Why banks should shift to offense and invest amid market uncertainty

It’s no secret that the current economic environment is unpredictable. Inflation has driven prices to their highest adjusted point in decades, while student loan debt and a reliance on unsecured lines of credit continue to drive uncertainty. This means that at a time when banks are poised to generate “cycle” high-net interest margins, they’re instead forced to prepare for volatility: increasing loan loss reserves, optimizing their workforce, and scrounging for deposit bases. In fact, loan-to-deposit ratios have shot up at an accelerated rate—with the upper quartile of banks exceeding 90% in Q2 2022 due to competitive yields and inflationary spending. The recent turmoil spurred by deposit concentration and the demise of Silicon Valley Bank has further put the spotlight on risk management and clouded the immediate future of small and mid-market banks.

These circumstances—and a looming market correction—pose a number of questions to banking leaders: Do we simply batten down the hatches and play the defensive game of tighter budgets and conservative underwriting? Or do we invest in improving our competitive position in the market when the majority of institutions are gun shy? 

The simple answer is both. 

Facing an economic downturn, banks should play offense 

Traditionally, banks have taken a defensive approach when preparing for an economic downturn: reducing credit risk in underwriting, reevaluating new product offerings and pricing models, and optimizing their workforce and footprint. That makes sense, especially as inflationary pressures and declining home and auto prices have the potential to drastically reduce household capabilities to service debt.  

That stance could also leave them at risk of falling behind their peers—not to mention increasingly popular digital banking options.  

As we’ve learned from previous recessions, the companies that combine defensive tactics with strategic offensive investments in customer experience, technology, and risk management can emerge from a downturn victorious. Here’s why banks should adopt this approach—and how they can get it done.  

Why banks should take an offensive approach 

During the 2008 downturn, Forbes columnist Tim Bajarin asked Intel’s CEO what the company would do given the economic reversal. “He did not even hesitate a second,” Bajarin recounts, “and told me that during downturns, Intel doubles down on R&D, looks for more talent to fill future needs, and accelerates expansion plans. He reasoned that tech, especially semiconductors, was never going away and that Intel and major tech companies needed to be ready when demand rose again.” 

It's a story told time and time again: Companies that make strategic investments during a downturn—particularly in technological innovation—come out of them on top.  

Why? Others are cutting back, while recessions “are typically short-lived and followed by long periods of growth and prosperity.” A volatile economic landscape—especially in a post-COVID banking world—presents more opportunities for digital capabilities to play a role. 

Fortunately, today’s financial institutions are better positioned to make these investments than in 2008, largely because banks are more prepared than they were during the Great Recession. Their competition might also be on their back feet: Though consumer adoption of digital banks has skyrocketed in recent years—and attrition rates from traditional banks to these players are growing—the downturn is hitting newer upstarts the hardest. Venture-capital funding for fintechs is down 32% YOY and many companies in the sector have laid off employees. Traditional banks also have more experience with risk management and regulations than most fintechs, an important consideration today when regulators are pushing for lending parameters to return to “normal,” pre-pandemic levels.  

Despite those headwinds, the paradigm shift fintechs helped set in motion is irreversible. Customer expectations have changed, and banks must now compete on a product and service level as opposed to a traditional vertical business model. Convenience and prompt service is the new currency of loyalty, which many digital banks understand. This shift presents another opportunity for more traditional players amid a downturn—if they can put the digital-first customer experience strategies in place to achieve it.  

Three key offensive strategies 

Given the shift in customer expectations, the importance of digital transformations, and banks’ existing regulatory expertise, traditional financial institutions should look to go on offense in these three key areas as they prepare for a downturn. 

Customer Experience   

Digital products and services with simple and effective UI/UX (e.g., digital payments, mobile banking, and online banking) became the gold standard during the pandemic. It forced banks to compete on a product and service level with newer, tech-focused rivals. Yet most banks only excel at providing basic functionalities, and non-traditional players are grabbing market share: more than a quarter of Gen Zers and nearly a third of Millennials now use a digital bank as their primary checking account provider.  

