Digital Banks – How does a Bank of the Future Look Like?

The world around is changing with every minute. We want to live faster, more actively, and efficiently. We want to live life to the fullest. The primary goal of all the innovations and disruptions in many industries is to implement these desires into reality. Digital era is already on the doorstep and is going to disrupt our “outdated” way of life. Are we ready for it? It is quite a controversial question. Millennials nowadays operate with the terms that are absolutely unfamiliar to the older generation, but for many of us, these terms and concepts have become an integral part of our everyday life. So, are we ready for the total disruption? In fact, the answer doesn’t matter, as the global mechanism of changes is already running and all that we can do is to surf the wave of new technologies and get used to them.

We have already discussed how the store of the future will look like, but what about the banks? What disruptions will the financial industry face? In the era of smartphones, we have the whole world in our pockets and we are used to performing lots of operations without leaving home or on the way to work. Whether digital banking will replace the “banks – dinosaurs” of the financial industry or are we going to still need them? Digital disruption has already started. Lots of digital banks are popping up, even though some of them are merely one-trick apps or features rather than proper financial institutions which are being regulated and licensed. However, this alone is forcing the traditional banks to hurry up in order not to miss out on the Fintech Revolution. The race for clients has started. Can the incumbents survive the Fintech revolution and come out stronger, continue to dominate or are the traditional banks following the path of the dinosaurs?

A + B + C + D = Bank of the Future

To date, the financial industry represents an ever increasingly converged ecosystem in which financial services are provided both by banks and by platform companies with roots in e-commerce and social media. What do the banks need to get the “Bank of the Future” title? It is not enough to follow the new technologies as artificial intelligence, machine learning, and other forms of automation. To become banks of the 21st century, they have to make a total revision of their operational and technology systems. The formula of the bank of the future is quite simple and consists of only four components:

  1. A – Artificial Intelligence;
  2. B – Big Tech;
  3. C – Core Banking & Cloud;
  4. D – Digital Assets.

When adopting these four disruptive factors, the incumbent banks will be able to drive their business forward and start a new stage of their development.

In 1995, Bill Gates said, “Banks are dinosaurs, they can be bypassed”. Yes, even after two decades, the banking dinosaurs still exist. Moreover, they make up the bulk of the whole financial industry. However, as well as with dinosaurs, everything may change at one moment. With the coming of the smartphone era and the rapid growth of Internet platform conglomerates, the technological meteor hit the financial industry and triggered the FinTech revolution. The Bank of the Future is creating right now in front of us, and we are the main witnesses of this growth. We decide what it will look like and which technologies will be involved. We are the key players of this game and a decisive factor of what will happen and what not.

Nowadays, people need banking, not banks. So how do incumbent banks stay relevant?

  • They have to become faster;
  • They have to become smarter;
  • They have to become more efficient.

Banks evolving into the new landscape will require:

  1. Focus on digital transformation;
  2. More straightforward business mix by geography and products;
  3. Better existing financial returns allowing management to divert attention from the near-term firefighting.

To stay relevant, banks will also have to transform their existing business model, culture, organizational structure, and technology infrastructure. Including the ABCs of the FinTech alphabet in the strategic game plan will allow performing digital disruption in finance.

“A” or Artificial Intelligence and Automation

Artificial intelligence has already influenced many industries allowing them to become more efficient, simple, and modern, but it isn’t going to stop changing the world around us. Banks that are aimed at entering the new level of development and want to catch the wave of the newest technologies are exploring AI uses in consumer and wholesale banking. Which are the areas of the biggest focust?

  • Robotics (automation of the routine tasks);
  • Chatbots (digital dialog with customers);
  • Cognitive (changing rules and adapting);
  • Analytics (big data mining).

With the implementation of all these AI uses, banks will be able to become smarter, faster, and more robust.

AI in Banking

The majority of banks in the US and Europe are built on 1960s-70s mainframe technology that is product-based, not customer-based, and it significantly complicates the successful implementation of AI at an enterprise level. Of course, today there are some FinTech upstarts, which systems are based on machine learning and artificial intelligence. They require minimal human intervention, are faster and more efficient. But the reality is that the number of these banks is still a minority. Whether it means that the whole bank industry should be recreated from scratch with the focus on AI and ML or the incumbent banks yet have a chance? They have it, and the FinTech is not a sentence for the “past-generation” banks. Several banks are already beginning to centralize their data assets and are leveraging hybrid cloud architectures to speed up the transition. The broad adoption of AI and automation will have a significant impact on the distribution of banks and servicing channels. Increased use of automation and AI-driven systems will allow banks decreasing cost efficiencies by employing fewer workers, as repetitive human tasks can be replaced by machines that can understand human behavior and make decisions. Thereby the necessity in a high number of branches will also be reduced. The number of bank branches and people employed in the financial services sector may decline by 50% over the next ten years.

Today we have people doing work like robots. Tomorrow we will have robots behaving like people. And it is called development and growth.

