Once considered the domain of industry disrupters and fintech start-ups, the world of digital finance is now playing host to an altogether more traditional sector. Established financial institutions, spurred on by increasing competition from digital challengers, are making their presence felt in the digital sphere – bringing with them a wealth of experience and expertise.
However, traditional financial institutions cannot expect to arrive late to the party and instantly supplant digitally native competitors; that is to say, companies which were founded with the sole purpose of offering digital financial services. As we move from an age of technological revolution, to one of evolution, traditional financial service providers must strive to offer the most innovative, the most advanced, and the highest quality of digital services if they are to survive beyond the digital age.
If a technological revolution is the period of dramatic change in which one set of technologies is very quickly replaced by another, then the near universal acceptance of digital technology as a part of everyday life signals that we are now entering a period of technological evolution, albeit evolution taking place at a staggering pace. The digital revolution replaced the 350- year- old cheque, for example, with automated payments; a technology which, in the last few years, has evolved to allow ever quicker payments and transfers, not only from credit/debit cards, but now from a smartphone or smartwatch – and even plastic cards may soon go the way of the chequebook and become a rarely-seen novelty. Such changes to the way in which customers transfer funds may be the most publicly visible way in which retail banks have embraced digital technology, but it has not been enough to retain every customer, or to alter the impression that traditional banks are playing catch-up to digital disrupters.
UK-based digital-only challenger banks Monzo and Revolut, for example, offer the same instant payments and mobile banking, as well as a host of other advantages; such as the ability to hold multiple currencies simultaneously, to purchase cryptocurrencies and help to save/invest spare funds. Given this, it is perhaps unsurprising that the two start-ups have six million users between them; but these European challengers are insignificant compared to their counterparts in Asia. Alibaba offshoot Ant Financial, which is headquartered in Hangzhou, China, reportedly has over one billion users worldwide, and was valued by its most recent funding round (in 2018) at US$150 billion. Significantly, the valuation puts it behind only the four state-owned banks, and insurer Ping An, among China’s financial institutions. Ant Financial’s main rival, Tencent’s Shenzhen-based WeChat Pay, boasts 900 million users every month. According to a 2018 report by Accenture, which analysed over 20,000 banking or payment institutions, such new entrants to the banking market are now amassing up to one third of all new revenue.
These new entrants can generally be divided into two distinct categories; challenger banks and non-banking financial institutions (NBFIs). Challenger banks are relatively small, digital retail banks, set up with the intention of competing for business with large, long-established national banks. NFBIs are defined by the World Bank as financial institutions ‘that [do] not have a full banking license and cannot accept deposits from the public’, but can ‘facilitate alternative financial services, such as investment (both collective and individual), risk pooling, financial consulting, brokering, money transmission, and [cheque] cashing’ . Becoming fully-fledged banks could be the next step for many successful NBFIs.
In 1997 Bill Gates famously claimed: “We need banking, we don’t need banks anymore”. He meant, of course, that traditional financial institutions were becoming unnecessary; that digital technology would instead enable the necessary processes which banks traditionally facilitate. Over 20 years and one global financial crisis later, however, and traditional banks and financial services are still going strong. Despite the dramatic numbers above, traditional institutions have not yet been usurped by fintech start-ups– but they are being challenged. Although, for many, traditional financial service providers remain the most trusted and respected vehicle with which to conduct their banking (regardless of the recent financial crisis which rocked the public’s trust in such institutions), new entrants are siphoning off vast amounts of new revenue. And although, at present, traditional retail banks and financial services still dominate the industry, how long this remains the case may come down to demographics.
This does not mean that traditional financial institutions are fated to become redundant; established banks and financial service providers retain numerous advantages over their newer digital counterparts, advantages which are still recognised by the vast majority who continue to make use of their services. While fintechs and digital start-ups have, by and large, been specifically founded to exploit gaps in the existing market, or to target particular groups of people, traditional financial institutions are able to cater to much wider range of needs and people. Moreover, established banks have far greater economic significance and are still much more influential in the wider global economy; traditional banking focuses on managing risks and navigating complex economic and legal infrastructure to concentrate on the macro, as well as provide high-quality services for the individual. By comparison, digital disrupters are more focused on the micro aspects of user-experience. This may make them more appealing to younger users, or to those who distrust the ‘establishment’, but it does not make them more any more responsible or accountable in the global economy.
Over the last 10 years, traditional financial institutions – and especially those institutions operating in international financial centres – have spent billions implementing compliance measures, such as Anti-Money Laundering (AML) and Know Your Customer (KYC) rules, in the face of unprecedented levels of scrutiny and pressure from governmental and intra-governmental organisations across the world. While digital technology has been instrumental in facilitating ever-more efficient compliance procedures within traditional institutions and fintech start-ups alike, many challenger banks and NBFIs have failed to measure up in recent years. Perhaps, by virtue of being leaders in their field, digital disrupters are often the first to encounter new problems and public criticism, particularly in the areas of data protection and online security. In 2018, Ant Financial was forced to apologise after users became outraged that by using one of Ali-pay’s spending tracking functions, they had automatically opted-in to sharing their personal data without their knowledge. And it emerged in March of this year that Revolut is facing scrutiny from UK regulator the Financial Conduct Authority (FCA), after a whistle-blower claimed that the company had simply turned off its automated ‘international sanctions compliance system’ for a period of three months.
