The pace of change, albeit belated compared to other disrupted industries, such as travel, retail, media, is forcing a rethink of the traditional banking model.
To date, most innovation effort has focused on improving the customer experience, through more products and services being offered online or via mobile devices. Bank customers are now used to app-based banking, mobile payments and biometric security to make their lives easier.
At one level, this digitisation of the banking experience is both welcome and expected by banks and customers alike, as it speeds up processes and makes the experience more convenient. In most cases it is also more intuitive than traditional methods, as anyone who has ever completed a paper-based application can attest. However, this has ignored the underlying infrastructure. Banks are still saddled with a cost of operation which is unsustainable in a market where revenue opportunities and margin continue to be eroded.
Legacy bank infrastructure runs on technology designed for the face-to-face banking age. Change was infrequent and slow, and new features tended to be added to the core platform, which is now unrecognisable from its original form. The supporting operations and processes have also undergone significant overhaul, but these too are unfit for current requirements.
The competitive advantage of challenger banks is their agility, enabled by a modern technology backbone. This has led to lower operating costs and new business models based on charging for value created, not services provided. Customers too are underwhelmed at having to pay for banking services that are free in other areas of their lives. Imagine being asked to pay for holding an account with your preferred airline, online grocer or content streaming service.
To date this wider choice of provider has been limited to more ´fringe´ banking services where FinTech firms have cherry-picked niche, profitable services such as Foreign Exchange, Crowdfunding, Digital Payments, Low Cost Investment. This has provided customers with greater speed, control and convenience, and eaten away at profitable bank services, exposing the high cost of operating an ageing core without the effective subsidy of profitable add-on services.
However, switching numbers in core bank accounts, the ´crown jewel´ for banks in terms of customer ownership and valuable data, have remained low, at less than 6% of all UK bank accounts since the Current Account Switching Service (CASS) was launched in 2013. We expect this to increase following the implementation of Open Banking.
In an Open Banking world, the threat to traditional banks is amplified, as while they hold more data on their customers through increased transactions, this is offset by fewer and less personal contacts. This makes building the ´sticky´ relationship they seek more challenging. As both challenger banks and the BigTech firms court once loyal bank customers, and increase their own potential, traditional banks could feel further pain.
The BigTech firms, including Google, Apple, Facebook, Amazon have two factors that Fintechs and Challenger Banks do not. Namely, scale of customer base and brand trust that traditional banks would historically consider their ace card.
The fightback from the traditional banks may take one of three forms. First would be to level the playing field by modernising the technology platforms which keep their costs high and their speed to market low . This would reduce their competitive disadvantage vis-à-vis the newer entrants, but is a long, costly and painful route. Some have tried, none has yet fully succeeded. BBVA for example has won plaudits for adapting processes, corporate culture, management structure, and focused on customer innovation to meet the forthcoming challenges. It sees this as the beginning of its digital transformation journey.
Second would be to create a ´Utility´ provider, either led by a single, scale bank -or a group of banks. Such a utility could offer the commodity and industry-wide services that drive much of the current cost and inflexibility (fraud prevention, data storage, reconciliations, on-boarding are all prime candidates). This again has both advantages and drawbacks, as although a single service provider to the industry would bring down cost of operation and -in areas such as fraud prevention- provide better data to all parties, banks remain reluctant to cede their independence and share services with their traditional competitors. An early example of a UK banking utility was seen through Intelligent Processing Solutions Limited (iPSL) cheque-clearing service, set up in 2000 as a joint venture between Barclays, Lloyds and Unisys.
A third option would be to enter into more active collaboration with the BigTech firms. So far, these non-bank technology titans have been wary of becoming deposit-taking entities in their own right, through fear of burdensome regulation and further scrutiny, though they covet the data and frequency of transactions that banking customers offer. Here, HSBC has partnered with Amazon Web Services (AWS) to cloud-enable its development operations, and AliPay has signed a partnership agreement with BNP Paribas, Barclays and UniCredit amongst other fledgling collaborations. Deeper, more ambitious tie-ups could take this model much further. In future, BigTech firms may feel that this is an industry ripe for their brand of disruption, and as such is their next logical conquest.
Whichever the option taken by traditional banks, it is clear that the disruptive force of technology from new players has moved from potential to real threat.
As BigTech firms begin to take a more active interest in banking, the barriers that prevented FinTech firms from scaling up and expanding their offerings (lack of reach, lack of a widely recognised brand, lack of funding) begin to disappear.
Traditional banks can therefore no longer afford to be special, in the sense that they still see their businesses as too complex, too unique, too specialised to be performed and provided by non-bank partners. The overhead of owning and operating a full bank service within the bank´s own walls is prohibitive. The cost of compliance with regulation and patching up the creaking technology infrastructure have proven this.
Overcoming this ´cultural debt´ and the fear of change is the main challenge for traditional banks. We see three key actions to transform banks from within, and make them relevant and competitive in the newly disrupted banking market:
- Identifying the key value-adding services that customers expect from them, and retaining these. Ensuring that these differentiators are delivered to world-class standards
- Sourcing the ´commodity´ services from leading technology partners to enable low-cost, scalable operations that can adapt to market and regulatory demands
- Providing, partnering to provide, or procuring the ´utility´ services delivered at an industry level to optimise cost/revenue and value as part of a banking ecosystem.
People continue to need banking services, though not necessarily all from banks. The services themselves are changing rapidly, enriching the financial user’s journey and transforming the banking industry. The challenge for banks if they are to continue to be relevant, is to change with them.