The doom-mongers have long been predicting an existential crisis in banking. Banks are being assailed on every side — by FinTech start-ups, Big Tech and regulators. They must maintain 24/7 operations and interoperability, deal with the demands of regulatory compliance, and contend with their own internal culture around innovation. So, it is a case of panic and freak out? Or keep calm and carry on? PCM examines the possible futures of banking.
Banking was born and the business model has been so successful, it has hardly changed in 5,000 years. Banks borrow money, lend it out at a higher rate and keep the difference. Now banks must face the challenge of what the World Economic Forum calls the fourth industrial revolution. This builds on the digital revolution, fuses various technologies and blurs the physical and digital spheres. This cannot but have implications for what banks do, how they do it and how they make money.
TECH COMPANIES WITH BANKING LICENCES
Speaking at the Mobile World Congress in 2014, Citi CEO Michael Corbat explained how his bank moved $3 trillion in business and institutional financial flows on an average day. On peak days it was closer to $9 trillion or more than half the GDP of the United States. Nearly all of this was moved electronically. “In many ways, we see ourselves as a technology company with a banking licence,” he said.
Since then various bank executives have declared their organisations to be technology companies (e.g. JPMorgan, Goldman Sachs). Or aspired for their organisations to become technology companies with banking licences (e.g. DNB Norway, ING). However, the extent to which banks need to become technology companies to succeed in the future is a moot point.
“What you tend to find is that banks are still actually banks using technology, rather than being a wholesale technology development shop,” say Chris Skinner, financial commentator and author of Digital Human.
The true technology companies, such as Amazon, Facebook, Tencent and Alibaba, are technology-first to enable commerce. They then move into finance and banking as they are adjacent to commerce. Their focus is primarily on getting more traffic — more commerce — on their platform, so they can give away banking services. “That’s where banking is very different because it still wants to make money out of banking services with technology,” says Skinner.
This difference in thinking is neatly encapsulated in the terms TechFin and FinTech. TechFin is generally where technology comes first and is applied to finance. Whereas FinTech puts finance first and applies technology. “If you are approaching things as FinTech, you are taking the existing system and making it more effective and efficient with technology. But with TechFin, you’re using the latest new technologies available to create new exchanges and stores of value,”
TechFin is also more prevalent in countries with little to no established banking infrastructure. Whereas FinTech is more prevalent in Europe and the US. It takes the legacy world and improves it with technology rather than creating a new world from scratch.
SAME OLD, SAME OLD
Indeed it seems as if the way banks do business in developed markets has scarcely changed in years, despite technological and societal changes. The same few firms dominate. New entry is modest. Innovation is incremental. Products and services are static. Full-service retail banks offer a selection of current and savings accounts, loans and mortgages that are similar to each other and to what they have always been.
Digital was seen initially as a new way to automate old processes to cut costs. Or as a new channel to distribute old products. But the combination of consumer expectations, technology and regulation has finally begun to bite. David Brear, CEO and co-founder of digital banking consultancy, 11:FS, is bullish. He claims never to have experienced such a dramatic change in the mindset of senior management as in the last 18 months.
“The reality of the situation has hit home to senior bankers in Europe, the US and Asia. Change is no longer optional. It’s mandatory,” he says. Organisations have tried transformation, whether technological or cultural, yet few have managed it. At the same time FinTech competitors and challenger banks are not going away. “The openness to working in very different models and partnerships will transform how the destiny of many banks will pan out,” says Brear.
Banks place a lot of emphasis on the regulatory frameworks being prohibitive. Or their legacy technologies being the underlying reasons why they cannot do things at the speed, scale or cost. Fundamentally all these things come back to culture, thinks Brear.
Cultures within banks have led to a level of apathy. Banks have grown large and lethargic in terms of the processes they have put in place. There is a degree of apathy towards human experience and delivering beyond a one-size-fits-nobody approach. It affects how banks take products to market, how quickly they react and how they talk to customers. “What we are seeing with FinTech is the young pup teaching the old dog new tricks,” says Brear.
“The big adaption is to go from macro services in physical distribution to micro services in digital distribution.” Chris Skinner Author
AVOIDING FASTER HORSES
Customer expectations are increasingly being shaped by businesses outside banking and financial services. Customers are not comparing banks with other banks, but with other facilitators of ease in their lives: Uber, Airbnb, Apple and so on.
Banks have perhaps been too focused on the functional aspects of their service at the expense of the emotional. An emotionally engaged customer is worth six times more than an emotionally unengaged one, according to one estimate. And around 80 percent of decisions are made emotionally, irrespective of what customers may say out loud.
“A lot of banking communications have been quite alienating for the general public for a long time,” says Brear. “People don’t really understand APR. If you communicate to people in a way they don’t understand, they probably stop talking to you.” Tone of voice and products are areas in which almost every bank could improve. The best worst example of this is probably the monthly statement.
The move to digital merely replicated the paper statement on to a smaller screen. Mobile banking offered an even smaller version. When Brear used the ‘jobs to be done’ methodology with a UK retail bank, the exercise revealed that the statement was being used for around 65 tasks. These ranged from a proof of address to a budgeting or fraud prevention tool to name but three.
