A complex regulatory scene
The passing of the Patriot Act, Title III in 2001 would herald a new era in regulatory measures, many of which focus on combating money laundering and terrorist financing. Three years later, Basel II emerged to ensure banks have adequate capital to assume the risks they expose themselves to. Around this same time, the industry adopted IFRS reporting standards and MiFID was introduced to standardize regulatory disclosures and increase transparency across the EU's financial markets. Then the financial crisis struck in 2008, resulting in a major process of regulatory reform that gave birth to Basel III.
Fast-forward 10 years and GDPR and PSD2 come into effect, adding more complexity to the regulatory landscape. Regulations have cost banks around $270 billion in compliance costs per year and $321 billion in fines. But it’s not just regulation that is changing the way banks go about their business. A new breed of banks, agile and digital in nature, is also threatening the status quo.
Challenger banks and new fintech companies are changing the game
Investment in fintech has grown steadily since 2013, going from $18.9 billion that year to $111.8 billion in 2018 (as KPMG’s research shows). Most of these new market entrants focus on payments, personal finance management and credit solutions. Wealth management and insurance services are also picking up steam.
The biggest impact of these newcomers is an improvement of the customer experience. While most banks are still using legacy systems, mobile-first banks like Chime in the US and Netherlands-based bunq, to name a few, are redefining transactions and ease of use. It’s no surprise to see that 76% of banking professionals feel that part of their business is at risk due to new fintech. An Accenture study estimates that competition from nonbanks, along with other factors, could cost banks “$280 billion in payments revenue by 2025.”
Mergers, acquisitions and investments seem to be the preferred strategy for banks eyeing these fintech products and looking to develop their own. CNBC reports that major Wall Street banks have participated in 24 deals this year alone. The market is also consolidating and has been for some time. In the European Union, the market contracted from 8,525 credit institutions in 2008 to 6,250. The numbers are similar in the United States, where the number of commercial banks sat at 7,077 in 2008 and fell to 4,717 in 2017.
Besides M&A, cooperation with some of the bigger tech players is also growing. Let’s take a look at the impact Amazon, Google, Apple, Facebook, WeChat and Alibaba are having.
Compete or collaborate with big tech
Amazon launched Amazon Pay in 2007 and has since become a force of its own when it comes to online finance. The company has made several fintech investments. All of them revolve around their core e-commerce business and expanding to international markets. India and Mexico have been the focus so far. On the merchant side, they have also developed a loans service (Amazon Lending) for businesses to finance stock which can then be sold on the Amazon web store. They have also been in talks with several banks to develop a checking account service and have considered entering the home insurance market. Amazon’s goal is clear-cut: giving customers a seamless experience.
Alibaba, the Amazon of the East, is betting on a similar strategy. Their Alipay ecosystem offers financial services within the app: insurance, payments and more - all with the push of a button and offered in collaboration with banks.
Google is another big tech firm collaborating with banks. The company’s recently announced partnership with Citigroup will allow customers to open a bank account through Google Pay. Compliance and KYC principles will remain in Citigroup’s domain, while consumers enjoy a modern user experience. This has raised some significant privacy concerns, but only time will tell if Google will sell their customers’ purchasing data or not. Still, 57% of millennials would reportedly switch their existing bank for a better banking technology platform, so there is a market that’s ripe for the taking.
Like Google, Apple is also collaborating with banking incumbents to expand their fintech offering. The company’s partnership with Goldman Sachs allows US consumers to get their own Apple credit card through an Apple interface. Although it was met with skepticism and a gender-bias scandal at the outset, unique selling points include more security (you need the card and your phone to shop) and cash-back rewards for certain purchases, which are paid out on a daily basis. A recent announcement shows that Goldman Sachs has lent out about $10 billion in credit to Apple customers so far.
Facebook is taking a very different approach. Like Amazon and the others, they also ultimately want to retain their customers’ attention by offering payment services within their own environment (such as Facebook Pay). Unlike the other big tech firms, they also made an attempt to launch Libra, their own “cryptocurrency.” The crypto experiment’s future is unclear and it’s currently on hold due to regulatory pressure, but it certainly poses a risk to central banks all over the world.
Comparable to Facebook, WeChat is a remarkable contender for banks as well. The messaging app now turned fintech giant, enables users to pay bills, recharge mobiles, make online purchases and money transfers, and pay using QR codes at merchant stores in China and abroad. The company effectively transformed China from a cash-based to a cashless society.
What do all of these developments reveal? Collaborations between banks and big tech giants are likely to increase. Ultimately though, big tech is focused on customer “stickiness” and banks will have to compete for consumers’ time. The challenge for incumbents is to develop equally enticing and seamless service offerings, while still relying on foundational legacy systems that are excruciatingly difficult to migrate to the cloud.
It’s high time to embrace the cloud
Although there is an upswing in cloud adoption lately, many banks and other financial services companies are still reluctant to go all-in. In a 2018 study, 43% of executives said their bank lacks a strategy to move to the cloud. Security concerns abound. Nonetheless, the cloud is a key enabler for banks to offer the seamless digital experience customers crave. Many of the legacy IT systems incumbents currently use have become redundant and expensive to maintain. In the UK, nearly 50% of banks fail to upgrade old IT systems as soon as they should. In the US, 43% of banks still use COBOL, a programming language dating from 1959. Layering solutions on top of these old systems inevitably leads to inefficiencies and outages. Often, these core banking systems do not run on real-time, making it nearly impossible to develop the type of solutions consumers demand today. It’s high time for banking executives to upgrade their systems. Taking an incremental approach, as EY suggests, can help to embark on this journey with the right degree of oversight.
So, what’s next?
Banks have to rethink their role in the financial landscape of the future. The ongoing pressure of regulation may push some to prioritize survival above innovation, but this strategy will not hold out much longer. Acqui-hires, fintech investments and collaborations with big tech may prove fruitful, but banks need to increase their focus on the customer. To do this, a cloud strategy is crucial. Outsourcing anything that is not differentiating (back-office, payments and core banking) to other companies can also help.
