“If the rate of change on the outside exceeds the rate of change on the inside then the end is near,” Jack Welch, the former Chairman and CEO of General Electric, famously once said. Nearly 20 years on, this observation seems more and more applicable to the banking industry.
Since the global financial crisis in 2008, banks have faced a perfect storm. Historically, they would have recovered the 6 percent loss in Return on Equity (RoE) in the few years following 2008. The fact that this hasn’t happened is due to two factors; regulatory changes that have resulted in more capital being needed for a certain volume of business, and a fundamental shift in technology.
Technology has created a new norm. Start-up companies, often referred to as fintechs, have attracted significant investment venture capital, and have entered the market offering technology-led and customer-centric banking services. These offer a superior customer experience, low (or zero) fees, and a simple product set targeted at delivering customer value. They are able to do this by integrating data driven customer and mobile first technologies. Barriers to entry are almost non-existent, bringing Bill Gates’ 1994 statement that “banking is necessary, banks are not,” closer to reality. While banks need to respond to this shift in the landscape, investments in technology offer almost the only way to return to pre-2008 RoE (Figure 1).
New way forward
All is not lost for banks, but big changes within them tend to be longer term. Banks still have millions of customers keeping their money with them; they are also regulated, and this reassures customers their money is safe and that they will be treated fairly. Bank executives also understand the nature of providing services on a continuous 24/7 basis, which is what customers need. Nonetheless, banks must respond to the ongoing shift in customer requirements, and quickly, so that they can take advantage of the opportunities it offers, as well as the threats it introduces.
This is where digital banking comes in. But digital banking is more than just developing a mobile app and connecting it to the bank’s existing back-office applications. The ability to conduct transactions over mobile and internet channels are pre-requisites for doing business today, but they are not differentiators and do not allow banks to use the lessons learnt from fintechs.
A modern digital bank, as demonstrated by new start-ups globally, can expect to achieve – on average – 25 percent less from a cost-income perspective than traditional banks, which are incumbent in the same market. To achieve this quantum leap in lower cost and higher revenue requires a re-imagining both of the customer experience and bank operational processes. This involves very high levels of automation based on data-driven and highly integrated front-to-back application technologies.
Open banking has the potential to tighten the competitive noose even further as customer relationships and their data becomes available to third parties, even as customer data privacy becomes more important and high profile. Collaborating with third parties has the potential to recover another 6.3 percent points in RoE by establishing an ‘ecosystem’ platform that taps into new business models. Highly complex, fractured legacy environments designed around lines of business and products, supported by significant manual intervention, are simply not fit for purpose in 2018.
To transform into a truly digital business, an integrated front-to-back data-driven banking platform is the foundation. According to Celent, banks currently spend somewhere between 70 percent to 80 percent of their IT budget on the maintenance of their current systems, just to keep them compliant and operational, leaving 20 percent to 30 percent for innovation. But this does not support participation in a fast moving and competitive landscape.
One approach is to create a separate ‘digital challenger’ bank, which eliminates the constraints imposed by existing complex legacy technology, as well as the legacy internal mindset of how banking should be. Freed from these constraints, a bank can focus on the customer and the value that can be delivered using integrated customer-centric applications and embedded analytics to drive a relevant contextual customer experience and smart automated operations.
This is called a ‘build and migrate” strategy, creating a parallel digital business environment into which the bank can then migrate its customers, employees and other stakeholders over time. This puts the customer at the centre of the bank’s universe – an outside-in approach to banking.
That said, a build and migrate approach may not be suitable for all banks. A more traditional approach is an in-place incremental progressive transformation, where customer segments, or lines of business, are progressively migrated to a new integrated digital banking platform. The same outside-in management thinking needs to be applied as the bank progressively transforms to the new business model. Whatever the approach taken, a policy of doing nothing seems more and more risky. The world is moving, with customer expectations changing, and the technology used by banks to serve customers must to keep pace.