Banks should fix back office complexity to secure profit

21 September 2015

Banks should focus on back office technologies in order for them to stay nimble and safe, meet regulatory requirement, and compete with start-ups, research by Accenture shows. According to the consulting firm, while on demand digital solutions for front end banking services are rapidly proliferating, including mobile and online banking channels, the back office at many banks still operates under legacy systems.

The banking industry is in many ways already inherently open to digitalisation. Much of what a bank historically did in the back office, such as the processing of numbers on pieces of paper, has been transferred to digital means. And while the back office has long been digitalised, the front end remained visibly analogue, with branches, paper cheques and cash and more recently, plastic cards.

A recent report from the BBA in partnership Accenture, titled ‘Digital Disruption: UK Banking Report’, finds that today the digital situation is rapidly changing for the customer facing end. Changes in consumer behaviour in favour of digital transactions as well as the advance of technologies are opening up the potential for a wide range of banking services to being offered in digital space. Banks, in response, have started developing and delivering more and more of their traditional services through digital channels.

Accenture and BBA: UK banking report

Mobile banking for minor services, such as account checking and transfers, has grown rapidly and more than triple in four years, with monthly usage levels of 8% in 2010 jumping to 27% by 2014. The kind of services offered through digital channels is also on the increase. In 2014, 45% of UK customers surveyed by Accenture that purchased a banking product in the previous twelve months did so through the internet channel, of which 6% via a mobile device.

The back-end
While the front end has recently shown considerable progression in terms of digitalisation, the back office – according to the Accenture report – is proving to be a serious difficulty for banks wanting to create digital services and meet the increased disruptive competition from start-ups. The central issue is the ‘hardwired’ complexity which exists in the back office of many large banks. The ‘core’ of a bank’s backend is often a wide and complexly interacting interdependent network of legacy systems.

Banking backend legacy system

This complexity exists in a number of different forms. One is that a variety of rules regarding functions, which may no longer be of these times, continues to exist in the program code in ways that makes removing the process difficult. These include according to the consulting firm: “the general ledger, the bank’s product factory and business rules.”

Other issues exist in the synchronisation processes and the web of rules that manage the delicate balance and harmonisation required in operating a real time current account. The ‘evolution’ of the system on top of itself in sometimes ad hoc ways means that “such complexity is the result of an accumulation within banks of thousands of minor software patches and variations, sometimes over decades. Systems have evolved, but not by design, and the outcome for banks has been the creation of enormous and intractable complexity.”

Legacy system

Legacy consequences
The consequences are multi-varied according to the report, including decreased security as legacy systems have more holes for smart hackers, increased risk from things going wrong in one or more subsystems, reduced agility as legacy systems need to be considered in any IT development, and increased costs associated with keeping it all running.

The lack of engagement with dealing with the problem of legacy systems and complexity in the back office also has a number of external consequences for banks. Regulators continue to be keenly interested in the transparency of banking entities, which makes intractable complexity an issue. It is not however merely oversight that is at issue, new entrants to the market are coming in with highly sophisticated back office ‘off the shelf’ banking solutions and will soon be competing for customers expecting full digital service. Metro Bank, Aldermore and Shawbrook can be seen as examples.



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.