sales staff
can offer customers the product knowing they will be accepted. These de-
cisions will then need to be pushed out to frontline branch, call-center and
online channels.
Product: The card offering could be integrated more tightly with retail bank
offerings – e.g., with overdraft credit lines, integrating transaction data with
debit and bill pay for spending analysis, direct debit of payments, integrated
statements, etc. This would enhance cross-sell appeal, but new capabilities
would need to be developed.
Partnering for mutual benefit

Issuers do not have to be a bank with an extensive branch network to
play the relationship game. They can also partner in developing distinctive
value propositions and use partners’ low-cost acquisition channels. The
old co-brand partnership model should be a thing of the past. The new
paradigm is about meeting a partner’s core business needs and building
real customer loyalty, rather than focusing on points and “10 percent off
first purchase” deals.
When designing partnerships, issuers need to consider both the needs of

their partners and the needs of their partners’ customers.
Deal structure with partners: Issuers will have to become more attuned
to the core business needs of their partners. For example, the partner
may be trying to enter new markets, drive trip frequency, or get cus-
tomers to buy new categories or try new channels. Meeting a partner’s
needs will likely lead to more partner engagement and better card eco-
nomics. Another solution could be to strike profit-sharing deals that
allow partners to benefit from the true upside rather than the traditional
“bounty” payment for new accounts and purchasing points.
Value proposition for end customers: Customers want a positive ex-

perience from the partner, and partners want to improve customer
loyalty. The two should not be hard to match
Issuers should consider how digital up, assuming the card issuer understands the
underlying motivations. For instance, tiered
technologies can enhance the
points-based airline programs could be re-
customer experience while vamped to support an airline’s goal of raising
stripping out costs. Moving to revenue through baggage fees and on-board
food sales, while delivering meaningful experi-
digital marketing alone could
ential rewards to customers, such as frequent
reduce the overall cost structure by flyer status, upgrades, or priority boarding
30 to 40 percent. rather than points. Some partnerships have al-
ready experimented with this:
Continental/Chase gives cardholders their first checked bag free,
while Delta/American Express awards elite qualifying miles that count
toward higher status. These are still only targeted efforts and fall
short of being fundamental changes in the core value proposition to
harness the power of experiential rewards, but they are a step in the
right direction.
Reinvention in the digital age

Issuers should consider how digital technologies can enhance the cus-
tomer experience while stripping out costs. Moving to digital marketing
alone could reduce the overall cost structure by 30 to 40 percent. This is
still a business that relies too heavily on paper: direct mail, statements,
check remittances, etc. Issuers should embrace the full capabilities of the
Web and other digital technologies. Imagine what the user interface would
look like if Apple issued an “iCard.”
To date, most issuers have only recreated their paper statements online,
making no attempts to use the full capabilities of the Web. But taking paper
out of the system means more than just having a PDF version of a state-
ment for download.
There are also clear business benefits beyond cost-cutting. Steering cus-
tomers towards direct debit to pay card bills actually improves the risk profile
of the customer and takes the check remittance out of the system.
***
The credit card industry has been incredibly resilient and innovative over
many decades. It developed rewards and affinity value propositions, per-
fected direct mail in financial services and took analytics-based marketing
and pricing to a new level. The challenges facing the industry today are
daunting and have brought it to another crossroads. It is time for the industry
to find innovative ways to serve consumers and to reinvent the business for
continued growth and profitability.
Note: This article is an updated version of an article of the same title that appeared in McKinsey on Payments, June 2009.
New Market Realities for

Mortgage Lenders
The refinancing boom of 2009 and 2010 delivered a much needed lift to
earnings and spirits alike in the beleaguered mortgage lending market.
This optimism, however, may be short-lived. As with the private label mort-
gage boom following the 2001 recession, the current market owes more to
U.S. economic and monetary policy than to any fundamental improve-
ments in the housing market. In fact, as the refinancing wave subsides and
home purchase incentives go away, there may be little that can keep the
current momentum going until the fundamentals of housing supply and de-
mand balance out. This could take until 2013 or 2014. At the same time,
the passing of the Dodd-Frank Act marks the beginning of potentially
sweeping changes to the mortgage market. This process will culminate
with the reform of the government-sponsored enterprises (GSEs). As
lenders think about strategy for the next 18 to 24 months, they should an-
alyze the substantially altered market landscape and outlook. There is no
shortage of challenges: declining market size, legislative uncertainty con-
cerning GSEs, increased regulatory scrutiny, and competitive trends. The
days of turning lead into gold from the private-label era are over. The task
for mortgage lenders now is to build a model for success that meets the
demands of this new reality.
Scanning the new mortgage landscape

Mortgage lenders will face an array of challenges even when the U.S. econ-
omy and housing market start to show glimmers of life. Across almost every
dimension, the market is being reshaped, and to succeed, lenders have to
understand how these changes are playing out.
Several factors are leading to a decline in the size of the mortgage market
that is likely to persist for the next few years. Low interest rates and bond
yields, government support in the form of mortgage-backed securities
(MBS) purchases, and tax credits for first-time homebuyers may be obscur-
ing the degree of this decline, but the signs are evident: about one-quarter
of borrowers had negative equity in their homes at the end of 2009 (an ad-
ditional 20 percent of mortgages had a combined loan-to-value ratio greater

than 85 percent).1 To make enough from a sale to afford a new down pay-
ment, these homeowners will have to stay put until prices improve. In addi-
tion, consumers with damaged credit histories,
Managing the convexity risk including borrowers with modified mortgage
associated with the servicing asset loans, will have severely limited (or zero) access
to credit, reducing mobility and further lowering
will require renewed focus on risk
the demand for new home purchases.
management and balance sheet
Several macroeconomic factors are also likely to
optimization through more depress the mortgage origination market over the
deliberate allocation of capital to next two to three years. Home prices hit a peak-
to-trough decline of 30.6 percent through late
the mortgage assets.
summer 2010.2 And historically low interest rates
today will suppress refinancing potential over the next few years. Origination
loan-to-value ratios are also down, from an average of 80 percent at the end
of 2008 to 74.5 percent in 2009.3
The non-agency secondary market is unlikely to make a return for perhaps

another two years. After peaking at over $1 trillion in 2005 and 2006 and dip-
ping to $10 billion in 2008, non-agency MBS are forecasted to reach roughly
$250 billion in the next few years.4
Finally, building activity is at a historical low. Monthly housing starts have

dropped by 50 percent and were running at below 50,000 per month in mid-
2010 compared to over 100,000 in 2007.
Another salient feature of the mortgage market is unstable pricing equilibrium.

The financial crisis triggered unprecedented consolidation, with the top four
lenders now accounting for over 60 percent of the origination market. The
large monoline originators that flourished during the pre-crisis mortgage boom
are, for the most part, gone and are unlikely to return in force, given the col-
lapse of the private-label market. And now that the ability to originate high-
margin non-conforming loans is limited, the conforming loan is no longer the
accommodation product it became in the private-label era. These factors may
1 First American Core Logic, Fiserv/MBA

2 Case-Schiller, economy.com
3 FHFB
4 Estimate based on deal information and general publications from SIFMA, Bloomberg, Fannie Mae, Federal Reserve, Freddie Mac,
Ginnie Mae, First American Corelogic Loan Performance, Thomson Reuters.
lead to a period of more rational pricing in the conforming market, which has
once again become the bread-and-butter segment for lenders. At the same
time, the decline in refinancing production in 2010 may lead to a scramble for
volume as lenders struggle to downsize or integrate their origination platforms.
With the steep, simultaneous decline of servicing, origination and investment

income in 2007 and 2008 undercutting the “macro hedge” (increased pro-
duction earnings offsetting the losses in servicing during refinancings), mort-
gage lenders will need to refresh risk management and capital allocation
strategies. Even if increased production income at least partly offsets the re-
alized impairment of the servicing assets, the unrealized impairments will
continue to create significant earnings volatility for most lenders in the origi-
nate-to-sell business. Managing the convexity risk associated with the servic-
ing asset will require renewed focus on risk management and balance sheet
optimization through more deliberate allocation of capital to mortgage assets.
The decline of the broker channel and stand-alone home loan centers is
leading to a much greater emphasis on retail channels. This shift will force
lenders to enhance their branch sales capacity, increase the effectiveness of
loan officers (LOs) and develop strong direct ca-
The decline of the broker pabilities. Banks will also need to innovate and
find ways to lower retail commission expenses
channel and stand-alone home
and manage the attrition typically associated with
loan centers is leading to the LO channel.
a much greater emphasis on Originators are likely to experience increased
retail channels. costs of mortgage production as consumer pro-
tection is at the top of regulatory and legisla-
tive agendas. A sharper focus on quality by GSEs will require lenders to
go to greater lengths to identify fraud and reduce underwriting and pro-
cessing defects. At the same time, market-driven activity (e.g., a ramp-up
of repurchase requests) is adding to the overall cost burden of mortgage
loan production.
Several trends are conspiring to create a very challenging credit loss environ-
ment. Deeply underwater borrowers who are not responding to existing loss
mitigation modification programs, along with more than $800 billion of floating
HELOCs at historically low interest rates, represent a looming challenge for
default servicers. In addition, continuously high rates of unemployment and
underemployment are contributing to delinquency and foreclosure levels that
are likely to remain above historical averages for several years.
Current legislative and regulatory initiatives will affect several market prac-
tices, likely reducing production revenues and increasing the cost to origi-
nate and service mortgage loans. Increased state regulation, certification of
loan officers, bans on certain types of sales commissions, greater disclo-
sure requirements and stricter regulation of borrower fees (including pre-
payment penalties), are among the potential and confirmed changes that
lenders will face (Exhibit 1). But the most significant impact of regulation
may come from possible changes in regulatory capital requirements – both
for whole loans and securitizations. Investing in whole loans seems unlikely
to be more profitable on an ROE basis, while under the Dodd-Frank Act,
private-label securitization of non-qualified mortgages has already become
significantly more capital intensive, leaving lenders at the mercy of the con-
forming MBS market.
Funding risks, and in particular the challenges associated with the conforming
MBS market, may become the big surprise over the next 12 to 18 months.
Since the majority of the conforming production in 2009 was effectively funded
through government purchases as part of its quantitative easing program, the
record low yields in the conforming MBS market and the resulting massive
Exhibit 1
Mortgage lending faces increasing regulatory pressure

Bank capital Bank balance sheets have contracted
require- Further contraction possible due to higher risk weights
ments
Likely outcome
First-loss Proposal that issuers retain material interest in securitized credit Heightened bank
legislation exposure capital require
ments and
Share of exposure retained and other conditions still unclear proposed first loss
Potential for servicers to require “skin in the game” legislation will
fundamentally
Government Government funding programs have provided significant liquidity impact the role and
funding to MBS market size of bank
programs balance sheets and
These programs have prompted concerns over the size of
private label MBS in
Treasury/Fed balance sheets
future housing
finance.
Legislation From 2000 to 2007, GSEs’ retained portfolios grew considerably in
reducing size and risk, with a 53% increase in mortgages on balance sheet, Consumer
GSE size prompting concerns over future systemic risk protection laws will
be strengthened to
prevent a repeat of
Consumer Anti predatory legislation pending approval would require creditors lending practices
protection to determine borrower's ability to pay leading to the crisis
laws Consumer Financial Protection Agency could increase product
specific regulation
Source: SEC as reported by SNL; company 10Qs; The Roles of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks in Stabilizing the
Mortgage Market (6/18/09); FHFA; Press search
wave of refinancing early in the year are largely a by-product of U.S. economic
and monetary policy (Exhibit 2). In the first half of 2009, the U.S. government
purchased the equivalent of 97 percent of all MBS issued and 82 percent of all
originations. In total, the Federal Reserve’s program has purchased over $1.25
trillion in agency MBS, approximately 60 percent of total 2009 originations. The
announced completion of the Fed’s MBS purchase program in 2010, com-
bined with what appears to be a muted investor appetite for fixed-rate U.S.
mortgages, could lead to significantly higher MBS yields for conforming pro-
duction, resulting in margin pressures or higher rates for borrowers. In the
most extreme scenario, increased MBS yields could push the mortgage rate to
levels that would virtually halt most refinancing activity, leaving lenders scram-
bling to win in the slowly recovering purchase market.
Imperatives for mortgage executives

The basic outline of what is required for mortgage players to succeed in the
new market environment is not wholly unfamiliar. Near- and mid-term condi-
tions call for a return to fundamental strengths such as high-quality under-
writing and processing, and in certain areas, a shift in emphasis or objectives
Exhibit 2
The federal government has been funding most of the

mortgage market
Mortgage originations by source of funding
U.S.$ billion
1,500 995
0% 5% Fed purchases
2% 5%
Treasury purchases
Fannie Mae purchases

60% Freddie Mac purchases
MBS Issuances Other MBS purchases

67%
Portfolio lending
8%
9%
2%
3%
22% 18%
2008 FH 2009
Source: Inside Mortgage Finance, Federal Reserve Bank of New York, US Treasury, Freddie Mac and Fannie Mae monthly summary
(e.g., for secondary market execution). Most mortgage lenders will need to
make explicit choices and trade-offs and increasingly approach mortgage
strategy as part of overall consumer banking strategy.
Redefining business objectives

The U.S. mortgage business is both cyclical and volatile (Exhibit 3). This fact
has been well-documented. Unpredictable swings in production volume, as-
sociated pricing expansion and contraction, significant operating leverage and
the changes in the fair value of mortgage servicing rights (MSR) are among
the usual drivers. Then there is the industry’s love affair with market share and
current earnings. The impact of making these metrics primary business objec-
tives is unmistakable: market share targets exacerbate pricing pressures,
while the focus on current earnings typically leads to suboptimal through-the-
cycle decisions, excessive risk-taking and ineffective use of capital.
We expect that lenders will begin pursuing a more comprehensive set of

business objectives. While mortgages will undoubtedly represent an impor-
tant earnings stream for many banks and hence call for market share, volume
and profit objectives, other measures of success will become equally impor-
Exhibit 3
Industry cyclicality contributes to a highly variable ROE
Cycle timing Estimated future industry ROE

Percent
Through the cycle 12 14
Refinance boom Current point

19 20+
in cycle
Bottom of the 4 6
refinance cycle

tant: earnings and value at risk, capital usage, ROE, through-the-cycle earn-
ings and overall customer franchise value.
Most lenders will need to make several trade-offs to rebalance this broader
set of business objectives and realign their origination, servicing and balance
sheet strategy. Decisions on retaining servicing will be very important. Book-
ing servicing at production implies higher current earnings, but also places
more earnings and value at risk. Funding whole loans on the balance sheet
stabilizes the earnings volatility associated with a servicing book, but will also
increase capital consumption, may drag ROE below the cost of equity and
can result in the build-up of credit risk. Selling loans on a correspondent
basis, in turn, frees up capital, eliminates the earnings volatility and risk asso-
ciated with the servicing asset altogether, and boosts ROE. However, it can
diminish the franchise value of customers, who will now receive mortgage
statements from another retail bank (Exhibit 4). Three actions will be particu-
larly important in the near term:
• Set the originations capacity target. Two of the most critical decisions in
practice will be to determine the optimal mix of whole loans and servic-
ing assets on the balance sheet and to determine the maximum size of
Exhibit 4
ROEs differ significantly for different business model choices

Balance
sheet ROE after tax Revenue Cost Key risks/
approach Percent drivers drivers considerations
Hold Upfront origination Origination & Significant capital

whole fee income servicing costs requirements to hold
loan on 5 8 Earn NIM throughout Credit whole loans
balance duration of the loan provisions Duration and
sheet (3 5 yrs) convexity risk
Credit/delinquency risk
Sell Upfront income from Origination & Capital required to be

whole origination fees, gain servicing costs held against MSR
loan and 12 14 on sale and MSRs Mark to market High MSR convexity
retain Servicing strip and gain/loss on
MSR Significant MSR
ancillary fees/income MSR & hedges volatility and hedging
throughout duration
of loan
Sell Upfront income from Origination Limited capital

whole origination fees, gain costs requirements
loan and 15 20 on sale and MSR
release sale
MSR No ongoing income

the overall mortgage portfolio relative to originations capacity. The first

decision will determine the risk-return profile of the business, while the
second will protect the franchise from runoff risk, i.e., the risk that a
mortgage will get refinanced, resulting in the loss of net interest or serv-
icing income. Given the preoccupation with the opposite risk today –
that loans will stay on the balance sheet longer due to their low interest
rates – lenders will need to exercise an even greater discipline in manag-
ing portfolio growth in the near term.
• Set the secondary execution strategy for servicing. The pursuit of current
production earnings has pushed most lenders into booking servicing
rights on their balance sheets. At origination, the value of the right to serv-
ice the loan is capitalized if a lender decides to retain it, and recognized
both as an asset and as current period revenue. More servicing rights,
therefore, means more production profits. The servicing rights, however,
consume capital and produce significant quarterly earnings volatility. To
maximize production revenues, lenders are frequently tempted to book
excess servicing rights – over and above what Fannie Mae and Freddie
Mac would require them to hold – increasing capital consumption, causing
more earnings volatility in the future, and reducing the ROE of the mort-
gage business. Some lenders are starting to reevaluate how they make
secondary market decisions around servicing and beginning to consider
ROE, liquidity and long-term earnings implications. We expect more
lenders to follow suit.
• Understand the implications of the new objectives for business processes
and incentives. Finally, balancing business objectives will require deeper
structural changes to business models and processes. In particular,
budget and business planning processes will need to include a discussion
of returns on capital and its underlying drivers. Management incentives
across sales, operations and capital markets (typically based on origination
volumes, revenues or, less frequently, income) should be reevaluated
through the ROE lens and cascaded through the organization appropri-
ately, calling for required changes to the MIS and reporting systems.
Clarify originations strategy and align the sales model

