Introduction
The term digital finance immediately brings to mind a marriage of complex electronics/software/computer technology and financial products. This topic is much broader in scope and its study requires a multifaceted holistic analytical approach. In this book we cover all these factors to present the reader with a comprehensive pictureâstarting with the socio-economic factors in the last decade that led to the growth of this field to the developments in the fields of artificial intelligence and the evolving legal/regulatory framework to deal with the developments.
It must be mentioned that the Financial Services Industry (FSI) was gradually stabilizing after the 2008â2010 crisis. It was at this stage that certain basic socio-economic policies underwent a radical change. Coupled with such changes, the technology developments made the tasks extremely difficult for them particularly in the USA.
In our discussions, we will give examples or provide information about the experiences or developments in various countries. This is primarily due to the fact that this is a rapidly evolving field and no country provides a unique answer about the various developments. The reader who, in all likelihood, is primarily leading the team involved in planning for the digital future of his organization will find that the answer lies in a thorough study of these aspects with a special focus on factors unique to his country/organization.
It is likely for example, that a senior executive of a Public Sector Indian Bank may be more worried about the issue of Non-Performing Assets and the possible write-downs than the problem of crimes committed using connected devices such as mobile phones and the issues of computer resource loads and balancing with the advent of Internet of Things (IoT). Such an attitude would be dangerous as the nature of digital/electronic transactions lends them to exponential growth and in a short order what appears to be a trickle of a few thousands turns into a flood of millions. The example of mobile phones and their rapid acceptance in countries where a landline telephone was a luxury only a few years back is a good example of this phenomenon.
To give an overview of our analysis in this book, we start with the socio-economic conditions in the Western countries that led to several developments and significant changes in the working and regulations of Financial Institutions. We follow that with a comprehensive review of the various technologies, the Internet and associated developments. Next, we review the impact of these technologies on Banks, Insurance companies and Brokers. A thorough look at the various cyber-laws, crimes, and the associated risk management is followed by a discussion on the overall risk management practices and developments. We study the impact of all these developments on Human Resource management and how the operations and marketing function will evolve. The final chapter will review the changing regulatory scenarios for Financial Institutions.
How it Got Here
During the last ten years, the Financial Services Industry was caught in a great flux. No doubt, part of it happened because of indiscriminate investments and excessive borrowings. Had it not been for a massive pumping in of funds (tax payersâ money), the industry could not have even survived. A great catastrophe was averted because of this timely intervention by the Governments and Central Bankers. True it is, that the institutions were saved. Serious students of the financial scene have raised doubts about the efficacy of such methods in the long run. Their main complaint is that it is not certain that such measures benefit the ârealâ economy! Questions like "Could only some parts like affording protection to the depositors have been more useful?" have no easy answers. We must, however, add that no government can allow the majority of Financial Institutions to be crippled.
The crisis that enveloped the industry took many by surprise. It is indeed unbelievable for an industry which had a great deal of stability and a very stable business model. Its customer base was very well nursed and many of them were known to the banks/insurance companies through their association going over generations. The author distinctly remembers a function which he chaired to felicitate customers having their accounts with the bank from 1908 to 1983. Some of them proudly announced that their accounts existed when the chairman at the meeting was not even born. Perhaps, the bankers of those days were known not only for their functional specialization but also for their âfamily physicianâ like position. It, therefore, came as a rude shock when the very existence of the financial industry was in question and the trust relationship built over a period of time was blown to pieces.
The Financial Services Industry went through a very difficult period during the years 2008â2010. It would not be wrong to say that had it not been for the massive support extended by the Governments and Central Banks there could have been a systemic collapse. There was a certain price to be paid for the assistance extended. The regulators wanted the Banks/Financial Institutions (FIs) to adhere to certain capital norms, and also strictly to adhere to quantitative restrictions on activities. Banks were also required to review their Risk Management practices, Corporate Governance systems, Bonus and Reward systems, to name only a few. In a sense these changes cold easily be initiated and completed since the steps required to be taken were solely within their own âjurisdictionâ and very much under their control.
