There is no lack of rhetoric around the ‘disruption of the banking industry.’ This is because there are several questions that industry observers continue to ask:
- How will innovations (like marketplace lending or blockchain) transform legacy banking operations as we know them?
- Will incumbent banking organizations continue to dominate or will there be a disintermediation of banking organizations by the fintech start-ups?
- Will legacy banking organizations and fintech players be competitors or partners in the future?
Even without the answers to these questions, it is agreed that banking is going to look a lot different a decade from now (or maybe even by 2020). In the report, “Banking Reimagined: How Disruptive Forces will Radically Transform the Industry in the Decade Ahead”, Deloitte examine how current and future trends will come together to influence the future of banking.
Not If, But How?
The question surrounding the banking industry today is not whether the industry will be transformed, but how it will be transformed. New competitors, new technology, and new consumer expectations are impacting the banking industry faster and to a more significant degree than ever experienced.
The friction caused by legacy systems and processes, combined with an increased focus on improving the entire consumer journey, is what is attracting new players. Yet, despite these opportunities for fintech start-ups, and an ever increasing interest by investors, reaching meaningful scale has been challenging.
The five megatrends Deloitte sees transforming the banking industry and payments in particular are:
- A new organizational paradigm focused on simplification and agility
- A focus on brand equity and an improved consumer experience
- A blockchain-based payment system
- An increased importance of machine learning
- A consolidation of the marketplace lending industry
Despite this upheaval, Deloitte believes the banking industry will emerge stronger in the future.
Since the economic crisis of 2008, financial services organizations have been simplifying their business and operating models for both economic reasons and to reduce organizational complexity. Now more than ever, banks and credit unions realize that they can’t be “all things to all people” and that it is more efficient to outsource and/or divest from noncore activities. These changes have resulted in staff reductions, reduction of physical footprint and digitalization of processes.
The concept of extended partnerships, where there is an increasing reliance on a network of partners, service providers, and industry utilities, is expected to become more common across the industry over the next decade.This extended ecosystem, while offering some obvious benefits, such as reduced costs and complexity, also raises some new concerns around operational risks according to Deloitte.
Digital Brand Equity
While historically, banking brands had been some of the most respected, the financial crisis hit all financial institutions especially hard. Most banking brands have yet to recover from the reputational damage experienced during the crisis. In fact, when compared to other industries, banks have experienced the least growth in brand value over the last 10 years.
As digitization of all industries continues, consumers will expect banking experiences to replicate those in other industries. With significantly fewer visits to a local branch office or even a phone call to a customer service representative, conveying a consistent brand experience will be more challenging. The importance of developing personalized experiences based on data analytics will be paramount.
Brand equity in the industry will also increasingly flow from partnerships that are established with others in the ecosystem. Service differentiation and customer experience will increasingly become the major deciding factors, with the ability to deliver real-time insights and offers, transparency and integrated commerce opportunities becoming more important.
Blockchain-Based Payment Systems
Deloitte estimates the value of global transactions at $26 trillion annually with billions of dollars in fees, but states that the systems that facilitate this volume of payments are inefficient, antiquated, and incapable of satisfying worldwide demand. The impact of competition to address these needs will be greater efficiencies, an improved consumer experience and the prospect that traditional firms may lose control as the impact of digital technology increases.
Because of these inefficiencies, every payments channel has experienced transformation. Examples include online (PayPal), mobile (MPesa), contactless (Apple Pay®, peer-to-peer (Square, Venmo, etc.), cross-border remittances (Ripple Labs), and cryptocurrencies (Bitcoin). The biggest transformation of payments may be on the horizon, however, where blockchain could bring vast efficiencies by speeding up transactions and diminishing transaction costs for everyone involved.
Deloitte projects that blockchain innovations will be the most transformative change in the payments system for the next ten years. Their prediction is that all payment volumes will increase dramatically by 2025, spurred by Internet of Things (IoT), digital payments and direct corporate payments. Changes to payment infrastructure can facilitate increased volume, while decreasing fee margins. Decreasing the need for intermediaries can reduce costs, while increasing access around the world.
