NOT long ago, the BRICs were lionised as fast-growing superpowers-in-waiting. These days Russia is portrayed as a corrupt petrostate. India is ensnared in red tape, unable to muster the political will to break free. The mighty Chinese economy has slowed in recent weeks (see article). Even South Africa, which considers itself to be the “S” in BRICs, seems sluggish and hidebound next to the gazelles to its north.

Now it is Brazil’s turn. Much is being made of Brazilian threats of huge fines and prison sentences against executives of Chevron, an American oil company, after a small leak of oil off the coast. Critics have taken to complaining about Brazil’s expensive welfare state and dependence on commodity exports. Its torpid economy ground to a halt in the middle of last year. Admittedly officials say that they deliberately cooled the economy, to drive down an overvalued currency and astronomic interest rates. Yet their expectation of growth of 4.5% this year and a bit more next looks implausible.

Does Brazil deserve the backlash? Some of the criticism is misplaced or inaccurate. Unemployment is low, wages rising and foreign direct investment pouring in ($67 billion in 2011, a record). Most economists reckon that Brazil can continue to grow at around 3.5% without triggering higher inflation. Many countries would love to have Brazil’s highly productive farms and its big new oilfields, two of the sources of its commodity dependence. Compared with Russia, China and even India, Brazil more clearly enjoys the rule of law. Its welfare state represents a defensible political choice for a country of yawning inequalities. Above all, Brazil’s strength is a democracy that has yielded broad political continuity and economic stability.

Even so, its government must start to confront the country’s weaknesses. That 3.5% growth rate may seem lavish by Western standards, but it is below both what Brazil needs to be to continue recent social gains—and what it could be. Some of the sources of the faster growth of recent years may now be exhausting themselves. These included a bonus from the stabilisation, opening and reform of the economy in the 1990s, and a huge lift in the country’s terms of trade, thanks to China’s appetite for commodities. Henceforth Brazil’s labour force will not grow as fast, even as the pension bill rises. Domestic credit cannot go on increasing at today’s rate, as households are starting to struggle with debt (see article).

At the same time, Brazil has turned itself into a very expensive place to do business. The government blames the currency for this; it has gone to great lengths to drive its value down. But the government itself is responsible for much of the “Brazil cost”. Not only has the tax burden risen from 22% of GDP in 1988 to 36% today, but the tax system is absurdly complex. Most of the money goes on over-generous pensions and wastefully big government, rather than transfers to the poor.

The minimum wage is now three times that of Indonesia or Vietnam (no wonder manufacturers are struggling). Businesses face pointless regulation. Lack of investment means freight costs are high. And the state has started messing around with business: a rule that 65% of equipment for the deepwater oil industry must be produced at home guarantees that developing the new fields will be slower and costlier than it need be.

Time for another burst of reform

Dilma Rousseff, the president since January 2011, says she is starting to tackle some of these problems. She wants to eliminate the fiscal deficit, has started to cut taxes for favoured industries, has invited private investors to modernise four airports and is assailing a banking oligopoly that has helped to keep interest rates up. But the picture is uneven: her effort to drive down costs is too timid; she was responsible for the silly new protectionist oil regime; and the impression is that she is prepared to settle for growth of under 4%.

That would hurt Brazil. Investors will start looking for higher-growth markets in Latin America—Peru, say, or Colombia and soon perhaps Mexico. The poor, who supported Ms Rousseff in large numbers, will suffer most. She should treat the backlash as a warning. Brazil cannot run on autopilot.

A HUGE GLOWING wall blinks blue and red at the torrent of commuters as they flow up the escalators and into the halls of Orchard Road station, one of the busiest on Singapore’s transit system. As they pass the wall it spews out useful information: the weather, the latest news headlines, movements in the markets. Behind all this are the changing advertisements for Citigroup’s latest deals, on offer right by the concourse. This is a bold attempt to entice customers into a branch that looks nothing like a bank: there are no doors to keep robbers out, no counters to shelter cashiers. Instead there are massive touch-screen televisions on the outside walls and gleaming white benches with tidy rows of Apple computers. Neatly dressed assistants brandish iPads with smart black leather covers.