“B” or Big Tech

Big Tech is the B in the ABS of digital disruption in financial services and finance is being re-imagined and re-created by BigTech players with the proliferation of mobile platforms, a growing middle class, and favorable government policies. The Internet-based companies-giants as Amazon, Alibaba or Facebook have already captured a great part of consumers’ attention and time. These companies view payments and financial services as a tool to significantly enhance client stickiness. Traditional banking is being challenged by these tech giants leveraging their strong customer bases, vast user data pools, agile technology platforms, and deep funding pockets. The payments and transaction services are the first area of disruption by BigTech, but the final objective is the creation of the integrated financial ecosystem as part of a holistic customer engagement strategy. The question is “Do clients want to do banking with Big Tech?” According to a survey, 57% of Millennials stated that they would change their bank for a better tech platform, while 65% would consider leaving a firm if digital channels were not integrated.

BigTech is coming for the financial sector

Even despite the benefits, the question of the Big Tech adoption remains opened and, as any global changes, requires time.

“C” or Core Banking, Cloud, and Challenges

A customer expectations revolution is expected as cloud and more modern architecture offers solutions to legacy IT issues and could help significantly improve efficiency, agility, and speed to market. However, legacy bank IT systems have arguably reached the point of redundancy as complex integration of outdated systems is becoming too costly, so the core infrastructure overhauls are expected to gain importance only over next few years. Among the main drivers of IT investments there are:

  1. New improved tech (cloud adoption);
  2. Focus on data quality, accessibility, standardisation, and utilisation;
  3. Major cyber breach;
  4. Greater investors focus on costs savings.

In the banking industry, IT expenses as the percentage of revenues are higher than in any other (up to 9%) and, according to the analyses, approximately 15-20% of the banks’ annual costs are allocated to IT nowadays.

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Cloud and improved, more modern architecture offer solutions to such legacy IT issues as a promise of efficiency, agility, and speed to market. Move to the cloud can provide the cost and efficiency savings, while the reworking of legacy applications provides the benefit of agility, nimbleness, and speed-to-market with product development. In addition to this, public cloud usage offers additional cost savings, as the software (or infrastructure) will be managed externally.

Besides cost savings, leveraging of the cloud allows flexibility. For the banks, a chance to increase their speed to market with applications is a great benefit, particularly relative to the ineffectiveness of legacy IT to deliver changes with speed.

What is the banking sector?

“D” or Digital Assets

2017 is considered as the year of cryptocurrencies, and from that time crypto has caused so much noise all around the globe, that you will hardly find a person today who has never heard about bitcoin. The total market capitalisation of all crypto combined scaled $660 billion in 2017. Although 2018 was the year where most crypto currencies lost 70-90% of their value, the blockchain technology remains and further development of use cases is being made. If the Internet is a disruptive platform created to facilitate the dissemination of information, then the blockchain technology is a disruptive platform which is designed to facilitate the exchange of value. The blockchain is a database that uses a cryptographic network to provide a single source of truth. It allows untrusting parties with common interests to co-create a permanent, unchangeable, and transparent record of exchange and processing transactions without relying on a central authority. Unlike the traditional payment model which requires central clearing to transfer money between sender and recipient, blockchain relies on a distributed ledger and consensus of the network of processors. Main attractions of blockchain offering are pictured below.

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What are the central blockchain applications?

  • Smart contracts. These contracts are entered between two or more individuals and are written as code into blockchain public ledger. They are automated and can execute/enforce themselves automatically when reaching a certain trigger event (for example, expiration date or a strike price) according to coded terms.
  • KYC chain. KYC-chain allows individuals and companies to manage their identity securely – users own a key to their data and identity certificates, choosing which information is to be shared with whom. They can also help financial institutions ease the process of onboarding new customers by eliminating manual paper-entries.
  • Reg-Tech. Regulatory Technology is leveraging new technologies to improve regulatory reporting and monitoring, as well as compliance processes for financial institutions. This area has already got a high demand as banks attempt to keep up with new regulations, KYC / AML norms, and are looking for ways to be more efficient.

Conclusions and Highlights

How can we sum up all the disruptions in the financial sector? Implementing the new FinTech technologies and innovations helps banks to enter the next level of development and reach the underserved populations in these markets. The payments industry is confidently evolving with branch banking gradually turning into e-banking and has increased use of payments wallets. Summing up the ABCs of the FinTech alphabet we can conclude:

  • A – Artificial Intelligence, B – Big Tech, C – Core Banking & Cloud, and D – Digital Assets are the main components of the FinTech formula;
  • Incumbent banks can stay relevant if they become faster, smarter, and more efficient;
  • The number of bank branches and people employed in the financial services sector may decline by 50% over the next ten years with AI implementation;
  • 57% of Millennials would change their bank for a better tech platform;
  • Blockchain technology will improve data security, digitise manual processes, verify the authenticity of customer onboarding documents, and improve speed/accuracy of regulatory reporting.

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The speed of technologies development nowadays is stunning, and a lot of efforts should be made to surf the wave of innovations and get used to them. FinTech coming gives a chance for the incumbent banks to a total rebirth. Whether they will start a new chapter in their development and keep afloat or will extinct as dinosaurs? We’ll see in the not so distant future.

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Alexej Pikovsky

Passionate about investing in private and public companies and a successful track record across different industries and geographies. German Academic Foundation Scholar and Research Affiliate at the Centre for Global Finance and Technology at Imperial College London. Addicted to reading and sharing industry deep dives. Enjoy!