The increased emphasis on retail channels creates its own challenges, as re-
tail production does not come cheaply. In particular, LO originations continue
to be expensive. As retail networks consolidate, lenders must manage high at-
trition rates among their loan officers, while incurring 55 bps to 60 bps of
commission costs in the channel. One alternative is to migrate customers to

direct channels. Several lenders are already receiving up to a third of their re-
tail production through the Web and telesales channels. Some banks are
starting to experiment with consumer direct technology and telesales in
branch. While there have been few notable successes thus far, the reward for
banks getting consumer direct right will be significant. For banks that continue
relying on loan officers, managing sales effectiveness and containing attrition
will be ever more important, as cost pressures begin to mount with the decline
in refinance volume. The good news is that opportunities for improvements
abound, given the wide dispersion of sales performance, limited focus on key
drivers of productivity and the frequently mercenary culture of the channel.
While reports of the death of the broker channel have been exaggerated, it
does present a formidable challenge. While lenders have typically managed
this channel for volume, getting it right will require either adopting B2B man-
agement standards and applying commercial lending principles or moving
upscale in the broker space and focusing on the most reputable partners.
The latter approach has enabled a handful of lenders to maintain a smaller
number of handpicked broker relationships managed for end-to-end eco-
nomics with strict quality and risk management
Some banks are starting to controls in place. Those that can maintain their
presence in this channel and manage the associ-
experiment with consumer direct ated operational and credit risk will have an ad-
technology and telesales in branch. vantage in a market with a declining share of
While there have been few notable refinance volume.
successes thus far, the reward for A number of correspondent lenders have enjoyed
strong margins. The move by many community
banks getting consumer direct banks and credit unions to offload convexity risk al-
right will be significant. lowed correspondent lenders to purchase deeply
discounted servicing assets. The correspondent
channel will continue to be an important element in managing run-off risk, but
correspondent lenders will need to assess their own levels of convexity risk and
determine the optimal size of the correspondent channel. Increasing pricing
competition will likely require correspondent lenders to develop value proposi-
tions based on benefits other than price alone (e.g., private-label servicing).
Overall, sales strategy needs to fit the desired size of the mortgage and serv-
icing assets on the balance sheet. As lenders continue to exit the wholesale
channel, they will be less able to manage run-off risk through increased
wholesale originations during refinancing periods. While extension risk (i.e.,
risk of borrowers less likely to prepay) dominates prepayment risk in the near
term, a three-year mortgage strategy should balance originations capacity
with the size of mortgage and servicing assets.
Reengineer the operating model

The current business environment calls for a more flexible operating model.
Cost-effectiveness, scalability and pull-through rates will be a priority for
lenders, if significant declines in origination volumes materialize. Successful
originators will also stand out through their excellence in customer service
(e.g., by providing accurate terms to borrowers). Cost takeout and downsiz-
ing will be priorities, especially for banks that have recently acquired mort-
gage platforms. Platform and system integration, along with rationalization of
sites and production overhead, will regain the priority status they lost in the
middle of the 2009 refinancing cycle.
Process reengineering can also improve lenders’ cost positions. A significant

but hard-to-measure cost in most origination shops is that associated with re-
working applications to correct processing and underwriting errors. The need
for rework and multiple file touches by underwriters and processers reflects the
large share of agency origination, lower-than-expected appraisal values and
multiple layers of condition requirements. This may be where originators have
the most potential to innovate. There are multiple opportunities in virtually any
originations shop: more accurate condition generation, better feedback loops
between condition and application underwriting, upfront identification of appli-
cation segments with high expected fallout rates, staging the use of third-party
resources and the associated costs to match the probability of closing, build-
ing fail-safe rules into workflow to reduce rework, better prioritization of condi-
tions clearing, balancing automated workflow rules and manual processing and
ownership of file, and applying lean disciplines to reduce waste and create flex-
ibility. Customer document collection in particular has become increasingly
problematic. Making it easier for customers to track the status of an applica-
tion and to clearly identify and submit documents – or to allow lenders to ob-
tain documents on their behalf – would dramatically increase pull-through rate
and allow lenders to close loans in a more accurate and timely manner.
The growing regulatory burden, as well as cost and operational risk associ-
ated with loan originations, may encourage banks without the required
economies of scale to shift to some variation of lending on a correspondent or
even broker basis. In this model, the mortgage could become an accommo-
dation product to existing customers, eliminating the challenge of managing
capacity through the cycle, as well as reducing the convexity risk associated
with the servicing asset. This shift could offer additional opportunities for
lenders in the wholesale channel to innovate their value propositions.
At a practical level, many mortgage lenders have an integration of some

scale underway. It is critical that lenders do not let shifting integration
timelines, proliferation of IT systems and fragmented vendor relationships
undercut their execution of required process changes. With significant vol-
ume declines likely, cost efficiency and process effectiveness will be of
critical importance.
Preserve capital through next-generation default servicing strategies

While troubles in subprime and Alt-A have stabilized somewhat, high unem-
ployment continues to lead to delinquencies and foreclosure rates that ex-
ceed historical levels (Exhibit 5). History shows that unemployment continues
to rise for months after the National Bureau of Economic Research declares a
recession to be over, and mortgage investors and servicers need to be pre-
pared for further trouble.
Exhibit 5
Delinquency and foreclosure rates are expected to stay above

historical levels over the next few years
Delinquency rate
Estimates
Percent of outstanding loans
12
10
4 4.0
2
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Foreclosure rate
Percent of outstanding loans
1.5
1.0
0.5
0.3
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: Mortgage Banker's Association: National Delinquency Survey; Economy.com

Despite the early successes of the Home Affordable Modification Program

(HAMP), it appears the majority of borrowers delinquent 60-day-past-due or
more will either remain ineligible, fail the net present value or debt-to-income
ratio tests, or fail to complete the trial period. Contact rates with borrowers
remain low, and borrowers are notoriously slow to return the required modifi-
cation documentation. The future performance of modifications remains un-
certain, prompting questions about how many losses will be averted and how
much pushed into the future periods. Most servicers have put a tremendous
amount of effort and investment and expense dollars into building better loan
modification factories, but increasing the adoption rates of HAMP and deliv-
ering non-HAMP treatments represents a significant opportunity for most.
Dealing with these challenges will require a more fundamental understanding

of borrower motivations and behaviors. Some questions servicers need to
pose are: Why are borrowers unwilling to talk to the bank? Why do borrowers
decide to give up on the property? How do they view modification offers? Is
there a sense of entitlement? What drives low modification rates? What are
the main behavioral barriers to broader adoption? What behavioral factors
trigger re-defaults and how can they be reduced? Servicers need more in-
sight into attitudes toward banks and debt, emotional and cognitive factors in
borrowers’ decisions, as well as the impact of negative equity and borrowers’
balance sheets.
The next generation of treatment strategies will need to build on lessons

learned as well as new consumer behavior insights generated through re-
search. The latter will play an even more important role in a world where in-
creasing numbers of losses will come from a new segment of mortgagees –
prime borrowers.
Create franchise value from retail mortgage relationships

Despite much lip service paid to the idea of incorporating mortgage more
tightly into the retail banking franchise, many of the largest mortgage origina-
tors – and even most regional banks – have treated residential mortgage
lending as a separate business. This will have to change.
Lenders must capture the full value of the mortgage relationship. Mortgage
customers tend to have higher deposit balances, stay with the bank longer
and perform better on the bank’s other credit products. Recent efforts also
suggest that mortgage can be an acquisition product for new customers
through targeted cross-sell executed at the right time during the application
and product cycle. Consumers do, of course, view mortgage purchase as a
distinct transaction in which rate plays a dominant role. But while rates are
paramount, mortgage buyers are also willing to reward the lender with more of
their business in exchange for real value – convenience, speed and certainty,
and rate discounts.
To create franchise value from mortgage relationships, banks can look more
closely at their retail banking customer base and improve cross-sell efforts for
new-to-bank mortgage customers. Customer
Retention and modification transfer teams, which would work during the origi-
strategies will play an important nation process to encourage attractive customers
to migrate other financial relationships to the bank,
role in preserving the franchise are a good start. The originations and sales strat-
value for existing mortgage and egy should take into account the bank’s brand and
deposit customers. physical branch presence. There are also opportu-
nities for product innovation, predominantly in the
jumbo/non-conforming and home equity space. Retention and modification
strategies will play an important role in preserving the franchise value for exist-
ing mortgage and deposit customers.
***
While it is too early and there are far too many headwinds to call an end to
troubles in the mortgage lending market, it is not too early for lenders to
begin a transition from defense to offense, and to begin planning strategy on
a longer-horizon timeline. A clear understanding of the current environment,
coupled with strategic planning, will position lenders for success in the new
mortgage market.
Rebounding in Small Business

Banking
Small business banking is at a crossroads. The financial crisis exposed weak-

nesses across a number of core capabilities in the space, leading to unprece-
dented losses. Unsurprisingly, banks retrenched, virtually shutting down small
business lending. While these events have shaken the industry, small business
banking will recover, and winners will emerge. This is a rich and under-pene-
trated market, and banks that are willing to invest in delivering credit, stability
and a positive customer experience stand to gain significant share.
Small businesses have always been a critical part of the U.S. economy, with an
estimated 34 million in the country today. On average, small businesses are
more profitable for banks than the average retail customer, as they often have
a steady stream of deposits and many require consistent access to credit. An
estimated 30 percent of total pre-tax profit from U.S. financial services is re-
lated to small business, with 10 percent coming from small businesses, them-
selves, another 10 percent coming from small business owners, and the final
10 percent coming from small business employees. While the latter two seg-
ments are often ignored, they are critical to captur-
While optimism is growing, ing the full value of the small business opportunity.
uncertainty continues to limit small As recent events have demonstrated, however, the
business investment. nature of small businesses makes them highly sus-
ceptible to broader economic changes. The finan-
cial crisis hit this sector especially hard, with approximately 50 percent more
small businesses declaring bankruptcy in 2008 than in 2007. Uncertainty con-
tinues to limit small business investment.
These difficulties extend, of course, to banks serving small businesses. Rev-

enues and profits shrunk from peak levels in 2007 to barely break-even in 2009
(Exhibit 1). While this is primarily due to credit losses, tightening spreads have
also reduced overall deposit profitability. Banks are seeing not only the highest
charge-off levels in a decade, but also declining balance growth, as underwrit-
ing standards get stricter and fewer small businesses apply for credit. The low
point for small business banking profits was likely 2009, with losses reaching
nearly $25 billion (or 6 percent of loans outstanding), and most banks strug-
gling to break even within their small business franchise.
The small business cards market has also been under siege, paying now for
the higher credit limits and relaxed underwriting standards of the boom years.
Some institutions have been shuttered due to heavy losses (e.g., Advanta);
other major small business card issuers have significantly slowed underwriting.
Despite the challenging environment, the upheaval in the small business

banking space has created opportunities. Small businesses have historically
been an under-served segment, and several large players have slowed their
customer acquisition rates and cut back on their small business offerings.
Customers are likely to flock to banks that can provide the credit and serv-
ices they need. And while there has never been a clear market leader in small
business banking (the top 10 small business lenders have only 30 percent of
total loan volume), the current uncertainty provides the perfect window for fo-
cused institutions to gain share.
Banks should be cognizant, however, that not all small business segments
will recover at the same rate. Pockets of opportunity will begin to emerge,
and banks should be prepared to take advantage selectively.
Exhibit 1
Small business banking profit pools

Small business and business banking Deposit profitability
profit pool historical and forecast 26
(2007 – 2013E)1 23
$ billion
39
2007 2008 2009E 2010E 2011E 2012E 2013E

31
Loan profitability
26 9
5
22
15
2007 2008 2009E 2010E 2011E 2012E 2013E
8 Credit card profitability

4
3
2
2007 2008 2009E 2010E 2011E 2012E 2013E 2007 2008 2009E 2010E 2011E 2012E 2013E
1
Small business profit pool estimates include business with < $10 million in annual sales
Source: McKinsey Small Business Profit Pool Model
Trends shaping the recovery

With the thawing of the lending market, and a return to GDP growth, the
small business banking market should begin to cautiously recover in 2010
and 2011, and return to higher profitability in early 2012. Recent events have
shifted the industry landscape, and three trends will shape the recovery:
• An underwriting model in flux. In the wake of unprecedented small business

losses in lines of credit and cards, underwriting is going through an over-
haul. This is likely to both increase cost and slow overall growth, as banks
revert to manually underwriting smaller loan sizes in hope of reducing de-
faults. Score-based approaches have been scaled back (with lower ap-
proval limits) and banks are layering in additional attributes and
requirements. There will also be a reduced role for small business credit
cards and unsecured lending products in the near term, until underwriting
models can be trusted again. This will have a particularly hard impact on
profitability, as credit cards bring in more revenue and profits than traditional
loans or credit lines.
Given the expected decline in traditional credit cards, banks are also rethink-
ing the card model and moving to innovative charge-card type offerings, in
which balances are either paid off at month’s end or secured by collateral.
While these types of credit products are relatively novel in the United States,
countries including Brazil and China have been using non-traditional credit
models, such as receivables-backed credit cards, for years.
• A shifting competitive environment. The small business competitive space

is still taking shape following the financial crisis. In today’s tight credit en-
vironment, business banking customers are more willing to switch primary
institutions, and banks that are lending are grabbing share from more con-
servative peers. At the same time, as banks reshuffle and cut staff, many
small business relationship managers (RMs) have switched institutions,
often taking their customer relationships with them. The chaotic merger
and acquisition activity in late 2007 and 2008 has also led to increased
switching propensity among customers of acquired institutions. These dis-
locations in the market are creating windows of opportunity for proactive
banks, which could translate into longer-term advantage.
• Increased role of government and regulation. There is also still much uncer-
tainty concerning the long-term ramifications of regulatory change for the
industry. Further disclosure and reporting requirements are likely to accom-
pany increased government intervention, which will raise banks’ cost to

serve. Although the ultimate impact of increased government scrutiny is still
uncertain, banks will need to closely watch the situation for both opportuni-
ties and challenges.
Winning in small business banking

While the credit crisis will leave lasting scars, some banks will emerge as
clear winners in small business. To join the ranks of those winning institu-
tions, banks need to quickly address and focus on four critical elements of
their business model.
Segmentation and coverage

As a first step, banks must reexamine how they define the small business
segment from the size of the businesses they serve to the coverage and re-
sourcing models they employ. Historically, small business has often been
the forgotten step-child, with most large and regional banks rolling the busi-
ness in with retail and spending limited time and effort understanding cus-
tomer needs. Moving forward, serving small business should be a
well-planned, strategic decision, based on careful analysis of the customer
base, in-footprint growth opportunity, cost to serve customers, and the cul-
ture of the bank.
Segmentation in small business can drive significant value, but needs to be

simple and actionable. At the highest level, segmentation and sales coverage
should be based on size, as the revenues of a
Historically, small business business often dictate the complexity of its bank-
has often been the forgotten ing needs. For instance, smaller small businesses
tend to behave more like consumers, while larger
step-child, with most large and
small businesses trend toward more complex
regional banks rolling the business product needs, such as cash management.
in with retail and spending limited Once a bank has executed this top-level segmen-
time and effort understanding tation, it can begin to target a small number of
sweet-spot industries. The choices will vary by
customer needs.
bank, considering footprint and risk profile, but
should be based on a thorough evaluation of what segments are most attrac-
tive, given the unique profile of the bank. Characteristics such as
account/transaction activity, product needs (credit-only versus cash manage-
ment plus credit), growth potential and industry risk (expected losses, volatil-
ity) should all be considered. As an example, more than half of small business
profit pool revenue is in industries with relatively lower volatility (Exhibit 2). An-
other important consideration is level of deposits; deposit-rich industries are
particularly attractive in today’s environment. Through analysis and select in-
dustry targeting, banks can construct a balanced customer and product
portfolio, thus improving overall returns on the business.
Underwriting model
Banks must fully reexamine and rebuild their small business underwriting
processes and models, both for cards and the broader set of lending prod-
ucts. Getting the underwriting model right is a critical part of restoring confi-
dence and profitability to industry.
To drive this end-to-end improvement, banks need to address three key

levers. These levers will not only improve the underlying predictive power of
their underwriting models, but also reduce the pricing variability and leakage
issues that erode bank margins.
Exhibit 2
Average volatility by small business size and industry

Average annual revenue by industry and revenue band Profit Volatility1
Percent of total, $ billion < 40%
40 23 63
4%
Manufacturing 40 50%
10% 6%
Real estate services 18% > 50%

18%
18%
Retail sales
20% 18%
2% 15%
Agriculture/mining 2%
3%
Construction
9% 9%
Trans./Comms./Public Utilities 2% 8% 3%
Wholesale sales 4% 5%
6%
Business services 12% 9%
9%
5%
Health/Social services 6% 6%
6% 2%
Personal services 7% 5%
18%
Professional services 15% 16%
0 1.0 MM 1.0 MM 10.0 MM Total

