The Quantitative Impact of Digital Transformation

The scale of financial commitment to digital transformation

The evolution of bank-FinTech narrative towards a hybrid model ensures short-term gains in terms of ROI, long-term bets on specific technologies, the FinTech product roadmap being in line with the bank’s own roadmap, etc.

Source: MEDICI’s 2018 Global State of FinTech Report

In their effort to automate more parts of their businesses, about 50% of the world’s financial services firms are planning to acquire FinTech startups in the next several years. About 8 out of 10 institutions foresee making strategic partnerships with P2P lenders, digital money transfer platforms, and a myriad other firms that are reshaping the business of money. A number of institutions start with creating internal innovation engines in forms of API markets, developer hubs and portals — Visa Developer Center, Capital One’s DevExchange Developer Portal, Citigroup’s global API developer hub, BBVA API Market, and more.

Digital transformation touches every aspect of the banking business, with RPA investments alone expected to have a $6.7 trillion global economic impact — a plan that will result in a 40-45% growth of global spending on technology. The estimated global market potential of RPA stands at $8.75 billion by 2024. US banking digital transformation spending is estimated to grow at an annual rate of 22.5% by 2020, with most of the established banks allocating nearly 40% of their IT budget to meet the goals of this digital transformation.

Overall, worldwide spending on digital transformation technologies (hardware, software, and services) is expected to reach nearly $1.3 trillion in 2018, an increase of 16.8% over the $1.1 trillion spent in 2017.

The International Data Corporation (IDC) estimates that the majority of digital transformation spending in 2018 ($662 billion) will go toward technologies that support new or expanded operating models as organizations seek to make their operations more effective and responsive by leveraging digitally-connected products/services, assets, people, and trading partners. The second largest investment area in 2018 ($326 billion) will be technologies supporting omni-experience innovations that transform how customers, partners, employees, and things communicate with each other as well as the products & services created to meet unique and individualized demand. IDC suggests that information will also be an important investment area ($240 billion in 2018) as organizations strive to obtain and leverage information for competitive advantage through better decisions, optimized operations, and new products & services.

Measuring the impact of digital transformation in the financial services industry

Digital transformation touches a variety of business functions in the financial services industry, with the adoption of AI/ML having a profound impact on the way institutions and customers interact, customer experience (CX), the delivery of services, internal operational efficiency, and one of the most critical and costly functions of any national/regional/international institution — regulatory compliance.

CX

IBM emphasizes that customer behaviors are changing at a pace never seen before. Like many other industries, banks face competition from nimbler and more client-centric entrants. With today’s customers expecting a hyper-personalized experience, 89% of enterprises are investing in tools and technologies to improve their CX initiatives.

A study of US banking customers found that 56% prefer more of a digital than a personal relationship with their bank. Among millennials, the number is even higher — 70% prefer to interact with their banks online. AI-powered chatbots and voice applications have seen a rapid adoption to address an increasing need for personalized experiences in a cost-efficient manner.

The mobile-first, digital everything world skews the way institutions sell and cross-sell — 46% of executives expect that more than half of their sales will rely on digital channels within the next five years. Building delightful digital experiences is increasingly definitive of one’s success in the market. However, delightful experiences are not focused on trying to figure out how to sell the same set of financial products in a new interface but rather on figuring out what the customers are trying to achieve and how to enable them to do it best and fast. With that, the delivery channels and the services themselves are actively redesigned to allow customers to perform the necessary functions seamlessly — in 2018 and beyond, payment is a fading experience.

About 29% of smartphone users immediately switch to another site or app if it doesn’t satisfy their needs (e.g. they can’t find information or it’s too slow). By focusing on customers’ actual main pain points, businesses can not only improve the usage of services but also build continuous loyalty with their target audience and significantly improve business metrics. Simply adding necessary features in mobile banking apps may lead to higher usage with the target audience. With the New Dominion Bank, for example, enabling mobile deposits led to a 45% increase in new account openings and a fifth of banks’ customers using the feature.

The mobile deposits feature led to a 10% increase in new account openings for Conestoga Bank and $1.5 million in average deposits made through the feature.

The Mercantile Bank of Michigan saw a monthly enrollment for Consumer Deposit Capture (CDC) increase by 400% with the mobile deposits feature. More than 20% of mobile banking customers were using the mobile deposit feature within just four months.

With the alignment of the business model and the buy-in of the C-suite, Bank of America undertook a user-centered redesign of its process for account registration. Thanks to this re-engineering process, the number of online banking registrations rose by 45%.

Operational efficiency driven by customer-centric service delivery

Some estimates suggest that banks can remove around 20-25% of their cost base by leveraging this digital shift to transform how they process and service. Oracle estimates that chatbots could save $174 billion across insurance, financial services, sales, and customer service.