With a few taps on the iPad, Han Kwee Juan, Citibank’s boss in Singapore, shows how a customer spending a few thousand Singaporean dollars a month on a Citibank credit card could earn thousands a year back in rebates, discounts and other rewards. How about consolidating credit-card debts into a personal loan? The saving could be more than S$600 a year, he says.

This branch is worth close examination because, together with its siblings along Singapore’s transit lines, it reflects a radical change in the way that Citi (and a growing number of other big banks) thinks about its large network of branches. For decades those branches were seen mainly as places where customers came to deposit or withdraw money. More recently some people assumed that they would be swept away by the internet and other waves of innovation. “Ten years ago the consultants said to us that we had to scrap our branches and go straight to the internet,” says Alfredo Sáenz, the chief executive of Santander, a big Spanish bank. “But I had heard those kinds of statements before with the credit cards and ATMs…I’m old enough to remember.”

Branches were seen to be under threat because they are expensive. They usually occupy a prominent corner in a pricey part of town, and they cost a lot to man. Because they get robbed every now and then, even the smallest will usually have at least four people on site at all times, even though three of them may have nothing much to do. For most big retail banks, renting, equipping and staffing branches can easily account for 40-60% of their total operating costs, with computer systems making up most of the rest.

Despite the predictions of the death of branch banking, in most countries the number of branches has increased over the past decade. In America, which is still the world’s richest banking market, the number of branches and offices has risen by 22% since 2000, to almost 90,000. In Europe, too, the number of bank branches has increased steadily over the decade, rather too much so in Spain and Italy. Spain, for instance, has some 43,000 branches, about half as many as the whole of America, a country with almost seven times as many people and a land mass 20 times larger than Spain’s.

Branches continue to thrive because people still think that money is special and want reassurance that their cash is safe. “Location is still the first and most important decision-maker when you choose your branch,” says John Stumpf, chairman and chief executive of Wells Fargo, an American bank. “After that you might bank online, you might not go back to visit that bank again…but that location is where you think your money is.” Baudouin Prot, the chairman of BNP Paribas, a French bank, reckons that “most of the customers still want a branch somewhere nearby…you still need a shop around the corner.” And Rob Markey of Bain, a consultancy, thinks that people “crave physical interactions with human beings in the branch” to make them feel that their money is well looked after.

Intriguingly, it seems that where a bank has lots of branches, it attracts more customers. JPMorgan Chase, America’s biggest bank, opened more than 200 new branches last year and plans to add 150-200 annually over the next five years. Most of these will be in areas where it already has a big share of the market. “It always has been more valuable to increase your market share in an existing market than it is to go to a new market,” noted Jamie Dimon, the bank’s chairman and chief executive, in a recent letter to shareholders. Todd Maclin, head of consumer and business banking, reckons that each new retail branch will earn the bank an average of $1m a year.

This simple rule—that the bank with the greatest branch density in a given market will win the most custom—has defined banking for generations. A study for America’s Federal Deposit Insurance Corporation in 2005 found that banks with bigger branch networks were more successful at increasing revenues and more profitable than those with smaller networks. Having a dense branch network not only helps banks gain a large share of the market, it also allows them to charge a bit more for loans or pay a slightly lower rate of interest. “Until now branches have been expensive but highly efficient billboards,” says Peter Carroll of Oliver Wyman, a consulting firm.

Despite all the innovation and new technology that has gone into banks in recent decades, the basic drivers of retail banking have remained much the same over the past 100 years. But that is about to change, for three reasons.

This time is different

The first is economic. Since the financial crisis the profitability of retail banking in many rich countries has plummeted because of rock-bottom interest rates and tangled regulation. In some places, such as America and Britain, new regulations have also slashed the fees banks can charge. Banks everywhere have to hold much more capital. In America retail banks have traditionally made about half their profits from gathering cheap deposits in cheque accounts on which they pay no interest and then lend out at a profit. Yet with official interest rates close to zero, lending rates have slumped, squeezing margins.

