Bank 4.0 Read online

  14See: USDA Report—“The Potential Impact of Changes in Immigration Policy on U.S. Agriculture and the Market for Hired Farm Labor”.

  15See: Quartz.com—“Just five tech companies account for a quarter of the US stock market’s blockbuster year”, 30 October 2017.

  16Source: EDF/Fortune—“Renewable Energy Is Creating Jobs 12 Times Faster Than the Rest of the Economy”.

  17Source: TFR commodities review 2016—www.tfreview.com.

  18Source: Compare http://www.corporateinformation.com/Top-100.aspx?topcase=b https://coinmarketcap.com/.

  19See https://www-01.ibm.com/common/ssi/cgi-bin/ssialias?htmlfid=GBP03467USEN.

  Part 03

  Why FinTech companies are proving banks aren’t necessary

  6 ➡ FinTech and TechFin: Friend or Foe?

  7 ➡ The Role of AI in Banking

  8 ➡ The Universal Experience

  6 FinTech and TechFin: Friend or Foe?

  As […] technologies develop and season, they’re going to create a totally different way of doing banking and financial services. Now we will see the possibility—not necessarily the probability—of what we call a “Kodak moment”, where increasingly banks become irrelevant to their customers.

  —Antony Jenkins, Former CEO of Barclays, founder of FinTech startup 10x Future Technologies

  If you go to Google and type in FinTech, among the top automated search terms that appear are “FinTech killing banks”, “FinTech disrupting banks”, “will FinTech replace banks”. If you follow through on such searches you’ll find pages and pages of news stories from the major financial news outlets, along with blogs, press releases and so forth proclaiming that, yes, FinTech will kill banks. But then you’ll equally find a plethora of articles showing that it’s all much ado about nothing and banks are not only up to the challenge, but will outlive the “fad” of FinTech. Some will argue this is a zero-sum game, that it will all work out with FinTechs and banks living in some sort of technological harmony once the dust settles. The truth is somewhat more complex.

  Will FinTech (or TechFin) kill banks? Most certainly some banks, but not all. Will banks (or regulators for that matter) kill some FinTechs? Absolutely, but again, the FinTechs that succeed will become an established part of the future of financial services and, as Antony Jenkins forecasted above, FinTechs and TechFins are materially changing what financial services itself means.

  Investment levels show that the FinTech “fad” is far from over: it’s either still getting started or we’re right in the thick of it. Strong investment of US$8.7 billion in Q4/17 propelled global FinTech funding to over the $31 billion mark for 2017, sustaining the same high level of investment seen in 20161. This brings the total global investment in the FinTech sector over the past three years to US$122 billion2. The number of VC transactions exceeded 1,000 for the fourth consecutive year in 2017. This is part of a wider trend of increased VC investment in technology firms; in fact, 2017 marked the highest spend in venture capital since the dot-com boom. A total of $84 billion was invested in over 8,000 technology companies and startups last year3, with FinTech taking more than a third of that investment. Rather than this being a bubble like the dot-com boom, there are now numerous FinTech startups that are large, high-value brands with established and profitable customers bases. Many of these startups are at least as big as their equivalent competitors who are listed, public companies. Like Uber, many of these companies have elected to remain privately owned for now.

  Ultimately this means that whether or not you truly believe FinTechs will kill banks is largely irrelevant. The investment flooding into emerging technology players is already changing financial services demonstrably, and these startups are changing financial services at a much faster rate than banks are able to respond to. As these new entrants continue to get greater and greater access to funding, this makes future disruption even more likely4.

  Let’s make the argument even simpler. If Ant Financial and Alibaba, LuFax, Simple, Square, TransferWise, Betterment, Stripe, Venmo, Xero, SoFi, Credit Karma, Coinbase and others didn’t exist, would banks be investing in technology at the same rate that they are today? Or would the status quo have continued to reinforce a slower rate of change? Ultimately the new benchmarks in economic performance, leveraging of social media and network effect, customer acquisition across digital channels, cross-sell and upsell strategies tied to behavioural models, and so forth, are inexorably linked to key FinTech players who have change the game and moved the goalposts.

  For example: if you were Jack Ma starting up in financial services, would you begin by building bank branches or appointing agents and advisors to build your business? Or would you use first-principles thinking to outline more aggressive growth methods in the digital age? I’ll let Jack Ma answer that question:

  I made a bet [with the CEO of Walmart]: in 10 years we’ll be bigger than Walmart, based on the sales. Because if you want to have 10,000 new customers, you have to build a new warehouse and this and that. For me?… Two servers.

  —Jack Ma, Founder of Alibaba, speaking at the 2015 World Economic Forum

  Figure 1: Jack Ma speaking at the 2015 World Economic Forum (Image credit: WEF).

  Jack Ma has been very clear that as the founder of the largest FinTech startup in the world, there’s no advantage in the digital age to building physical infrastructure to grow a brand. If you want to grow fast—it has to be digitally enabled.