Chatbots and voice technology are playing a key role in changing the way consumers are interacting with institutions, which results in significant improvement in cost and operational efficiency. A recent study of 34 major banks across several geographies (US, EU, Singapore, Africa, Australia, and India) by MEDICI Team found that 27 out of these 34 banks have implemented AI in their front-office functions in the form of chatbots, virtual assistants, and digital advisors. Across these regions, some of the most prominent banks in this space are Bank of America, OCBC, ABN Amro, YES BANK, etc.

While the amount of intelligence and abilities to communicate at a human-like level have been largely overestimated across industries, intelligent bots do represent a shift towards conversational interfaces, through which businesses can serve their customers 24/7 in the most efficient manner and at a high rate of customer success. BNY Mellon estimated that its fund transfer bots alone were saving it $300,000 annually by cutting down the time its employees needed to spend on identifying and dealing with data mistakes and accelerating payments processing.

Another bot BNY Mellon had in production in 2017 allowed the bank to process trades that fail to be automatically processed on its custody platform because of issues such as incorrect information. The bot investigates the reason for the failure and corrects the issue, cutting down processing times by 30%, according to the bank.

In June 2017, the Royal Bank of Scotland’s bot was answering 60% of the basic questions which, in the past, had to be addressed by humans.

Tinkoff Bank — the first fully digital bank in Russia that has about 7 million clients — converts 100% of incoming calls into text using Israeli NLU technology that it went on to develop for two years after the purchase. Oleg Tinkoff, the Founder and controlling shareholder of Tinkoff Bank, claimed in 2017 that the bank’s NLU tech surpassed Siri in its accuracy of speech recognition and understanding. Right now, the bank fully automates 20% of customer interactions using AI and NLU — no human intervention happens — saving 720 hours/month for the customer service department.

According to Oracle, by 2020, 80% of brands will use chatbots in their interaction with their customers.

A heavy shift towards building increasingly human-less yet hyper-personalized fully digital experiences brought the financial services industry to a whole new generation of digital-only banks — incumbent and challenger. It appears that operating banks with zero branches place digital-only banks on the upper end when it comes to offering better deals to customers, creating a uniquely differentiated CX; physical branches are estimated to cost banks $4 per transaction on an average, while PC and mobile banking cost $0.09 and $0.019 per transaction respectively. In fact, about 78% of the time that customers spend on offline banking services is wasted. It’s as big a loss for the customer as it is for the financial institution.

Regulatory compliance

Banks globally are now spending in excess of $270 billion per year on compliance and regulatory obligations, having 10–15% of their staff dedicated to compliance on average. Large US and European banks are spending as much as $20 billion a year on technology to help them comply with the newly evolving regulations such as MiFID and PSD2.

Compliance costs for FIs amount to substantial parts of total expenses, with a negative correlation between the size of the institution and the percentage of total costs. While banks with assets ranging from $1 billion to $10 billion reported total compliance costs averaging 2.9% of their non-interest expenses, banks with less than $100 million in assets reported costs averaging 8.7% of their non-interest expenses. Fines levied on banks by US and UK regulators will top $400 billion by 2020.

Regulatory compliance is one of the most critical and resource-consuming functions for institutions. Since 2008, there has been a 500%+ increase in regulatory rule changes, and with increasingly complex regulatory environments, 300+ million pages of regulatory documents will be published by 2020 and 600+ legislative initiatives need to be cataloged by a medium-sized sell-side institution in order to have a holistic view of their rulebook. Analysts today spend 90% of their time only on data collection & organization and only 10% on data analysis.

Meanwhile, investments in regulatory software can lead to an ROI of 600% or even more with a payback period of fewer than three years. What does the digital transformation in regulatory compliance function exactly mean for institutions?

Arun Iyer, EVP of Hexanika, estimates that implementation of RegTech solutions can lead to significant cost savings (upwards of 40-50%) when revenues and margins are under pressure as a result of reduced manpower, lower cost of technology, and improved decision-making.

Fenergo, for example, a provider of client lifecycle management software solutions for investment, corporate, and private banks, shared a case study demonstrating the opportunities regulatory and compliance software opens for institutions. For Fenergo’s global investment banking client, the manual and highly inefficient KYC client review process was accumulating to thousands of hours of interactive (fully engaged) time to complete. On average, it took 27 hours to complete the KYC review process for one medium-risk client. And that calculation did not even include the additional elapsed time for review, the time it takes for clients to respond to the financial institution’s request for additional or the updated data and documentation. With 2,500 to 3,000 clients classified as ‘medium risk,’ it meant that the KYC client review process for medium-risk clients took between 67,000 to 81,000 hours to complete for that client.