In breaking new ground, it is inevitable that these disruptive entrants to the financial industry will be the first run into stumbling blocks and, in this area, established financial services providers have the distinct advantage. Traditional institutions are able to learn from the mistakes of digital start-ups and develop their own offerings in a much more stable regulatory environment in which international standards, such as the European Union’s General Data Protection Regulation, have already come in to force, or are shortly to be implemented. Moreover, given that established financial institutions have spent the last decade investing in technology and procedures to improve compliance right across the corporate structure, one might say that they are better equipped to responsibly drive forward the evolution of digital banking than the start-ups which currently dominate it.
Innovation Over Imitation
In order for established banks to survive and develop within the digital space, however, they need to continue to innovate. Many of the new entrants that have been discussed here are growing at an exponential rate, and these are only a few, choice examples of current digital offerings in the financial services industry. Ant Financial’s valuation of $150 billion did not only take the company to sixth place within Chinese financial institutions, it surpassed some of the largest and most long-established organisations in the US, including American Express (US$88bn), Goldman Sachs (US$87bn) and Morgan Stanley (US$89bn). If such growth continues at its current rate, these new entrants will move beyond amassing new revenue and begin challenging for ever-greater numbers of traditional institutions’ existing customers. It is no longer enough, therefore, for organisations to adopt technological advances only when forced to by their mainstream competition – financial service providers must strive to match even the very vanguard of digital disrupters.
Fortunately, it appears that many traditional financial institutions are now preparing to meet the challenge. Ernst & Young’s 2018 Global Banking Outlook report found that 85 per cent of banks considered the implementation of a digital transformation programme to be a priority for 2018. The key word here is ‘transformation’; as established institutions are now looking to radically change their digital infrastructure, rather than to simply adapt their existing organisation to the minimum needs of a digitally connected market. While this is undoubtedly motivated by the threat from new entrants, it is also the case that many financial institutions may be experiencing a liquidity moment, with other expenses beginning to fall. EY believes that most financial institutions have now ‘crested the peak of regulatory-driven investments in systems and talent’ and that compliance-related costs will begin to decline from 2018 onwards; while according to the International Monetary Fund (IMF), global litigation costs are also shrinking dramatically, down from US$137 billion at their peak in 2014, to US$47 billion in 2016.
It seems, therefore, that established financial institutions have both the will and the opportunity to invest in digital innovation. EY’s report found that 62 per cent of banks expect to become ‘digitally-mature’ leaders by 2020 – but in such a rapidly evolving sector, one must remember that a ‘digital leader’ is a moving target. The report stresses that banks cannot expect to create one innovative product and remain ‘digital leaders’ forever. Instead, established institutions must foster a sustainable and innovative environment, and not view innovation as a means of reaching the mirage of ‘digital leadership’.
In order to do this, established financial institutions will need to focus on acquiring (or partnering with) key talent. A 2016 report from UK law firm TLT, which consulted 145 senior IT decision-makers from a wide range of financial institutions (from the largest retail banks to niche service providers), found that most banks are still putting their in-house IT teams at the forefront of their digital strategies. This approach may be problematic in the long run, if institutions forget that technology is an enabler, and not an end in and of itself. In-house teams also often have to battle against unhelpful legacy infrastructure, and can find that their initial ideas, however brilliant, are not able to percolate through to the other side of the corporate structure. If such blockages exist, it may be helpful for financial services providers to partner with fintech start-ups. Both TLT and EY suggest this approach as one of the more efficient, and we are certainly seeing the beginnings of successful collaborations between such organisations; such as that of Barbados-based Bitt Inc and the Eastern Caribbean Central Bank (ECCB), here in the Caribbean. It is a strategy which is becoming increasingly popular, with just over half (53%) of C-level executives at mid-size banks and credit union surveyed by Cornerstone Advisors What’s Going on in Banking report, stating that fintech partnerships would be important in 2019.
Once again however, much depends on the attitudes of the players involved. Fintech companies will need to be strong and stable in order to be taken seriously, while banks will need to become nimbler in adapting to change and more open to new ideas. In successful partnerships, be that between two distinct companies, or internal talent and corporate governance, both parties will recognise the need to adapt their thinking in order to really profit from a marriage of innovation and experience. For those institutions which are able to capitalise on the opportunity however, and evolve apace with industry disrupters and digital challengers, the rewards will be great – for themselves and for the customer.
In response to Bill Gates, then: Yes, we still need banks. With their market experience and expertise, stable infrastructure and economic clout, established financial institutions are still absolutely necessary. It goes without saying that the global financial status quo that technologically advanced new entrants seek to disrupt, would look vastly different were it not for the continuing influence and careful management of these institutions. The rise of fintech challengers, far from signalling a final fruition of Gates’ prediction, only indicates that customers may now wish to consume their banking in a slightly different form. For established financial institutions which put their customers front and centre, the decision to innovate in the digital space is merely a natural step in their evolution.
 "Nonbank Financial Institution", World Bank, 2019 <https://www.worldbank.org/en/publication/gfdr/gfdr-2016/background/nonbank-financial-institution>
Peter Dunn is the Chairman for Holdun Investments, Inc. He has previously worked for the government of Quebec, Canada.
Stuart Dunn is the Chairman and Founder of Holdun Family Office. Peter has founded several investment firms that include Gryphon Investment Council, Bladon Securities, Holdun Investments and Holdun Asset Management.