The past two years were a litmus test of sorts for all standard operating procedures and technical systems in the financial sector. It showed both inefficiencies and deficiencies — broken digital account opening processes, subpar back-office procedures, and a lack of online customer engagement mechanisms.
We’ve all learned our lessons and know who’s a winner. But let’s be real: this was just another crisis. More will come and go. Yet banking will remain an in-demand service.
The question many are now asking is who will own the banking experience? Traditional financial service providers, digital-first players, or tech companies? Because all of them are trying to dominate.
The changing shape of financial ecosystems
As consumers, banks, and governments alike progressively recover from the economic slump, the financial sector is getting more bullish about growth prospects.
Consumers’ balance sheet is in excellent, outstanding shape — coiled, ready to go and they’re starting to spend money. Consumers have $2 trillion in more cash in their checking accounts than they had before Covid primarily due to reduced personal spending.
Investment in FinTech has also resumed. In the second quarter of 2021, US FinTech companies attracted nearly $7.5 billion in venture capital, up by 70% from a year before. Banks are gearing up for aggressive growth too. According to Forrester, most plan to increase already lavish spending on tech by double-digit percentages in 2022.
The line between FinTechs and traditional banks are getting blurrier by the minute. Technologically, the leaders in both categories are on similar levels — both have completed a major chunk of frontend and backend transformations in response to operational and customer cues.
From the market perspective, incumbents still have larger customer bases and hold more capital. Successful FinTechs have managed to attract and retain only certain market segments — Millennial consumers or the underbanked — and have eroded incumbents’ profitable service lines such as cross-border money transfers, personal investment, and lending to some extent.
Since the mid-2010s, the financial sector has been talking about the great “unbundling” of banks. But we believe that somewhat different market dynamics will emerge over the next decade.
Consumers are not ditching their primary banks. They just no longer recognize one institution as primary because they’ve amassed a portfolio of financial products from banks, FinTech companies, and TechFins.
The percentage of U.S. consumers using technology to manage their finances has increased from 58% to 88% (86% in the UK). More people use financial apps than social media (72%) or video streaming services (78%).
What’s more, the growth has been tremendous among all demographics including Baby Boomers, with whom adoption of digital banking surged from 39% to 79% over the past year.
Thanks to technology, FinTech companies have commoditized access to what was once seen as complex or exorbitantly expensive services — personal financial management, fast loan pre-qualification and approvals, portfolio management, and so on.
However, because of unbundling, no financial player now has a complete view into consumers’ financial lives — not even a consumer’s primary banking institution. And that’s the challenge the industry will have to tackle next.
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Financial trends for 2022: A shift to ecosystems
Banks and FinTechs now occupy equal space on consumers’ phones (and in their minds). But the problem is that everyone has limited mental bandwidth.
When financial products become too numerous, one of them must go. Or bundle back up with others, but on better terms.
Banks and FinTechs are aware that they cannot capture the market without each other’s help. The bar for the connected customer experience is set high. Few can reach it fast enough on their own.
For banks, legacy technology and lack of expertise often stand in the way of agile finances. FinTechs, on the contrary, can’t make the regulatory machine move faster than it goes. Similarly, aggressive customer acquisition and market expansion also require time and/or major cash injections.
Finally, growth and innovation are hard to pull off on your own. Every side has its strengths and weaknesses:
But together, banks and FinTechs can complement and reinforce each other.
Today, it’s no longer bank vs FinTech or bank vs neobank. There are leaders at each end as well as laggards struggling to catch up. In the middle stands a confused consumer who was first enticed by the accessibility and variety of financial offers but now wants clarity and convenience above all else.
The financial market has enough room for everyone, especially if all players join forces and start working on an equitable ecosystem, where value trickles from one player to another through joint offers, tech and operational partnerships, and transparent data exchanges.
In the next decade, ecosystems will be an industry mega-trend that serves as a springboard for other shifts.
In 2022, we’re already seeing some moves in that direction.
1. Embedded finance and financial services from tech companies
Over 90% of multinational companies have mentioned planning to expand their activities in business ecosystems. Many of them (not just GAFA) are looking to move to the financial turf.