1 Change in NIBT from 2009 to 2013/Average Revenue of 2009–2013
Source: McKinsey Small Business Profit Pool Model
• Improve credit process boundaries and design. Prior to rebuilding credit

models, banks need to take a hard look at the number and types of mod-
els and processes they are using today and where
The ability to leverage proprietary they are drawing the “chalk lines,” or limits, be-
customer data, and the analytic tween them. Depending on the volume and size of
loans processed, banks may want to employ a
skills to exploit the outputs, can
mix of pure score, score-plus and manual credit
give banks a competitive processes, each with varying predictive power
advantage over their peers. and marginal cost. Deciding where and how to
use models is a trade-off between efficiency and
effectiveness, balancing evaluation cost and timing against potential credit
losses and lost profitable accounts.
• Upgrade data and credit models. Small business lending models often
have the lowest Gini coefficient (degree of predictive power) in the banking
industry. This can be dramatically improved through the use of enhanced,
richer data sets, more frequent refreshing of the model (every two to three
years), and the addition of a qualitative credit assessment (see sidebar).
With this approach, banks can see increases of between 30 and 35 points
in their small business Gini coefficient, which can have a sizeable bottom-
line impact. For example, improving underwriting models by just one per-
cent (raising the Gini coefficient by a single point) can reduce credit losses
by $3 million per year on a $10-billion portfolio (assuming a 2 percent loss
What is a QCA?
In addition to traditional quantitative scoring models, banks can benefit from incorporating a qualitative probability
of default (PD) rating model, QCA (qualitative credit assessment), to improve the predictive power of the process.
QCAs can be complementary to statistical scoring models or can stand alone. If used correctly, they can be ex-
tremely powerful, increasing the Gini coefficient of models by more than 15 to 30 percent.
A true QCA approach is a highly standardized qualitative assessment tool with between 15 and 25 questions and
a clearly defined and balanced set of answer options. The answer options are designed to be objective and ob-
servable, making this process very different from the ad-hoc “expert RM/underwriter” judgment used by some
banks. QCA questions are focused on real risk drivers, such as demographics, market position, company opera-
tions and management, and each is assigned a weight based on its relative predictive power. The end result is an
effective and efficient PD rating tool that can significantly improve small business underwriting performance with-
out significantly impacting speed or cost.
rate). Improving the Gini by 20 to 30 points can reduce credit losses by up

to $100 million on a $10-billion portfolio.
When upgrading models, banks need to move beyond the traditional data
sets and incorporate more creative variables, such as industry and sector-
specific inputs and geographic factors, to build maximum differentiation
and predictive power. For example, banks could look at recent industry
failure rates as a new model input to developing the probability of default
(PD) score. On average, small businesses focused on construction had
approximately 1.5 times greater business failure rates than those focused
on professional services (Exhibit 3). This suggests that banks that identify
higher-risk segments and adjust their models accordingly could see lower
losses than peers.
Additionally, banks should integrate existing customer information into

their scoring models, including business owner personal data such as
DDA history, savings account balances and credit card usage. The ability
to leverage this proprietary customer data and the analytic skills to exploit
the outputs can give banks a competitive advantage over their peers.
Exhibit 3
Business failure rates by industry

Indexed failure rates by industry1
Percent of overall failure rate
Overall 100
Health and social service 67
Professional services 80
Business services 80
Personal service 80
Agriculture and mining 88
Real estate 97
Wholesale 100
Manufacturing 102
Retail 117
Construction 119
Trans./Comms/Public utilities 123
1 Average of Dun & Bradstreet and U.S. Census reports

Source: Dun & Bradstreet June 2009 U.S. Business Trends report, U.S. Census Bureau 2006 Business Tabulations report, McKinsey analysis
• Make the right offers and reduce leakage. Even when models are correct
and generate accurate PD, many banks still have challenges with pricing
and offer discipline, with significant inconsistencies across products and
RMs. This disparity leaves a considerable amount of money on the table
and can often quickly be improved with enhanced pricing tools and analysis
and frontline incentives.
Accurate pricing requires understanding the drivers of expected loss, which is

based on the PD, expected loss given default (LGD) and estimated exposure
at default. Correctly estimating LGD is especially critical in lending to small
businesses, as they typically have a higher PD, and inaccurate LGD esti-
mates damage profitability by underpricing high risk and overpricing low risk.
The recent crisis demonstrated the weaknesses in existing models, and
banks now need to revisit and refine those models. Additionally, even when
the recommended pricing is correct, many banks have weak offer discipline,
creating wide variations in profitability (Exhibit 4). While this can be addressed
through strengthened pricing guidelines and realignment of incentives, it may
also require a shift in mindset, in which RMs are focused on longer-term prof-
itability implications, as opposed to shorter-term volume targets.
Exhibit 4
Pricing discipline by relationship manager

Actual rate versus target rate (for signed contracts)
Percent, N = 60
2 1 0 1 2
Average loan priced

11 basis points
below target rate
Average = 0.11%
Relationship banking
Banks must also move away from single-product customers toward a multi-
product, relationship-based approach. This is a large opportunity in the small
business segment, as banks can capture not just the small business ac-
count, but also the business owner’s personal account and potentially even
employee personal accounts. Business owners represent an additional 10
percent of the financial services profit pool and tend to be much more afflu-
ent and profitable than the average retail customer.
As we describe in “Back to the Future: Rediscovering Relationship Banking”

(page 56), the relationship banking approach is about more than cross-sell; it
is about serving the customer in a more holistic and coordinated manner. Su-
perior service, a high-touch customer experience
The ability to consider a business’s and multichannel support are all critical to a rela-
risk across both personal tionship banking approach.
and professional deposit and Relationship banking also allows banks to leverage
proprietary data about customers to make more in-
lending accounts can result in a
formed lending decisions. This drives customers
15 to 25 percent increase in with good credit to do more of their lending busi-
approvals, but few banks today ness with the bank, as that bank will be able to uti-
lize unique, customer-specific data to create a
have this capacity.
better offer for the customer. The ability to consider
a business’s risk across both personal and professional deposit and lending
accounts can result in a 15 to 25 percent increase in approvals, but few banks
today have this capacity. Additionally, banks with a cross-product perspective
on their customers can offer multi-product approvals, pre-qualifications or
product recommendations at the same time, creating more hooks for the cus-
tomer to bring further business to the bank.
Portfolio management and collections

Lastly, improving small business portfolio management and collections
processes are foundational capabilities that banks cannot afford to ignore.
These capabilities are critical as banks emerge from recent heavy losses
and will create a sustainable advantage when the cycle turns. Portfolio
management and collections should be seen as part of a disciplined ap-
proach – along with underwriting and credit processes – to consistently
reviewing and managing loan performance.
Portfolio management focuses on identifying changes in a client risk profile

and proactively managing that risk to reduce potential losses. Critical activi-
ties include creating models to predict changes in industry risk, developing

early warning systems that flag high-risk accounts and conducting regular
account reviews across the entire portfolio. For example, research has shown
that when businesses are in financial distress, they are likely to increase their
credit line utilization. One large bank saw average line utilization spikes of 24
percent, 34 percent and 133 percent across three different credit products in
the months leading up to customer default.
Superior collections practices can also significantly improve loss ratios in

small business lending. Small business collections are distinct from consumer
and commercial collections and require a dedicated approach that leverages
both the personal and individual-driven approach used for consumers and
the commercial skills and mindsets that allow collectors to stress-test infor-
mation and make decisions on a business’s ability to pay. Best practices in
small business collections include identifying the right segmentation (based
on balance and risk), developing collector load ratios based on account com-
plexity, developing clear and simple tools to guide interactions, and empow-
ering the front line to offer treatments. By establishing dedicated small
business delinquency and workout groups, banks can capture significant
value that would have otherwise walked out the door.
***
Small businesses were hit especially hard by the financial crisis and are still
working through the aftermath. But this critical piece of the U.S. economy is
poised for resurgence. As small businesses recover, they will look for banks
to deliver credit, stability and a positive customer experience. Banks that are
willing to invest in improving core capabilities and developing clear strategies
about what segments will be most profitable stand to gain sustainable share.
Stepping Into the Breach:

How to Build Profitable Middle
Market Share
The $50-billion U.S. middle market banking segment, comprised of compa-

nies with between $10 million and $500 million in annual revenues, is under-
going a dramatic competitive shift. The distressed condition of many
specialty finance and monoline lenders is clearing wide swathes of opportu-
nity and tipping the balance of power toward commercial banks. Regional
banks have stumbled as well, creating opportunities in the broader commer-
cial sector, while some megabanks have retrenched in certain geographies
and sectors. It is a great moment for gaining share in the market. Best-in-
class lenders reap ROEs of 20 percent or higher. However, getting to best-in-
class is not as simple as picking up where specialty lenders left off.
To step successfully into these profitable gaps in the middle market land-
scape, banks need to reinvent the business model and redefine best-in-class
execution. We see nine imperatives for banks seeking an edge in this market.
Build relationships
Banks pursuing profitable middle market share must follow a path we see as
critical across the entire banking spectrum. What we are calling relationship
banking has a basic premise: in order to attain sustainable, profitable growth,
expand relationships with your best customers.
To step successfully into profitable This approach, while not new, is in stark contrast
gaps in the middle market to the expand-at-all-costs approach of the past
several years. It is also particularly relevant for
landscape, banks need to reinvent commercial banks with large national clients.
the business model and redefine These larger clients – and even some more local
best-in-class execution. businesses – have needs that go beyond the
lending products that are usually a bank’s entrée
into serving them. And while lending is critical to securing relationships in the
first place, it is not nearly as instrumental in driving profits as other products,
such as cash management services (Exhibit 1).
Stepping Into the Breach: How to Build Profitable Middle Market Share 47
To begin, banks need to make clear distinctions between how they serve
local middle market clients and large national corporate clients. A one-size-
fits-all approach to relationship banking is not sustainable. Banks suffered
steep losses in the smaller middle market segment during the crisis, often
driven by an overreaching attempt to lend in geographies and industries
where they did not have sufficient experience or knowledge. For smaller
clients, best-in-class banks will return their focus to their home turf, looking
to build scale on a local level with in-footprint clients. Competitive advantage
in the smaller middle market segment will derive not from over-extension and
volume, but from targeted lending in areas banks know best.
For larger, national-scale clients, banks need to leverage lending interactions

into deeper and more lasting relationships based on products and services that
are both stickier and more profitable. (Although they are demanded more by
large corporate customers, some middle market businesses may also need
specialized finance products such as FX and interest rate derivatives.)
Redesign client coverage and account planning

Regardless of client size, an important foundation of relationship banking is
seamless coverage and rigorous account planning.
Exhibit 1
While credit is important to securing middle market relationships,

cash management drives economics
68 percent of middle market But cash management
relationships involve credit still drives profitability
Upper middle market Average revenue per mid-market client indexed

bank relationships1 (100 = lending only)
3,000
Percent of total
Cash
management 32 1,000
only 800
100
Credit only 25 Lending Lending + Lending + Lending +

only cash investment cash
manage banking manage
ment ment
Credit & cash (or other (or other CB
43 corporate products) +
management
banking Investment
Percent product) banking
of lending
2008 30 50 10 10
clients
1
Survey of 1,608 U.S. corporations with annual sales over $100 MM; of these, corporations with sales from $100 MM to $500 MM
considered upper middle market
Source: Phoenix-Hecht, 2008; McKinsey analysis
There is great opportunity in targeting profitable industry sectors or verti-

cals that are aligned with a bank’s existing capabilities and geographic
footprint. Banks should also consider which products are most profitable
and build capability to serve sectors that rely heavily on those products.
For example, cash management, that profitable standby, is in high demand
with professional services, retail, insurance, government and non-profit
clients (Exhibit 2). Cash-centric clients spend two times more than their
credit-intensive peers and also use more products (8 for cash-centric ver-
sus. 6.2 for other segments).
Understanding customer needs is also crucial for banks in designing relation-

ship manager (RM) coverage. Our research has shown that larger and smaller
clients value different RM attributes. As an example, smaller clients place a
higher value on product knowledge, whereas larger clients tend to value in-
dustry and local market knowledge (Exhibit 3).
To capture the combined value of geographic footprint, product knowledge

and industry expertise, best-practice commercial banks support their re-
Exhibit 2
Industries with higher cash management use are more profitable

Cash-centric Complex cash and credit needs
(20% of companies, 25% of profits) (27% of companies, 29% of profits)
Retail International trade Hotels Restaurants
Attorneys Governmentt/public Transportation Healthcare
sector (e.g., municipali- (hospitals)
Consulting Wholesale trade
ties, school districts)
High Technology Publishing
Financial intermediaries
Insurance Non-profit/membership
Some manufacturing organizations
Healthcare
(provider/doctor Sophisticated opportunists
Cash groups)
(44% of companies, 35% of profits)
management
usage Large/public companies across industries
Large government/public sector entities
Agriculture Construction
Low Mining Entertainment
(e.g., film finance)
Transportation
Real estate
development
Credit-centric
(44% of companies, 35% of profits)
Low High
Source: McKinsey analysis Credit usage
gional coverage with a meaningful degree of industry and product overlay.

They deploy front-line teams by geography and use industry sectors or
verticals to cover specialized sectors. Across regions, generalist RMs are
the primary customer contacts, working closely with product specialists
who provide targeted support. Industry verticals have dedicated expert
RMs and support teams.
Beyond coverage, it is very important to develop and institutionalize an

account planning process that prioritizes customers in each target group
and results in a holistic approach to customer-level profitability. A rigor-
ous planning process starts with the selection of potential clients and
the scheduling of meetings. Next, a relationship manager should con-
duct a needs assessment for identified clients by each product and pre-
pare action plans, finalized with a direct manager and product
specialists. With action plans complete, next steps should be defined
through activity plans that create a visible interface and a transparent
schedule for participants in the account plan. Finally, reporting mecha-
Exhibit 3
Large and small middle market customers value different areas

of expertise
Most important attributes of relationship manager
Percent of respondents by revenues
$2 – 5M $5 - 25M $25 - 100M $100 - 500M $500M – 2B
Knowledge of
48 32 35 25 35
credit needs
Product
specialist 24 17 17 8 4
Industry
knowledge 17 22 16 29 29
Local
knowledge 7 23 22 33 29
Other 5 8 9 5 4
Source: McKinsey Corporate Banking Survey, March 2009 (based on 400+ responses from McKinsey’s proprietary panel)
nisms should be established to follow up on, track and review results of

action plans before closing.
Capitalize on disruption in the monoline space

Many players in sub-segments of the commercial space, such as monolines,
are experiencing severe disruption. Savvy financial institutions will step in
and take share by meeting pent-up credit demand. For example, at one
large regional bank, current cross-sell rates for lease products to middle
market and corporate banking customers were 3 to 7 percent, compared to
10 to 30 percent for a best-in-class institution. This leaves significant oppor-
tunity for deeper product penetration (Exhibit 4). In particular, the vendor
channel represents an attractive growth opportunity for well-capitalized
banks due to competitor dislocation and certain captive finance companies
scaling back their presence.
Enhance product offerings

To take full advantage of market opportunities, banks need to honestly assess
their product capabilities, identify gaps based on the needs of client seg-
ments, and develop competitive offerings.
For example, a bank could develop a standardized cash management product

for the low-end middle market or a suite of derivatives, FX and other special-
ized finance products for larger firms.
However, banks will need to go a step further and improve the functionality
and efficiency of delivery for the product suite, which could mean upgrading
systems, platform integration and reporting. The key drivers of customer satis-
faction are access to systems, delivery of information, reliability of systems, ef-
fective issue-tracking and rapid resolution.
Revamp end-to-end underwriting and credit adjudication

Weaknesses in commercial lending and underwriting processes have con-
tributed to both significant levels of customer dissatisfaction and unprece-
dented losses. This dissatisfaction can be addressed though the adoption of
two important principles:
• Functional excellence reduces excessive touch points, unclear accountabil-

ity, over-stressed roles and sub-optimal spans of control by creating spe-
cialized roles for each component of the credit process (e.g., client service,
transaction management, credit and portfolio management).
• Expert choreography improves process efficiency by eliminating wait

time, reducing unnecessary duplication of work due to lack of expert co-
ordination; defining clear, differentiated “flight paths” based on deal
complexity (e.g., auto-decisioning for select customers); and creating
process champions.
Streamlining credit delivery can lead to a 30 to 50 percent increase in produc-

tivity. At one U.S. regional bank, an analysis revealed that almost 75 percent
of an 11-day approval process was spent on hold time. Reducing even a per-
centage of such delays, which are partially caused by approvers working on
higher-priority items, would speed delivery and leave clients more satisfied.
Reduce risk-weighted asset leakage

The current regulatory environment, in combination with limitations in balance
sheet capacity, make it more important than ever for banks to reduce capital
Exhibit 4
There is significant opportunity to grow lease cross-sell into existing

customer base
Representative bank cross-sell rates by division compared to competitor benchmarks
Representative bank
Current cross-sell rates Best in class
of lease products into
banking customers
Division Percent Factors impacting cross-sell Value potential
Small 15 30 Small businesses likely to have one $15 million for each
business primary banking relationship additional percent
Highest propensity to lease (80%) age point increase in
cross sell
7 Relatively more difficult to penetrate
due to high volume of potential
customers
Middle 15 30 Smaller number of customers/RMs $5 million for each

market make identifying customers for additional percent
cross sell easier age point increase in
High propensity to lease (70 80%) cross sell
5
Relatively easy to cross sell if credit
relationship in place
Corporate Most price sensitive $4 million for each