The other big sources of income were fees and charges on overdrafts, late payments on credit cards and fees charged to retailers when customers use their debit cards. New regulations introduced as part of the Dodd-Frank act in America outlaw some of these charges and cap others. Sherief Meleis of Novantas, another consultancy, reckons that thanks to low rates banks are about $60 billion a year worse off than in 2007 and that new rules are trimming their revenues by another $15 billion or so. With such a steep drop in income, about 15% of the current branch network tips over into unprofitability, he says.

In Europe too, low interest rates “are having a very significant impact on retail banks”, says Pedro Rodeia of McKinsey. He reckons that, on average, big European retail banks are currently losing money on about half their customers’ accounts. For some banks the ratio is even higher. “Until now, why would you close branches? There wasn’t the financial imperative,” says Michael Poulos, of Oliver Wyman. “This time it really is different…you will see people closing a significant number of branches.” The potential savings are large. European banks could probably cut their costs by some €15 billion-20 billion a year by getting customers to do more banking online, according to McKinsey.

Give me a buzz

As it happens, customers are already turning to both the internet and their phones for banking without much prompting. The widespread adoption of the smartphone is proving to be the first big innovation in banking that is actually causing people to make fewer visits to bank branches. Earlier waves of innovation, such as ATMs and telephone banking, promised to reduce the frequency of visits but turned out merely to increase the number of transactions by making it more convenient to withdraw money, say, or to check a balance.

Smartphones and tablets, by contrast, are radically changing bank customers’ behaviour, causing them to visit their branch far less often but sharply to increase the number of transactions with their bank. When banks first introduced very basic mobile-banking systems that allowed customers to check their balance by text message, interactions went up from an average of nine to 20 a month, says CeCe Morken of Intuit, a maker of personal-finance software used by consumers and banks. When banks started to produce banking applications for smartphones with touch-screens, “we got shocked because engagement went up into the 30s,” says Ms Morken. What makes smartphones so convenient is that they allow customers to go online almost anywhere and at any time of day. Many now pay bills or send money to family members abroad over their phones while they are away from home, perhaps commuting to work.

For banks, the most immediate benefit of smartphones is likely to be the chance to automate transactions such as depositing cheques, which are still mostly paper-based and therefore expensive. This is particularly important in America, where cheques still account for about a quarter of all non-cash payments. Most big American banks have introduced applications (“apps”) that let customers photograph cheques as a way of depositing them, cutting down on millions of branch visits. The customers seem to love them. JPMorgan says that over the past year customers deposited 10m cheques by taking pictures of them (though that is still only a tiny proportion of the 25 billion cheques handled by American banks each year). Further ahead, phones will displace cheques entirely as it will become possible to send money from one phone to another and small businesses will accept card payments over their mobile phones.

The third big trend is that people are becoming used to doing complicated things such as buying airline tickets or filing tax returns online. The main drivers of this are often industries other than banking. Sometimes it is even the state. In Denmark, for instance, the government oversees the issue of digital identity certificates which can be used on both government websites and for online banking. Whatever the agent of change, it seems clear that as people become more comfortable online in other areas of life, they also seem willing to do more of their banking on the internet. Matthew Sebag-Montefiore of Oliver Wyman cites a Danish banker who got an online divorce, using the Danish government’s website. “When you are comfortable divorcing online, banking is easy,” says Mr Sebag-Montefiore. Banking, in short, is becoming less special.

In America transactions conducted in bank branches are now falling by about 5% a year, says Mr Meleis of Novantas. In Asia the trend is even clearer. McKinsey reckons that branch visits across the region have fallen for the first time since it started collecting data 13 years ago. In the Netherlands only half of all bank customers have stepped inside a branch in the past year. More than 80% use the internet for banking.