Open Banking has reduced the barrier to accessing financial services, and tech-led companies are profiting from this. What’s more, they already have an edge over traditional banks thanks to a convenient online experience (or the ability to create one).
That’s a major advantage because 81% of adults say the quality of the online experience determines who they bank with. All generations favor a stellar digital banking experience.
46% of those in the 55+ age group stated that online banking experience was “very important” compared to only 26% of 18-24-year-olds.
But the bigger question is who will deliver it and how?
In the next decade, innovation won’t just come from existing financial service providers. Companies adding financial services for the very first time will partner with existing market players to launch embedded financial services or joint products.
We are already seeing this in the works:
- Apple and Goldman Sachs plan to launch a buy now, pay later option to compete with other players in this profitable vertical.
- Square has presented basic business bank accounts together with Sutton Bank and will likely further expand the service portfolio.
- Uber’s alliance with BBVA Mexico has proven to be a success. More markets will follow.
- The German subsidiary of Telefonica launched an o2 Banking service with Solaris Bank — a current/checking account with add-ons such as a debit or credit card.
The advantage all these companies have is the ability to collect large swaths of data on consumer preferences and then use it to launch the right type of offering. Then they can extend big data analytics to new financial data to further refine their offerings and target consumers with great precision.
Surely, this foray into the financial sector isn’t all smooth. Big Tech companies are under heavy regulatory scrutiny. In fact, Google has abandoned its earlier plans to launch a digital banking service. But it’s certainly not the end of their ambitions.
Big Tech firms will remain partners to the financial sector. After all, most already provide critical cloud infrastructure and data analytics services to banks for running their operations. Plus, with Open Banking, we’ll probably see more embedded finance scenarios where non-tech players use partners’ services in their products.
Challenges and opportunities for 2022–2030
- Every company now has the chance to become a financial company thanks to banking as a service (BaaS) and Open Banking.
- Traditional banks and FinTechs can become partners to new tech entrants and profit from this low-margin, high-volume revenue stream.
- For that to happen, however, better relationship governance is required, both operational and technological.
2. Digital currencies land in banks
Decentralized finance (DeFi) and non-fungible tokens (NFTs) were two hot subjects in 2021. But are these the remains of earlier blockchain hype or major new trends in the financial sector? We believe the second.
For years, global banks have been looking for ways to soften the impact of markets (and governments) on their operations.
Technology has finally caught up with that demand and now allows banks to create private business ledgers and issue central digital bank currency (CBDC).
A central digital bank currency is bank-supplied electronic cash customers can use to make online payments and transfers.
Source: Bank of England — Central Bank Digital Currency: opportunities, challenges, and design
The only difference between traditional currency and central digital bank currency is that the latter won’t be overseen by any public authority. Instead, central banks will retain full control over the money supply and exercise greater control over monetary policy. Likewise, as we carry less physical cash, CBDC can ensure that populations always have access to central bank money.
Nearly every central bank in the world did some work on digital currencies. Some 60% are working on “proof of concept” testing, though just 14% have actually launched a pilot program or are in development.
Consumers are on board too: 73% say they trust their financial institutions more than the government when it comes to banking and personal finance, while 51% feel the opposite way.
So who plans to mint digital currencies?
- Banque de France and SEBA Bank conducted a successful joint experiment. The FIs used a central bank digital currency to simulate a settlement of listed securities. Banque de France simulated CBDC issuance on a public blockchain but added an extra security and confidentiality layer using smart contracts.
- The US Federal Reserve is working with MIT to research and experiment with different designs for a digital dollar currency.
- The European Central Bank is assessing different scenarios for launching a digital euro within the next several years.
- China is ahead of the curve and has already tested an e-CNY during a recent shopping event. Unlike Western counterparts, the local coin isn’t blockchain-based.
Challenges and opportunities for 2022–2030
- Central digital bank currencies can improve the speed, efficiency, and security of payments as well as lower the cost of global payment systems.
- Bank-issued stablecoins can also accelerate the digital economy and help launch new products like more affordable cross-border transfers and Real-Time Gross Settlement (RTGS) services.
- However, the financial sector will have to agree on the terms of coexistence for CBDC and standard cash as well as design operational infrastructure for such coins jointly with the private sector.
