Can banks compete successfully with nontraditional adversaries such as broker/dealers and the industrial giants who are busy picking off attractive business lines? In this competitive context, what must banks do to survive and prosper?

It is obvious that the demand for financial products and services is not growing at the rate it did in the 1980s. Federal fiscal policies, low levels of real economic growth, declining household saving rates, and shifting demographics all play roles in this regard.

We expect these factors to persist, causing growth in demand to remain sluggish for the foreseeable future.

However, it seems clear that the effects of the economy will generally be more pronounced in the commercial markets, in which credit products account for a substantial percentage of the demand. Incremental demand for these is particularly sensitive to low real economic growth.

Faster Growth Expected

The situation in the consumer markets is a bit different. Overall, we expect that consumer financial services will grow at a faster rate than those in the commercial area. As the population ages, demand is likely to shift away from credit products and toward savings and investment vehicles.

Considering its size, growth and profitability, we believe that the retail savings and investment market will continue to be the most attractive opportunity available to both banks and their competitors for at least the remainder of the decade.

Unfortunately for banks, the returns on their traditional savings products are reaching historic lows as nontraditional competitors target the saver and, increasingly, investor market segments historically served by banks.

List Getting Longer

The past 20 years have clearly been a period of dramatic change in the banking environment as the profits guaranteed under regulations of the 1930s have been eroded by changing technology, regulation, and competition.

Businesses once reserved to commercial banks have been systematically pentrated by new competitors able to offer the same or a better product more cheaply. The list of such product areas is long and growing.

Well-established trends:

* Mortgage processing -- Nontraditional competitors such as Source One, GMAC, Lomas, and Shearson have captured substantial shares.

Retail auto loans - Substantially captured by auto company finance arms such as GMAC.

Current inroads:

Credit cards - Sears, AT&T, and GM are taking an increasing "share of wallet" while lowering the profitability of the business.

Consumer savings - Broker/dealers and mutual funds are rapidly eating into banks' historically stable certificates of deposit.

As a group, banks have systematically been forced to cede ground to outside competitors - ground they may never regain. To replace the lost income, many banks have entered new areas that offer higher yield, but more risk - commercial real estate, highly leveraged transactions, lending to lesser-developed countries. Some banks have shown a newfound interest in middle-market lending.

Pyrrhic Victories

With some exceptions, the short-term successes banks have achieve in these businesses have been Pyrrhic victories. Because the ultimate business risks have been poorly understood, long-term results have for the most part proved disappointing.

Banks also were reluctant to acknowledge the implications of the slow historic trend away from their traditional saving products.

Only in the last two years has it been realized that disintermediation is not an issue to be managed.

Suggested Guidelines

Banks in general have not seemed especially willing or able to compete in businesses where they do not hold an overwhelming advantage over nonbank competitors.

With regard to investment and savings products, several important guidelines suggest themselves:

* Understand that the retail market is far from monolithic. One of our clients has identified twelve market segments with substantially different needs, wants and perceptions. You need to target those segments where you are most likely to experience success.

* Tailor the capabilities of distribution outlets to target segments' needs and wants, while matching outlet costs to segment sales potential. This can result in multiple channels and outlet configurations.

* Recognize that manufacturing your own products, and simultaneously distributing those of fund complexes, are not mutually exclusive alternatives. Positioning a bank as an objective financial adviser may prove problematic if too much emphasis is given to any one manufacturer's products, including those of the bank.

* Resolve conflicts between those brokerage and trust businesses. To accomplish this, consider assigning, exclusive responsibility for individual market segments.

There is certainly more to it than mastering the few points I've mentioned here. But addressing these issues will go a long way toward achieving success.

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