Bradesco, one of Brazil’s biggest banks, has been an enthusiastic early adopter of new technologies. It was one of the first banks in the world to offer internet banking, starting in 1996, and it remains at the forefront of innovation. Its ATM machines have biometric sensors that can recognise customers’ palms to save the need to remember PIN numbers (the machines also check that the blood is flowing to forestall macabre robberies). The bank also offers loans by iPhone. It reckons that the cost of handling a customer transaction via an automated telephone system is just 6% of what it would be in a branch. Some 93% of all of its customer transactions are now self-service.

“Technology for us is almost everything,” says Domingos Figueiredo de Abreu, Bradesco’s vice-president. Even so, the bank has recently opened 1,000 new branches, many in poorer parts of the country. These include a “bank on a boat” that travels up and down the Amazon’s tributaries, allowing people to open accounts and borrow money.

Coffee and iPads

The conundrum facing Bradesco and most other banks the world over is that even as their customers make less use of branches for everyday transactions, the banks have yet to find an equally good way of drawing in new customers and doing more lucrative business with existing ones. “Our goal is still to fill the branches with customers,” says Lukas Gähwiler, who runs the Swiss banking business of UBS. “Every conversation (in a branch) is a potential advice and sales opportunity.” So instead of doing away with branches, banks are trying to reinvent them. Many of their experiments seem to involve coffee and iPads, and the word “branch” is rarely used.

In the middle of Paris, the ornate iron and glass doors of BNP Paribas’s flagship “concept store” look out directly onto the Opéra. Away from the chandeliers and down a carpeted corridor you will find bright red, green and yellow beanbags, more white benches with iPads and rooms with couches and flat-screen televisions. “Here we are in the lounge,” says Nathalie Martin-Sanchez, who oversaw the creation of the branch. “The customer can see an adviser while having a coffee…it is designed to encourage more proximity, more interaction, more personal contact.” This is a laboratory where the bank can test ideas such as getting customers and their financial advisers to sit side by side or letting customers speak to specialists on a video link.

Online banks, meanwhile, are trying to build a physical infrastructure to supplement their online offering. The new, bright orange ING Direct Café near San Francisco’s Union Square serves coffee from Peet’s, a speciality Californian coffee roaster, and freshly made snacks at reasonable prices. But as well as asking how you want your latte, the baristas also inquire politely if you would like to talk about money or open a savings account. To reinforce the sense that this is not a bank, there is a rule against transactions. If you try to deposit a cheque, you will be given an envelope to post it to a processing centre.

Whereas banks in the rich world are trying to make their branches more like shops or cafés, retailers in emerging markets look set to leapfrog them by turning shops into banks. In Brazil one of the country’s fastest-growing providers of small loans is Magazine Luiza. Its main business is selling home appliances and electronics through stores and online catalogues. Yet it also finances three-quarters of its customers’ purchases and collects payments on their loans from its network of more than 600 shops. Unlike banks, which want their customers to visit their branches as little as possible, Magazine Luiza encourages its customers to come in to pay their monthly bills in cash because it gives them an opportunity to sell more to them. “I cannot really tell you if we are a pure retailer or a financial company,” says Frederico Trajano-Vendas, the firm’s sales and marketing manager. “We are a mixture of the two.”

But the new branches that are getting the most attention (and, it seems, custom) are Citigroup’s. The resemblance of its branches to Apple’s iconic stores is more than passing. When Citigroup decided to build its new network in Singapore, it hired Eight Inc, the firm that had designed Apple’s stores. The bank’s experiment in Singapore marked an attempt to scale up quickly in a sophisticated and competitive market. Its 26 branches have gone up in some of the busiest parts of the island and have won an outsized share of business. The bank is now replicating its Singapore strategy in Hong Kong, where it has opened a huge flagship branch in a former clothes shop in Mong Kok. “We’re finding that if you have one of those branches it is worth ten ordinary ones,” says Jonathan Larsen, Citigroup’s head of retail and business banking for Asia.

Branches are unlikely to disappear, but there will be far fewer of them, and they will look quite different from the current model. They will also be far more efficiently run. It is the world’s most overbanked country, Spain, that offers some of the most interesting lessons as to how that will be done.