Large corporate customers have additional percent
10 20 age point increase in
multiple, diversified relationships, and
are most likely to lease with one of cross sell
3
their banks

wastage. Our experience shows that risk-weighted asset (RWA) optimization

can reduce leakage by 15 to 25 percent and increase revenues by 8 to 12
percent in the relevant books of business.
There are four major sources of capital wastage. The first are internal mod-
els that calculate capital requirements based on regulatory approaches that
do not maximize capital efficiency. Second are poor credit processes –
lacking state-of-the-art monitoring and workouts – that lead to higher regu-
latory risk parameters and capital requirements. The third source is prob-
lems in collateral management: lack of updated collateral values and errors
in timeliness and booking of credit lines and collateral. Finally, data quality
issues directly translate into higher capital requirements; for instance, regu-
lators may impose additional capital requirements for low data quality.
These problems can be addressed with a capital-optimized business model

built around six actions:
Stemming the tsunami of commercial loan losses

Default trends in commercial loan portfolios typically lag consumer loans by 12 to 18 months and are emerging as the
next major casualty of the global credit crisis. Banks that are already reeling from a liquidity and capital crunch will
likely face high default volumes and major losses in their commercial portfolios through 2010. The signs pointing to
this tsunami of losses are clear. Delinquency and charge-off levels in commercial real estate (CRE) and commercial
and industrial loans (C&I) are four to eight times higher than historical averages; at some banks they are even worse.
The Federal Reserve’s stress tests in March and April 2009 projected losses over the next two years, under adverse
economic scenarios, at 10.6 percent of CRE outstanding and 5.8 percent of C&I. This translates to $600 billion for the
19 banks tested. Over the next four years, we expect combined losses in these two areas to be in the range of $500
billion to $1.2 trillion, depending on the severity of economic scenario.
Many institutions are unprepared to deal with this level of losses, having allowed their loss mitigation capabilities to atro-
phy. The situation calls for immediate action. Banks must redesign commercial loss mitigation structures and support-
ing mechanisms and use proven and effective best practices. Banks need to catch problems early instead of waiting for
them to trickle down. They need to assign their best people to workouts rather than reserving them for business growth
initiatives, and sharpen the accountability and transparency of loss mitigation efforts. Additionally, compensation philos-
ophy should be based on well-defined targets, rather than vague or broad top-down targets. Finally, banks need effec-
tive reporting on both activities and outcomes so early interventions can succeed.
Best-in-class banks can reduce commercial loan losses by 10 to 15 percent by following through on three imperatives:
• Strengthen early-warning mechanisms. The key to successful loss mitigation is identifying and working on at-risk
loans early. Failure to do so ensures that many loans will be dead on arrival at the loss mitigation group. Early de-
• Establish clear rules regulating client acquisition to avoid exposure to

clients likely to be unprofitable, given operating and capital costs.
• Provide commercial guidelines and tools that direct the front line toward
highest RWA-return products and maximizing collateral without jeopardiz-
ing RWA return.
• Instill risk-adjusted pricing, e.g., through a regulatory capital-compliant
risk-adjusted pricing tool per client and transaction, and introduce a seg-
ment-specific pricing process.
• Offer clients solutions for improving their financial profile and thereby their
credit rating.
• Set up market placement enablers through product, system and organiza-
tional features to selectively leverage possible market placement opportu-
nities (e.g., syndication, securitization).
tection triggers allow banks to quickly identify and prioritize high-risk loans, based on the external economic outlook
and metrics specific to the debtor. Banks should also identify high-risk portfolio areas and sectors and develop spe-
cific action plans for them.
• Install world-class workout and restructuring processes. To effectively manage large volumes, institutions must ensure
that their processes and procedures are scalable, structured and consistent. This requires clear decision rules to
quickly move high-priority loans from the business to the loss mitigation group. Workout groups need checklists for
file preparation and execution. Leaders must also ensure that different groups adopt the same practices and monitor
each group’s activities to identify outliers with low recovery rates or high average resolution times. And once these
groups are spotted, the root causes of these problems must be addressed; for example, leaders must understand
each group’s criteria for selecting workout strategies.
• Enhance organizational capacity, structure, reporting and capabilities. The average caseload per loan workout officer
has increased by a factor of three to five. Banks must increase their capacity and ensure that they distribute the work-
load equitably. To manage the complexity and severity of the loan losses, they can create groups that deal with different
sizes of loans and staff them with loan officers with the necessary skill sets (including skills from different sectors, e.g.,
CRE, structured finance and retail). These employees also need the right tools, so they can select strategies that maxi-
mize value, set priorities and monitor recoveries and costs. To improve performance management, banks should de-
velop key performance indicators and link compensation incentives (and future employment) to value creation. Finally,
given the heightened demand for transparency – from internal and external stakeholders – banks should develop struc-
tured, consistent and action-oriented reporting dashboards on portfolio trends, efficiency and effectiveness.
• Optimize product mix and design by using more capital-efficient

product types for both short- and long-term financing that deliver
similar value to clients (e.g., overdraft instead of short-term struc-
tured solutions).
Broaden and intensify portfolio management

In the wake of the financial crisis, management of risk in the loan portfolio
has taken on heightened importance. Banks must develop more rigorous
portfolio management processes to track aggregate exposures by com-
pany, sector, region and industry. They must instill processes in their risk
paradigm and scenario analysis to test implications on various events and
develop contingency plans to respond to different scenarios.
Further, banks must identify and monitor high-risk client segments and
accounts, based, for example, on the likelihood of events that could
impact the industry and cause the client to fall into delinquency, such
as production disruptions, demand fall-offs and supplier or key cus-
tomer bankruptcies.
Furthermore, loan portfolio management should inform and drive proactive

actions. As an example, banks should identify single-product relationships
and work to either deepen the relationship or end it, if there are no signs of
cross-sell efforts succeeding.
Strengthen loss mitigation

Loss mitigation capabilities atrophied over the course of the last boom
cycle and must be transformed. Delinquencies and charge-offs have in-
creased six to eight times in commercial real estate and commercial and
industrial loans, across segments, creating a drag on capital and earnings.
There are three areas where banks need to focus: early warning; workout
and restructuring processes, and organization/capability incentives and
tools. (See “Stemming the tsunami of commercial loan losses,” page 52.)
Unleash talent
Performance management in commercial banks needs improvement.
Much ink has been spent describing how incentives have led to behav-
ior adverse to the interests of banks and their shareholders. A good
example is relationship managers who are incented to sell loans by vol-
ume, without consideration or accountability for the long-term prof-
itability or health of the loan. A less egregious, but still important
example is that relationship managers are not incented strongly enough

for cross-selling.
Banks need a complete redesign of incentive plans across the enterprise:

for the front line, product specialists, loss mitigation and support functions.
Both quantitative and qualitative aspects need to be considered. Pay pack-
ages must account for profit, health and volume of products sold and over-
all client profitability.
***
There is clear opportunity for banks seeking a stronger foothold in the prof-
itable middle market. Distressed and dislocated players are leaving a wide
open field, but simply stepping into the breach would be a mistake. Winners
in the space will be those institutions that reinvent their business model not
only to grab share, but to build sustainable, profitable relationships.
Back to the Future:

Rediscovering Relationship
Banking
The financial crisis and ensuing recession, coupled with regulatory changes
related to fee income, have exerted enormous pressure on U.S. retail banks
to develop profitable growth engines. Instead of relying on mergers, de novo
expansion and underwriting, banks must now derive greater value from ex-
isting customers. There are three primary ways this will happen: by driving
product sales and fee income through up-selling and cross-selling; increas-
ing retention of high-value customers; and mitigating losses with specific
risk strategies based on the entire customer relationship. In short, banks
must successfully take on the relationship banking challenge.
Such success has been elusive. Perhaps the biggest indicator of the
shortfall is that the average cross-sell metric for the banks in our research
stands at a relatively low 4.6 product categories per household, against a
theoretical maximum of 13 (Exhibit 1). Furthermore, more than 70 percent
of the cross-sell total occurs at account opening, implying that the lifetime
value of a consumer often remains untapped (Exhibit 2, page 58). In addi-
tion, only a few U.S. banks have taken initial steps toward developing a
full customer relationship view – let alone incorporated it into their sales,
service and risk strategies.
Our work suggests that banks have been slow to adopt a relationship ap-
proach because of their siloed nature. Most banks serve their customers
through product-focused channels, oriented only to whether the customer
needs a specific product. These efforts generally meet with limited success in
generating either sales or greater customer satisfaction. Similarly, efforts to
serve customers across product lines are often hampered by an inability to
view the entire customer relationship or by systems that cannot service multi-
ple products.
Banks must address the full range of customer needs across all financial prod-
ucts at all touch points. Only in this way will they reap the rewards of increased
cross-selling, enhanced risk decision-making and customer retention.
Back to the Future: Rediscovering Relationship Banking 57
Challenges
Five obstacles have accounted for the lackluster results in banking cross-sell
performance to date:
• Cross-selling in a silo. Sales forces generally do not have the ability or in-
centive to offer a broad range of products. For example, few banks’ mort-
gage channels offer customers a checking account, even during
refinancing, although the eventual value from a checking account can far
exceed the value from the refinancing. This is due either to a lack of en-
ablement (e.g., awareness, training or tools) or incentives.
• The operational challenge. Operationally integrating a single cross-sell

campaign is difficult. U.S. banks have historically grown through acquisi-
tions. Business units cobbled together often share different systems, op-
erational platforms and processes. The result is that few banks can truly
offer the full product suite at account opening, where, as previously men-
tioned, 70 percent of cross-selling occurs. Similarly, few banks can view a
customer’s full range of products and total household profitability when
making subsequent sales or servicing decisions.
Exhibit 1
Cross-sell effectiveness varies across banks

Number of product/service categories per DDA household1
Non-DDA
Total CRI2 DDA related related
Low bank 3.9 2.9 0.6
Average3 4.6 3.4 1.2
High bank 5.1 3.6 1.6
+31% +25% +138%

1
13 Product categories: DDA-related (DDA, debit card, direct deposit, online banking, bill pay, overdraft) and non-DDA-related (savings,
MMA, CD, mortgage, home equity, credit card, investment account)
2
CRI: Client relationship index, a measure of the average number of product categories penetrated per DDA household
3
Average across all banks in survey; sample average product penetrations were used in 4 cases when a bank did not report data for 1 of the
13 products/services
Source: 2008 McKinsey Cross-Sell Benchmarking Survey
• Siloed support functions. Support functions such as risk, marketing or data

support align to business units. This structure works well when banks need
to make product decisions in silos. However, as customers aggregate their
relationships, the arrangement no longer serves the bank well. For exam-
ple, many banks cannot assess a customer’s real holistic risk profile or see
sales opportunities based on gaps in what the customer has because they
are constrained in knitting together data across the businesses.
• Disconnected channels. Different businesses often own different channels,

which are typically not interconnected in a customer-friendly manner. As a
result, at many banks, the branch may not fully service loan products
(e.g., questions to a personal banker about credit cards require calling
into a card call center).
• Reliance on new customer driven growth. Credit-driven growth in the run-

up to the financial crisis resulted in a surge in new customer acquisitions.
Cross-sell naturally became less important than selling the first product to
a new customer. In the wake of the recession, this scenario is changing,
as new acquisitions have dropped sharply.
Exhibit 2
Account-opening is the single most important time for cross-sell

Products per new retail household by time since first account opened1
Percent of steady state value average across all participant banks and branches
100
77
72 73
30 days 60 days 180 days Steady state2
1 Includes all new personal/retail household (not just DDA HH) originated within the branch network during the first two months of the annual
data sample analyzed (Jan-Dec 2007); for purposes of this metric, direct deposit, online banking, bill pay, and overdraft were not counted
as product accounts. Other personal loans were added as a product account
2 Average product accounts per retail household as of December 2007
Source: 2008 McKinsey Cross-Sell Benchmarking Survey
Real relationship banking

Only by addressing these challenges will banks build deeper relationships
with customers and increase cross-sell. Relationship banking will succeed
only when customers feel that they are dealing with a single bank and not
separate businesses. Customers must also see real value in the model; for
example, their bank provides better advice based on a more complete view
of their financial picture, or better prices based on the relationship’s value, or
more convenient service. To achieve this, banks must present themselves as
a single entity across multiple channels and have a single view of the cus-
tomer across the different products he or she uses. Finally, banks should
focus on customers who offer the highest long-term relationship value. All of
these imperatives have profound implications for sales, risk and operations.
The rewards for banks that can crack the relationship banking nut are signifi-
cant. Deepening relationships with existing customers clearly make for attrac-
tive economics. We have found, for example, that customers with two
products are disproportionately more valuable in terms of revenue than the
combination of two similar customers (each of whom own one of the prod-
ucts). This relationship multiplier – driven by higher balances and usage – can
account for up to a 25 percent increase in revenues. There are also signifi-
cant retention benefits depending on segment.
Risk benefits also accrue from relationship banking. Our analysis has shown
a 10 to 25 percent lower risk from customers that have deeper, multi-product
relationships with a bank. And integrating operations to deliver a seamless
customer experience can result in further savings of between 5 and 15 per-
cent in the areas addressed. Typical drivers of these savings are better orga-
nizatonal spans and layers, fewer broken transactions, pooling benefits,
de-duplication of platform or functions and, most importantly, sharing of best
practices across the consolidated groups.
A systematic approach
Taken together, these benefits can significantly boost the profitability of a
bank. To achieve these results, banks need to take a systematic approach
that addresses the friction points outlined above:
• Product design: To bundle or not to bundle products has been an intense

debate in the industry. Our research suggests that bundles can help drive
higher cross-sell performance to some extent, but contrary to conventional
wisdom, their impact is truly felt in non-demand deposit account (DDA)
products rather than in DDA-related products. There is 9 percent higher

cross-sell rate in non-DDA products among banks that bundle. (The lack of
DDA impact may stem from sales forces offering DDA-related products as
part of the customer discussion, regardless of whether they are bundled or
not, and not doing so for non-DDA products, which then require active
bundling.)
More broadly, U.S. retail banks have only recently started thinking about
other innovations in product design that could encourage deeper relation-
ships. For example, most bundles are fairly rigid combinations; banks
should offer more flexible options through dynamic pricing, features or
services. Banks could also bundle across product categories at the value
proposition level. For example, Manulife offers a combined deposit and
credit account. As Canada’s first flexible mortgage account, it combines a
mortgage with checking and savings, using the net balance to calculate
Three models: A global perspective on relationship banking

We looked at banks in the U.S., Canada, Europe, South America and Asia to understand the state of relationship
banking and found that banks on this journey fall along a spectrum into three models:
Phase 1: Sporadic cross-sell with some consolidated servicing assets

Several U.S. banks fall into this group. Phase 1 banks typically have cross-sell programs that are carried out in-
silo (e.g., bundles that are limited to the deposit suite). Most have started on the journey towards consolidating
servicing assets, but have done so primarily as a cost-saving move (e.g., using a single off-shoring vendor). A
good example of this is a single call center technology platform that makes it easier to route calls across skill
sets. Another is the move towards an integrated data architecture.
This basic capability level makes sense for most banks. Consolidated servicing assets can be refocused from
being simply cost-saving efforts to revenue-enhancing efforts (e.g., an enterprise call center is better placed to
adopt relationship servicing).
Phase 2: Enhanced “moment of truth” support

These banks are delivering the right operational, organizational and risk tools to the front line at account opening,
onboarding and problem resolution. Defining features include: operational integration of the account-opening
process (e.g., product selector tools, product configurators, integrated loan applications, coordinated risk view or
single score, pre-qualifications across products); the ability to welcome and fulfill customers across product silos
(e.g., coordinated welcome call, single cross-sell group doing follow-up, joint fulfillment, single statement); and
the client’s interest – which positions the account to serve as the client’s
primary current account. Bundling does not need to be just product related
– banks can bundle over time, allowing customers discounts for loyalty
achievement across products, or bundle across people, offering rewards,
services or discounts for family participation.
The goal should be to craft the bundle based on customer needs. While
companies in other industries have taken this to heart, only a select few
banks offer products that can be configured based on customer prefer-
ence. Too much flexibility can be confusing for customers and salespeople
(not to mention expensive to implement), and too little results in inactive
products or higher loss rates. But linking bundle design tightly to needs as-
sessment helps overcome this. To do this, banks need to dramatically in-
crease their emphasis on the frequency and quality of customer needs
assessment. Our research found that only 40 percent of branches conduct
integrated call center abilities to solve multi-product problems (e.g., cross-trained agents for high-value cus-
tomers, one 800 number).
Some banks in the U.S. and others in Canada, South America and Europe are Phase 2 banks. One Spanish
bank can calculate and incent their front line on household profitability, allowing them to make the relative trade-
offs across products much easier to resolve.
Phase 2 is easier for smaller banks to pull off in entirety. Regional banks, closer to their customers than national
players, but still large enough to bring relevant scale to bear (e.g., in their call center operations and product
range), may be best positioned. Larger banks with massive product silos will likely find relationship banking
harder to execute due to ingrained organizational and operational legacies. For them, the answer could lie in
finding the deepest pain points that inhibit building relationships with the most-valued clients and surgically fixing
them, rather than implementing broader relationship initiatives.
Phase 3: Technology enabled

Phase 3 banks are truly the next generation of relationship banking and use a heavy dose of technology to en-
able features such as: multichannel functionality that enables customers to apply for any bank product using a
mobile phone; video conferencing that allows call center agents to join a customer’s browsing session; ATM
payments for products across the spectrum (including investments); and dynamic household-profitability-based
decisions that drive service levels in channels.
a structured needs assessment the first time a customer enters the branch.
• Relationship sales: Banks configure and train sales forces in a generally

siloed manner, specializing by product. This means that customers inter-
ested in other products have to be referred to other channels or sales
forces, a process that results in high leakage or customer dissatisfaction
(e.g., from re-submitting basic information).
A relationship sales approach would differ in several ways. First, a cus-

tomer’s file is reviewed across products to determine gaps. This approach
requires deep data-mining and validation. Second, high-potential targets
are approached in a coordinated manner across products by a quarter-
back who always remains the common touch point. Third, formalized
teams across business units (e.g., small business, retail and mortgage)
must coordinate to address customers’ needs across unit boundaries.
This helps create a name-face recognition between team members, mini-
mizing referral leakage and ensuring that follow-ups are conducted (Ex-
Exhibit 3
New account follow-up drives stronger cross-sell performance

Banks miss valuable opportunities to discuss Follow-up contributes to
new products at follow-up conversations cross-selling success
Number of branches by onboarding behavior observed1 Product categories per

