November 20, 2016
With close to $14 billion in venture capital invested in a range of FinTech companies globally in 2015, and ~$19 billion in the first nine months of 2016, the industry is expected to blossom beyond expectation and have a transformative effect on traditional financial institutions. Over time, the race for a market share only gets more interesting, since banks are not waiting to part with their customers and value streams, and are noticeably active in innovative projects and initiatives.
However, there is a particular sector where traditional institutions don't have much experience innovating - digital banking. Meanwhile, challenger banks are getting licenses one after another not mentioning their outstanding UX, increasing the pressure for incumbents. With accelerating pace of innovation in the financial services industry and ever-consolidating efforts of FinTech in dethroning banks, what can banks do to respond?
At the end of September, The Development Bank of Singapore (DBS) made an attempt to answer that question in the report called New Avatar: Banks Watch Out for Banks, offering two main strategies for banks to fight challengers on their turf: 1) serve existing products digitally so that they are faster, cheaper and easier; and/or 2) adopt a customer ecosystem approach which integrates banking into customers’ daily lives.
DBS estimates that financial institutions that are not able to adopt a digital model may see a drop in ROE by ~18% over a five-year timeframe. However, retail banks that are able to reinvent themselves could see a substantial increase in ROE, around 18%, largely driven by the lower cost of serving customers and the efficiencies they will reap.
Most importantly, the report forecasts that the share price of a digital-savvy retail bank would be 50-80% higher than that of a non-digital bank in a similar timeframe.
An increasing number of bank invests efforts and funds to lead the digital wave, among which are well-known innovators Barclays, BBVA, DBS itself and others. Those banks are launching or getting actively involved in a range of initiatives including innovation labs, accelerators, incubators, etc. The ones to be at the forefront have adopted technological platforms based on APIs. DBS reports that 18% of its wealth customers and more than half of SME customers were acquired by the bank in 2015 via digital platforms.
By redesigning their value chain and operations to deliver services in a more convenient and cost-efficient manner, banks can lower their cost of acquiring and servicing clients, as well as offer cheaper and better user experience and products at the convenience of the customer. Indeed, as the benefits of digitization have been widely recognized over the past few years, banks around the world have adopted new technology across all of their services – account opening (Citi, SunTrust, US Bank, Liberty Bank, etc.), deposit taking, lending, wealth management, advising (robo-advice) and payments.
Digital account-opening has enabled banks to reduce the need for documentation and cut down on back-office operations. Robo-advisors offer investors ease and simplicity at a very low price – much lower than the fee an investment adviser at a major financial institution would charge. Robo-advising platforms overall are expected to play a major role in wealth management in the future, facilitating collaborations/acquisitions between banks and tech startups (Cambridge Savings Bank partnered with SigFig, US Bank and FutureAdvisor, Goldman Sachs and Honest Dollar, etc.).
Banks are also cooperating efforts with tech startups to cut the cost and time taken for international payments (over 25 banks and Ripples Labs). DBS suggests that blockchain payment protocol introduced by Ripples could lower fees and commissions from as much as 5% today to 0.50%, making payment facilitators like Western Union and the payments divisions of banks uncompetitive. Tie-ups are also beneficial in standing ground in face of such massive competitors as PayPal and Alipay.
Automation is also believed to result in near-zero human errors and faster operations. Lloyds Banking Group, for example, was reported to be able to reduce its 700-odd processes to just 23, allowing the bank to reduce the time taken to close accounts from 30 minutes to 3 minutes.
The second strategy was born in a non-bank sector but will have a tremendous impact on banks’ customer loyalty if adopted properly. Technology, commerce and code-first companies like Baidu, Alibaba, Facebook, WeChat and Tencent have chosen a clever strategy of cultivating an active usage habit and unprecedented loyalty in masses to their primary products in order to expand their functionality with high-yield features in the future.
An example elaborated in the report is the service portal Tencent, which is used by over 500 million people for daily communication, payments, and wealth management. Baidu’s 500 million users that account for over 45% of banked users in China use the search engine to look for wealth management products and can even buy one of Baidu’s own funds on the platform.
Facebook Messenger is another example, which we have discussed before. Upon closing up on a critical mass and building a strong usage habit, Facebook expands its all-in-one apps’ capabilities to address a range of daily routines with help of AI-enabled chatbots. Messaging giant WeChat is one of the most interesting and successful ‘deployment’ of an app into daily routines. The platform is nothing less than a miracle – users can book appointments with doctors, call cabs, book flights, invest in financial products and more.
As for financial institutions, the idea is quite similar and requires heavy and long-term involvement in customer’s life and a deep understanding of their needs at a particular stage in life. As we have emphasized before, the bank of the future will not acquire customers, it will nurture them. The approach requires a deep and clear understanding of the tasks the customer is trying to get done and the full suite of services required to achieve that (DBS’ Home Connect , ICBC E-Mall, HDFC Bank’s SmartBuy, Maybank’s M2U Pay Snap & Sell, OCBC Travel Insurance, etc.).
Without substantial investments in tech-powered innovation and revamp of traditional banking organizational culture, it's difficult to imagine a scenario in which banks can expand their market share in the years to come. Traditional players have important strengths to leverage, though, such as rock-solid reputation, the payment and clearing house systems and business networks built over decades and stringent risk management measures.
Those strengths come in handy in uncertain periods of market performance and, coupled with modernization efforts and integration of the latest technological advancements, it will allow traditional institutions to maintain an international monopoly. DBS reports that by 2020, retail banks in the US may spend up to 4% of their revenue on digital initiatives (US retail banks spent $16.6 billion on digital transformation in 2015 and expects this to grow at a CAGR of 10.4% through to 2019).