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FINANCE has seen plenty of dramas over the years. But one thing has remained constant for a century at least: the branch banking system. Across most of Europe a handful of large banks, each with thousands of branches, stand astride their national markets. In America Depression-era legislation constrained the growth of big national banks, but at the state level the bricks-and-mortar architecture is pretty similar. While the rest of the sector innovated, expanded and collapsed, retail banking has been staid and reliable.

Now an upheaval is coming, driven by technological changes—the growth of internet usage on smartphones, the rise of “big data” computer processing and the increasing willingness of customers to do complicated things online. These developments have long promised to transform the way banks do business and organise themselves. As our special report this week argues, they are starting to do so.

Really smart phone

The revolution will be most visible on the high street. Branches will become less important and there will be far fewer of them. Those that remain will look quite different. Instead of walking into one to deposit cheques or get statements, most people will do this on the fly from their mobile phones. Instead of opening wallets in shops and being confronted with a choice of whether to pay by cash or plastic card, they will wave a phone at the checkout. On it will be a virtual wallet provided by a firm such as Google, PayPal, Square or some company that hasn’t been thought of yet. If you have forgotten your phone you will type in your phone number and a secret code (or simply speak your name) and carry on shopping.

If this was just a more convenient way of paying, the banks would probably shrug. But it also promises to overturn your existing financial relationships. Instead of reaching for the first card that happens to be in your wallet to pay for a $2 cup of coffee (and risk being charged a $35 penalty by your bank for exceeding your overdraft limit), your phone will choose the best method of payment. Credit cards with the highest rates of interest, or the meanest rewards schemes, will be shunted to the back of this smart wallet. Repayments will automatically be channelled to pay off the most expensive loans first. Penalty fees for inadvertent overdrafts will become things of the past.

These changes will give bank customers more clout, allowing people effortlessly to find the best deals, mainly at the expense of banks’ profits. Some of the biggest beneficiaries will be migrants, who have been failed by a banking system that charges them up to 20% of the sums they regularly send to support their families at home. People with bad credit scores will also surely no longer have to pay interest rates of 1,000% a year to payday lenders. But virtually all customers should gain.

This will undermine the old model of retail banking. Pricing will become more transparent. It will be harder to pretend that banking is free when in fact it relies on customers giving banks virtually interest-free loans in the form of deposits; harder to profit from the disorganisation or sloth of customers who slip into unauthorised overdrafts or roll over balances on high-interest credit cards while leaving cash in low-yielding savings accounts. Banks will probably have to accept lower margins on credit cards, personal loans and mortgages.

Yet there is a big opportunity for banks, too. They will cut costs by closing many of their branches. Banks will also tap into new sources of revenue by mining their enormous troves of customer data. A bank that knows what you have just bought or where you have booked a holiday will be able to offer real-time discounts on related products (much as Google targets advertising at people based on their searches). The retail revolution will also offer the best banks the opportunity to gain new economies of scale through their IT platforms.

In most retail revolutions politicians have had to do little other than move out of the way. But banks are different: their central role in the economy means that governments have to make sure that they are both accessible and safe.

In terms of access, some worry that as banking moves further online, the old, the poor and the computer-illiterate will be excluded from the financial system. But the simple, low-cost mobile-banking systems that operate in countries such as Kenya, India or Brazil suggest otherwise.

The issue of safety is a tougher problem. Oligopolies that generate fat profit margins and leave banks with little incentive to take risk actually suit regulators. They have a built-in safety cushion; and if it comes at a cost to consumers, so be it.

That cosy world will disappear as banking goes truly digital, and new intermediaries emerge between the banks and their customers. Many regulators, fearing that change and competition will bring greater risk, will be inclined to smother some of this innovation, by stifling start-ups or keeping foreign rivals out of their home markets.

They should resist that temptation. The basis of financial stability remains ensuring that banks have enough capital and liquidity to stay in business when times are tough. As long as they do, banks should be left to compete as hard as they can.

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