The Digital Banking Revolution

How Fintech Companies are Transforming the Retail Banking Industry Through Disruptive Financial Innovation

Luigi Wewege, Michael C. Thomsett

• Publisher: De Gruyter
• Year: 2019
• ISBN:
  9781547401611
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

Emergent innovative financial technologies are profoundly changing the way in which we spend, move and manage our money, unlike ever before, and traditional retail banks are facing stiff competition. The global financial crisis in 2007–2009 led to large losses, and even the collapse of a significant number of established banks shaking the trust of financial customers worldwide. The Digital Banking Revolution is an insightful look at how financial technology and the rapid rise of financial technology companies have brought welcome changes offering flexibility to the banking industry.

The book offers a unique perspective on the consumerization of retail banking services. It delves into the many changes that financial innovations have brought about in banking, the main financial disruptors, the new era of "banking on the go, " and financial innovations from countries around the world before concluding with a discussion on the future of banking including optimizing structures, new strategies for business outcomes, and human resources in the digital era.

Chapter 1 Introduction

Banks have always fought to gain absolute power and market share, knowing their competition and serving a marketplace that had relatively few alternative choices. However, the battlefield is changing as financial technology advances and new players emerge. Today, financial customers have become restless, demanding more from their financial service providers than ever before. Many retail banks around the world have now reached a pivotal moment in their history, and they need to transform through financial technological advancements to stay relevant, or risk the possibility that agile financial start-ups could confine them to a limited utility role. This challenge comes at an inopportune time for retail banks just as industry profitability is stagnating and customer loyalty is becoming even more tenuous.

Regional banks experience an average of 11% attrition overall, and as much as 20–25% for first-year accounts. One study by consultants Bain & Company concluded that on average, 29% of regional bank customers would change banks if it could be done easily. In fact, the time and effort involved in switching banks is an outstanding reason that many customers do not switch banks.¹

At the same time, regional banking is growing quickly, adding fierce competition to the market, with rapid change continuing to intensify. For example, with narrowing spreads between long-term and short-term lending, profits are being squeezed and regional banks are being forced to streamline their cost and expense levels.²

These banking trends are not the same as those of the distant past, when growth had everything to do with increased customer accounts and savings rates. Today, dominated by fintech trends, banking has changed completely.

To illustrate how rapidly new technology can transform an industry, consider that it took just 18 months for Google to erase 85% of the market capitalization of the biggest GPS companies in the world after the launch of its Google Maps app. Alibaba, China’s equivalent to Amazon, became that country’s largest multinational holding company only nine months after entering the market.

These examples show how today’s technology-enabled disruptors can dramatically change markets in a short period. For many, the first real disruptor to enter the banking sector in the current era was PayPal. Initially, traditional banks treated PayPal as an annoyance, limited to eBay and with little potential to disrupt the highly lucrative and bank-dominated payments industry. How wrong they were. At the end of 2018 it had $15.45 billion in revenue, and was more valuable than its parent eBay, which booked $10.75 billion in revenues in 2018 and has been growing at about 8% per year.³ PayPal revenue for 2019 are estimated to grow to $18 billion. Average revenues are growing at 18% per year.⁴

PayPal has paved the way for the payments space to be transformed, with popular retailers having also shown remarkable success moving into payments. It’s all about convenience and speed. Banking under the PayPal model doesn’t even require leaving home; and it doesn’t end there. For example: the Starbucks Rewards loyalty program handles 30% of the company’s United States-based transactions, and 1.9 million new customers signed up to the program in 2018.⁵

These trends are symptoms of what is occurring in the market today, and of the role technology is playing. Previously, a tight regulatory environment acted as a barrier to entry for those who wanted to access the banking industry, but today these barriers have become more relaxed. To illustrate, PayPal has been a licensed bank in Europe since 2007, and Facebook, which has more than 250 million users in Europe, was authorized in late 2018 by the Central Bank of Ireland to handle payments across the entire European Union, through its service, Facebook Pay.⁶

Other new entrants that have grown rapidly without the need for regulation include Google with Google Pay, TransferWise, and SimplePay.⁷ Many of these nonbank financial institutions have all relied on similar “white-label” services, such as those offered by The Bancorp, Inc., which is able to provide regulated banking services to its clients’ customers. This is accomplished through the development of internal regulatory systems, designed to protect customers without the need for outside oversight. The CEO of The Bancorp explained this concept in 2017:⁸

As new core team members, these individuals bring game-changing experience to us in the operations and risk management arenas. Their demonstrated, senior-level track records in large, complex institutions give us a greater capacity to reengineer our platform. We have now attained critical mass in our management talent, and are poised for the next phase of transformation that will enhance our platform for clients and spur us toward innovative growth.

