Is the way young people use financial services changing the risk profile of financial service providers?
It’s an intriguing question since there’s no doubt that young people are indeed interacting with banks, pension funds and other financial service providers very differently from the way their parents or grandparents did. Gone are the days when a young person would open an account with one of the major high street banks – filling in forms in person, over the counter – and then gradually build up a portfolio of financial products, reflecting their professional and personal journey – a current account, a savings account, an overdraft to buy a car, a pension plan, a mortgage to buy a house, life insurance, and so on.
That’s a simplified view, of course, but even allowing for over-generalisation we have to recognise some fundamental differences in the way in which younger people are using financial products.
Most obviously, they are interacting digitally, over phones and tablets, and see little point in time-consuming face-to-face contact. Intuitively, one would say that this enhances risks around cyber-security, increasing the vulnerability of customers and institutions to fraud and theft from outsiders. But one has to be careful here. Digitally savvy young people are well aware of the risks around cyber-security – probably far more so than older users. (My 12 year old daughter, who is a long way from buying her first investment product, has already had numerous lessons in school about staying safe over the internet.) So, if we’re going to blame digitalisation for increasing cyber risks in banks, we probably ought to focus on risky behaviour by the older generation rather than by young people.
Secondly, the emergence of small specialised financial service firms, particularly those engaged in investment management, money transfer, and small-denomination credit, enable customers to spread business over multiple providers. Historically, customer acquisition has been expensive for the high-street banks, which is why cross-selling to existing customers was so important for profitability. Not only does digital finance greatly reduce the cost of customer acquisition while also facilitating customer acquisition by new digitally-based firms, but public policy around ‘open-banking’ is reducing the value of the accumulated information on customers that the high street banks enjoy while also reducing customer inertia in the face of competitive offerings from rival firms.
So, the notion of a ‘financial services supermarket’, cross selling to customers and providing a significant proportion of their financial needs, is increasingly outdated. We are looking at a more variegated landscape in which customers interact with a variety of financial institutions, and switch between them more frequently than in the past.
That begs the question of whether the inherent profitability of financial services will increase or decrease in this more volatile market. Is a residential mortgage still profitable if the customer switches to another provider after five years? Can banks charge enough for current accounts without pushing clients into the arms of start-ups who are willing to loss-lead during their first few years?
We have to keep all this in perspective. Banks have been trying to poach their rivals’ residential mortgage customers, by offering ‘teaser rates’, for more than 20 years. The notion that a current account is free of fees and charges was abandoned many years ago. Yet the big banks have continued to make money, with their profitability more dependent on global interest rates, economic cycles and periodic crises, than the slow and incremental changes in the cost of financial products.
New generations of young people have been changing society’s relationship with traditional high street banks for decades, and most of those high street banks are still with us.
The dangers of historical myopia – ‘this time it’s different’ – are huge.
I wonder if we are missing the bigger picture here.
What we can assert with confidence that there are some fundamental changes to life and work patterns occurring as a result of increased life expectancy and an unwillingness of firms to fund generous pension plans.
Young people in western Europe can expect to live until they are at least 90 years old. They will have to work longer in order to fund a retirement that will also be longer. They will have to retrain, or upgrade their skills, during the course of their working lives, perhaps taking time out of paid employment to do so. Meanwhile, younger people are entering the work force later (often with debts due on student loans) and are less likely to enjoy employer contributions to a pension fund.
So, the real threat that young people present to financial institutions lies not in the way that they use financial products, nor in changes to the inherent profitability of the products themselves, but in the increased financial vulnerability of young people themselves. It’s going to be much harder for young people to acquire capital to fund their retirement, or an investment in late-life education, than it was for their parents or grandparents.
If young people are becoming less financially secure, then, as a class of customers, they present greater risks to banks.
And this is not simply a risk factor for financial institutions – it is a challenge for public finance and society as a whole.
Andrew Cunningham is the founder and managing director of Darien Analytics Limited, a UK-based consulting firm that focuses on risk, regulation and governance in both developed and emerging markets. He is also a Visiting Professor at the London Institute of Banking and Finance.