Percent DDA household1
4 100
Percent
8
5.12
71 17
4.50 +14%
No Formulaic Personalized Personalized Total

follow up follow up2 dialogue but dialogue and
did not did discuss Any No
discuss new new follow up follow up
products products call (29%) call (71%)
1
Calculated based on 24 responses from Wave 1 mystery shopping
2
“Formulaic follow-up” characterized as short, scripted conversation with no personalization
Source: Mystery shopping; 2008 McKinsey Cross-Sell Benchmarking Survey
hibit 3). Fourth, periodic customer relationship reviews assess additional

sales potential (e.g., reduce leakage) across all products and business
units. Finally, retention programs are structured in a cross-product manner
(e.g., a decline in DDA balances for a customer who also has a credit card
triggers an alert in both business units).
This work is not easy, especially when targeting mass customers (as op-
posed to high-net-worth customers) with limited sales capacity. Indeed,
we have found that up to 40 percent of a bank’s mass customer base can
be unprofitable. The important point therefore is to select customers who
have high potential relationship value. Identifiers such as direct deposit or
online bill pay sign-ups often flag this relationship potential, as do other
pragmatic approaches to segmentation. Focusing on the truly valuable re-
lationships and de-emphasizing less valuable relationships can help with
capacity issues.
• Service to sales: Each service interaction with the bank is an opportunity

to sell, and each sale should really be about serving the customer with a
product. Our benchmarking shows that best-in-class banks sell 4 to 8
products per 100 calls through the call center. To offer the right product
without referring the customer, an agent needs a broad knowledge of the
product set. One regional bank has cross-trained 10 percent of its agents
across nearly all the deposit and loan products it offers.
• Relationship risk: Banks should take a cross-product view of the customer

when calculating risk. If they neglect to do this, they can misprice the true
risk, which can result in lower approval rates for good risks and also limits
banks’ ability to offer multi-product approvals or qualifications at account
opening. An integrated view of risk, incorporating
Each service interaction with deposit and loan information, supports features
the bank is an opportunity to sell, such as a single risk score, joint decision-making
and pre-qualification at account opening.
and each sale should really
be about serving the customer Banks therefore need to incorporate the relation-
ship view into their pricing and decision-making
with a product. algorithms, using all internal information (across
deposits, loans, wealth management) and external information (from bu-
reaus, promotion or distribution partners – where regulations permit in-
formation-sharing). They also need to develop the capability to
underwrite products jointly in order to support bundled selling, as well as
relationship collections capabilities to make collections more effective
and ensure that the right approach is adopted for higher-value relation-
ship customers.
• Relationship servicing: Ninety days after the average customer opens an

account, banks’ cross-sell drops off sharply and the rest of a customer’s
tenure with the bank accounts for only 30 percent of the total products he
or she buys. This large opportunity remains untapped due to two factors.
First, banks typically service most of their retail customers in the same
way without regard to their relationship value. Indeed, as we noted earlier,
at one bank over 40 percent of the customer base was unprofitable on a
fully allocated basis, while the small proportion of truly valuable relation-
ship customers accounted for more than 80 per-
At one bank over 40 percent cent of the bank’s profit. Second, servicing assets
of the customer base was and processes are fragmented into product silos,
leading to lost opportunities to deliver on the rela-
unprofitable on a fully
tionship promise. For example, valuable cus-
allocated basis, while the small tomers often need to call multiple service
proportion of truly valuable numbers for products they were sold in a bundle.
relationship customers Banks need to be able to recognize and serve

their customers based on their relationship value,
accounted for more than 80
delivering superior cross-product service to the
percent of the bank’s profit. more valuable customers and channeling less-
valuable customers to self-serve options. This focus on customers with
true relationship value should enable better cross-sell and retention,
while reducing costs. The call center is the main venue for realizing this
opportunity – customers with high relationship value should experience
shorter service queues, receive service from more skilled agents, or be
eligible for special offers. The same agents would also be superior at
service-to-sales techniques.
Relationship sales, risk and servicing efforts must be supported with organi-
zational changes along the following lines:
• Product-line ownership: Consolidating organizational ownership for prod-

ucts that customers typically buy jointly facilitates the development of
well-integrated bundles and channel strategies. Several U.S. regional
banks have recently consolidated lending business ownership.
• Operational sites: Consolidating servicing assets is difficult without a sin-

gle leader. One bank that wanted to integrate its call center onto a single
platform first appointed a shared service owner to oversee its operation.
• Risk and marketing analytics: An integrated risk or analytics function that

spans businesses can help better coordinate customer data analysis and
risk assessment across products.
Organizational silos can be broken down in different ways: through organiza-

tional moves (e.g., a single-channel leader), through incentives or through
workflow. This can be the trickiest part of any relationship banking strategy
and must be carefully tailored to the individual bank, personalities and cus-
tomer preferences.
***
The ideal of relationship banking has always been a sound one. It makes
good sense for banks to deliver a unified experience to their customers and
to cultivate loyalty from those customers that are most profitable. What has
often been missing, however, are the sales, risk, operational and organiza-
tional capabilities to support this vision. Given today’s pressures on profits,
the time is ripe for banks to get relationship banking right.
Big Fish in Small Ponds:

Why Regional Banks Need
Critical Mass
The United States has long had one of the world’s most fragmented retail
banking markets. More recently, however, assets and customers have be-
come ever more concentrated in four national “megabanks.” Together, these
institutions dwarf their regional competitors and pose a formidable competi-
tive threat. Despite their size and scale disadvantages, however, regional
banks have an opportunity to fight and win against these giants. To do so,
they need to concentrate their energy on their local markets and focus on
building what we call local scale.
Understanding the concept of local scale and aligning strategy accordingly

could give regional banks a substantial boost not just in the battle for de-
posits, but also in performance across the board. It will, of course, amount to
little if they cannot also excel in execution. The big banks may have
economies of scale on their side, but a targeted strategy, combined with a
local market approach, will enable regional banks to flourish.
Local matters
If banking was just a numbers game, then virtually everyone on the field
would be heading back to the showers. The four megabanks – Bank of
America, Citibank, JPMorgan Chase and Wells Fargo – collectively have 25
percent more branches than the top 10 publically
The bigbanks may have traded regional banks combined and 80 percent
more assets.
economies of scale on their side,
In fact, among them, the megabanks hold ap-
but a targeted strategy, combined
proximately three-quarters of U.S. retail banking
with a local market approach, will assets and control 40 percent of deposits. This is
enable regional banks to flourish. still less concentrated than in the U.K., for exam-
ple, where the five biggest banks account for
close to 90 percent of the assets and 57 percent of deposits. Nonetheless,
considering that there are 16,000 depositary institutions in the United States,
Big Fish in Small Ponds: Why Regional Banks Need Critical Mass 67
Exhibit 1
Four banks dominate the retail banking landscape

Top U.S. publicly traded banks and thrifts by assets
$ billions; 2Q 2010
Megabanks Top 10 regional banks

2,364
2,014 1,938
1,226
283 262 197 171 155 135 112 94 68 61
Bank of Chase Citi Wells U.S. PNC Capital Sun- BB&T Regions Fifth KeyBank M&T Hudson
America Fargo Bank One Trust Third City
Number of branches1
5,860 5,230 1,010 6,157 2,350 2,530 980 1,690 1,315 1,660 1,280 950 640 131
Percent of footprint that overlaps with superbanks

67 92 98 89 96 83 90 89 83 100
1
Branch and footprint data based on 2Q 2009 numbers
Note: Excludes asset servicing/asset management banks (BNY Mellon, Northern Trust, State Street, etc.)
Source: McKinsey analysis, SNL Financial
four banks holding 40 percent of deposits reveals the extent of the concen-
tration. Even the smallest of these four, Wells Fargo, has $1.3 trillion in as-
sets, 4.5 times more than PNC, the next-largest institution (Exhibit 1).
New kids on every block

The consolidation in the banking sector and the rapid evolution of these na-
tional megabanks has shaken up almost every geographic market in the
country. Regional banks have reason to be concerned, as they suddenly find
themselves competing head-on with one or more banking giants in almost
every market within their footprint. Seven of the 10 largest regional banks
compete with a megabank in at least 85 percent of their markets, with Sun-
Trust and Capital One, for example, encountering the megabanks across
more than 95 percent of their footprints.1 Many regional banks may see this
as a daunting proposition. After all, the big banks have enormous national
marketing budgets, can lure the brightest talent, and should be able to pass
on to customers the benefits of their scale in operations.
1 Geographic markets in the analysis were usually at the county level or metropolitan statistical areas depending on the
population density.
Regional bank fears are compounded when one realizes that where the
megabanks compete, they generally become the dominant player. Wells
Fargo, for example, ranks in the top three for branch share in 85 percent of
its markets, while Bank of America and Chase manage this feat in around 75
percent of their markets. By contrast, most regional banks muster a top-
three spot in just 40 to 60 percent of their markets.
Despite the onslaught from the big banks, McKinsey research shows that the
regional banking model remains robust. However, regional banks must be very
disciplined both in managing their footprint and ensuring superior execution, if
they are to thrive. Regional banks can excel by delivering a “best of both
worlds” strategy, which requires the bank to be deeply embedded in its local
communities in order to deliver more personalized service (similar to commu-
nity banks), while also providing the full product and service suite at a similar
price-point to the megabanks. On average, 70 percent of a regional banks’
profits derive from what are essentially local revenue streams: retail accounts
and local and regional businesses. In other words, the more “regional” they can
be, the more they appeal to their most critical customer base.
Managing the S-curve

In order for a best-of-both-worlds strategy to be effective and for regional
banks to have the opportunity to bring these local skills to bear, they must
first build critical mass in their core markets. Without critical mass, regional
banks will struggle against their larger competi-
Regional banks must be very tors, continually lagging in deposit share and re-
disciplined both in managing their maining an also-ran in the market.
footprint and ensuring superior Critical mass, in this context, is based on the rela-
tionship between the share of branches and the
execution, if they are to thrive.
share of deposits in any given market. Plotting
branch share against deposit share for all banks in a market inevitably shows
that the greater the branch share, the greater the deposit share, but the real-
ity is more nuanced. We analyzed over 250 major counties in the United
States and found that an S-curve relationship exists in over 80 percent. We
define critical mass as the area on the local market S-curve where a certain
level of branch share begins to yield disproportionate returns in terms of de-
posit share (Exhibit 2).
Although S-curves can vary in shape and slope, the underlying structure of
most curves is similar to that shown in the exhibit. When a bank has low
branch share in a given market, it is likely to see lower marginal returns and
punch below its weight in regards to deposit share. When it has reached mo-
mentum branch share (the left-hand border of critical mass), it can enjoy in-
creasing marginal returns. As a bank reaches the inflection point on the curve
where the rate of deposit share growth begins to slow, it is likely to be a lead-
ing player in that market. Eventually, the rate of deposit share growth begins
to slow as expansion continues and a bank reaches saturation point. At satu-
ration point, no matter how many more branches a bank adds, the impact on
its share of deposits will be very small.
Achieving critical mass requires understanding the shape of local market S-

curves (which will vary depending on market demographics and the competi-
tive landscape) and strategically focusing branch investments in markets
where critical mass can reasonably be obtained. Our research shows that, on
average, regional banks can reach critical mass by achieving at least 6 to 8
percent branch share, which could be as low as four branches in Fairfield
County, Ohio, or as high as forty branches in Palm Beach County, Florida.
Exhibit 2
At critical mass, banks reap disproportionate returns

Market S-curve
Percent
Moderate marginal High marginal returns Low marginal returns

returns
(subscale)
Deposit
share
Inflection
branch share
Momentum Saturating
branch share branch share
Banks have moderate Banks reach critical Banks have low and Branch
marginal returns mass in branch share, decreasing marginal share
(deposit share) on their with increasing marginal returns on branch
branch investment returns that peak investment
at the inflection
Source: McKinsey analysis, SNL

The S-curve of any given market will evolve over time. Not surprisingly,
larger and more attractive markets have seen greater competition in recent
years, resulting in a flattening of the S-curve. This flatter S-curve makes it
tougher for a bank to capture disproportionate returns; that is, it takes more
branches to achieve a smaller increase in deposit share. For example, in
2003, New York County had 450 bank branches, and a bank reaching satu-
ration point could expect to hold around 45 percent of deposits. Fast for-
ward to 2008, the county had more than 40 percent more branches, and a
bank reaching saturation point could expect only 30 percent deposit share
(Exhibit 3).
Additionally, changes in market landscape (e.g., through M&A), demograph-

ics or customer behavior can also have an impact on the shape of the S-
curve. For example, a large acquisition can lead to the combined entity far
exceeding saturation share in a market and thus distorting the S-curve. The
curve will usually revert to a more standard (and statistically significant) shape
within one to two years, as the new entity stabilizes and the market adjusts.
Exhibit 3
A case example: New York County’s flattening S-curve

Branch and deposit market share by bank
Percent, 2003 2008
Deposit Saturation
share point1
50 47%
46%
–16%
33%
30 30%
25 Chase 2003
2005
Citi
20 2007
2008
15
10
HSBC
0
0 5 10 15 20 25 30 Branch share
1
Saturation point is the maximum deposit share a bank can expect to get in this market by increasing its branch share.
Source: 2008 McKinsey Branch Benchmark; SNL 2008
Interestingly, the growth of online and direct banking has not had a substan-
tial effect on S-curve dynamics. Research shows that although the younger
generation is less likely to visit a branch to research a new product, 80 per-
cent of 18- to 30-year-olds still prefer to visit a branch to open a new ac-
count. This share increases by age group, suggesting that branches and
physical presence will continue to play a key role in bank success.
Tempting as it might be simply to map every market and attack those where
a bank has yet to reach critical mass, this is clearly a flawed approach for re-
gional banks. Spreading investments too thinly
Success will not come from across the footprint is always going to present
casting the net too wide, nor from enormous management and balance sheet prob-
lems and increases the chances of continuing to
targeting seemingly lucrative but play second fiddle to the entrenched megabanks.
competitive markets where a bank Success will not come from casting the net too
has minimal presence. widely, or from targeting seemingly lucrative but
competitive markets, where a bank has a minimal
presence. Instead, regional banks should focus their resources on a set of
core, strategic markets that offer the biggest potential for improvement, in
order to achieve local scale.
Perhaps the most compelling argument in favor of cementing a regional

focus and critical mass in a series of core markets comes from our analysis
of regional banks’ performance against megabanks. When the regional player
had a branch share that was at or above the saturation point for the market,
it outperformed the megabank by approximately 5 percentage points in terms
of deposit share, even when the megabank, itself, was also at saturation
point. Both banks were among the market leaders, but the regional bank was
outcompeting a theoretically more efficient rival. Although a number of execu-
tion-related factors likely contribute to this performance, the analysis shows
that once a regional bank achieves local market scale, it is no longer at a dis-
advantage to a megabank, despite the latter’s greater access to marketing
and resource dollars. We are not arguing that branch investment alone is suf-
ficient for sustainable success, but the analysis implies it is a necessary con-
dition – and one that regional banks need to recognize as they plan their
investment strategies.
Winning across the board

As banks reach critical mass in a market, they not only attract disproportion-
ately more deposits, they are also able to generate superior benefits across a
number of critical measures of bank performance – including non-DDA cross-

sell, product mix, employee and branch productivity, risk and pricing. Addi-
tionally, building local scale does not just affect the bank’s consumer
franchise, it is also heavily correlated with small-business, mid-market and
commercial penetration.
Revenue and productivity

Combining the S-curve analysis with McKinsey’s proprietary branch bench-
marking survey shows that building critical mass can have significant impact
on a bank’s revenue and productivity (beyond just DDA). If we look at cross-
sell rates, there is a striking correlation between the cross-sell rate of non-de-
posit products and the percent of markets where the bank is in the top three
for branch share. This suggests that as banks gain deposit share, they also
improve their ability to cross-sell non-DDA products.
This relationship may seem obvious, but it demonstrates the importance of

branch presence in building multi-product relationships and increasing cus-
tomer loyalty. One might think this relationship is driven purely by bank-spe-
cific execution, but even for a single bank, cross-sell rates are higher in
markets where the bank has a top-three position, versus markets where it is
not a leading player (i.e., number six or lower). This suggests that improving
cross-selling requires not only a targeted sales pro-
As banks reach critical mass gram and strong front-line execution, but also criti-
in a market, they not only attract cal mass in branch share.
disproportionately more deposits, Additionally, leaders with critical mass – that is, with
they are also able to generate a top-three position in a majority of markets (exact
figures will vary according to the market) – also
superior benefits across a have a more attractive mix of deposit products than
number of critical measures of “laggards” (defined as banks ranking fifth or lower
in branch share). While leaders generate less than
bank performance.
30 percent of new deposit sales from free DDA
products, these low-margin products account for 25 percent more new unit
sales at the laggards. This leads not only to lower revenues for the bank, but
also lowers customer loyalty and reduces cross-sell opportunities, as free
checking customers tend to have lower balances and higher switching rates.
Leaders also sell a greater percentage of the more lucrative savings products
(e.g., savings accounts, MMDAs, CDs).
Finally, one of the most pronounced performance differences between lead-

ers and laggards is in productivity, both at the individual and the branch level.
In our sample, sales of deposit products per FTE were 43 percent higher for
the leading banks, and deposit product sales per branch were a staggering
109 percent higher. This suggests that leading banks are either able to at-
tract more affluent customers, grab a greater
In addition to revenue and share of a customer’s deposit wallet, attract
productivity improvements, higher-skilled staff, offer better rates, or, more
likely, some combination of all of these. Although
McKinsey research suggests that
some of this difference is probably driven by exe-
banks with critical mass cution, the sample considered 40 distinct coun-
may also see improvements in ties, with a number of different banks representing
leaders and laggards across those counties.
pricing and risk.
Given the wide variation in market performance
and operating styles across these banks, it is fair to conclude that critical
mass played a significant role in the productivity variation.
Pricing and risk

In addition to revenue and productivity improvements, McKinsey research
suggests that banks with critical mass may also see improvements in pricing
and risk. For example, a bank can price more competitively in markets where
it has a leading position than in those markets where it does not. Looking
specifically at various money market products, the rates were, on average,
10 to 20 basis points higher in markets where the bank did not have critical
mass than in those where it did. This difference translated into a $120,000
annual pricing opportunity per branch, or a $6 million opportunity, assuming
50 branches in the market. This analysis implies that as a bank builds pres-
ence and scale, it no longer needs to compete as aggressively on price.
Preliminary analysis also suggests that building critical mass can help banks
achieve a superior risk selection. For a large regional bank, mortgage delin-
quency rates were over 500 bp higher than the top three banks in markets
where the bank could not muster better than a top five ranking. This is partly
because the leading banks have a better choice of applicants and can more
easily pick the best risks. In addition, a regional bank with a strong presence
should have better local knowledge of risks than a bank with a far smaller
footprint in that market.
Small business and middle market

Building local market critical mass can also have a significant impact on
the success of a bank’s small business and middle market banking fran-
chises. There is a strong correlation between branch critical mass and busi-
ness customer penetration, clearly suggesting that a bank will have greater
success – in both small business and middle market – in locations where it
has invested in building a significant retail infrastructure (Exhibit 4). This might
seem obvious, but it contradicts the strategies that many regional banks
have recently pursued: aggressively investing in middle market capabilities in
locations where they have limited physical scale. Middle-market customer re-
lationship managers rarely sit in branches, so the assumption has been that
branch presence was not critical for success.
This analysis suggests that small business and middle market customers
value local presence as much as retail consumers do and, therefore, re-
gional banks should have a coordinated strategy across their local busi-
nesses (i.e., retail, small business and middle market). These businesses
are usually separate entities with distinct growth plans, so this will require
more coordination and collaboration across the bank.
Exhibit 4
There is a strong correlation between branch critical mass and

small business/middle market penetration
Geographic
region/market
for sample bank
Small business Middle market

penetration/market share penetration1
Percent Percent
45 60
55
40
50
35
45
R2 = 79% R2 = 70%
30 40
35
25
30
20
25
15 20
15
10
10
5
5
0 0
0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80 90 100
Share of branches in counties Share of branches in counties where
where 1, 2 or 3 position 1, 2 or 3 position
1
As defined by primary relationships
Source: 2008 McKinsey Branch Benchmark; SNL 2008
What now for regional banks?

