One of the reasons for writing this blog has been to disseminate unbiased information about personal finance to an interested audience. I want to share knowledge on personal finance topics and make a difference in the world for those who are struggling with their finances. There would obviously be other sources for this information, e.g., schools – which utterly fail at teaching very practical knowledge on personal finance for a variety of reasons or e.g., banks – which utterly fail to deliver unbiased personal finance information. I want to focus on the latter today and analyze why banks are doing so poorly at catering to their customer needs.
The purpose of banks
If you asked an economist, the purpose of banks in a well-functioning economy is quite simple. Bank have to fulfill three roles: 1) They should help those who have money, 2) they should help those who need money, and 3) they should help those who wish to transact. Everything else which banks might do – from prop trading to macroeconomic research – could be questioned by purists.
Helping those who have money – that is hopefully you, as you are on your journey to financial freedom 😉 As you gather cash through your saving habits, bank should be eager to take your deposits and pay interest on them. This help for the cash rich saver could go further, to help with investments in the capital markets to earn higher yields. I know that this might all sound idealistic and does not fully account for the realities of zero interest rate environments currently prevalent in many parts of the developed world…but if bank take their customers’ interest seriously, deposit gathering and investment advice should be at the core and center!
Helping those who need money – ultimately, banks would not be too happy if they just gathered deposits alone. They would rather “invest” their assets in loans to customers (again in exchange for interest) and thus bring the cash back into the real economy while also balancing their balance sheets. This economic purpose to balance between cash rich savers and those in need for a loan, is and remains the core function of banks. Along with this transformation of deposits to loans, banks typically take risks, esp. credit risk (the risk of the debtor of the loan defaulting) and engage in term transformation, i.e., the deposits have much shorter maturities than the loans yielding a risk premium for banks.
Helping those who wish to transact – the third functionality which rounds up the role and purpose of a bank. There are multiple types of transactions which come to mind: paying your rent via an electronic transfer, issuing a letter of credit for an exporting producer or advising a corporation in an M&A transaction. An important difference to the two functions previously mentioned is that transaction support does not make use of the banks’ balance sheet but rather earns the banks fees without absorbing capital.
You will have correctly noted, that banks do not per se have the responsibility to educate their customers on personal finance topics. This is not part of the three roles banks are serving, as described above. In plain English: This is not a bank’s job – full stop. In pure theory, it would be just market forces which would ensure a good deal for the customer looking to make use of bank on the occasion of one of the three roles. Consumer protection regulation in many markets around the world nowadays requires banks to inform their customers and avoid “unfair advantages” in favor of the bank. This somewhat amends the banks responsibilities as they engage with their customers. So, through the back door, such an obligation to inform customers has come into play, at least for retail customers.
What I clearly have not mentioned as the purpose of banks, however, is “improve RoE”, “increase the number of products per customer”, “reduce the Cost-to-Income-Ratio”,… These goals, however, I hear frequently in my professional life as a strategy consultant as bank managers seek to improve their businesses. All these KPIs might be helpful to improve the economics of the business model, but they ultimately do not help to better serve the banks’ customers. These KPIs are exclusively introverted and do no look at the quality of the relationship the bank has with its customers.
Rather than only missing out on customer centricity, there is an even bigger risk as banks aim to improve their internally focused KPIs. Take “increase the number of products per customer” as an example. Conventional retail banking wisdom suggests: The more products the customer has, the higher the profitability of the customer will be. At the same time, the customer relationship would become more sticky and rich, as the customer is more actively engaged with the bank. Improving this metric might therefore sound like a worthwhile cause. The increase of products in the banking relationship might, however, be completely contrary to the customers’ needs. Does the customer really need all of these products which count for the KPI? Are these products in line with the three purposes of a bank or nice to haves? Do the products serve the customers best interests and are they the most competitive ones in the market? A no or just doubts regarding any of these questions could severely harm customer satisfaction, as the following example will show.
Wells Fargo – an example of what can go wrong
The US banking giant Wells Fargo had been an admired company for many years. Jim Collins had profiled the bank even in his book Good to Great*! Particularly its performance on customer profitability used to be stellar. Apparently, Wells Fargo had done everything right – if you read the bank’s vision statement, you come to the conclusion that this is pretty well focused on the customer as opposed to the banks interest:
We want to satisfy our customers’ financial needs
and help them succeed financially.
Well, but then something had severely gone wrong! The relentless focus on customer profitability and notably the KPI “number of products per customer” had yielded very bad outcomes. Team members at the bank’s branches had started to open customer accounts without the customers’ consent. While this obviously improved the KPI and drove up profitability, it was clearly against the customers’ best interests and in harsh contradiction to the vision.
The results of the practice have been a full blown disaster! Wells Fargo had to enter into massive remediation action and compensation schemes to make their customers whole. Certainly, there was massive reputational damage which harmed the bank’s brand. Even more painful, the regulator put a cap on the bank’s balance sheet, ultimately preventing growth until the compliance issues have been fully sorted out. Wells Fargo today is therefore not a growing bank but one which is managed to improve its profitability.
For me, this is a warning case study of a bank which lost sight of its customers. The intentions of the vision statement were fantastic. But through the internal optimization of the sales force, the bank lost sight of the vision and ultimately severely harmed its brand. It is to be seen whether management is able to rebuild the brand and regain customers’ trust. For full disclosure: Side by side with Warren Buffet, I own share in Wells Fargo and am thus invested in the rebuilding of the brand.
Banks should focus all of their attention on their core reasons to be: 1) helping those who have money, 2) helping those who need money, and 3) helping those who wish to transact. If bank succeed at radically putting their customers at the center of their activities along these three functionalities, customers will certainly notice. I am deeply convinced that such a customer centric approach will yield handsome returns in many ways. Not only will profitability follow quasi automatically as customer satisfaction stays high and pays its dividends. There should also be no fear of disruption form startups which presumably cater to customer needs better and more efficiently.
What is your perspective? Why are banks so poor at putting their customers’ interest first and providing personal finance advice? Would be great to hear your perspective in a comment!