Incumbents vs fintechs: harnessing the power of digital technology
As we are all aware, today’s digital technology is inextricably woven into the fabric of our daily lives through social and economic interactions because technology is driving change in almost every major industry in our economy.
The financial services industry is not immune to the current trend of digital technology and digital transformation, although the industry’s risk-averse nature kept the banks on the sidelines until the early part of the last decade when it came down to innovation.
While the incumbent financial institutions embraced information technology to some extent in the 2000s, these institutions surprisingly ignored the fintech entrants during the early part of the last decade due to the age-old conventional assumption regarding the perpetual existence of high barriers (assets such as brand reputation with higher market power, economies of scale, working capital and infrastructure that incumbents have built over the years) to entry into the financial services sector. This led to complacency, and the incumbent institutions were reluctant to cannibalise their existing legacy cash cow products and services.
However, as the cloud computing model and overarching cloud-native technology related to security, governance and migration processes matured and the threats from the emerging fintechs and big-techs grew around the second half of the last decade, financial service institutions jumped on the cloud-first consumption-based pricing model and digital transformation bandwagon.
The major financial organisations went with new ‘digital product and services development’ strategies using a host of technology investment practices, novel solutions through accelerator programs, acquisitions and partnerships – thus infusing digital technology into their products and services to lower their cost of offering and eventually achieve competitive advantage.
The strategic move is contingent upon the time and money the incumbents are willing to invest to penetrate the new marketplace and increase market share while satisfying evolving consumer expectations.
Phases of digital technology
The following section briefly explains the phases of adoption of digital technology by incumbent financial institutions and how digital technology forces at a macro-level enable the reigning institutions to shape their go-to-market strategies, revamp operation resiliency and redefine value-propositions to combat fintech disruptions:
As we have witnessed over the last decade predominantly, the first phase of digital transformation in the financial services industry kicked off with private cloud enablement to build the foundation of digital transformation. It was followed by the consolidation of bank branches, virtualisation of data centres and enhanced customer insight with Big Data ecosystems and robust data lakes that helped banks overcome information asymmetry, contain operational cost and drive customer-centricity.
These were underpinned by lean architecture, bimodal IT and security fortification efforts over the last few years. The cogent strategy enabled financial institutions to serve the evolving needs of increasingly omni-channel customers, while the existing branches acted as strategic centres for complex transactions.
Around the same time, due to the easy access to technology and capital, the contemporary small mom-and-pop fintech firms primed themselves and geared up with innovative solutions such as peer-to-peer lending, crowdfunding and mobile payments. These helped fintech firms such as PayPal, Square, LendingClub and Credit Karma manifest themselves as major challengers to incumbent financial institutions.
The second phase initially got off the ground with the arrival of the current global pandemic. The upheaval driven by COVID-19 precipitated innovation and transformation in financial services organisations. In order to achieve efficiency, banks automated middle and back-end business processes using RPA and started to offer intelligent and conversational chatbots augmented by AI and ML technology, while the wealth management sector came up with robo-advisors.
Further, the incumbents exploited public cloud arbitrage (AWS, Azure, GCP) and built hybrid cloud models complemented by flexible micro-services and API-based containerised application portfolios and DevOps practices to scale, increase velocity and render differentiated and personalised customer experience through real-time access to financial data and analytics.
In the meantime, the novel ideas and innovative business models used by fintechs during the pandemic – often unregulated – offered compelling and value-added financial services that fulfilled the unmet demands of customers. However, due to the ever-expanding nature of our digital economy that accelerated to fight back against the crisis, financial institutions have been impelled to strengthen cybersecurity postures and build white-label products and services, at times in collaboration with fintechs.
Eventually, the move helped the incumbents cater to the ever-changing needs of their customers by reinforcing trust and delivering customers with products and services with added security and convenience, particularly in regulatory technology (regtech), AML/KYC, fraud detection, risk management and customer onboarding. In the process, the traditional banks redefined the employee experience by increasing the number of remote employees with virtual collaborative platforms in order to sustain employee productivity while partnering with some high-tech firms.
