Are ecosystems the key to boost bank returns?

Networks of ecosystem partners and access to more data lower costs of customer acquisition.

Building an entire services ecosystem can be a daunting challenge for banks due to its costs and complexity, but it can be their best chance to boost their return on equity (ROE). Some banks such as DBS Bank are opting to join existing ecosystems instead, but that comes with the risk of losing control and dominance if ecosystem owners roll out their own digital financial services plays. Still, analysts argue that adopting the ecosystem play has become a must for survival.

“For the past several years, banking returns have been stuck between 8% and 10%,” said Miklós Dietz, senior partner at McKinsey & Company. “Absent any mitigating actions, we estimate that the ongoing digitisation of the industry could cost banks more than four percentage points of ROE by 2025—an unsustainable loss that will drop returns well below even the cheapest cost of capital.”

“The best option for many banks to lift returns to something like the go-go years of the early 2000s—to say nothing of the tremendous margins that digital firms now command—will be to embrace the ecosystem environment,” he added.

Dietz reckoned that in a basic ecosystem play, banks acquire platform power that helps them retain core customers and improve crossselling. Banks will be much more conspicuous to digitally-minded customers and will be able to offer products better suited to their needs.

“If you look at where the threats and opportunities will be, it’s absolutely in the world of ecosystems,” said Mohit Mehrotra, partner and co-leader at Monitor Deloitte. “That leaves banks with two strategic choices: Do I build my own ecosystems or do I participate in ecosystems?”

Mehrotra added that some Russian and Chinese banks are already building their own digital ecosystems, whilst some banks in India and Indonesia opted to integrate in them. DBS Bank, for instance, has been creating ecosystem partnerships and now has a massive banking API developer platform. These collaborations include DBS digibank in India that has acquired 1.6 million customers since its launch in 2017.

Based on McKinsey research, Dietz also said that improvements from an ecosystem strategy can add close to two percentage points to ROE, with further ROE increases in the offing as networks of ecosystem partners and access to more data lower costs of customer acquisition, possibly to as little as 1% of historical costs.

He warned that, over time, digitalisation will sharply reduce banking revenue pools as digital attackers gun after incumbent banks’ higher-margin businesses, which produce 47% of revenues, 65% of  profits, and an ROE of 20%.