Slow growth, new regulation and digitisation – driving innovation in the banking sector
Since the global financial crisis the banking industry has witnessed three mega-trends: slow growth, digitisation and new regulation. None of these trends look likely to abate any time soon and in fact, it appears that all of them are set to intensify in the short to medium term.
Chris Truce, head of fintech at Saxo Bank, examines how banks can best manage these pressures, evolve them into opportunities and hence make themselves more competitive.
The pressures which banks are currently facing were cited in McKinsey’s Global Banking Annual Review 2016, which predicts a slower recovery in economic growth (surveyed banks’ average Return on Equity at best equalling their Cost of Capital); an evolutionary digitisation of the industry (demanding higher than ever capital expenditure); and harsher than expected scenarios for regulatory reform. In short – no growth and higher costs to comply with reforms.
In particular, the pressures of digitisation are fierce. In developed economies, they exist in several forms. Firstly, regulators, who were initially more conservative about “non-bank” entrants into financial services, are now becoming more open to new players. Over time, many experts such as McKinsey, BCG and Accenture are anticipating that global technology providers may be able to insert themselves between banks and their customers, thus creating disintermediation and owning the vital customer relationship. Secondly, banks are competing fiercely amongst each other to form partnerships with fintechs, in order to provide new products and services to their increasingly tech savvy customers. Finally, and perhaps most importantly, many banks are working hard on digitising processes and outsourcing larger pieces of the value chain in their middle and back offices in order to improve cost/revenue ratios.
Outsourcing of the digitisation process enables an institution to integrate entire business verticals (such as stockbroking or wealth management) into their existing interface(s) with the use of an external provider’s Open Banking interfaces (APIs). Behind the scenes, the outsourcing provider supplies the technology, skilled human resources and mature processes (the Business-as-a-Service, BaaS model), leaving the institution to invest in the digital relationship with their clients. In this model, the institution enjoys the competitive benefits of improved client journeys and user experiences thanks to the increased investment on their side, whilst leveraging the outsourcing providers’ resources to deliver the more commoditised components of the value chain at a reduced upfront cost with lower ongoing operational expenses. These can be spread out over the duration of the new business line.
This BaaS business model is the core for most modern Open Banking solutions which are particularly attractive to banks at the moment. With little or no growth, operating costs (both people and technology) have come under increased scrutiny hence this modern concept of connected financial BaaS solutions is a highly effective way for banks to achieve an effective digitisation strategy within reasonable timeframes and without higher allocations to capital expenditure budgets. This leaves them with more ‘readily available resources’ – a highly attractive path for CEOs and their board members.
So how should banks approach building a digitisation strategy (potential comprised of multiple BaaS providers)? The key is for banks to take advantage of the networked economy and the future broader digital distribution. As an example, if a bank can optimise the use of their client’s digital time (i.e., the time clients spend outside of the banks’ digital channels) then the bank has an opportunity to foster a deeper more meaningful digital relationship increasing client value. A 2015 report by Ofcom, the UK communications regulator, found that the amount of time Britons spend online had doubled in the previous decade, largely thanks to increasing use of smartphones and tablets. This will rise further as the quality and range of available services continues to surge.
This is best illustrated using a consumer industry example such as online retail giant Amazon. Through the pioneering of algorithmic recommendation engines based on machine learning, Amazon is highly advanced in predicting consumer behaviour and can endorse future purchases which may be of interest to their users, based on a combination of navigation behaviour and purchasing activity both on an individual and aggregated level. The difference now is that this capability is no longer confined to Amazon’s own site or apps. When an Amazon customer accepts cookies on its site, the firm is then able to collect real-time behavioural, contextual and time related data that, when combined with their existing information on the user’s Amazon site navigation and purchasing preferences, can make even more accurate predictions on his or her return to the Amazon site. Moreover, Amazon has the ability to place highly targeted content on other sites frequently visited by that user, for example promoting books or other products that fit the customer’s current interests thus likely improving their users entire digital experience.
Banks are used to defending their slice of an estimated $100 billion industry. However, many have not yet made optimal use of the networked economy centred on the broader digital distribution of every single consumer good and service which is estimated to reach $60 trillion by 2025 (according to McKinsey’s Global Banking Report 2016). The opportunity here is that by shifting to an Open Banking business model, banks could capture a tiny share of this networked economy which could be worth much more than their respective share of the significantly smaller banking industry.
Many banks are beginning to embrace digital transformation, recognising the opportunities to enhance the user experience by delivering customisable services across multiple platforms and, where appropriate, sourcing complementary services from third parties via OpenAPIs. But the full potential of such investments will not be realised if banks and other financial technology (Fintechs) firms don’t continue to push the boundaries, exploring the opportunities of digitisation to better understand and fulfil clients’ needs and desires.
Big data analytics and artificial intelligence (AI) programmes that have been driving client knowledge and understanding in consumer-facing sectors are becoming increasingly available to banks. This is enabling them to match their marketing messages to customers’ fast-changing priorities more accurately, thereby increasing interaction levels and, ideally, transaction volumes. Converting client interests into financial transactions is the ultimate goal; as should be generating tangible value from the networked economy. Furthermore these same programmes can also aid in the development of more engaging and accurate methods of evaluating a client’s knowledge, experience, appropriateness, and investment risk tolerances. This approach will better equip these firms to present the right investment products and services to the right investors, thus aiding in the sustainability of the entire financial industry.