It is clear that there are major advantages to being a bigger fish in a smaller
pond, despite many banks’ attempts to expand into larger and seemingly
richer waters. Indeed, the point is more relevant now than ever before, as re-
cent events have made the seas rougher and the competition tougher.
This insight leads to four major implications for regional banks – each of
which should be adapted to a bank’s strategy and position.
First, banks that have extended themselves into new regions or markets
should rethink their footprint strategy. As previously mentioned, we esti-
mate that a bank must build at least 3 to 5 per-
Most regional banks are cent branch share in any market to begin to
already in several markets where attract a disproportionate level of deposits and
position itself to be a leader in that market. Most
they are not leaders and therefore
regional banks are already in several markets
need to prioritize investments in where they are not leaders and therefore need
locations where they can to prioritize investments in locations where they
can reasonably reach critical mass. Being lured
reasonably reach critical mass.
into, or continuing to invest in, supposedly at-
tractive high-traffic markets that require a huge roll-out of new branches
(e.g., more than 20) may turn out to be futile.
Second, as M&A activity heats up in retail banking it will be important for ac-
quirers to consider the impact of potential purchases on their local scale.
Banks should actively seek to acquire smaller banks/branches in attractive
markets where they are currently below scale, especially in today’s invest-
ment-constrained environment. For example, when M&T Bank bought Provi-
dent Bankshares Corporation in May 2009, it picked up 135 new branches,
90 percent of which overlapped with M&T’s pre-acquisition footprint. These ad-
ditional branches quickly increased M&T’s branch share in these markets by
more than 85 percent and had an immediate positive impact on M&T’s posi-
tion on the market S-curves.
Third, regional banks need to take full advantage of their best-of-both-

worlds strategy and invest in local specialization and a personalized cus-
tomer experience. Building critical mass will ensure that regional banks can
compete with the megabanks, but local specialization will enable them to
win. Unfortunately, over the past few years, many regional banks were cap-
tivated with the idea of becoming national players and moved the other way
– trying to gain national scale and losing their local touch. Our experience
suggests this is the wrong approach. Regional banks should look to their
community banking roots when addressing customer-facing activities. Of
course, we understand that banks must still operate in standardized ways,
with full compliance and efficient processes, but local branches need to be
given some entrepreneurial freedom, with the ability to react and adapt to
local market needs.
Finally, as banks begin to look to local market S-curves to help drive invest-
ment decisions, they should also consider opportunities to move up to the
S-curve (as well as to the right) (Exhibit 5). Many banks have a large num-
ber of markets (40 to 60 percent is typical) where they are below the S-
curve, implying that they are not getting their fair share of deposits based
on branch share. This gap is due to poor bank/branch execution in those
markets and suggests banks are not fully capitalizing on their branch infra-
structure. Although addressing the execution deficiency can be as simple
as adding resources or changing operating hours, it more often requires
Exhibit 5
Using the S-curve to support strategy
A: Build critical mass B: Improve execution
Invest in new branches in markets where the In markets where the bank is below the
bank is near the steep part of the S curve, S curve, move up to the S curve (i.e.,
moving into the area of critical mass (starting capture “fair share”)
point can be below or above S curve)
Deposit Deposit
share share
Percent Percent
Predicted
new position Add a small
number of Improvements
branches, with in execution
increasing can increase
Predicted
marginal deposit share
new position
returns with no
additional
Bank current
position Bank current position
Branch share Branch share

Percent Percent
Source: 2008 McKinsey Branch Benchmark, SNL

significant shifts in the mindsets and behaviors of the front line, which can
be a challenging endeavor.
***
For regional banks, achieving critical mass across the majority of a bank’s
footprint should be a long-term objective that drives investment and acquisi-
tion decisions for years to come. The benefits are significant, both in terms of
individual branch performance and the bank’s ability to compete in a given
market. In the interim, we believe there is significant value to ensuring a bank
gets its fair share of sales relative to its branch presence, in addition to in-
creasing branch share and achieving critical mass. This requires banks to
identify markets where branches are underperforming and to focus on more
traditional execution levers such as performance management and sales
force effectiveness to raise their game. Pursuing this parallel approach of
moving both up and across the S-curve will create growth and profitability for
regional banks.
Improving Branch Performance

In Retail Banking
Despite the evolution and added convenience of alternative channels, the

branch network continues to be the heart of most retail banks. Many cus-
tomers still harbor strong preferences for the personal interaction that only
branches provide. Even remote users want to know that they can take
their more complex transactions to a local branch. With retail banks facing
a range of pressures and pursuing growth through deposits, it is more im-
portant than ever for them to get the most out of their branch invest-
ments. Our ongoing analysis of branch networks across the United States
reveals exactly where these networks are falling short and how banks can
make improvements.
A vital link for banks

Personal interaction and service rank highly in the consumer decision
process about where to bank. While alternative banking channels deliver
added convenience, it is branch offices that customers turn to when they
seek assistance with non-routine financial needs and where prospects go to
learn about and open accounts. Banks have acknowledged this by continu-
ing – until recently – to invest heavily in growing their branch networks.
Today’s economic environment places significant pressure on operating costs

across most industries, and for retail banking a substantial portion (60 to 70
percent) of these costs are centered in branch networks. Recent and ex-
pected regulatory changes will put additional pressure on profitability. So
while the branch is still a core asset and a vital link to customers, banks will
need to take a hard look at their branch networks to ensure that their contin-
ued investment results in strong returns.
Room for improvement

The results of our recent branch benchmarking surveys clearly reveal that
the branch networks of many U.S. retail banks have been operating well
below their full market potential. Through executive interviews, data col-
lected across a range of banks (most recently, 8 of the top 10, represent-
Improving Branch Performance In Retail Banking 79
ing 21,000 branches) and market types, and in-depth analysis comparing
sales productivity, we discovered that banks can earn considerably higher
returns on what typically is their largest resource investment. To ensure
branch performance was compared on a level playing field, we developed
a proprietary Market Adjusted Performance Index (MAPI), which incorpo-
rates differences in wealth, demographic and competitive factors across
branch trade areas. The following are a few areas where we found signifi-
cant shortcomings:
• Disparities in sales productivity: There are significant differences in sales

productivity among branches, both within a given bank’s network and
among banks themselves. High-performing banks frequently are three to
four times more productive than low-performing ones, as measured by units
sold per full-time salesperson (Exhibit 1). Even adjusting for market type and
opportunity differences, the disparities remain substantial within bank net-
works. The bank network that performed best in personal DDA accounts
shows a wide range of branch sales productivity that is remarkably similar
to the lowest-performing bank network (Exhibit 2, page 80). These findings
Exhibit 1
Branch sales productivity varies significantly among banks

Personal DDA units sold per FTE, by bank Branch median
to 85th percentile
200
Branch median
to 15th percentile
Branch average
150 Study average
100
50
0
A B C D E F G H I J K L M
Higher-performing banks Lower-performing banks
Source: 2008 McKinsey Branch Benchmark survey

suggest that significant value can be reclaimed by raising sales productivity

in underperforming branches to levels consistent with market potential.
• Metrics not reflecting market differences: Banks frequently rely on ab-

solute metrics that do not reflect market opportunity differences which are
often substantial. Instead, they should normalize performance objectives
for branches and individual bankers based on the opportunity within their
trading areas, recognizing that sales potential varies according to the de-
mographics, wealth and competitive structure of each micro-market. Ad-
justing for these marketplace variables enables branch network
management, as well as branch managers and their staffs, to better un-
derstand the extent to which branches may be over- or under-performing.
• Overemphasis on units sold: Although total balances are a key driver of

revenues, banks frequently define sales goals in units, such as the number
of DDAs acquired, and downplay factors such as high average balances
and the sales potential for other products. In fact, our findings reveal that
branch trade areas with strong potential for DDA unit sales have only a
weak correlation with those showing strong potential for acquiring high-
Exhibit 2
Branch sales productivity varies widely regardless of

network performance
Underperforming branches
Branch performance relative to sales potential
for personal DDA accounts Overperforming branches
Bank A Bank B
(low performer (high performer for
for personal DDA) personal DDA)
0.0 1.0 2.2 0.0 1.0 2.2
Note: MAPI (Market-Adjusted Performance Index) of 1 indicates actual sales = potential.

Source: 2008 McKinsey Branch Benchmarking survey
balance DDAs and for selling other products. More broadly, we note an
ongoing misalignment between activities that actually create long-term
value for branch networks and the activities network management tends
to routinely stress.
• Over-branching in top-tier markets: The marginal rate of return for increas-

ing branches in a given market follows the familiar S-curve, where the
bank’s share of deposits for the respective market increases with each
branch added until the network effect eventually starts to diminish. Branch
saturation of top markets, combined with slower deposit growth, has put
increased pressure on branch economics – a change that has become
pronounced in the largest metropolitan statistical areas. Meanwhile, sec-
ond- and third-tier markets have shown relatively stronger growth. Over-
branching has also started to flatten the optimal branch density curve for
many markets, thereby lowering the optimal deposit share for banks with
the greatest number of branches in those markets.
• Suboptimal local market density: In contrast to over-branching, we also

found many markets where banks continue to operate with inefficient
branching levels. An earlier McKinsey analysis of branch performance in
more than 100 markets between 2003 and 2007 revealed that, on aver-
age, banks begin to accrue disproportionately higher shares of deposits
once they attain approximately eight percent branch density. This repre-
sents the initial inflection point in the S-curve noted earlier. Remarkably,
however, we found banks operating many
Low-performing branches branches in markets with suboptimal branch den-
suppress overall network sity. National banks had 16 percent of their
branches in markets where they had suboptimal
performance and reduce return on density, whereas smaller, regional banks had al-
invested capacity. most 50 percent of their branches in markets
where they had suboptimal density. Low-perform-
ing branches suppress overall network performance and reduce return on
invested capacity. While market entry necessarily involves an initial period
low performance, successful network development strategies center on
quickly attaining optimal branch density levels in all markets entered. (See
“Big Fish in Small Ponds: Why Regional Banks Need Critical Mass,” page
66, for more on this topic.)
• Inappropriate resource allocation: Branch staffing is often based solely on

transaction volume, with little apparent consideration of local market op-
portunity. This ensures customer service consistency across branches,

but also starves branches in higher opportunity areas where increasing
sales staff would boost branch performance. Importantly, resource alloca-
tion that ignores local market opportunity can leave such opportunities
wide open to competitors and prospective market entrants. Our study
found that, unlike low-performing banks, those that lead in sales produc-
tivity typically maintain staffing levels 30 to 70 percent higher in their high-
opportunity branches than in their low-opportunity branches – even after
adjusting for transaction volume (Exhibit 3).
Making the branch network pay

The findings discussed above suggest several steps banks can take to signif-
icantly improve performance:
1. Pursue markets based on opportunity and ability to achieve optimal den-

sity. For banks that have not yet done so, it is important to begin by devel-
oping a clear understanding of both existing and target markets, keeping in
Exhibit 3
High-performing banks staff branches according to both market

opportunity and transaction volume
Indexed increase in median branch FTEs based on transaction volume and market opportunity
Number
Laggard bank Staffing only increases Leading bank Staffing increases with
based on transaction both transaction volume
Transaction volume Transaction and opportunity
volume volume
High 432 409 416 395 502 High 291 310 320 338 375
Med 281 289 281 263 270 Med 231 244 253 263 273
high high
Med 232 222 219 220 213 Med 191 206 213 216 237
Med 182 175 176 168 169 Med 150 174 172 179 186
low low
Low 100 126 145 152 150 Low 100 144 170 149 175
Low Med Med Med High Low Med Med Med High
high low high low
Market opportunity for branch Market opportunity for branch
Source: 2008 McKinsey Branch Benchmarking survey

mind that markets change – sometimes radically – over time, so data devel-
oped five years ago might no longer be accurate. Demographics, competi-
tion and economic conditions change continually and in the process can
quickly render specific markets more or less attractive. Armed with a clear
knowledge of the prevailing nature of the bank’s markets, management
should prioritize them based on their respective attractiveness, branch den-
sity and competitive set.
As discussed earlier, branch performance peaks when branch density

reaches the optimal level for a particular market. It is therefore essential at
this point to assess the current branch density
Maintaining a lean level relative to the optimal range for each mar-
organization is always key to ket and carefully consider the bank’s ability to
attain that range. Because opening and closing
maintaining peak performance; branches is typically a complex and costly
it is especially important during process, various factors can limit the ability to
attain optimal branch density. Where circum-
economic downturns.
stances make it extraordinarily difficult to
achieve this goal, it may be prudent to withdraw from that market. Branch
oversaturation should also be avoided.
Existing presence in low-opportunity markets also deserves consideration. If

branch density is still well below optimal levels in these markets, improving
performance might require exiting the market altogether or minimizing costs,
such as staff and marketing expenses.
2. Align sales and service capacity with market opportunity. The sales capacity
of branches should reflect current market opportunity within branch trading
areas. Because market opportunities continually shift, staffing levels need to
keep pace and ensure optimal performance. Reassessing sales capacity on a
branch basis and reallocating it according to marketplace changes is best
done on a regular schedule.
In allocating branch resources, it is also important to remember that some ac-

tivities and processes add significantly more value than others. Those that add
little value probably warrant careful reconsideration with the aim of reducing
service demand and capacity requirements to the extent possible without hin-
dering performance in other areas.
Realigning branch resources according to local market opportunity levels and

service requirements also enables network management to identify areas of
over- and understaffing and thereby adjust overall network staffing to current
needs. Maintaining a lean organization is always key to maintaining peak per-

formance; it is especially important during economic downturns.
3. Manage according to branch peer groups and reward performance based

on market-adjusted metrics. Most mid-size and large banks operate in multi-
ple, highly diverse markets, but assigning the same goals to downtown met-
ropolitan branches and their suburban counterparts, or even to downtown or
suburban branches in vastly different metropolitan areas, usually is short-
sighted. To be meaningful, goals should be consistent with prevailing condi-
tions and opportunities in the branch’s trading area.
A very helpful approach is to segment branches into peer groups based on

trade area similarities. Doing so allows more meaningful normalization of
standards and objectives and helps reveal a network’s true performance win-
ners and losers.
Peer grouping of branches is also a highly useful tool for creating incentive
plans that are consistent with local market opportunities. Plans that reward
performance levels that are perceived to be unattainable in the employee’s
local market do little to motivate performance; conversely, easily attainable
performance levels typically reward mediocre performance. Both objectives
and incentives, then, should reflect the branch’s local market opportunity.
Looked at a more broadly, banks should motivate and reward sales produc-
tivity and other market-driven performance measures according to market
opportunity levels. Regional and local market managers generally face dis-
parate market conditions, so a single set of incentives, recognition plans,
training programs and sales guidelines will inevitably influence field manager
performance differently in each market. Market and region-adjusted targets
are important tools in any effort to enhance branch network performance.
***
Customers increasingly demand multichannel access, but it would be a mis-
take for banks to lose focus on the branch. It is still the heart of the retail
banking experience. In today’s environment, banks need to make informed
and systematic decisions on where to pursue scale, how to strike the right
sales and service capacity balance, and how to set goals and reward per-
formance. If they do so, the heart of retail banking will keep beating strongly.
Banking on Multichannel
Technology continues to rapidly change the way consumers behave and in-
teract. Virtual channels are becoming more relevant, with the increasing pen-
etration of high-speed Internet connectivity and Web-enabled mobile devices
allowing consumers to spend more time online. Bank customers will not only
continue to use a mix of channels, but will use non-branch channels for in-
creasingly complex banking transactions
While retail branches remain a core banking channel, research shows that
customer traffic is in some cases flat or declining, as customers come to
rely more heavily on direct channels. In fact, online banking and call cen-
ters account for 55 percent of transactions today (Exhibit 1, page 86).
This shift can be a positive development for banks, but they must be
ready to provide customers with a rich set of capabilities and a seamless
experience across all channels. Successful execution of such a strategy
has tangible economic rewards, but requires the right set of investments
and development of new capabilities.
Given the overuse of the term multichannel over last decade, it is important
to establish what we mean when we use it. True multichannel banking pro-
vides a rich set of products and services to customers in a seamless and al-
ways available fashion across all channels. Seamless here indicates that
across channels customers have a consistent experience, can see the full
view of their relationship, can shift at will (e.g., mobile to online), and can pick
up an interaction where they left off (e.g., part-way through the application for
a product). Multichannel banks also provide the appropriate levels of support
(e.g., online channel supported by click to chat/call available 24x7) to let cus-
tomers select their channel of choice based on usage context (e.g., on way
to work, at home on computer after dinner) at any time of day and complete
a satisfactory interaction. Banks that build multichannel capabilities that meet
these criteria will enjoy rich economic rewards over the next decade.
Tangible economic rewards

