Competition within the banking industry has never been fiercer. The days of traditional banking are gone. Social networking, alternate payment systems, peer to peer lending and non-bank financial institutions are all changing the business of banking, redefining intermediation. Examples include payments and financial-supply-chain solutions (Square; Tungsten), financing (Google-backed OnDeck Capital; Amazon), and foreign exchange (OzForex). These new entrants are using technology to deliver very low-cost transaction based financial services that can be scaled rapidly on shared platforms. Without an efficient architecture platform traditional banks have to transform to stay in the game. But the majority of tier 1 banks are still tied to legacy systems and worry that moving to modern system means high risks and continue to build on old architecture. However, lessons from new non-bank financial institutions in the micro banking sector may provide some insights. Microfinance institutions are citing higher returns on equity at three percentage points above the average for the entire industry in the last four years.
Mass need equals mass benefit
Transaction costs define the customer for traditional banks. This has kept mainstream banking fighting it out for the 0.8 to 1 billion consumers who earn >$15.000/pa and providing only payments services for 1.5 to 2 billion consumers who earn $3K $15K/pa. The rest, the 3 – 4 billion people are either not served or are underserved by formal finance. This mass market is the world of microfinance.
Microfinance has over the past 30 years taught us that the poor pay their loans and are good reliable customers when banks provide quality services, at a transaction fee that is sustained by the business of the customer. However, there are still 2 billion people on this planet not served at all! This represents a huge global market for financial institutions that have the capacity to change and take advantage of the opportunity to serve the global demand for financial services closer to the bottom of the economic pyramid.
But with growing competition from non-banks, particularly in areas where high profit/cross sales opportunities can be found e.g. payments, forex, remittances and micro-loans etc. the future is very uncertain. With shared services and critical mass achieved through social networks and Internet based services, prices are dropping. In addition, the cost of one additional account, unit or virtual branch (tenant) is also dropping dramatically, increasing price competition for traditional banks that carry the cost of owned infrastructure and legacy systems. As a result, it is quite possible that many banks may be forced to retreat from retail while more adept network based players take advantage of the value added business and payments and reap the associated benefits. To avoid being left behind banks must run on an efficient, flexible system as a matter of urgency.
Microfinance equals mass-market retail. Microfinance customers all need to pay bills and have access to basic finance like any other person. Financial inclusion is about banking business at a lower cost point. Large volumes of low value transactions as opposed to low volumes of high value transaction. Solutions have to fit the culture and circumstance of the mass market in developing economies. Last mile technology is used to extend the flexible and adaptive product and service delivery mix available on modern open core banking systems such as T24. Microfinance has learned hard lessons and is no longer trying to build systems. It has realized the efficiency in acquiring the right package solution and accessing highly adaptive and scalable technology. The importance of a platform for best of breed solutions to extend services to the client where the client lives and works without building physical infrastructure. Mobile solutions and leveraging off existing infrastructure and relationship through agency banking meets the client half way; dropping the costs of engagement and exploiting the efficiency of scale with network based banking platforms.
Off the shelf can also mean flexible
It is important that microfinance institutions are able to exploit the capabilities of enterprise level software being used by large-scale institutions and commercial banks. They must be able to offer clients a wider range of financial products, and provide management with information necessary to manage risk and opportunity. Small financial institutions need sophisticated enterprise level banking technology to cater to the ever-changing requirements of the retail client and provide the transparency required by regulators. This technology is needed to better understand profitability and financial risk through the provision of timely data and management information.
Packaged solutions now offer highly pre-configured options including the features, products and reporting specific to microfinance and community banking. This supports the specific operational and processing requirements of organisations engaged in retail, community and microfinance banking in emerging markets: micro lending institutions, smaller retail banks, large commercial microfinance institutions and global networks of financial intermediaries and credit unions.
Shared costs, efficiency ensured
Microfinance takes on the challenge of transaction costs. It therefore comes as no surprise that microfinance institutions were one of the first types of financial institutions to adopt a software-as-a-service model (cloud) for their 'model' core banking systems.
A cloud model is proven to directly translate to less upfront, capital expense and reduced IT overheads. IT operational spending can also be reduced through a cloud approach. Staffing costs in the IT department or for outsourced IT Support for deploying, operating and maintaining applications and underlying infrastructure can be extremely expensive and many of these costs are greatly reduced in a cloud environment. And a cloud approach can reduce IT support costs; in downtime and in human costs of diagnosing and fixing problems. Through the Internet both the support team at the cloud core-banking provider and the bank can be logged into the system, looking at the same screen/data/problem at the same time. However, operational issues with cloud solutions are rarely a concern; a cloud core-banking solution should be exceptionally robust because cloud solution providers cannot afford service failure, and therefore quality is a priority.
In addition, continual software upgrade fees, replacing outdated servers and other variable costs are virtually eliminated with cloud computing. Most banks that have moved to the cloud greatly appreciate the consistency and predictability of paying a fixed monthly cost for their IT needs. A bank should only pay for the services they use and with cloud core-banking solutions being updated automatically as the upgrades become available and when these upgrades occur, there is no downtime or added cost for the bank.
Applying the model outside of microfinance
Microfinance is all about efficiency. It has to be; a microfinance customer doesn't respond to traditional banking marketing. They purchase based on ease of access and relationship. The same as millennials in more advanced markets. In the fast moving world of payments and social networks people have the ability to source financial services from a multiplicity of different sources. Financial services are about convenience and can be switched instantly.
With 33% of millennials stating that 'they won't need a bank at all in 5 years time' it has never been more relevant to rethink your business and prepare to compete in a new world of lateral networks and non-banks. A pre-configured core-banking "service" in the cloud does not suit all but for those entrants that want 'in' without having to invest in infrastructure it may be the solution to power new ideas. So learning from the 'underdog' may eventually enable you to become 'top dog'.