It is predicted that the third phase will include a higher degree of technological convergence giving rise to post-crisis hybrid digital branches with AR/VR/MR delivering an immersive experience and an API-based Open Banking platform model complemented by biometric security and wearable banking built around intelligent IOT-enabled devices. This will take place primarily through asymmetric competition between the incumbent financial service organisations and the fintechs as well as the big-tech firms.
This is critical since big-techs have the customer data and technology underpinning them to challenge the big banks. The coopetition between Western Union and Google Pay, JP Morgan and Amazon, Goldman Sachs and Apple are some examples of strategic partnerships that helped the formers redefine the banking ecosystem and expand into other segments of the market.
While the new entrants continue to disrupt the competitive landscape and reformulate how financial services are developed, provisioned and consumed, technology leaders of the major financial institutions should embrace and tap into the digital technology ecosystem in a very disciplined manner – eventually enabling the incumbents to unlock new values, bring new capabilities to the market and enhance the customer journey, particularly for the millennial population, while ensuring business and operational resiliency. Matured and transformative blockchain technology-based banking along with payments via cryptocurrency and non-fungible tokens (NFT) using distributed ledger technology will certainly pick up steam around this phase.
Furthermore, blockchain will foster microfinance and financial inclusion for the underserved community as well. Some recent examples of investments made by incumbents that made a big splash in the market include the creation of ‘JPM coin’ by JP Morgan and the ‘utility settlement coin’ by UBS and Bank of New York, as well as the acquisition of blockchain security start-up CipherTrace by Mastercard in order to expand its fraud detection capabilities across the digital asset ecosystem.
Last but not least, the fourth phase will usher in a new period around the later part of this decade comprising of the highly anticipated quantum economy and banking built on quantum computing. However, with the confluence of technology and market forces such as cloud computing, AI, blockchain, IOT, automation, platform models and data monetisation along with data aggregation, profit distribution due to regulatory disruption, new forms of systemic risk, reduced switching costs with high marginal value when it comes to payment, demonetisation, bionic workforces and the cashless society in the future hyperconnected quantum world, there will be a major consolidation among the financial institutions, fintech firms and big-techs due to the shifting value-chain – leading to disintermediation of the traditional broker channels with a fundamental shift in the transformation of financial services business models.
Although two-thirds of customers worldwide are already using fintech products and services and are satisfied with them, in summary, it can be stated that C-suite leaders and senior executives at financial institutions ought to drive the amalgamation of the relationship-based high-touch approach with a high-tech digital strategy – supplemented by data-driven decision-making processes to engage customers in a meaningful manner and survive the threat of disintermediation. Additionally, leaders need to boost investor confidence by demonstrating quick wins through short-term gains in order to sustain digital transformation and reap long-term benefits.
Although technology plays a pivotal role in the digital journey, there are certain cultural elements and elements of organisational behavior that leaders at all levels should consider nurturing continuously in all phases of digital transformation to build organisational agility and ensure that innovation is ingrained in the organisation’s DNA, particularly in a post-pandemic era.
Interestingly, some of the elements might be critical, but they are all required to be successful in this digital era. The elements include breaking down cultural inertia, fostering and perpetuating strong employee experience with a collaborative and agile culture of delivery across business and technology groups, developing a customer-centric mindset, achieving business buy-in and experimentation with the notion of ‘fail fast and relearn’.
However, the efficacy of the digital journey is contingent on the rigorous risk management functions across the organisation to reduce risk in their innovative digital services and continuous transformation of the underlying operating model, organisational structure and organisational behavior conducive to an agile digital transformation journey.
About the author
Paul Pal currently serves as the CTO, Chief Technologist at DXC Technology, and oversees a segment of the Banking and Capital Markets tower in the Americas region.
He has held a number of leadership roles and executive positions at leading financial institutions over his 24-year career.