The banks and insurance companies were faced not merely with regulatory and compliance rules but it was also becoming clear that there were equally complex and important issues that had to be handled before there could be a semblance of normalcy. One of the issues of great significance for Financial Institutions pertains to the customersâ loss of trust in the Financial Services Industry and to an extent even in the wider social ethos. The fact that the bankers paid themselves hefty bonuses after the crisis did rankle with various social groups and the resentment was expressed through public demonstrations. Nearly 40% of the existing customers closed their accounts and the newer customers did not mind shifting their accounts or demanded a reward for sustained relationship.
The income inequalities, which were becoming a noticeable feature of the emerging social strata looked like applying salt to the wound and fueled the resentment further. Surveys showed that a number of people openly gave vent to their feeling and maintained that they had very little faith in their financial service provider. [we the 99%]
The growing use of the Internet, emergence of Google, Apple, Facebook, and Amazon (GAFA), and social media were impacting the way the social and economic activities were being conducted. Advances in the use of computers, development of sophisticated algorithms, and robots are rudely shaking up the manual work practices in banking and insurance industries. The technological advances drastically modified the banking needs and the ways to meet them. Retaining the customers was becoming difficult against the onslaught of Financial Technologies (FinTech ), and disruption by new competitors who were invading the FIsâ turf. We would, in the next chapter, describe the FinTech attacks and its impact on eroding the FIs customer base. Briefly put, the FinTechs were attacking the soft underbelly. FIs had to bear a heavy cost burden in complying with the regulatory requirements. The FinTechs had no such need as they did not have regulatory oversight. It would be useful to briefly touch on the competition which FIs have been facing. Unlike in the past the competitors were no longer other FIs but tech savvy companies with a large customer base, very deep pockets, and highly innovative technical expertise. In the USA these could easily be identified as GAFA. In China, we have Alibaba and Ten Cents. They could undertake not only transfer of funds and payments but also lend moneys to customers. These conclusions were arrived at after extensive discussions with bankers, consultants, and those connected with the industry. It became clear that the products offered by the banks could easily be unbundled and the competitors could do cherry picking and âdisruptâ the profitable segment. We could briefly draw the following conclusions.
- 1.Innovations in Financial Services are deliberate and in the short run somewhat predictable
- 2.The innovations have greatest impact where they employ business models that are platform based, data intensive, and capital light
- 3.The major impact would be felt in Banking and Insurance
- 4.The incumbent institutions will employ parallel strategies: aggressively competing with new entrants while leveraging existing assets
- 5.Collaboration among regulators
- 6.Such disruptions will not be a one-time affair but would be a continuous pressure to innovate that will shape customer behavior and business models and long-term structure of Financial Services Industry.
It would be seen that the sector is at cross roads. It has certain options. It could take over the FinTechs if possible. The road it takes would depend on where it wants to go. Should the banks close their branches? Should operations be fully digital? In case it was decided to have some branches how should they be manned? Should branches be replaced by Apple stores like entities? Still more complex issues pertain to the transition phase. How do we bring about these changes? Managing the transition is by no means going to be easy.
It would be useful to clarify the way in which we would examine these issues. We would be looking at them from the point of view of a corporate planner. A corporate planner looks at the years gone by and ahead, for the next few years, covering the plan period. Such an approach has two advantages. Firstly, it is firmly rooted in the broad organizational context. Secondly, the balance sheet implications of such proposals have to be kept in mind.
At the moment there is a great uncertainty about the future. The speed with which changes are coming could well be described as hectic. One could make guesses about what the industry is likely to face but the skill lies in anticipating when it would happen. A planner has to take the plunge. The old stars have died, but no new ones are seen.