Damian Kozlowski
CEO and President

In today’s digital world, winning and retaining customers hinges on creating value to enhance convenience and quality beyond mere financial transactions. This marketing strategy is embraced by major digital players such as Apple, Amazon, Alibaba, and Google. For retail banks, this requires a dramatic shift in strategic focus from being a provider of financial products and services to becoming a provider of solutions. Banks cannot respond to these threats by simply being more technologically advanced or reducing the number of branches they operate, but by rolling out better mobile and online banking services.

What banks need to do is first defend their competitive position and learn how to play a greater role, not just at the exact moment of the financial transaction but before and after it as well. For retail banks to regain control in this era of digitization, as well as succeed in an increasingly competitive market, they will need to outsmart and outmaneuver the new financial disruptors, primarily smaller banks growing into a regional presence or new start-up banks.

Disrupters are flexible and able to move quickly. Their products have expanded as well, far beyond traditional banking. These disrupters offer insurance, consulting, financial planning, retirement and estate services, and more. This new range of “value chain” products are competitive with regional banks.

One of the greatest disrupters is the new banking system itself. Banking services are now being provided by the “sharing economy” in which information technology and decentralized assets are replacing traditional banks.

Even blockchain is surging in the banking industry. Though many of the numerous blockchain companies will not likely survive, those that do will compete directly with banks on all levels. The digital economy is becoming the mainstream economy, but many old-style bankers have not recognized this trend.

To the extent that blockchain companies will be able to provide resources for customer service, operational efficiency, and the use of big data, the digital revolution potentially may crush many regional banks, if not others spanning the entire industry. In this new economy, customer intelligence—values held by a bank’s customers and priorities in service—may become the greatest driver of revenue and profits in the future. The digital banks today have access to more information about customers than brick and mortar banks ever had in the past. Simply stated, this is a profound competitive advantage.

Beyond these market advantages, digital banking will employ robotics and AI to further reduce costs and create even more market advantage. The combined capabilities under this model include analysis of emotional intelligence, logical reasoning, self-supervised learning and training, and pattern recognition that no bank teller will ever be able to duplicate.

Infrastructure will also be remodeled and become dominant, through cloud-based processing. Many institutions already use software-as-a-service (SAAS) for traditional processes such as HR and financial accounting. But this technology is exploding and will quickly dominate consumer payment processing, credit scoring, billings, and current account tracking.

These revolutionary changes will require increased cyber-security, and many institutions already are addressing this. It will take time, however, due to cross-border data transactions, complex new technologies, use of third-party vendor services, new security threats, and the increased use of the internet of things (IoT).

Although this new digital reality is moving quickly, the range of threats facing retail banks is daunting. Figure 1.1 outlines the biggest challenges threatening banks’ ability to grow at present in the US marketplace, the world’s largest. The remainder of this introduction will focus on the elements of Figure 1.1 as they affect the US—which is highly regulated and well developed, with local banking being the norm. We will look at how these elements will affect the rest of the world in detail later in the book.

Source: Bank Director © September 2015. The Financial Brand.

Figure 1.1: The biggest challenges threatening your bank’s growth.

To explore these challenges in more detail, the following sections explain and compare the digital challenges that banks face specifically in the US, but also in the rest of the world.

Regulatory Compliance

Many relatively new reforms and regulations were introduced following enactment of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Now, nearly a decade later, many lawmakers and regulators are taking another look and identifying sections of Dodd-Frank that could be rolled back or softened. At the same time, some members of Congress have encouraged the House Financial Services Committee to preserve regulations. In other words, it is not certain whether regulations will be amended or kept in place in coming years.

Competition from Other Banks

Most economists believe that competition is a positive force in banking. Regional banks are figuring out how to become more competitive in the years following the 2008–2009 problems in the financial sector overall. Some have learned that it is possible to compete by partnering with fintech companies, developing lending networks to provide alternatives to customers, and building revenue-sharing systems so that banks are able to cooperate with one another rather than compete head to head.

Regulation from the CFPB

The Consumer Financial Protection Bureau (CFPB) enforces a dizzying array of regulations in its oversight role for banks. Compliance demands considerable time and resources.

Within the CFPB’s jurisdiction are equal credit opportunity rules, home mortgage disclosure requirements, electronic funds transfers, fair debt collection practices, licensing of mortgage loan originators, disclosure rules for banks not offering Federal Deposit Insurance, rules of practice, fair credit reporting, real estate settlement procedures, truth in lending, and truth in savings, among others.

CFPB regulations go even further, imposing and enforcing regulations about policies and procedures, records, equal access, disabilities, rulemaking, investigations, and official notifications.⁹

Becoming More Efficient

Regional banks have recognized the need to become streamlined and efficient organizations. In an effort to cut costs and enhance profits, regional banks need to critically address several issues. These include optimizing service delivery and even determining whether the number of physical bank branches makes sense. If branches are not profitable, they can be closed. Past standards that “more is better” were based on the assumption that future profits required having more branches, but today this standard does not always make sense.

The application of new technology and improved internal processes also improves efficiency, but past systems, including limiting a labor force, are not as ...