According to Deloitte, “This desire to exploit blockchain technology is not restricted to retail payments. In fact, there is equal potential in the corporate space as well, considering applications in trade finance, cross-border payments and payments reconciliation.
Not surprisingly, the report projects continuing growth of mobile payments and wearables, with Internet of Things (IoT)-enabled mobile wallets may finally reach critical proportion before 2020, making many forms of consumer payments seamless, nonintrusive, and hassle-free. The concern with this integration of payments within all that we do daily is that banks and credit unions will lose control over the customer experience.
Interestingly, while innovation in payments continues unabated, retailers and banks in the United States continue to struggle with the migration to chip card technology (EMV), illustrating that legacy payment infrastructure in the US is a serious impediment to any modernization effort. Deloitte warns, “In our view, while the promise (of payments innovation) is real, the path to actualizing the potential will not be easy. There is simply too much legacy overhang in making this transition. It will take enormous effort on a collective basis to migrate to a blockchain-based trading and settlement infrastructure.”
AI and Machine Learning
Automated trading has been in place for decades with the electronification of exchanges and algorithmic trading have already diminished the role of the human trader in a number of asset classes, particularly in equities and futures. The performance of machines to make intelligent decisions is only going to accelerate exponentially in the near future, according to Deloitte. It is expected that markets will become more efficient, making opportunities for competitive differentiation fewer, reducing overall profitability.
Despite the automation of trading, tailored human insights and strategic advice in building algorithms and making investment decisions will become the main competitive differentiators. This will result in an investment in specialized, human expertise that should be able to differentiate their offerings in the marketplace.
As in the area of payments, distributed ledgers could potentially hold vast promise to radically transform trading transactions, which in the past required a trusted intermediary. As with payments, legacy systems and thinking will impact the speed of this transition. It is believed that it will take enormous effort on a collective basis to migrate to a blockchain-based trading and settlement infrastructure.
A number of developments have combined to impact the competitiveness of legacy banking organizations in lending, including:
- A stricter regulatory environment for legacy banking organizations, compared to non-banks.
- Record-low interest rates, which have negated banks’ traditional retail funding advantage.
- Reduced barriers to entry through technology, with new players able to enter without huge upfront investment.
- More tech-savvy consumer base with higher expectations of digital delivery and reduced loyalty to traditional banking organizations.
In response to these marketplace changes, and unburdened by legacy systems or regulatory constraints related to holding deposits, marketplace lenders such as LendingClub, Prosper, Kabbage and SoFi are exploiting innovative technology to remove frictions in traditional lending processes. That said, with only $15 billion in loan originations in 2015, these marketplace lenders have yet to make a significant impact on the $3.5 trillion non-mortgage consumer debt in the United States.
Despite predictions that marketplace lending will eventually disrupt banks, legacy banks and marketplace lenders would rather partner than compete. Examples include Citi’s partnership with LendingClub, OnDeck’s association with Chase for small business loan origination, and Avant’s relationships with JPMorgan for securitization.
One prime reason is that MPLs have already created nimble technology platforms from scratch, while legacy organizations would not need to recreate the wheel. Alternatively, legacy banks and credit unions have the vast majority of existing relationships.
Preparing for the Future
New entrants will continue to bring disruption to the marketplace, but legacy financial institutions will still dominate and lead the charge for innovation. This is because banks and credit unions maintain strong relationships with consumers and businesses. That said, traditional financial institutions risk losing control over the “consumer experience” as small fintechs and large technology companies offer new solutions that reduce friction and take advantage of digital advances.
Deloitte’s recommendations to the banking industry is to strategically invest in innovation by partnering, hiring, crowdsourcing, and piloting – engaging with different players to develop new solutions across the banking spectrum; and proactively working with regulators in the shaping of standards and protocols around new technologies.