  “For me? Two servers”

  The future of financial services is clearly about financial services experiences embedded in technologies that are ubiquitous. Technologies that allow rapid scaling. Technologies that solve the big problems of financial inclusion, fraud and identity theft, friction, and so forth. FinTechs are consistently first to market with experiences on the technology platforms that account for the vast majority of daily access to financial services. In China, Alipay and WeChat were first to market, and dominated. In the US PayPal, Venmo and Square pre-dated the likes of Zelle by years. The first banks to launch digital onboarding were neo or challenger banks. As a result, when these players get scale, they end up forcing incumbents to mimic the experience that customers now know is possible5.

  Every FinTech in the world has the same basic mission. Kill not the banks, agents, brokers and insurers of the world, but kill the friction associated with financial services today. They do that willingly and it is at the very core of their mission. For banks, they often have to battle legacy system constraints, compliance-based apathy and resistance, lack of executive support, and the fear of cannibalization of their existing “channels” before they can even start transformative projects. What this means is that FinTech’s are consistently more efficient at deploying investment capital for the purpose of removing friction, when compared with incumbents.

  Thus, it is inevitable that the fastest-growing financial services organisations we see around the world today are not banks, but the FinTech, technology and challenger bank startups. Does this mean we won’t need banks in the future? You don’t have to channel Bill Gates today to know that in much of the world people are using FinTech’s every day to do stuff that only banks used to do. In fact, in 20 markets surveyed by EY last year, consumer adoption of FinTech was on average 33 percent, with China as high as 69 percent of the internet-enabled population.

  I’m not arguing that every bank will disappear. However, the standards by which banks are held to is no longer their own—it’s more than likely that the day-to-day banking experiences you enjoy in 2025 will have been most heavily influenced by technology startups than by incumbent banks who have innovated. FinTechs and TechFins are shaping the landscape that is to come. Not regulators, not banks.

  Figure 2: FinTech Adoption Rates across 20 Markets (Source: EY FinTech Adoption Index 2017).

  Norman Chan, the head of the Hong Kong Monetary Authority, cited this exact problem when announcing a seven point plan for Hong Kong to compete globally on a regulatory basis. In his speech giv
en at the annual HK Institute of Bankers conference, Chan said incumbent banks have been unable to innovate quickly enough, so for Hong Kong to maintain its leadership as an International Financial Centre the HKMA has turned to FinTechs. Let that sink in—Hong Kong is pegging their future as a leading financial centre on encouraging innovation from FinTechs, not relying on incumbent institutions. The lack of innovation by incumbent players has now become a market threat.

  Digital only banks have seen greater take up outside Hong Kong. For example, UK regulators have encouraged the development of challenger banks as a way of bolstering competition in the sector. Meanwhile, incumbent banks in Hong Kong have been much slower to close physical branches than rivals because of the high profitability of individual branches in Hong Kong, and the comparatively slow take up of digital services by customers…

  —Norman T.L. Chan, HKMA Chief Executive, 25 January 2018

  When you look at the most disruptive innovations in the world over the last 250 years, from the steam engine to the telephone and computer, what we see is clear evidence that first principles design thinking creates the fastest innovations, the biggest leaps, the most disruptive market changes. Those shifts very, very rarely come from incumbents innovating themselves incrementally over long periods of time. It’s why Antony Jenkins called it a “Kodak” moment for banks. The fact that Kodak invented the tech behind digital cameras, but still couldn’t adapt to the digital age and thus imploded, is a relevant analogy.

  Figure 3: Kodak’s original digital camera prototype (Image credit: Kodak).

  This doesn’t have to end in tears for banks. Firstly, money behaviour is pretty sticky so changes in customer behaviour admittedly occurs more slowly in financial services than, say, music purchases or digitisation of video, but financial behaviour isn’t so sticky that it can’t be circumvented as the EY study cited earlier demonstrates. In many instances, the big disruptions we’re seeing in financial services are the result of network effect6. Money needs to move—we pay merchants, we pay bills, we send money to our friends, we pay our rent—if those people are on a particular network we share in common then our behaviour shifts, along with our money. Payments represent up to 80 percent of our daily interactions with financial institutions, so if you change the way you pay, that opens up risk for credit access, savings, merchant acceptance and many other areas that flow on from that shift.

  In China, where there are less legacy payments behaviour around plastic and cheques (for example), the shift has be able to occurred much faster, because network effect has less resistance. If you’re one of those bankers that insists that Brits and Yanks will still be using cheques in 30 years to pay for stuff, then you are in effect arguing that your economy is going to willingly fall behind China, India, Kenya and most of Europe in terms of day-to-day money movement, and probably as a financial centre of excellence. It’s why I can never agree with the argument I hear from bankers that “regulators won’t let it happen”. That’s ludicrous. Look at Shanghai, Hong Kong, Singapore, and London regulators—to name a few. They all are sandboxing, going open banking, enabling rules for ICOs and working with FinTechs, because they realize the future of financial services is being built today. If these countries and cities want to remain as leading financial centres, stopping FinTech advances would slow innovation considerably. Why on earth would a regular protect legacy behaviour in this fast-paced environment that is transforming financial services? They would do so at their market’s peril.

  Let’s talk about where these new players are impacting specifically.