Banks must work harder to make themselves relevant, which may involve shaking off unhelpful legacy thinking. And adapting from supplying commodity, analogue products to offering intelligent digital services. This also ties in with the move from a pull to a push model. Instead of the customer enquiring of their bank, the bank could inform their customer of relevant offers proactively to a connected device.
“The big adaption is to go from macro services in physical distribution to micro services in digital distribution,” says Skinner. He cites the example of insurance contracts. These typically work on an annualised basis because they are difficult to administer in a physical network. A digital network creates opportunities for insurance products that last for days or even hours.
Delivering micro services on mobile networks is an example of re-inventing financial services through technology. “This is where I think the digital human gets the opportunity. Every human on planet earth is included on that network, whereas in the traditional banking system two-out-of-three people were excluded. That’s the real revolution: that everyone is now included in the network,”says Skinner.
LIPSTICK ON A PIG
The future of banking is not AI, Blockchain, biometrics or any one single technology. However, technology does shape internal systems and internal thinking. Legacy IT infrastructure is a practical reality for
Incumbents know that their technology is hindering their ability to grow, bring new products to market quickly and support regulatory change. New entrants — FinTech, non-banks and Big Tech — are using the latest cloud-based, modular technology. Unencumbered by technology, budget or mindset constraints, they can more easily adapt to current and future demands of customers and regulators.
“The future of banking is to be open, to collaborate and to be future-proofed by having the technology that allows you to do so,” says says Sheri Brandon, chief commercial officer, five degrees, a supplier of next-generation digital banking platforms. “It’s not so much becoming a technology company but enabling yourself as a bank to plug in technology from others.”
Historically retail banks worked in silos according to business lines. Loans, mortgages, investments, cards were separate silos, each with its own back-end system. The front-office interfaces connected directly to the back-end.
“What we are seeing is that banks have put lipstick on a pig. They have put front-ends and ESBs (enterprise service buses) between the silos to report back to the customer as if they have one back-end, which they don’t,” says Brandon. They strive for a single view of the customer, but the work-around does not really work.
A three-tiered systems architecture presents a possible alternative. It introduces a mid-office between the traditional front- and back-office. This contains central functions, such as business processes, communication and customer data management. It is surrounded by an API and integration layer, enabling banks to easily plug in services from third-party providers.
When a new front-end channel appears, there is no need to re-build all the intelligence for that channel. It merely consumes the services from the mid-office. Holding customer data in the mid-office also simplifies compliance with GDPR and PSD2 requirements. The back-end systems then become thin layers to handle transactions and create products.
Technology is a great enabler but it is often people who are the barrier — they have legacy mindsets. When bank staff are imbued with current thinking and processes, it can be very difficult for them to imagine servicing their customers more seamlessly through a digital process. Digital transformation is as much about cultural as technological transformation.
“The future of banking is to be open, to collaborate and to be future-proofed by having the technology that allows you to do so,” Sheri Brandon, chief commercial officer, five degrees
Banks may struggle in this area as their boards lack technology experience. Only six percent of board directors and three percent of CEOs of leading banks have professional technology experience, a 2015 Accenture survey found. More than two-fifths of banks have no board members with professional technology experience. When many of the biggest challenges facing banks are connected with technology and customers are avid users of technology, this is concerning.
Many organisations have hired an ex-Google representative or someone from a technology firm. This is a start as the cultural tone comes from the top. However it must continue throughout the organisation as one senior leader does not make a digital transformation good.
Other cultural or organisational barriers to digital transformation are typically the fear of cannibalising existing business, the need for new business and liability models, and the lack of an enterprise-wide digital strategy. Quarterly results are typically driven by incremental improvements. Whereas lasting change requires breakthrough innovation. Going against the prevailing grain of short-term thinking in favour of long-term sustainable returns requires leadership.
KEEP CALM BUT ACT NOW
Banking has survived for centuries because it is necessary, but banks are not. Banking by any other name or brand would smell as sweet. This hints at the possible disintermediation threat from FinTech and Big Tech if banks fail to remain relevant. Yet also how banking may transform into the infrastructure behind new structures, which change the fabric of how banking operates.
PSD2 and open banking regulations will turn banks and the customer data they hold inside out. This is naturally both an opportunity and a threat. The same applies to engaging with legacy. This may be legacy technology, systems, processes, mindset, culture or customers. Every organisation has a legacy issue simply because legacy is not about how long something has existed, rather what is inherited.
Change is and has always been the constant in banking. So, the situation in 2018 is not a case of panic and freak out. Rather keep calm but act now. As to how long incumbent banks in developed markets have to change, it really depends. Some banks have already started their digital transformations and have been working on them for at least a decade. Some started later. However there are still digital hold-outs.
“There are an awful lot of bankers, who believe that they do not have to change their business model because of digital. Those are the ones that are going to wither on the vine,” thinks Skinner. “My estimate is that they have got until 2020 to start digital transformation. If they have not started by 2020, then they will not exist in 2030.”
Brear agrees in as much as the opportunity is there for banks to lose. “Incumbent banks have all the branding, relevance and trust. They equally have all the customers and money to invest. There is an element of them having as much or as little time as they make.” FinTech and other competitors can only achieve scale and take something from the banks, if they choose not to react.
There is no one path to the future. So, as the computer scientist Alan Kay said, the best way to predict the future is to invent it. There has never been a more exciting time to be in banking.