3. Buy now, pay later (BNPL) and POS lending
Buy now, pay later isn’t a new concept. Consumer lending is a long-standing banking service. So why are companies like Klarna and Affirm seeing double-digit growth?
Source: C+R Research — Buy Now Pay Later Statistics and User Habits
Because they’ve leveraged technology to create a faster and simpler online lending experience. Customers don’t need to call up an agent or log in to an app to request a higher credit limit. Instead, they’re offered to pay in installments in one click. Customers are hooked, and banks are following suit.
What’s curious, however, is that many players choose to team up with BNLP companies instead of undercutting them:
- Klarna partnered with German CommerceBank. The bank gained access to Klarna’s BNPL feature, while Klarna got an opportunity to extend bank accounts to its users.
- Affirm launched high yield savings accounts with Cross River Bank to complement existing services. What’s more interesting is Affirm’s recent partnership with Amazon, as it excludes banks from the equation.
- Zopa, Revolut, and Monzo have also announced plans to launch no-fee BNPL-like credit products in 2022.
- NatWest and HSBC now allow cardholders to create installment plans for individual purchases with fees lower than standard credit card rates.
Clearly, BNPL is a hot service, eroding some of the lending profits. But it won’t kill off credit cards completely. BNPL can be an affordable alternative form of credit for people with thin credit files and limited credit history.
But because of that, BNPLs will soon have to get more diligent with customer vetting. Currently, most players don’t do much KYC or many credit checks. They also don’t report their loans to credit reference agencies.
And that creates a problem: other FIs can’t get the full picture of a customer’s obligations. This makes it easier for a reckless borrower to amass a lot of loans. So once again, joint action and improved data exchange could drive more cumulative value for everyone in this niche.
Challenges and opportunities for 2022–2030
- Buy now, pay later isn’t a novel concept, but digitization has made it more convenient and accessible to customers.
- Banks can beef up their profits by styling their lending as BNPL. Doing so will require some technical changes but has the potential to yield high returns.
- Partnerships with BNPLs can help other FIs gain visibility into customers’ lives and provide better personal financial management tips.
- BNPL companies, on the other hand, will soon need to address the emerging lending risks. Many will require better credit scoring capabilities.
4. Sustainability and inclusivity as new CX pillars
Banks don’t have as powerful of brands as tech companies. Fewer people truly like their bank or even trust it to do the right thing. But trust is a core factor that makes consumers stay with a traditional bank over a FinTech.
Trustworthiness and personal relationships, two areas of strength for incumbents, are the most important factors driving trust in PFRs, outweighing product impacts.
But since we still need to park our money somewhere, we stay with at least one bank. However, consumers gladly switch to alternative options from chummier and more transparent tech and FinTech companies.
Banks, on the other hand, are still rebuilding the trust lost during the previous financial crisis and the latest hiccups due to the pandemic. To date, incumbents have tried a lot of things:
- Using folksy, friendly names like Marcus for new products, de-jargonizing marketing, and making the fine print bigger
- Embracing open banking standards to give users much-demanded transparency
- Transforming the internal culture to gain better capabilities and processes in order to keep the promises made to customers
Yet a bigger battle is still ahead — extending greater care to vulnerable customers and building an inclusive customer experience.
According to the UK Financial Conduct Authority (FCA), there are four areas of vulnerability that banks must consider in decision-making:
- Customer’s resilience
- Customer’s capabilities
- Financial and health well-being
- Any special life events
How can banks do better on the above? By investing in better customer analytics and alternative financial data as proof of financial standing to make lending more accessible to underbanked consumers and people with thin credit profiles.
- Establish proper environmental, social, and corporate governance (ESG) that goes beyond paying lip service to regulators’ demands.
Speaking of the latter, both investors and consumers now expect financial institutions to take a more proactive stance on “green” matters. Europe, in particular, is leading the way with an array of sustainable finance regulations and taxonomies, pending final approvals.
Products such as green loans and mortgages, impact investment, and even checking accounts with carbon-tracking features are in demand among consumers.
How can banks go green?