  Where the new players are dominating

  Startups have the advantage of being free of legacy technology systems and tough regulation, both of which limit the digital developments of established financial services firms. As a result, startup companies can more efficiently create mobile-focused services or products that threaten existing financial companies.

  —“FinTech startups put banks under pressure”

  —Financial Times, 12 September 2016

  Already there are strong signals emerging that indicate FinTech’s and TechFin’s are starting to rewrite the underlying economics of financial services. It’s not just in building or deploying tech either, but operating expenses, acquisition costs, scalability, etc. Just like during the dot-com explosion, however, there are players capturing real revenue, players that are getting scale fast, and players that just won’t make it out of the starting blocks.

  It could be reasoned that there will be enough of these new players that are successful in getting traction that market expectations around certain metrics, KPIs and economics will inevitably shift. In that environment, incumbents may find themselves competing with one hand tied behind their back—a legacy organisation, technical and legal structure that simply is no longer economically viable in market terms.

  Think about the core elements of the day-to-day retail banking business, such as customer onboarding and distribution—what Jack Ma was alluding to in that earlier quote. It goes without saying that no FinTech neo-bank is launching branches today7, but think about the reasons why challenger banks haven’t led with a branch-based distribution strategy:

  •Compared with successful digital acquisition strategies, branches are simply too costly and too slow for the scale these businesses need, in the timeframe and with the available funding they have; most challenger banks have 12–18 months to prove their case and hence, raise more funding to continue to grow.

  •The cost of deploying a high impact physical location in a FinTech-rich city would likely be more than the entire development cost of a FinTech’s basic app or technology, and branch activity is declining demonstrably.

  •Every FinTech is trying to compete in real-time for customers, thus they must eliminate the need for a “wet” signature or face-to-face interaction, because the need for such would slow down revenue and growth detrimentally.

  •Investors simply don’t fund branch networks for FinTechs because they’re also all about rapid scale.

  •Acquisition cost per customer in-branch are five- to ten-times the acquisition costs via digital.

  Remember what Jack Ma said: “two servers”.

  We’re starting to see significant differences in customer experience, establishing clear new standards as a result of challenger bank innovations. Whether we’re talking neo-banks in the US, N26 across the EU region or the numerous challenger banks in the UK, digital customer onboarding is now a significant differentiator. When it comes to account switching in the UK, data shows that the length of time taken to open an account is a significant barrier to switching behaviour8. So, you’d think onboarding improvements would be a massive priority, let alone for reduced costs of acquisition. For incumbents, apparently not.

  Of the challenger banks in the UK, all of them offer account opening within minutes of downloading the app or going to the website. Starling and Monzo offer one-step 100 percent digital account application and opening, and others offer two-step identity verification processes. Of the major banks in the UK, only RBS has made progress towards a 100 percent digital account opening process9. Let that sink in—every challenger bank in the UK offers digital account opening, but only one incumbent bank can claim the same. In the US only 18 percent of banks and credit unions offer an account opening process via smartphone10, and of those only 24 percent allow customers to fully complete the process via mobile. For those of you doing the math, that’s less than five percent of US banks and credit unions that in 2017 offered 100 percent digital account opening via mobile. Less than five percent! Moven, Simple, Bank Mobile and GoBank have all had these capabilities for many years.

  Figure 4: Digital Banking Report data showing Digital Onboarding capability US-wide.

  In 2017 EY surveyed more than 22,000 digitally active customers and found 43.4 percent of them chose to use a FinTech due to ease of use/access. Clearly a primary driver of the growth in FinTech is simple account opening experiences and ease of use. Given the
data is clear, the lack of efforts by incumbents to rectify account opening friction is a good proxy for the whole FinTech vs banks argument.

  If you want to compete with FinTechs now and in the future, there’s something you absolutely must do—you need to get rid of the requirement to sign an application form with a wet signature. Full stop.

  Challenger or neo-banks also outperform incumbents on several other core metrics. According to KPMG11, the average return on equity for challenger banks in the UK market is between 9.5 percent for larger challengers and 17 percent for smaller challengers, as opposed to larger banks at 4.6 percent. Key factors behind the better performance is due to lower legacy IT costs, as well as a simplified product portfolio providing a CTI (cost-to-income) ratio just below 50 percent for the smaller challengers, compared to 80 percent CTI ratio for their incumbent counterparts.

  When you extrapolate these issues across multiple neo or challenger banks launching in a market like London, the medium-term effect will be to fundamentally change the way the market views retail banking economics. At some point (probably within the next five years), stock market analysts will start looking at retail bank branch networks and viewing all but the best-performing branches as inefficient mechanisms for retail bank operations, whether for acquisition or servicing. Compared with successful challenger banks, they’ll be viewed simply as outmoded, high cost legacy infrastructure.

  Figure 5: Challenger banks by country (Source: Burnmark as at December 2016).

  When it starts to hit the stock price, when every earnings call becomes about how fast you can divest yourself of your legacy branch networks, reduce costs, speed of acquisition and what percentage of your acquisition is 100 percent digital, then simply put, the pressure will be on retail banks to look more and more like a challenger bank. At least from an origination perspective. The same is going to be true of wealth management, insurance, payments, you name it.