Facing the Future: Digitising Incumbent Banks
August 19, 2020
The rise of digital banking alternatives poses a challenge to incumbent banks. How can they survive in such a competitive industry?
Technological innovation is essential in any organisation’s strategy as it supports the creation of distinctive products and services and enables it to stand out against the competition. This applies to all sectors of economic activity, including the financial services industry. Yet this industry has been slower in adopting new technologies when compared to others.
According to an RSM International study, the financial services sector has a high dependency on technology as a means to change business models (6th of 21 different industries). Yet in terms of capacity to implement digital transformation solutions which increase business efficiency and efficacy, financial services are found wanting, ranking 17th of the industries surveyed.
On the one hand, this is the result of the strong regulatory rules applied to banks and, on the other, the complacency many incumbents have felt when faced with the emergence of more effective digital competitors. On top of these, technological challenges have also played a role. Most banks have failed to understand that using the Internet for performing banking operations would only be the first wave of a tsunami of change in the way people manage their finances, therefore missing the opportunity to modernise their core systems.
It’s clear that incumbent banks have a lot of catching up to do to compete with their digital-native competitors. But how can they do this? And will they be successful in remaining relevant in a digital age?
The Update Challenge
Modernising core systems is one of the biggest digital transformation challenges banks face. Transitioning services to online channels has frequently led to the duplication of large quantities of data, resulting in additional degrees of complexity and reduced dynamism and ability to respond to market demands. Modernising can mean taking the risk of introducing errors into core banking processes, potentially leading to substantial losses and costly fines imposed by regulators. The risk-averse nature of many incumbents has undoubtedly influenced their decision not to make these structural changes earlier.
However, easy access to a number of services using digital technologies has raised customer expectations when dealing with their financial affairs. The gap between this expectation and the sluggish adoption of digital technologies by banks has created a breeding ground for initiatives aiming to provide digitally driven solutions for services that, up to this point, were the exclusive domain of incumbent banks. Digitising these services ultimately means that they can be executed in a simpler and more cost-effective way. Regulators, realising the value of these enterprises and start-ups, have since decided to compel banks to allow access to their clients’ information, with provisions in Europe being made under the Payment Services Directive 2 to allow for Open Banking. This has resulted in the creation of an open and competitive financial services market, encompassing incumbent banks as well as new FinTechs.
Supported by technological advances over the last few years, both in computational capacity and storage of large quantities of data, FinTechs have realised that they could establish their business on the fringes of the banks’ activities. In addition, lower operational costs meant they could address a market that the banks could not due to their perceived risk of these activities.
Through technology and organisational agility, FinTechs have the ability to continuously align with market conditions and new business opportunities, creating new solutions whenever necessary. This means more clients are attracted to trying out their services, without the risk of any long-term commitments. Such customer behaviours tend to be anathema to the traditional models employed by incumbent banks and the often long and bureaucratic processes that these institutions have maintained over the years.
Adapting to a Digital Reality
Incumbent banks have an ever-decreasing window of opportunity in which they can optimise their core banking systems and processes and to gain ground against their more agile FinTech competitors, mainly because many FinTechs have yet to reach profitability. With an established business and a large client base, banks have started to seize this opportunity to implement structural initiatives to make them more agile.
Key is the trend of incumbent banks forming partnerships with FinTechs with the aim of creating modern banking solutions. The bank gains the technological prowess and business model from the FinTech and the latter gains access to the bank’s client base. Other have opted to adapt their current systems without performing lower level structural changes, modernising business processes and products considered of high value to the bank.
Some incumbent banks have opted to create digital-first sub-brands. These tend to compete with the ‘mother-brand’, although there is an expectation that the incumbent will be able to transfer a large amount of business to the new bank without losing loyal clients itself.
Other incumbents have opted for a larger-scale operation in which they rebuild their entire core banking system, either by acquiring an already made product or through custom development with the help of a trusted technology partner.
Incumbents in a FinTech Future
Banks face enormous challenges to their way of establishing and developing business. Alongside FinTechs, the so-called BigTechs, such as Facebook, have also started to gain interest in this area entering as active competitors, further increasing the pressure on incumbents.
Despite this seemingly co-ordinated attack on traditional banking, in which they find themselves equipped with weaker technological infrastructures and without adequate tools, the truth is that most will survive. The important question is whether they’ll be able to maintain their position as customer-facing financial services providers or be relegated to the secondary role of executing someone else’s market strategy.
To find out more about how incumbent banks can flourish in an environment increasingly dominated by digital, take a look at our customer-centric digital transformation offer below.