- New product launches. Players in the wealth and asset management space can provide investors with tools to invest in green initiatives. That’s what Barclays and Deutsche Bank are doing. Or they can look into alternative types of sustainable financial products such as carbon tracking features, credit cards promoting sustainability rewards, green deposit accounts, or impact-oriented business banking products.
- De-carbonization. To date, around 50% of major financial services firms have set net-zero targets for 2050. How will they meet them? No one knows for certain, but CSR data and analytics will be crucial to first measure the current baselines and then work on progressive decarbonization plans.
Challenges and opportunities for 2022–2030
- Incumbent banks are still viewed as the most trustworthy entities. But few have done a proper job engaging vulnerable and underbanked consumers.
- New generations, however, have a lower affinity towards traditional FIs. They want to see more relevant, innovative, and competitive offers from their primary institution.
- Winning over new generations is crucial to future profits, since younger consumers are now deciding where they will keep most of their current (and future) wealth.
- Younger generations also want to feel empowered and educated by their financial service providers. Plus, they want to be equipped with the tools to support the causes they care about.
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5. Scalable artificial intelligence (AI) and machine learning (ML)
AI in banking remains a hot subject. According to a UBS Evidence Lab report, 75% of banks with over $100 billion in assets have some AI pilots underway. 46% of smaller banks are in this race too.
The high interest makes perfect sense, as the potential of AI in banking is lavish.
AI technologies could potentially deliver up to $1 trillion of additional value each year for the financial sector.
Some of the much-discussed AI use cases in finance include:
- Algorithmic credit scoring and loan underwriting
- Automated KYC and digital account opening
- Fraud detection and security analysis
- Robo-investing and asset management
- Personal financial management
- Risk and operational management
But are banks today truly AI-powered? Not to the extent many might think.
Despite running a cohort of successful trials for new AI/ML-driven products and services, most financial services companies struggle to scale their AI towards a wider range of operations. Why?
Because most standard financial processes are not suited for AI automation. They were never designed to be performed algorithmically. Thus, when banks attempt to apply intelligent automation in existing settings, havoc ensues. A rigid legacy banking core, a lack of effective data governance, siloed access to data, and outmoded operating models stand in the way of AI adoption.
It’s time to admit that we can’t prod AI to fit outdated processes. The financial sector needs to create fit-for-AI processes first. Then model different use case scenarios.
AI is a disruptive technology in the sense that its implementation often requires fundamental operational and technological changes across an array of systems. But many financial leaders lack a clear vision of how these transformations should be staged to achieve value.
At the most basic levels, banks will need to get four things in place to set the stage for scaled AI adoption:
- Modernize core banking systems to improve their capacity and flexibility for supporting fast data processing.
- Establish an API strategy to govern integrations between different internal and external services to gain access to more data.
- Create a data governance platform for collecting, analyzing, and distributing raw intelligence among connected services.
- Adopt DevOps processes for building, testing, and deploying AI models, as well as other tech products, in a standardized way.
Only once you’ve done all of these things does it make sense to start thinking about scaled AI implementation.
Challenges and opportunities for 2022–2030
- Intelligent automation isn’t a silver bullet for outdated, inefficient, and subpar processes.
- AI pilots can easily turn into a costly expense rather than a winning investment in banks with low technical and operational maturity.
- To scale AI and realize the most value from it, banks will have to transform their capabilities across several layers — infrastructure, data management, back-office processes, and customer engagement processes.
The race to build an end-to-end ecosystem is on
Finance is no longer the exclusive turf of financial institutions. With the entry barrier down (and being lowered further by technology and regulations), more players will enter the space. Should you be worried about the competition?
Probably, if you have no intention to switch to systemic thinking. Ecosystems provide all participants with the power to generate more revenue with little extra capital injection. Instead of building a new product, you can integrate an existing offer from a partner or rent out your services for a fee.
By doing this, you can not only tap into extra revenue streams but also improve your customer experience. By offering a wide array of embedded, interconnected services, you can fulfill a wider spectrum of customers’ needs at different life stages.
And those who manage to assume this position of a unifier in cross-industry relationships will be best positioned for growth over the next decade!
Contact Intellias to discuss how we can help you technologically prepare for transitioning your business to an ecosystem level.