The Ripple Effect: Digital Banking in Flux
In the 1970s, Toyota threw the automobile industry into disarray with their new approach to manufacturing and inventory control.
In the 1970s, Toyota threw the automobile industry into disarray with their new approach to manufacturing and inventory control. Manufacturers who continued to operate under the big-batch model, such as General Motors, were facing backlogs, excess inventory, inefficient processes and a more extensive workforce to hold it all together. Meanwhile others, spearheaded by Toyota, cut their production time from three weeks to three days, and improved the productivity of their employees and the quality of their products.
The stone drops for the financial services industry
Fast forward to today. In the same way, many financial institutions both in the United States and globally, retain decades-old legacy IT systems. Instead of replacing the compromised structure, they have opted for a Band-Aid approach to create new channels or address vulnerabilities, all the while losing profits through the gaping holes of inefficiency. But the fact remains, when a sector has faced technological disruption, the dominant incumbent ends up dislodged. This is the threat facing financial institutions that were previously industry leaders.
Ripples of disruption
One anomaly of the U.S. financial services landscape is that, while the country has produced leading disruptive technology companies, the lines have been clearly drawn between financial services providers and fintech startups. The call to arms has been sounded and fintechs have been identified as a threat, with traditional providers sticking their flag on their island with a hearty, “You are not welcome here!” But with these very companies increasingly becoming the providers which Americans in their 20s and 30s feel comfortable, this is clearly inconsistent with what the potential consumer base of banks want.
If financial institutions want to gain and retain those relationships, they need to look at how the industry has been disrupted, and how they can address that disruption. Temenos has found that banks and other providers must either learn from these disruptors and disrupt their own organizations, or they must partner with them in order to meet consumer expectations.
Disruption from technology companies outside of the financial services industry
Companies such as Google, Amazon, Facebook and Apple are widely predicted to take a significant role in retail payment fee avenues at the expense of banks, without seeking charters. Being transaction enablers allows them to earn chunky fees without the regulatory headache.
One trend that Temenos has identified is for large tech companies to partner with banks, such as when Apple Pay partnered with household names such as American Express, Bank of America, Capital One, J.P. Morgan Chase, and Wells Fargo. Of course, that means payments either do not flow through the bank or payment fees decline, but these institutions have viewed the overall integration as more valuable than, for instance, sharing their account holder data with Google, and the benefits of a secure and convenient payment method for their customers more valuable than nothing at all.
Disruption from financial technology startups
In addition to larger technology companies, there is a growing roster of smaller third-party vendors and innovators building new applications which are impacting how banks approach their customer relationships.
Movenbank, for example, has developed a scoring product called CRED, which uses social media as part of its credit and pricing decisions. This unique approach combines traditional scoring elements with the account holder or applicant’s standing on Facebook, Twitter and other social networks to help determine the consumer’s track record in paying bills and engaging in healthy financial activity. The method also gauges their ability to refer friends. All of these are elements that can inform credit decisions and pricing of financial products.
On Prosper, a peer-to-peer lending marketplace, borrowers list loan requests between $2,000 and $35,000 and individual lenders invest as little as $25 in each loan. Prosper services the loan on behalf of the matched borrowers and investors, and boasts over $7 billion in funded loans.
Other web-based lenders include the education loan provider SoFi and the small-business lender Funding Circle. These platforms attract borrowers seeking lower rates than those provided from traditional financial institutions. Companies like these will play a role in shaping how the financial institution of the future looks.
Disruption from financial institutions themselves
The other challenge financial institutions face is from so-called “neo banks”, also known as digital, or direct, banks. These banks might be new entrants, built around new core systems or they could be new, parallel brands, also known as a “bank within a bank”, launched by incumbent players either via their existing core system or on a new platform with a long-term vision for migrating clients over in the future.
The digital technology embedded in these challengers is often superior to the legacy systems on which traditional banks run. The competitive advantage and agility of these neo banks is evidenced in the speed with which their customers can open accounts via mobile apps, track spending in real-time and, in some cases, take out loans.
Direct banks also enjoy an obvious cost advantage over the brick-and-mortar model. According to a TNS survey conducted when this trend first emerged in full-force, deposits at the four largest U.S. banks who implemented the direct bank model – Ally Bank, Discover Bank, ING Direct (now Capital One 360) and USAA Federal Savings Bank – more than doubled in the five years to 2012, three times the industry’s average. The study found that direct banks were skimming off some of the industry’s most sought-after customers.
“Direct banks can no longer be dismissed as merely competing on the fringe,” TNS said. “They are quickly becoming mainstream.”
In the years since this trend began, Temenos has seen it evolve into a practice, proving TNS’s prediction more true every day.
Ripples hit the market
For those who are not familiar, every year, Temenos conducts a survey in conjunction with its annual Temenos Community Forum (TCF). Over 200 financial executives from around the globe participate, granting Temenos insight into trends throughout the industry, year over year.
Back in 2015, the results revealed that core system renewal was a more pressing factor for financial institutions in North America, compared to the rest of the world. However, the statistics also suggested that while North American institutions were aware of the need to improve the user experience, they were not yet responding to the potential of digital technologies as positively across the board as their counterparts across the sea in Asia-Pacific and Europe.
This is becoming the case less and less, with more and more banks looking at progressive renovation of their businesses in order to accommodate both the need for change, as well as the need to mitigate the risk of change. The survey that Temenos released at the end of 2016 revealed that the number of respondents who see core system renewal as a top IT investment priority increased compared to the previous year.
Year-Over-Year Comparison
| 2015 | 2016 |
| 43% of North American respondents saw core system renewal as the top IT investment priority, against 22% in the rest of the world. | The number of North American respondents who view core system renewal as a priority has increased to 67%. Additionally, at 42%, distribution of products and services (either via digital channels or branch network), and hence maintaining customer intimacy, is a top investment priority |
| 24% cited inflexible legacy systems as the biggest challenge faced by financial institutions in effective analytical use of data to support their business. | Up to 29% this year, when implementing their digital strategy, the biggest challenge for North American financial institutions is the barriers raised by inflexible legacy systems and hence lack of access to data which is locked in multiple siloes. |
| Improving user experience (26%) and data analytics to offer relevant products and services (26%) were the biggest areas in which North American financial institutions were investing. | Expanding on what we saw in 2015, at 33%, the biggest area of investment is the ability to deliver a consistent and fluid user experience across all channels in order to improve the overall customer experience, followed by enhanced data analytics for delivering relevant products and services at the right time (26%). |
Final Thoughts
Whether you choose to raise the competitive bar, or collaborate with fintech startups to meet evolving consumer expectations, the ripples of disruption have already permanently altered the financial services landscape. Financial institutions must become more creative and more responsive to the demand for a better account holder experience. This will involve a multi-faceted strategy shift: developing relevant digital strategies for internal and external use; exploring the potential of parallel banks and collaborating with third-parties (either disruptors or vendor technology partners) to help redefine more relevant ecosystems.
Financial institutions still have a key asset – detailed account holder data and a tradition of security and trust – that will allow some of them to emerge as winners in the race to remain the key financial partner for most consumers. But they must act now, before the next stone drops, or it will be even harder to overcome the next ripple effect.
Temenos recently conducted this year’s annual survey at the 2017 TCF in Lisbon, Portugal. Keep an eye out for the report covering the results and year-on-year trends to be published later this year!