That’s why there’s no better time for banks to focus on improving their capabilities. Doing so might include investments in: 

Operations

Foundational enhancements to improve a bank’s knowledge about their clients, what products they use, predicting what the next best product is given their lifecycle stage, and streamlining processes across technologies that support these operations, can have direct impacts to revenue optimization as well as product expansion. 

• Customer relationship manager and client communication functions 
• Integrated contract lifecycle management to manage streamline onboarding 
• Automation, decisioning, and workflow management 
• Descriptive and predictive analytics 
• Streamlined servicing functions and communications 
• Broader integration with enterprise systems 
• System modernization and simplification 

Customer Engagement  

Building upon operational enhancements, it’s essential that banks meet their customers where they are at and with the channel experience they expect. Disjointed service experiences and technology capabilities are seen by customers as significant distractors, driving the imperative for banks to invest in customer-centric experiences to improve overall engagement and satisfaction. 

• Customer-forward user experience/user interface design 
• Customer outreach and communication 
• Communication preference alignment 
• Modern application approach 
• Integrated self-service functions  
• Data-driven customer insights and product innovation 

Technology Integration  

As evidenced by the growth in digital banking, technology should no longer be perceived as just a cost center; it’s a fundamental element of a bank’s strategy. Those with established digital capabilities excelled during the pandemic, and 70% of businesses are planning to increase IT spending next year.  

These trends underscore the benefits of investing in technology ahead of a likely recession. To do so, banks should concentrate on the following four areas:  

• Agility: Focus on customer service and speed to delivery; move into product delivery practices that allow for speed and continuous innovation.  
• Strategy: Streamline internal systems, introduce AI to speed up decision making and reduce operational costs, and invest in API-driven architecture. 
• Data: Enhance KPIs to enable better risk management and obtain behavioral insights that can help mitigate risks early and offer products to fit customer needs. 
• Partnerships: Partner with fintechs to provide banking services outside existing channels and infrastructure (i.e., embedded finance). 

Risk & Regulatory  

Economic uncertainty drives changes in risk exposures and regulatory scrutiny as well as additional fraudulent activity. New changes already appear to be on the horizon, with Michael S. Barr becoming Vice Chair for Supervision of the Board of Governors of the Federal Reserve System this July (for a four-year term) and a newly appointed Chief Climate Risk Officer at the Office of the Comptroller of the Currency. Both have made public comments about tightening enforcement.  

At this critical juncture, banks that proactively prepare to respond to regulatory action and mitigate risk can gain an advantage over competitors focused primarily on defensive measures. To do so, home in on three key areas:  

• Risk posture: Fireproofing areas of risk and re-examining risk models and appetites are key to strengthening the overall risk culture. Upskilling and training the workforce in risk areas can help enable this process. 
• Regulatory response: Documenting overall regulatory exposure and mapping the control environment to the requirement ecosystem can help ease regulatory pressures and standardize response protocols to support compliance. 
• Mitigation strategy: Creating a greater understanding of the operational environment and strengthening risk management through broader system integration and a richer data environment can help mitigate risk and develop additional control requirements. 

Conclusion 

Today’s downturn presents the banking industry with a unique set of challenges and opportunities. On the one hand, banks are in a better position than their fintech rivals to double down on investments—and likely already made headway on the digital front during the pandemic. On the other hand, inflationary pressures and talent shortages are mounting, while non-traditional players continue to gain market share.  

Signs are mixed about what type of economic event we’re heading into, and this lack of clarity requires a different strategy. While some of the trends emerging across the economy are concerning, this is not the time to be timid. Historically, and especially during periods of transitioning technology landscapes, boldness in the face of uncertainty has proven to be an effective strategy that distinguishes you from your competitors.  

In the long run, these investments will improve efficiency, protect your customers, reduce risk, and increase market share. Those who hesitate may find themselves lagging behind once the market turns and challenged to meet ever-changing customer expectations.