Leading multichannel banks are already capturing benefits. Perhaps the most
obvious is improved cross-selling to existing customers. Every interaction in
any channel – including common service requests – can be a potential sales
opportunity when appropriate. An integrated cross-sell engine can identify

customer needs and help capture instant sales (e.g., offer and close on per-
sonal loans at an ATM) or generate warm leads.
Multichannel banking can also improve conversion rates. Frustrated cus-

tomers often give up on trying to complete transactions online when they find
the process too difficult. A strong multichannel offering is attuned to these
moments and proactively offers assistance (e.g., live online chat pop-ups
when customers spend too much time on one page). These actions reduce
abandonment rates for sales transactions significantly.
The enhanced functionality and experience that define multichannel banking

can help increase customer lifetime value and reduce churn rate. Innovative
tools and products such as bill-pay features, person-to-person transfers and
Exhibit 1
Direct channels are growing more quickly than traditional channels
Transactions CAGR (08-12)

Billions Percent
Online 12.6
Call center 4.3
33.3 Branch 0.2

30.0
26.8 ATM 0.4
23.3
19.7
17.8 18.5 19.3

17.0
15.9
14.4 14.7 14.7 14.8 14.8
14.6 14.9 15.1 15.1 15.1
2008 2009E 2010E 2011E 2012E

Source: Tower Group; McKinsey analysis
money management tools are all ways to provide a more compelling experi-
ence that builds customer loyalty and value for the bank.
Finally, a well-developed multichannel offering can strengthen a bank’s overall

brand promise, whether it be convenience, customer service or low fees, and
lay a foundation for satisfying customer expectations and further cross-sell
and up-sell offers.
The economic benefits of these various opportunities can be substantial; two

large regional banks found more than $250 million in incremental revenue by
providing improved functionality within non-branch channels and a consistent
multichannel experience.
There are also clear cost-saving implications in successfully implementing

multichannel banking. By providing improved self-servicing capabilities, retail
Multichannel in other industries

Over the past decade, several prominent brick-and-mortar retailers have focused on delivering a seamless and
consistent customer experience across channels. Companies such as Banana Republic and Best Buy offer cus-
tomers the flexibility to research products, make purchases and conduct service transactions easily across the
retail store, Web and call center. Some, such as J. Crew and LL Bean, have created a multichannel offering from
a traditional direct mail and call center business.
Each retailer has focused on different aspects of the multichannel experience. For example, Banana Republic
provides a consistent customer experience by using all channels to improve customer service (e.g., allowing
customers to return products online or in stores and to address service issues through any channel). In addition,
the company provides a single customer service phone number for issues across all channels, and call center
reps have detailed information about each customer’s activity in other channels. Finally, Banana Republic shares
customer data across channels to enable a high level of service and targeted sales offers.
Best Buy lets customers researching and purchasing products online see whether local stores have the product
in stock. The customer can then opt to have the product shipped to their home or placed on hold for pick-up at
the nearest store. Best Buy also uses customer insights from transactions in data-rich channels to inform mer-
chandising and promotions in another.
Even retailers at the leading edge of the multichannel customer experience acknowledge that they have a
long way to go. Customers are becoming more demanding and expect a consistent experience across all
channels for both sales and service transactions. Given that it can take years to develop a differentiated
multichannel strategy, firms need to invest in new technologies and incorporate the multichannel experi-
ence in their core value proposition.
banks can reduce the overall expense base while providing customers with
the same (or a higher) level of service for common transaction requests.
Banks can reduce the volume of balance inquiries, stop-payment requests,
account information updates and other common transactions to higher-cost
channels by ensuring that lower-cost (i.e., direct) channels can handle these
requests, are easy to use and reliable.
In the same way, a customer’s non-transactional needs can be answered

through self-discovery tools (e.g., mortgage price) and advice, allowing the
sales force to focus efforts on more complex transactions and cross-selling.
Finally, by developing a robust Internet offering, retail banks can realize signif-
icant savings in the area of customer acquisition. Benchmarks suggest that
the all-in cost to acquire new accounts through the Web can be between 15
and 45 percent lower than through the branch or call center (Exhibit 2).
The journey to best in class

Achieving the full benefits of multichannel is not an overnight project. For
most banks, this will take years, not months. The alignment of systems and
Exhibit 2
The all-in cost to acquire new accounts through the Internet channel
is 15% to 45% lower than the branch or call center
Average cost of acquisition for select consumer banking products, per new account
Checking Savings Credit Home

account account card Mortgage equity loan
Internet 143 121 55 225 191
Branch/ 328 179 115 318 265

store
Call center/ 250 193 100 287 220

phone
-43% -32% -45% -22% -13%

Source: February 2008 U.S., Canada, and U.K. eBusiness, channel and product manager online survey
data across channels takes time and, as we have noted, considerable IT ex-
pense. But these investments are a prerequisite to providing a consistent
customer experience.
The journey to excellence in multichannel has three major stages (Exhibit 3):
• In-channel excellence across the major customer touch points. The first
step is for banks to meet minimum industry standards for common end-
to-end sales and service transactions for each channel – ATM, branch,
call center, Web and mobile.
• Consistency across channels. Banks then need to standardize information

and align systems across channels, and develop uniform look and feel,
branding and messaging (e.g., product information, disclosures and
terms, product pricing and offers).
• Seamless multichannel integration. The next stage centers on enabling

customer transactions across channels. Customers should be able to
“click to call” from the bank’s Web site; and Web kiosks should be avail-
able in the branch. Customers should be able to start a sales or service
Exhibit 3
Journey to multichannel excellence in retail banking
Seamless multichannel
integration
Enable multichannel
transactions (e.g., “click
to call” from Web site,
Web kiosks in branch)
Additional revenue
Consistency across enhancement through
channels cross channel sales, lead
escalation
Standardize information
and align systems across Higher customer
channels satisfaction due to broad
channel usage
Provide consistent
customer experience
Channel of choice across channels (e.g.,
Achieve in channel excellence consistent branding and
for all channels (industry messaging)
standards for branch, ATM,
online and phone)
Enable end to end transac
tions in customer’s channel
of choice

transaction in one channel and complete it easily in another. If a cus-

tomer filling out an online credit card application has some questions, he
or she should be able to dial the call center and have the representative
view the application and help finish it. Finally, banks can influence be-
havior to use certain channels for specific customer segments or types
of transactions (e.g., online for check reordering, branch for jumbo mort-
gage applications).
Some leading global banks have already achieved key elements of a seam-
less multichannel integration through consistent investment and a test-and-
The “IT” side of multichannel banking

Providing customers with a multichannel experience – and capturing the benefits – requires a targeted set of infor-
mation technology-enabled capabilities. The broad aim of these capabilities is to provide the bank with a seamless
view of the customer; without this view, the bank cannot provide the seamless experience to the customer. The
primary capabilities required are:
• Consistent customer data. All channels should have a common, consistent set of customer data. This is
achieved through use of a single customer data warehouse and repository for product information. For in-
stance, there should be a single content management system, and data should be integrated across channels,
business units and products.
• Comprehensive view of the customer. To enable multichannel consistency, bank staff in all channels must have
a comprehensive view of the customer. They should be able to track customer interactions across all channels.
Call center and branch staff should have access to customers’ activity on the bank’s Web site, and should be
able to make the same offers to customers that they have seen online.
• Targeted customer messaging. A single, common marketing engine provides targeted and consistent customer
messages across channels. This prevents frustrating disjointed or repeated messages coming to customers
from different channels.
• Capturing customer information. A common application engine across products and channels will ensure that
all channels are requesting and capturing the same customer information. This results in less work for cus-
tomers, and minimizes complications for the bank when customers start an application in one channel but
complete it in another.
• Single pricing engine. Banks must ensure that price quotes to a customer are consistent across channels.
While many banks say they have such a common pricing engine, the reality is that customers often receive dif-
ferent rate quotes when pricing a single loan through the branch, call center and online channels. The causes
of this disconnect are often the pricing engine, content management system or latency issues in transmitting
price information from the engine to the customer.
learn approach over the last five years. Customers are presented with con-
sistent product offers and pricing across channels, and call center and
branch reps can see all interactions – regardless of channel – that a cus-
tomer has had with the bank. For example, a call center rep would know
what Web pages a customer has viewed, and what transactions a cus-
tomer typically uses an ATM for. Customer information is integrated across
channels, which gives the bank a single view.
Wide-ranging implications
Building consistent cross-channel capabilities and customer experience can
have broad implications for retail banks. There are often considerable IT in-
vestments required to enhance and connect various channels. There is the
shift to a sales focus for the call centers and online channels, which cur-
rently are often more focused on service transactions. Additional areas
where banks will have to manage change include:
• Shift in role of the branch network: The retail branch network serves as
the primary sales channel for many banks. A multichannel approach
will begin to shift this balance, with the branch network likely to experi-
ence a reduction in customer traffic and account sales volumes of 10
percent or more, as a portion of the total transaction volume moves to
direct channels.
• Creating multichannel owners: Banks need to establish clear owners re-

sponsible for defining and delivering the overall multichannel customer
experience. These owners need to have influence to ensure the coher-
ence of customer experience desired for each product and channel. A
multichannel approach requires an enterprise-wide vision and objectives
rather than the customary silo approach.
• Sustained, integrated cross-channel investment: Banks should establish

a funding mechanism to ensure that investments can be made across
channels and products. For example, the functionality required for multi-
channel mortgage sales transactions is similar to that required for credit
cards and other credit products. Banks should be able to leverage in-
vestments across products and channels. Banks will need to review the
competitive landscape and conduct test-and-learn efforts on an annual
basis to ensure that investment in each channel maintains parity with
peers. Any upgrades and investments made in one channel will need to
be integrated within the context of multichannel strategy.
• Refinement to the current operating model: Banks need to strategically

leverage scale across channels. Each channel has to be more tightly inte-
grated and share capabilities not only across lines of business within a
channel, but also across channels. For example, a single application en-
gine could be utilized for the credit card product as well as for the core
deposit and loan products across online, phone and ATM channels. Mak-
ing these changes can lead to structural cost reductions of 10 to 15 per-
cent of total non-branch channel cost.
• Modifications to the performance measurement and incentive systems:

Implementing a true multichannel offering will force banks to refine the
current performance measurement and incentive systems, which are often
set around sales targets through a specific channel. Each channel will
need to have product-level sales and servicing targets, but line of busi-
ness employees need to work toward driving customer interest in the
bank’s products regardless of which channel is used to complete the
transaction. These metrics have to be incorporated into incentive systems
for product and channel teams.
• Integrated insights from rich customer data: As multichannel capabilities

are deployed, it is important for banks to track customer interactions
within and across channels. They need to understand how and why cus-
tomers are interacting through particular channels. The information
gleaned from such a focus can be enlightening: for instance, are cus-
tomers migrating to one channel because their needs are not being met
by another? The top customer service requests received by the call center
should create the development agenda for building new Internet self-ser-
vicing capabilities and improving awareness of existing features.
***
The arguments for providing customers with seamless access across multiple
channels are numerous and compelling. Most banks are already offering
some level of access through all the customer touch points, and multichannel
will soon be ubiquitous. However, the banks that reap the full revenue and
cost benefit of this approach will be those that have done the thorough
groundwork, made the right upfront investments and developed capabilities
and mindsets to support it.
The Evolving Consumer:

Implications for Retail Banks
The financial crisis and recession have altered consumer banking behaviors
and attitudes toward their financial security. While it is not clear if these
changes will be lasting, it is nonetheless crucial for banks to develop the
strategies and skills to serve evolving consumers. Current trends indicate that
the customary means by which banks grow profits and attract new cus-
tomers will no longer suffice.
There is, of course, no single “new” consumer. Within the banking populace
there are divergent behaviors along financial and generational lines. However,
there are common threads. To guide banks in meeting changing consumer
needs, we have drawn four broad themes from our extensive research:
• Consumers are likely to continue spending less and paying down debt,
changing the dynamics of retail banking profits.
• Consumers view the investment market with skepticism, and reveal a

growing aversion to personal risk, with strong implications for banking
products.
• Older consumers are more anxious about – and thus more ready to ad-
dress – the state of their retirement savings.
• Consumers are becoming more empowered in their financial decisions

through social media and online tools, and banks will need new strategies
to engage and win them.
The post-crisis financial consumer

U.S. consumers came out of the financial crisis with a broadly more conserva-
tive and realistic attitude toward their finances. This is reflected in what they do
with their money, and how they view the future both for themselves and the
economy as a whole. They are also increasingly likely now to form their opin-
ions and make decisions based on input from friends and social networks.
While there are no simple silver-bullet solutions to serving today’s consumers,

understanding the following themes will help retail banks reorient their approach.
Exhibit 1
Consumers remain pessimistic on the economic outlook

In your opinion, how long will the current economic downturn last?
Percent of respondents
1 1 2
Less than 3 months
5 6 10 Around 6 months
25 22 Around 1 year
24 More than 1 year but less than 2
More than 2 years but less than 3
More than 3 years but less than 5
39 More than 5 years

38 30
17 17
18
10 10
8
5 5 7
Consumer expectations of the
March 2009 June 2009 January 2010 duration of the recession have
only modestly improved from
Source: McKinsey US Payments Map 2008-2013, release Q4-09 early 2009.
1. Consumers are spending less and paying down debt

Consumer sentiment about the overall economy remains low, with more
than 64 percent of consumers believing that the economic downturn will
last at least another year (Exhibit 1). And while there is a growing sense
among consumers that the downturn has hit bottom in terms of its severity,
they are still spending less and deleveraging. Early in 2009 our research
found that up to 90 percent of consumers had curtailed spending. Almost
two years later 61 percent are still doing so. 1 Our most recent surveys also
show an increase in the percentage of consumers planning to pay down
debt at a greater rate (Exhibit 2).
The increase in fiscal conservatism is reflected in a range of metrics. In the

third quarter of 2009 more than half of consumers surveyed indicated that
they no longer wanted to purchase many goods and services that they had
previously been purchasing. (More worryingly, some consumers included in-
vestments in retirement among their cuts in spending.)
1 McKinsey Financial Institutions Consumer Insights Survey, January 2010

Exhibit 2
Consumers are still planning to reduce debt

Which of the following best applies to you for each of the following loan or credit products?
Percent of respondents
Intend to open or 4.5

increase balance 3.4 3.8 3.4 4.0
3.3
2.7
Intend to close or 4.9 5.3
reduce balance 6.4 6.2
7.1
Mortgage Second Auto loan Personal Short term Education

mortgage loan loan loan
or Home
Equity loan
Net score -3.0 -1.1 -1.7 -3.8 +0.7 -1.3
Source: McKinsey Financial Institutions Consumer Insights Survey, Jan 2010
The net result for banks is a decline in lending balances and interest revenue,
and a shift in the customary sources of profits.
Implications
• With pressure on margins and a shift in traditional profit pools, banks will
need to become much clearer about understanding the lifetime value of
customers, and the incremental cost of acquiring and sustaining relation-
ships with them. A more fine-tuned examination of the long-term ROI of a
high-value customer can show that the return is not as high as expected.
Conversely, consumers undervalued by a bank can develop into loyal and
profitable customers. The implications of this longer-term ROI focus extend
across the value chain, and are particularly relevant to marketing decisions,
where heavy investments in a particular channel may not be cost-effective
when measured against the long-term value of the targeted consumers.
• Banks should also develop finer stratification of customer segments, going

beyond financial factors to include behavior. Simple but effective ways to
differentiate could include customized Web landing pages, more effective
subdivision of call center representatives to focus on valued customers,

and personalized service on remote channels.
• Banks can also take an explicit lead in creating products that foster and re-
ward more disciplined consumer borrowing. For example, in late 2009 JP-
Morgan Chase launched “Chase Blueprint,” a set of tools that gives
cardholders more control over their spending and their debt. Under the
new program, cardholders have the option of choosing which types of pur-
chases they want to pay off in full to avoid interest charges, and which
ones they want to pay off over time.
2. Continued aversion to market risk

Consumers continue to be guarded in their views on the stock market. These
views, however, are not uniform. Belief in the stock market’s resilience does im-
prove with age and with income (Exhibit 3). This may be because some older
consumers have lived through the ups and downs of the market. And only
those above 45 have witnessed positive total real returns from investments in
the stock market on average (including dividends). Another group that is more
Exhibit 3
85% of younger consumers do not expect stock market returns

above inflation over the next 30 years
What do you expect returns on the stock market to be over the next 30 years? Negative (<0%)
Percent of mass market segment respondents1
Neutral (0 5%)
60 Positive (>5%)
43
38
34
31
28
26
25
15
36 45 years old 46 55 years old 56 64 years old

