All the efforts to meet the demands of the pandemic were a prelude to what will follow. Banks and credit unions have largely met the challenge of front-end digitization, but can no longer ignore the need to do the same for their middle and back-end processes and functions.
This goes far beyond efficiency. These steps are required to implement artificial intelligence to the degree that many non-bank competitors can already do, and to be able to successfully participate in a world of embedded finance, AI, DeFi, crypto and more.
“Banking is still trying to figure out how to do end-to-end digitization,” observes senior IBM consultant Anthony Lipp. “Meanwhile, Big Tech has essentially reinvented how we think about consumer financial services.”
Banking is no longer its own separate value chain. Increasingly it is integrated along with other functions within these platform business models.
As IBM’s Global Head of Strategy for Banking and Finance, Lipp is in a position to see how the competitive trends, driven to a large degree by technology, are unfolding. With IBM for 12 years, Lipp has responsibility not only for advising financial services clients on strategy but for directing IBM’s own strategy for its global banking clients. Prior to joining IBM, Lipp was a consultant, partner and practice leader at McKinsey and PwC and worked in banking earlier in his career.
The Financial Brand interviewed Lipp about the most significant tech-related developments impacting the future of banking. The consultant addresses seven key areas, grouped under four broad themes in the edited highlights below.
Theme 1: The Impact of Platform Business Models
Given how much broader competition in banking has become, do you see the role of banks and credit unions changing?
Anthony Lipp: The scope of how financial services are consumed has broadened significantly, driven by new platform business, or ecosystem, business models — the Googles, Alibabas and Amazons — that break down the friction between traditional value chains.
Because a value transfer usually needs to take place on these platforms, payments was the first banking function to be disrupted. One example is the way Uber brings navigation, payments and the whole experience all together on a single mobile platform.
Initially non-bank players partnered with one or more financial institutions, but then realized, “We’re paying a lot for this service and there are alternatives out there. Let’s aggregate some of that value within our ecosystem as opposed to having that value leak out into the financial services industry.” That’s when digital wallets like Apple Pay really started to take off.
That created a lot of the change around how financial services is consumed.
What’s the role of financial institutions in these platform business models?
Lipp: Certainly they are a key part of it, but they’re not the drivers. And I think that’s something the industry has kind of missed. For a very long time, whenever people needed something financial — to borrow, for example — they’d have to come to a bank. Digitization changed that.
'Sticky' No More:
Financial services are now so digital that it's easy to embed them in other offers, and it's easy to enhance those offers in markets outside of banking.
People don’t wake up and say “I want to use my credit card.” They say “I need to do such and such.” That was true before, but now, more and more often the decision around how and when people consume financial services takes place within another value chain.
And that’s why you are seeing predictions that 25% to 35% of all banking revenues are going to migrate to these new models of consumption.
Theme No. 2: The Need for End-to-End Digitization
What is required for traditional institutions to compete successfully in the platform or ecosystem model you described?
Lipp: Usually platform transactions involve smaller dollar amounts, but there are many of them. So the model that banks need to build to be competitive is one of hyper efficiency — very low cost, extreme scale. That means financial institutions have to come up with alternatives to expensive existing processes.
They must make sure that their environment is fully digital enough. That means end-to-end digitization because it’s not just the interface with the customer, but it’s the middle and back office activities as well. And that enables you to become what we call “extremely digitized,” and to unlock the value of data and artificial intelligence.
Where does banking stand in achieving the end-to-end digitization you describe?
Lipp: There is a wide range of situations, of course. But the industry, overall, I would say, is very early in that thinking.
All the effort over the last two decades has been around digitizing the front end — it’s simply been too hard to deal with the middle and back office part of the process for most institutions.
For example, if you look at the statistics on use of cloud computing, the industry was fast to get on the cloud initially. But it flatlined quickly. Other industries, by contrast, accelerated in their adoption of cloud and other new computing platforms.
Also, because the industry has been so focused on trying to digitize its own environment, institutions have so far largely missed the opportunity of embedding financial services within other industries.
Theme 3: Impact of Blockchain, Crypto and DeFi
Blockchain has already been through a couple of hype cycles. What’s its significance to banking at this point?
Lipp: Interestingly, blockchain was probably overplayed the last few years. Talk of the potential use cases got ahead of the actual use cases.
However, as financial institutions think about these platform business models — which, fundamentally, are just a lot of parties that come together — you need certainty, auditability and sharing of that information within that group. And this is where blockchain becomes a real asset.
Lipp: One of the challenges we have as an industry is our processes are defined by our products. And our products just naturally drive how we use technology. However, the emergence of CBDCs (central bank digital currencies), NFTs (non-fungible tokens), cryptocurrencies and stablecoins are all redefining the different asset classes that are out there.
Hidden Benefit of Crypto:
Banking efficiency is driven by 100-year-old product designs. CBDCs, cryptocurrencies, NFTs and similar digital assets could help cut costs drastically.
The significance of staying up with these developments is that it enables financial institutions to hit the next wave of efficiencies. These new product designs will allow financial institutions to remove 50% to 80% of the cost from their processes.
DeFi — decentralized finance — seems like a threat to traditional banking. Or is it another opportunity in disguise?
“Decentralized finance offers financial instruments without relying on intermediaries such as brokerages, exchanges, or banks. Instead, it uses smart contracts on a blockchain.” — Wikipedia
Lipp: The banking industry makes money as a middleman. And there has been a need for that role because it ensures security, the tracking of transactions and managing risk. All of that now is available without having that middleman.
So as a threat to the industry, DeFi is significant. There’s aggregation taking place outside the financial services industry. Now the question is, does the banking industry become more secure and less risky as a result? It does, because all the riskier stuff is going to move out to these decentralized places where it’s harder for a central authority to manage and control them.
But what it also means is that the banking industry is exposed to a smaller universe of opportunity. I believe the industry recognizes that.
As new players and different regulatory environments emerge, we may see incumbents play the role of risk manager, providing insurance and security, and running the processes, activities and transactions in that environment. Clearly the biggest banks will want to play in this different financial space.
Theme 4: Most of AI’s Potential Has Yet to Be Tapped
It seems that many financial institutions regard AI mainly in terms of fraud monitoring, credit underwriting and chatbots. What’s the potential beyond that?
Lipp: With AI, banks and credit unions tend to go for the shiny objects. They want to go and use it, but their data environment is just not ready to do that.
To me, pre-scripted chatbots are not real AI. They’re about call volume mitigation based on data analytics. Artificial intelligence is actually learning from the content. When you move from just being an informational chatbot to actually becoming transactional and predictive, that’s where the difference is.
It’s similar with fraud and security. When you can predict when a breach is likely to take place and start building mitigation actions well in advance of that, that’s AI.
What about use of AI in bank marketing for greater personalization?
Lipp: It’s being used, but one of the biggest concerns from pushing AI to the limit in marketing is ethical issues.
In banking we’ve trained our customers not to expect us to be insightful and to predict. That’s because we say “We won’t use your information to do those sorts of things.” Whereas that’s exactly what’s taking place on all these other platforms out there. Customer data is being used to manipulate behavior and to drive certain outcomes.
Banks and credit unions can use AI and data to anticipate when a client is going to do something and communicate to them, “Here’s a product that will help you do that,” but they have a customer base that is maybe uncomfortable with that. Also, regulatory issues will likely become an issue. So the industry has to balance the potential with the ethics.