The implementation of Fenergo’s rules-based workflow platform resulted in a 37% improvement on case-handling time and efficiencies for the medium client risk category alone. This reduced the average handling time for each case from 27 hours to 16.47 hours each, shaving off a cumulative average of 27,380 hours in total for the medium risk client category for the investment banking client.

IBM is another very interesting frontrunner. In a January 2018 report that covered a variety of real-world cases studies with results to demonstrate the material benefits its software brought to various clients across use cases, a couple — examining the effect of IBM OpenPages® GRC Platform, the company’s governance, risk, and compliance solution — are particularly interest.

The first example is IBM’s work with HypoVereinsbank (HVB), a member of UniCredit, a major financial services institution headquartered in Italy. One of the leading players in the German banking market, HypoVereinsbank employs more than 12,000 people across around 300 branches nationwide.

With the goal to reduce the risk of losses, improve processes and controls, and protect its reputation with customers and regulators, HVB set out to streamline its risk and control assessment processes. By using IBM OpenPages software, HVB was able to automate reporting processes and simplify tracking for over 3,000 internal controls. As a result, HVB saw 33% reduction in personnel requirements thanks to better use of existing resources, as well as increased efficiency through automating risk & control self-assessment processes, and gained the ability to gain new insights into risks and controls helping to identify gaps and resolve glitches quickly.

Continental is another interesting case covered by IBM. The company develops intelligent technologies for transporting people and their goods. In 2016, the corporation generated sales of €40.5 billion. Continental employs more than 220,000 people in 56 countries. In other words, it’s a massive organization with risk, governance, and compliance being the top operational priorities.

For Continental, the challenge requiring a solution was to gain insight into areas of exposure across its subsidiaries worldwide in order to steer clear of business risk and to come up with effective ways to mitigate the threats. Using IBM’s risk, governance, and compliance platform to perform broad-scale risk assessments across its worldwide operations, Continental saw 75% fewer risks assessed at the Corporate Level, as minor threats are addressed at a lower level. Moreover, Continental was able to consolidate six risk management processes and four systems into a single solution.

While IBM is major league, there are defining moments for RegTech industry startups that have cases on their accounts as impressive as the tech behemoth. Ayasdi is one of those companies.

At the end of 2017, Ayasdi shared the results of its work with Citi — an institution that, as a reminder, operates in 98 countries, facilitating more than $4 trillion in flows each day, holds over $950 billion in deposits, and has over $620 billion in loans across their institutional and consumer businesses. Citi consistently struggled to pass its annual stress test with the Federal Reserve, failing two of the first three stress tests. To address the issue, Citi chose Ayasdi to supplement its capital planning process. The process began with the leaders of the bank’s business units reviewing the macroeconomic variables stipulated by the Federal Reserve. Aysadi enriched these variables using several techniques and created over 2,000 variables. Furthermore, the ML-powered software was used to correlate and analyze the impact of these variables on each business unit’s monthly revenue performance over a six-year period, uncovering statistically significant variables that were highly correlated with each business unit’s performance. The exercise allowed the bank to easily clear their most challenging regulatory hurdle. More importantly, the process compressed the resources required for a nine-month process requiring hundreds of employees to a three-month sprint with less than one hundred employees.

There are many more interesting cases where particular applications of RegTech solutions had positive quantitative implications for institutions in a variety of compliance-focused functions, such as governance, e-KYC/AML/CFT, data management, fraud monitoring and control, digital identity, risk management, etc.

For example, headquartered in the Netherlands, the Rabobank Group, which operates in 40 countries and serves ~10 million clients, looked at Accuity’s Compliance Link Trade Finance solution. The lack of a common, integral system for vetting trades across the Rabobank Group made it difficult to identify and understand what checks had been made, on which shipments, and when. It was also difficult to track the information and reasoning used in the decision-making process; not being able to demonstrate these checks and the associated rationale to the regulators was a core concern.

This lack of audit and proof did not correlate with Rabobank’s compliance team’s goal to ensure the bank was meeting all the necessary standards to manage their risk effectively across all parts of the organization. Since implementation, Compliance Link’s Trade Finance Module has been reported to increase operational efficiency, reducing 15-minute checks down to three minutes. By redistributing the workload with a clearer and more efficient process, the compliance team was able to focus on more important tasks, such as expediting trade bids and prioritizing customer satisfaction, while effectively and confidently serving and operating in some of the world’s most complex jurisdictions.

Seeking to manage operational risk and controls efficiently, HypoVereinsbank, for example, uses IBM OpenPages Governance, Risk, and Compliance (GRC) to evaluate its controls along processes across all departments. The bank performs internal audits of all process controls once a year, examining around 3,000 controls across various processes each time. The bank saw a 33% reduction in personnel requirements thanks to better use of existing resources and was able to obtain insight into risks and controls to identify gaps and resolve glitches quickly.