1
Mass market defined as income between $25K and $50K
Source: McKinsey Consumer Survey, March, 2009
optimistic about stock market returns is the affluent: the more money a con-
sumer has, the more hopeful they are concerning the stock market.
There is a broad shift away from risky investments to safer investments. The
percentage of people who intend to increase their investments in “safer in-
vestments” such as deposit accounts and money market funds is far higher
than the proportion who intend to increase investments in stocks and mutual
funds. We expect holdings in FDIC-insured products to grow at three times
the rate of investments in non-insured accounts.
Our customer experience research also suggests a shift in the drivers of con-
sumer satisfaction in banking. In 2009, trust became the primary factor in de-
termining satisfaction among those we surveyed, replacing branch service,
which was the leading satisfaction driver in prior years.
Implications
• Increased conservatism among mass market consumers should prompt
banks to focus on low-risk deposit and savings accounts that offer con-
sistent, modest returns. Consumers will favor proactive, end-date man-
aged investments with liquidity at lower fees.
• Banks should also move to meet increased consumer appetite for afford-
able guaranteed products. The challenge, however, is that consumers do
not have a clear understanding of these products.
• As risk appetite diverges along generational, educational and income-re-

lated lines, banks must develop ways to identify and align customers to
the appropriate portfolio. Banks may also shift how they communicate
with different consumers segments to address new anxieties. (For exam-
ple, in insurance, Geico put horn-rimmed glasses on its gecko
mascot/spokesperson in an advertising campaign reassuring mass con-
sumers of Geico’s longstanding financial stability and trustworthiness.)
3. The retirement security awakening

The financial crisis has shocked many consumers, especially older con-
sumers and less financially sophisticated consumers, into the belated realiza-
tion that they will not have enough to retire on. If this new awareness is not
quite a silver lining to the crisis, it is a positive development that consumers
are more ready to address the problem. And the problem is acute: our retire-
ment research suggests that the average American working household will
lack 37 percent of the income it will need for a safe and dignified retirement.
Exhibit 4
Banks are more trusted than other financial institutions,

especially among younger consumers
“How much do you trust the following entities with your money?” Most trustworthy
Percent of respondents1
Second most trustworthy
Age group
14
4
18 34
22 17 21 19
8 25
35 54
30 25 34 31
16 36
Over 55
23 29 25
35
Bank Credit union Mutual fund Full service Publicly traded Financial
company brokerage firm insurance planner or
company registered FA
Younger consumers trust Younger consumers exhibit
banks while older consumers ~10% smaller trust deficit
trust credit unions most than their older counterparts
1
Top-3 box responses (“trustworthy”) less Bottom-3 box responses (“not trustworthy”)
Source: McKinsey Financial Institutions Consumer Insights Survey, September 2009
The fact is that widespread reductions in household spending have not

closed the retirement gap for most. After years of low savings rates, few re-
port even basic levels of household liquidity, and many have a long way to go
to reach that level.
Implications
• There will be clear opportunity for banks as consumers turn to financial in-
stitutions for advice on bridging the gap between what they have and
what they need to retire securely. While trust in banks has fallen overall
since the crisis, they (along with credit unions) are more trusted than all
other financial institutions (Exhibit 4). Banks should build on this trust to
help transition their customers securely toward a more solvent retirement.
Those that deliver simple and consistent retirement advice are most likely
to build and maintain consumer trust and capture this opportunity.
• With growing awareness of retirement shortfalls, and with more than one-
third of households lacking access to workplace retirement plans, there will
be new appetite among consumers for retirement products. Specifically,
such products would include outcome-oriented solutions protecting against
market volatility risk (e.g., inflation- or principal-protected) and income-guar-
anteed solutions to provide stable retirement funds. Banks should work to

channel recent deposit flows into longer-term retirement-oriented solutions
(e.g., index-linked CDs or fund products with very simple guarantees).
4. The empowered consumer

Consumers are taking more active roles in gathering information and making
choices about their financial life. This trend is firmly in line with broader retail
influences, in which technology empowers consumers to gather and ex-
change information, compare products and prices, and share opinions and
experiences.
Our research mapping the consumer decision journey (or purchase

process) across a number of sectors suggests that social media is playing a
large role in this empowerment, enabling con-
Consumers have in many sumers to shape their own and others’ choices
ways been shocked into a more to an unprecedented degree. For example, when
purchasing auto insurance, consumers consider
conservative, careful approach to word of mouth advice to be twice as influential in
handling their money, and are more evaluating different options as either traditional
advertising or agent interactions.
apt – and empowered – to make
independent financial decisions. The emergence of sites such as Mint and
Wesabe, which aggregate a customer’s accounts
with different financial institutions and leverage a broad view of consumers’
financial life to make product recommendations, is threatening to put more
distance between banks and customers.
Implications
• With a more finely tuned set of tools and advice at their fingertips, con-
sumers can increasingly base choices more directly on the merits of each
banking product. Thus, the pressure on banks to differentiate their offer-
ings, or find new means of maintaining loyalty, will grow.
• Empowered consumers will have more freedom to define for themselves

what a bank actually is. Banks will need to respond by establishing new,
cost-effective service models to meet changing consumer expectations
and drive loyalty.
• The growing propensity of consumers to turn to family, peers and online so-
cial networks for financial advice will entail a sea change in how banks mar-
ket. The power of the bank brand will be susceptible to a broader range of
counter-influences. The best response to this fact is not to simply invest

more in traditional branding methods: the most successful players will de-
velop explicit strategies for systematically harnessing social media, includ-
ing potentially launching formal word of mouth lead generation programs as
P&G has successfully done in the consumer packaged goods market.
• Financial institutions must actively consider how they can win consumer
attention and expand their consideration set. Visa’s Facebook page for its
Signature Card, which alerts “friends” on the site about perks and events,
is an example.
***
Consumers have come out of the financial crisis with changed priorities. They
have in many ways been shocked into a more conservative, careful approach
to handling their money, and are more apt – and empowered – to make inde-
pendent financial decisions. The implications for banks are widespread, and
will have a direct impact on how they succeed, or fail. Retail banks should
act now to develop the products, services and channels to serve the needs
of their evolving customers.
Profiting Through Simplification
Coping with unnecessary complexity has become one of senior bank man-
agement’s most difficult – but also most imperative – challenges. The re-
wards, however, are considerable. Simplifying product, channels, process,
technology and organizational structure can significantly improve perform-
ance and customer satisfaction. In an environment in which banks are seek-
ing to reconnect with valued customers, these are important goals.
Taking a systematic approach can not only help reduce complexity, but
instill an ongoing mindset that prevents unnecessary complexity from
sprouting back.
Coping with a complex web

Complexity pervades retail banks like a vine creeping into every organiza-
tional crevice. We need not look far to locate the roots of the problem.
Throughout the last decade, banks pursued market share and profits largely
by adding products and services – from mortgages and home equity loans to
credit cards and money market funds. Each new offering required new sup-
port systems, sophisticated technology, distribution plans, policies, guide-
lines, training and marketing – all of which proved fertile ground for the
invasive growth of complexity. Mergers and acquisitions compounded the
problem as bankers struggled to prune and consolidate products, programs,
systems, branch networks and staffing, efforts that were often complicated
by the need to retain customers. Little wonder, therefore, that banks have
evolved into highly complex enterprises, often comprising weakly linked net-
works of functional, product and geographic silos that, taken together, can
be difficult for bankers and customers alike to fully comprehend.
Complexity is often, of course, necessary. Customized private client reporting,

for example, is a necessarily complicated endeavor. However, there are many
cases in which complexity is a by-product with no clear purpose. With growing
competition for deposits and revenues, banks will need to cut costs while re-
taining customers and deepening relationships. They can reduce costs through
aggressive pruning of complicated products and processes as well as staff po-
sitions that contribute little added value. Customers are unwilling to pay for un-
warranted complexity and often it is therefore not essential to long-term viability.
Five major factors drive complexity:
• Product portfolio. Years of operating in a product-centric mode have led

to a plethora of products, variations, special offerings and exceptions that
require systems, guidelines, policies, training and ongoing support regard-
less of the value they currently add to the organization.
• Distribution channels. Technological advances continue to enable new

and more convenient channels, leading customers to gradually abandon
less convenient alternatives.
• Processes. As products and channels expand, so do processes and often

duplication of processes, as in coordinating origination processes across
product groups. Complexity can stem from unnecessary process steps,
from duplicative work and from unneeded handoffs.
• Technology. Banks depend heavily on technology systems often com-

prised of multiple platforms and linkages. These typically require extensive
training, frequent costly updating, high security and 24-hour support.
• Organizational structure. As banks pursue new growth organizational

structures become more intricate, with product, back office, channel, IT
and other teams frequently involved in cross-matrix interactions.
As these key drivers illustrate, complexity is an organization-wide problem.

Consequently, a change in one area generally requires changes in some or all
of the others. Tackling the problem demands a systematic approach.
A systematic approach to simplification

Controlling complexity must be an institution-wide effort that has the full sup-
port of senior management. Uncertainty about how and where to begin such
an extensive task undoubtedly has led most banks to largely evade it. How-
ever, a comprehensive and systematic approach will result in gradual ongoing
improvement in customer satisfaction and bottom-line performance. Three
fundamental steps are critical for success: establishing a complexity baseline,
designing a customer-centric program plan, then diligently implementing the
plan and inculcating a simplification mindset.
• Establish a complexity baseline. This vital first step – often overlooked –

provides a solid foundation on which to build a program that will actually
be capable of rooting out pointless complexity. Identifying and applying
a series of relevant metrics across the areas that drive most complexity
can help reveal where it is most pervasive, and how it may also be driv-
ing unneeded complexity in other areas. When creating a baseline, it is

also important to estimate the relative cost and difficulty of simplification
in those areas where it is needed. This baseline information will provide a
footing for identifying hot spots and prioritizing simplification tasks
across the organization.
• Design a customer-centric plan. The most effective approach is often one

which takes a customer-centric focus. This means starting with the prod-
uct portfolio, then moving on to address distribution channels and
processes, and lastly operations and technology. Products, versions and
exceptions tend to proliferate over time with little attention paid to discon-
tinuing weak performers. Is offering 25 types of credit cards, for example,
really important to maintaining the current customer base? Reducing the
number of card types would simplify marketing and back-office opera-
tions, and would lead to bottom-line contributions from each. To gain a
clear perspective on which products are truly driving profitability, and
which are driving only more complexity, we suggest banks develop a grid
which measures products by both level (high vs. low) and kind (good vs.
bad) of complexity (Exhibit 1).
Exhibit 1
Assessing product portfolio complexity

Size of bubble indicates number of accounts
Good Products to keep

70% products
with high and Products to
bad complexity migrate/standardize
Kind of
complexity
(product margin)
Bad
Low High
Level of complexity
(Number of products in same segment, if product is actively offered, number of exceptions)
Note: Product portfolio assessed based on bank’s strategy regarding products and complexity KPIs
Exhibit 2
Evaluating complexity/cost of distribution channels

Products/channels to consider discontinuing
Main key
performance Call
indicators Internet VRU Mail center Branches
Product 1 Percentage of transactions 75% 20% 0% 5% 0%

Cost per transaction $0.7 $1 $2 $20 $50



Low High
Level of complexity
Note: Level of complexity was based on variability of channels (e.g., number of channels used) and cost of channel used
Banks should also consider whether the use of all channels for all prod-
ucts and services is necessary. Discontinuing channels that are seldom
used for a particular products or services can bring immediate gains in
simplicity (Exhibit 2). Similarly, processes often have unnecessary steps,
duplicated efforts and relatively pointless handoffs to certain areas or
departments; weeding out this type of complexity will streamline
processes, and thereby save both time – including the customer’s – and
expense (Exhibit 3).
Simplification in the product, channel and process areas will underscore

related opportunities in the bank’s technological and organizational infra-
structures. Experienced IT managers know that platform redundancies,
frequent systems updating, ongoing technical training and system in-
compatibility issues often add needless complications and expense to
bank technology systems. Moreover, organizations frequently grow new
limbs in these core areas to accommodate additions in products, chan-
nels and processes. Uprooting unwanted complexity in technological
and organizational infrastructures is therefore usually much easier after
eliminating it in other areas.
Exhibit 3
Measuring complexity of key processes by product

Activities
Performance Account Periodic
indicators openings Transactions transactions Administrative
Product 1 Throughput time (days) 10 1

Number of exception cases 30,000 70,000 N/A 6,000
Product 2 Throughput time (days) 5 1 6

Number of exception cases 45,000 50,000 60,000 3,000
Product 3 Throughput time (days) 20 8 1

Number of exception cases 60,000 100,000 60,000 30,000
Product 4 Throughput time (days) 5 53

Number of exception cases 100,000 300,000 N/A 45,000
Complexity level
Increase STP rate mainly
by process (not IT) Low
changes (e.g., allow fewer Medium
exceptions in forms)
Source: McKinsey analysis High
• Implement and sustain simplification. With a clearer view of the bank’s un-
necessary complexity, management can prioritize simplification efforts, es-
tablish budget allocations, assign task responsibilities and evaluate progress.
Unless there is a sustained effort to curb its re-growth, unwarranted com-

plexity will rapidly grow back and erase hard-won simplicity. Success
therefore demands an ongoing institution-wide effort to prevent the addi-
tion of unnecessary processes and systems. Senior leadership can assign
ownership of simplification efforts, set management objectives and budg-
ets, and develop tools to track improvements. These steps are critical to
ensure simplification will remain a priority.
***
Bank managers know that complexity can impede both organizational per-
formance and customer satisfaction. By adopting a holistic perspective of
complexity’s five leading drivers, financial institutions can give customers
the banking experience they want while also simplifying processes, chan-
nels and products.
About McKinsey & Company
McKinsey & Company is a management consulting firm that helps many of the
world’s leading corporations and organizations address their strategic chal-
lenges, from reorganizing for long-term growth to improving business perform-
ance and maximizing profitability. For more than 80 years, the firm’s primary
objective has been to serve as an organization’s most trusted external advisor
on critical issues facing senior management. With consultants in more than 40
countries around the globe, McKinsey advises clients on strategic, operational,
organizational and technological issues.
McKinsey’s Consumer & Small Business Banking Practice serves leading

North American banks on issues of strategy and growth, operations and tech-
nology, marketing and sales, organizational effectiveness, risk management
and corporate finance. Our partners and consultants provide expert perspec-
tives on a range of topics including corporate strategy, business model re-
design, product and market strategy, distribution and channel management,
the impact of financial services regulation and performance improvement.
The following McKinsey consultants and experts contributed to

this compendium:
Whit Alexander Daina Graybosch James McKay Greg Phalin

Philip Bruno Tommy Jacobs Howard Moseson Leonardo Rinaldi
Robert Byrne Piotr Kaminski Sudip Mukherjee Pablo Simone
Liam Caffrey Rami Karjian Fritz Nauck Vik Sohoni
Prasenjit Akshay Kapoor Sandra Nudelman Dorian Stone
Chakravarti
Catharine Kelly Marukel Nunez Sarah Strauss
David Chubak
Nick Malik Pradip Patiath Ameesh Vakharia
Marco De Freitas
Robert Mau John Patience Tim Welsh
Benjamin Ellis
Contact
For more information, contact:
Nick Malik Christopher Leech Marukel Nunez
Director Director Principal
(212) 446-8530 (412) 804-2718 (212) 446-7632
nick malik@mckinsey.com chris leech@mckinsey.com marukel nunez@mckinsey.com
Financial Services Practice
November 2010
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Copyright © McKinsey & Company
www.mckinsey.com/clientservice/financial_services

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Retail Banking 2010

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Financial Services Practice

The Future of Retail Banking

Deposit Profits: New Approaches for an Old Standby 8

U.S. Credit Cards: Looking at the Business Through a 16

New Market Realities for Mortgage Lenders 23

Rebounding in Small Business Banking 36

Stepping Into the Breach: How to Build Profitable 46

Back to the Future: Rediscovering Relationship 56

Big Fish in Small Ponds: Why Regional Banks Need 66

Improving Branch Performance in Retail Banking 78

The Evolving Consumer: Implications for Retail Banks 93

Profiting Through Simplification 101

Retail banking has historically been a large and stable business. In

These challenges would be formidable enough, if banks could simply

Specifically, winning banks will make progress on five broad imperatives:

• Focus on relationship banking

• Rethink distribution across channels

• Develop new value propositions that capitalize on evolving customer be-

• Reinvent underwriting models

• Ensure flawless sales and service execution

Focus on relationship banking

The rewards are significant. Deepening relationships with existing cus-

The third leverage point centers on building capabilities to support cross-

Rethink distribution across channels

Technology is of course an important part of this work. For example, banks

Develop new value propositions

To create successful new value propositions, banks need a clear picture of

Changes in consumer behavior are challenging, but also offer opportunity.

Reinvent underwriting models

Banks must rethink the mortgage lending model. To succeed in a difficult

In the small business market, underwriting models had been primarily

Underwriting in middle market also needs an end-to-end makeover. This

Ensure flawless sales and service execution

higher-performing level, banks must not only pursue optimal density in

Deposit Profits: New

Retail banking deposit-gathering is encountering a wave of pressures. Low

Regulation is also generating headwinds. Overdraft fees, which have ac-

There is no single silver-bullet solution to this array of challenges, but banks

• Rethink deposit fees. Banks must embrace more transparency in fees to

The deposit landscape

Rethink deposit fees

In 2009, penalty fees accounted for 38 percent of DDA account

closure of fees on statements. Rules requiring opt-in for courtesy overdraft

• Customer-driven approach. Our research shows that customers are by

Not all overdraft customer segments are alike

Attitudes Spenders who do not Consider themselves Comfortable with overall

Source: GCI/McKinsey Consumer Financial Life Survey, July 2009

• Tailored overdraft offerings. As overdraft policies become more transpar-

To do this successfully, banks need a more sophisticated understanding

Revise check deposit pricing

• Coordinated target-setting. Over the past several years, as other funding

We also find that there must be a commonly accepted picture of deposit

and product managers. This is not as simple as it may seem, particularly

• Sophisticated relationship pricing. Many banks take a siloed approach to

DDA account holders fall into four needs-based segments

1 Highly fee averse

4 Highly interest sensitive

Source: GCI/McKinsey Customer DDA research

• Cross-region pricing optimization. Many banks have sophisticated regional

• Coordinating marketing, sales and pricing. Many banks continue to strug-

Regional pricing models should transparently display multiple

Normalized elasticity Average market Optimal price by region

Region 1 30 1.20 1.70