The digital banking paradox

So too digital banking. How do we create a digital bank? Well don’t start from here. 

"Incumbent banks have a multitude of impediments to being an ideal digital financial institution.” 

Essentially that’s the argument which underwrites much of the discussion about digital banking, fintechs, would-be Ubers and Airbnbs of banking: if you want to be a truly digital bank, you can’t already be a bank.

That’s because incumbent banks have a multitude of impediments to being an ideal digital financial institution. They have multiple technology platforms, some – many – of which are past their use-by date. Their data is siloed, difficult to share, corrupted. Their cultures have not evolved from a true customer focus. They are heavily regulated.

That’s all true up to a point. But it’s interesting to flip these points on their head: are there benefits to being heavily regulated? There are as that is an imprimatur of security and customer protection.

Moreover regulators are becoming more adamant that as new financiers become more important they will also be subject to more regulation.

Multiple technology platforms and a confusion of data? True but what is harder: sorting the data for value or acquiring it from scratch?

Evolved

Banks indeed have been around for half a millennium. They evolved to support communities by securing the excess savings of some in the community and using them to fund the investment ideas of others who lacked funds.

Ideally, banks were trusted to keep the savings safe (using in a big safe in a big building) while properly managing the risk inherent in lending those savings out to entrepreneurs and households.

Groups of banks also built the infrastructure to facilitate payments, from letters of credit through to payment cards and electronic funds transfer.

But a bank is not the only answer to these economic needs of a community and that’s where new competitors come in. ‘Peer-to-peer’ lending, where investors and borrowers come together on a platform rather than via a bank, is now quite familiar albeit still relatively small scale.

Rival payment systems, including cryptocurrencies, are constantly emerging. Non-bank competitors like Amazon are encroaching.

Banks however are not defenceless. Despite the travails of the financial crisis and scrutiny like that from the financial services royal commission in Australia, banks are still trusted as protectors of not only savings but also personal information.

Historically the personal information coupled with historical financial data has delivered banks an almost insurmountable advantage in pricing risk.

Here is another front however: the move to ‘open banking’. The broad aim of open banking regulation, as already in place in the United Kingdom and coming to Australia, is to give customers ownership of that critical data which can be used to price risk. It is then up to the customer to decide who can use it to offer them banking services.

Alas

As eminent competition economist and Productivity Commissioner Stephen King observed at the recent Melbourne Money and Finance Conference “banking it is claimed is facing a period of disruption and uncertainty. Technological advances, it is argued will transform the industry and sweep away old institutions”.

But he went on: “alas, I am here to deliver the ‘damp squib’. Tonight it is my sad duty to say that the banking revolution is not around the corner. While there will be technological change that will improve services and benefit customers, this will be evolutionary not revolutionary”.

It is true new technology, fintechs and particularly open banking will dramatically lower the barriers to entry for new competitors – draining the protective moat around those impressive medieval fortresses the banks have built up through the centuries.

But will they crumble?

This is not the first time banks have been assaulted on these fronts. In Australia, in the highly lucrative mortgage market, new technology and new competitors launched a full on assault in the 90s.

Non-bank mortgage originators (many of them former bank officers) promised more personal service, securitisation brought investors and borrowers together more directly.

The new wave offered prices more than 2 percentage points lower and at one point were writing nearly a quarter of new mortgages. What happened? The existing banks bought some of them, others merged. Some failed in the financial crisis.

Supermarkets, with their superior customer knowledge, have long been seen as potential rivals, particularly in the UK. None of the retailer banks have succeeded.

Amazon, one of the world’s most valuable companies with immense customer data stores, is taking on the banks. As CB Insights notes, “from payments to lending to insurance to checking accounts, Amazon is attacking financial services from every angle without applying to be a conventional bank”.

But long before Amazon, Microsoft looked at the same strategy, buying up participants in bank value-chains and even buying banks themselves.

Of course this time may well be different. The combination of new technology, open data, massive non-bank rivals and customer dissatisfaction may turn the battle. But even when, as with the Australian mortgage originators, a new, cheaper alternative emerged, customers – for a range of reasons from security concerns to the relationship strength to simple inertia – masses of customers remained put.

Not so

Professor King’s argument was fundamentally this. Yes, this time is different but not so different banks will disappear. By making “bespoke” solutions more democratic, open banking will bring consumer benefits. New payments platforms will improve efficiency. Fintechs will disrupt traditional processes. But banks will persist.

“Most fintechs will aim to co-operate with the existing financial institutions, not disrupt them,” he argued. “They will aim to be taken over and have their technology incorporated into the product offerings of incumbents … do not look to the fintech sector to disrupt Australia’s current banking oligopoly.

“So for banking, the uncertainty will continue. But much of the uncertainty will revolve around regulation and product evolution not external disruption.”

In a recent speech Reserve Bank of Australia assistant governor (financial system) Michele Bullock broke the disruption of retail payments down into three categories: new channels, new technologies and new participants or ‘neobanks’. That template applies more broadly with disruption.

She emphasised new entrants are “expected to eventually meet the same requirements as other financial service providers, ensuring a level playing field”.

Banks in the past have not just responded by buying rivals – sometimes they’ve created their own ‘rivals’. In the 90s many incumbents built ‘direct banks’ which offered telephone and internet banking but not branches. One current example is the Israeli Pepper Bank – a distinct offshoot of the established Bank Leumi.

Nevertheless, there are signs neobanks are making genuine headway as this post about the UK situation from Chris Skinner makes clear.

The struggle for incumbent banks is actually more prosaic than hordes of barbarians at the gate. It’s actually getting their own castle in order, shifting to digital, harnessing their own data, better serving their customers.

In some cases – such as data management and use – the answer might actually be to bring in outside experts, by acquisition or partnership, as banks have long done.

Nomads

Consultancy Accenture has looked at the Australian context and identified nearly a third of banking consumers – whom they call ‘nomads’ – are not being served as they want.

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“Nomads make up a significant 30 per cent of Australian banking consumers,” the firm said in its Banking as a Living Business report.

“Mind you, banks still need to service the other 70 per cent of customer types; ‘Hunters’, on the lookout for great deals and who resist online-only services, and ‘Quality Seekers’, who prefer traditional service channels and the human touch,”

While these nomads want a digital experience and are prepared to try banking with Amazon, Google, Alibaba, Apple, Tencent or even Uber (known as GAFA by Accenture) it is the experience and convenience they want – not a particular kind of institution. But that means being properly digital - bank or otherwise.

Andrew Cornell is managing editor at bluenotes