Three Paths to Digital Transformation in Banking

Just about everyone in banking can agree that digital transformation is a strategic imperative for financial institutions that hope to remain relevant. But the right path to get there is a subject of much debate. Should you go all in and create a separate digital entity? Or should you slap on a digital front-end that preserves a back-end legacy infrastructure?

What’s the right path to digital transformation for banks and credit unions? According to consulting firm PwC, it depends on the depth of their pockets and their appetite for risk. A white paper released by PwC outlines three different options:

  1. Front End Only – Rolling out CX improvements and cosmetic fixes without retooling any of the tech infrastructure.
  2. Wrap and Digitize – Upgrade individual components and build on them as the bank or credit union continues to develop.
  3. Going Digitally Native – A fully digital customer interface supported by a fully digital and modernized back end.

Before picking one of these three directions, Julien Courbe, PwC Financial Services Advisory Leader and author of the white paper, says banks and credit unions must first determine how digital fits into their overall strategy before embarking on a me-too project that could be the wrong approach… and cost millions of dollars.

“While it’s important to keep up with competitors, you must tailor your digital transformation journey to your strategy and your needs,” Courbe cautions. “You can’t just follow in the footsteps of another institution.”

Courbe recommends that senior leaders in the banking industry ask the following three questions to figure out which approach is the right one for their institution:

  1. What do we want to be known for?
  2. Which consumer segments are we targeting?
  3. What are our core capabilities and points of differentiation, and how will a digital strategy strengthen them?

According to Courbe, all of the top 30 financial institutions and most second- and third tier banking providers have already initiated a digital transformation project of some kind, but these efforts are often ad hoc and fail to yield the expected improvement in profitability. And change is never easy in the banking industry.

A host of challenges create significant headwinds for any bank or credit union considering an undertaking of this magnitude — a legacy infrastructure hobbled by an aged core platform, an internal culture resistant to change, and an inherent aversion to risk. That means for most financial institutions, digital transformation will be a lengthy, iterative process, and very few will become digitally native any time soon.

Front End Only: The Path of Least Resistance

A front-end only digital strategy in which you focus your energy on CX and consumer-facing systems while ignoring the back-end (at least for the time being) is the easiest approach. Courbe says it helps to think of this path as a cosmetic strategy that only addresses superficial elements of the experience. Specifically, you make the mobile app and online banking interface as intuitive and attractive as possible, but don’t invest in any substantive changes to the underlying legacy systems.

While this is definitely the quickest and least expensive way to get a digital look and feel for your institution, it’s only a temporary fix — a digital “veneer” overlaid on a dated infrastructure that will still need gutting somewhere down the road. Behind the scenes, the institution remains limited in what it can deliver.

“Without integration of back-end systems and no fundamental change to the operating model, the experience will be not be significantly different than what customers had before,” says PwC in its report. “In other words, the front end promises what the back end can’t deliver.”

Courbe warns that this approach is really just a stop-gap strategy. Nevertheless, the front-end experience has the biggest impact on consumers and how they perceive their banking provider’s brand, so it makes sense for banks and credit unions to get busy pouring dollars into an improved CX. For some banks and credit unions — those that either don’t have the stomach or the budget for full digital transformation at this time — it may be the best alternative. They can at least remain competitive by appearing to be digital.

However, without integration between the front and back ends, you probably won’t realize the cost savings that ultimately make a digital-first strategy so attractive. If you’re not careful, all you may accomplish is adding costs to maintain a new front end — trapped in a into a quasi-digital environment where you’re constantly struggling to retrofit workflows and adapt processes in ways for which they were never originally designed.

Bottom Line: A front-end approach may seem penny-wise but pound-foolish, yet it still may be the right strategy for some banks and credit unions.

Wrap + Digitize: Gradual Iteration

This path replaces the front end with a digital experience for consumers while acknowledging that the underlying legacy systems have to go… at least eventually. With this approach, you fix the front end and create a roadmap outlining how and when you will retire your aging systems and replace them with new digital solutions. You get the big bang impact from revamping your front end while establishing a timetable for complete digital transformation.

Taking this path, PwC says banks and credit unions can use application program interfaces (APIs) to integrate data across product groups and functions. This integration layer gives employees a 360-degree view of the customer and sets the stage for modular, “plug and play” capabilities. With data integrated across the organization, the organization can become more agile. Instead of multiple sites for banking, cards, and lending, customers can have access to all of their accounts with a single sign-on. And employees can quickly turn data into real insights, customer interactions are more tailored to them. This bank has truly committed to transforming itself.

Bottom Line: The wrap and digitize approach yields a consumer experience that tends to be better than the front-end only path, but the transformation process can drag out over many years. Each improvement is made one by one, so it takes time to tackle all your processes. On the flip side, the costs are spread out, making it a more affordable approach and more attractive to management teams who are concerned that they may be disrupting too much at one time. This is a great option for banks and credit unions that need to take a more gradual approach.

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Going Digitally Native: Reinvent From The Ground Up

Some banks and credit unions choose to go all in. With this strategy, the management team typically starts over by defining the “minimally viable bank,” one that will offer just a handful of products. A basic retail bank, for example, might focus on deposits, payments, or lending. Many financial institutions pursuing this approach have decided to create an entirely new digital arm — a separate arm with its own consumer-facing brand that may eventually overtake the legacy brand.

Reducing costs is a big reason banks and credit unions should consider going digitally native. PwC says branch transactions cost roughly $4 each, while online and mobile transactions cost $0.09 and $0.19, respectively. But the main reason to go digital native is that it makes organizations much more agile. When you’re digitally native, you don’t have to spend months or years on IT initiatives only to find out that consumer preferences have changed in the meantime.

“It lets them adapt to rapidly changing customer tastes, and it lets them test and iterate rather than commit and hope,” explains Courbe. “The digital core and open architecture also allow flexible approaches for partnering with third parties to offer a range of products and services. It’s now possible to set up a fully functional, digital native bank using third-party architecture.”

If this is so attractive, why don’t we see more of it? Usually it comes down to perceptions of expense.

“Many financial institutions think it’s costly and time consuming to launch a fully digital bank, though this doesn’t have to be the case,” says Courbe. “Using cloud technology, it’s now possible to launch a digital native bank in months and at far less expense than ever before.”

“It’s tough to bring a culture of fast agility and a digital-first mentality into operations, finance, risk management and marketing.”
— Julien Courbe, PwC

But going fully digital means replacing the legacy core banking system, which can cause a raft of cultural and HR challenges — e.g., getting employees comfortable with a more modern customer experience. The ability to go to market faster with new products can also result in cultural dissonance; banking providers simply aren’t accustomed to doing anything on the fast track. The siloed departmental organizational structure served by centralized IT is another detriment.

To take advantage of the nimbleness of digital, argues Courbe, banks and credit units need to have IT capabilities in each department rather than rely on an IT department charged with competing projects from multiple areas of the institution. Think “distributed model” rather than “centralized model.” That’s why you shouldn’t expect the CIO or CTO to automatically jump on board. Losing control of some IT functions and distributing decisions is definitely scary and potentially threatening.

Furthermore, financial institutions now have to compete with fintechs, so getting the IT talent they need to shift to a distributed model can be a major challenge. Let’s face it, it’s difficult finding IT folks who are up on newer technologies and excited about working at a bank or credit union.

Bottom Line: The digital native strategy will ultimately deliver the biggest cost savings as well as the ability for the bank to adapt quickly when change comes. But the internal challenges could prove too painful for many banking providers.

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