Many of the macro assumptions which one could take for granted prior to 2016 cannot be considered valid. Deregulation, liberalization, and globalization were the basis for policies pursued for over the past thirty years. They were discarded by many governments. As if this were not enough, the Financial Services Industry had to cope up with political and economic changes arising from the emergence of the so-called nationalist policies. Such policies are today being followed by the USA, UK, and to some extent Austria, Italy, and so on. Even in countries like France and Germany, advocates of such policies seem to be emerging stronger and are trying to bring in such nationalist policies to the extent possible. It is always difficult to summarize the diverse currents that engulf the industry. We have therefore taken recourse to a somewhat archaic method and used the âOracle of Delphiâ technique. Such studies comprising surveys of CEO opinions and views of consultants and leading accountancy firms like PricewaterhouseCoopers (PwC), KPMG, and Ernst & Young (EY) highlight the important currents shaping the socio-economic environment. One could then draw some useful conclusions for oneâs organization based on the areas of strength and weaknesses.
This book examines all these and tries to generalize about the ones which could affect the industry both in the short run and in the long run. These are not mere academic exercises. One has to take decisions, commit resources, and chart out a course of action. At the same time, one would have to be nimble and be ready to modify/change a chosen course of action. Further the policy options and required responses can be diametrically opposite because the policies implemented by various countries and their governments can be as diverse as can be. We could best illustrate the point by referring to the regulatory scene. The costs for regulatory compliance are ballooning. They would assume considerable importance for the profit and loss account. The real impact is on the operations and the way the business carries out its activities. But currently in the USA the emphasis is on dismantling the regulatory and supervisory apparatus. In the UK supervisors are insisting on stringent regulations. Sam Woods, Deputy Governor and Chief Officer, Prudential Regulation Authority, in his speech at the Mansion House, stated that whatever the future shape of things to come the financial system must be robustly regulated.
The attempt is to see how these problems are met and the difficulties are overcome. Customer needs are no longer the same as in the past and considerable changes have to be made to satisfy them. In the first three chapters we consider the challenges that are coming up and later examine which route the Financial Services sector would take [or has followed] to meet these challenges to bring about a harmonious and symbiotic relationship between the staff and the new Artificial Intelligence (AI) driven performers, like robots. The FIs are going to be called on to serve previously excluded segments from the banksâ customer base. In a sense, countries like Kenya and Sub-Saharan countries have shown how even, or perhaps because of a weak financial structure, FinTechs have replaced the banks and have made a significant dent on their profit-making segments.
Various scenarios have and can come up. One such scenario could be a merger of FinTech companies and the existing FIs. The FinTechs are agile, innovative, and not burdened by legacy systems. The FIs have capital resources and a captive customer base to couple these activities and to serve the customers. The customer profile is changing. The customer is not only tech savvy but also wants services 24/7 and from any place. Bankers have to see that they can meet these ever-present challenges thrown up by their competitors.
We would at this stage consider two problems which the FIs had to deal with immediately after they had come out of the crisis. In the immediate aftermath of the crisis, and till about 2016[prior to the Trump era] they had to meet the myriad regulatory requirements that had been imposed. Coupled with the fact that they would be subjected to stress tests was an arduous requirement. In the uncertain world in which FIs operate, this was an extremely difficult imposition. Secondly, the FIs had to prove that they did take their responsibility as trustees and custodians very seriously and that utmost care had to be taken for safeguarding the resources entrusted to their care. Deposit insurance is a mere token and is not a substitute for what that trust could achieve.
Even though this was something within the control of the management, it required a clear examination of their own weaknesses and policy drawbacks. It could also highlight the performance, management policies for rewards and bonuses! There was a public outcry against the bonuses paid particularly since it was clear that the FIs were surviving because of the taxpayersâ funds that were made available for rescuing them.
We have made a bare bone analysis of the then prevailing situation because very few management teams show the courage to own their mistakes and to take remedial steps. We have experienced such situat...