Three ways the banking industry can stay relevant in the age of disruption

13 February 2018

The banking industry is being disrupted by innovation through digital technology, new regulation and increased competition. Although relatively belated compared to other disrupted industries such as travel, retail and media, the pace of change and its impact on business models, customer behaviour and operations is forcing banks to rethink their traditional banking model. Daniel MeereManaging Director of Axis Corporate in the UK, reflects on three ways traditional banks can fight back.

To date, most innovation effort has focused on improving the customer experience, through more products and services being offered online or via mobile devices. Bank customers are now used to app-based banking, mobile payments and biometric security to make their lives easier.

At one level, this digitisation of the banking experience is both welcome and expected by banks and customers alike, as it speeds up processes and makes the experience more convenient. In most cases it is also more intuitive than traditional methods, as anyone who has ever completed a paper-based application can attest. However, this has ignored the underlying infrastructure. Banks are still saddled with a cost of operation which is unsustainable in a market where revenue opportunities and margin continue to be eroded. 

Legacy bank infrastructure runs on technology designed for the face-to-face banking age. Change was infrequent and slow, and new features tended to be added to the core platform, which is now unrecognisable from its original form. The supporting operations and processes have also undergone significant overhaul, but these are also unfit for current requirements. 

Three strategies for banks to hold off BigTechs and challenger banks

The competitive advantage of challenger banks is their agility, enabled by a modern technology backbone. This has led to lower operating costs and new business models based on charging for value created, not services provided. Customers are underwhelmed too at having to pay for banking services that are free in other areas of their lives. Imagine being asked to pay for holding an account with your preferred airline, online grocer or content streaming service.

To date, this wider choice of provider has been limited to more ´fringe´ banking services where FinTech firms have cherry-picked niche, profitable services such as Foreign Exchange, Crowdfunding, Digital Payments, Low Cost Investment. This has provided customers with greater speed, control and convenience, and eaten away at profitable bank services, exposing the high cost of operating an ageing core without the effective subsidy of profitable add-on services. 

However, switching numbers in core bank accounts, the ´crown jewel´ for banks in terms of customer ownership and valuable data, have remained low, at less than 6% of all UK bank accounts since the Current Account Switching Service (CASS) was launched in 2013. Following the implementation of Open Banking, this is expected to increase. 

Open Banking

In an Open Banking world, the threat to traditional banks is amplified, as while they hold more data on their customers through increased transactions, this is offset by fewer and less personal contacts. This makes building the ´sticky´ relationship they seek more challenging. As both challenger banks and the BigTech firms court once loyal bank customers, and increase their own potential, traditional banks could feel further pain.

Quote Daniel Meere, Axis Corporate in the UK

The BigTech firms, including Google, Apple, Facebook, Amazon have two factors that Fintechs and Challenger Banks do not, namely the scale of customer base and brand trust that traditional banks would historically consider their ace card. 

Three strategies for traditional banks

The fightback from the traditional banks may take one of three forms. First would be to level the playing field by modernising the technology platforms which keep their costs high and their speed to market low . This would reduce their competitive disadvantage vis-à-vis the newer entrants, but is a long, costly and painful route. Some have tried, none have yet fully succeeded. BBVA for example has won plaudits for adapting processes, corporate culture, as well as management structure, and focused on customer innovation to meet the forthcoming challenges. It sees this as the beginning of its digital transformation journey.

Second would be to create a ´Utility´ provider, either led by a single, scale-bank or a group of banks. Such a utility could offer the commodity and industry-wide services that drive much of the current cost and inflexibility (fraud prevention, data storage, reconciliations, on-boarding are all prime candidates). This again has both advantages and drawbacks, as although a single service provider to the industry would bring down cost of operation and -in areas such as fraud prevention- provide better data to all parties, banks remain reluctant to cede their independence and share services with their traditional competitors. An early example of a UK banking utility was seen through Intelligent Processing Solutions Limited (iPSL) cheque-clearing service, set up in 2000 as a joint venture between Barclays, Lloyds and Unisys. 

A third option would be to enter into more active collaboration with the BigTech firms. So far, these non-bank technology titans have been wary of becoming deposit-taking entities in their own right, through fear of burdensome regulation and further scrutiny, although they covet the data and frequency of transactions that banking customers offer. Here, HSBC has partnered with Amazon Web Services (AWS) to cloud-enable its development operations, and AliPay has signed a partnership agreement with BNP Paribas, Barclays and UniCredit amongst other fledgling collaborations. Deeper, more ambitious tie-ups could take this model much further. In the future, BigTech firms may feel that this is an industry ripe for their brand of disruption, and as such is their next logical conquest. 

Banking is being disrupted by digital technology, new regulation and increased competition

Change is the only constant

Whichever the option taken by traditional banks, it is clear that the disruptive force of technology from new players has moved from potential to real threat. As BigTech firms begin to take a more active interest in banking, the barriers that prevented FinTech firms from scaling up and expanding their offerings (lack of reach, lack of a widely recognised brand, lack of funding) begin to disappear.

Traditional banks can, therefore, no longer afford to be special, in the sense that they still see their businesses as too complex, too unique, and too specialised to be performed and provided by non-bank partners. The overhead of owning and operating a full bank service within the bank´s own walls is prohibitive. The costs of compliance with regulation and patching up the creaking technology infrastructure have proven this. 

Overcoming this ´cultural debt´ and the fear of change is the main challenge for traditional banks. We see three key actions to transform banks from within, and make them relevant and competitive in the newly disrupted banking market:

  • Identifying the key value-adding services that customers expect from them, and retaining these. Ensuring that these differentiators are delivered to world-class standards
  • Sourcing the ´commodity´ services from leading technology partners to enable low-cost, scalable operations that can adapt to market and regulatory demands
  • Providing, partnering to provide, or procuring the ´utility´ services delivered at an industry level to optimise cost/revenue and value as part of a banking ecosystem.

People continue to need banking services, though not necessarily all from banks. The services themselves are changing rapidly, enriching the financial user’s journey and transforming the banking industry. The challenge for banks if they are to continue to be relevant, is to change with them. 

Related: Retail banks should not overlook active divestment strategy (by Callum Russell, a Senior Consultant at Axis Corporate).


The business and operating models of digital-only banks

04 April 2019

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.