While there is great uncertainty about the future of banking, one thing is becoming increasingly clear: the digital revolution that has pitted fintechs and banks against each other, in recent years, is beginning to approach an inflection point. Competition in many markets is tightening as new players vie for market share, but a digital meeting of the minds flickers on the horizon. Traditional banks are beginning to understand how to respond in force to the competition offered up by their fintech competitors, adding heat to the movement.
In a report published earlier this year, I discussed the future of the banking sector and the various, intertwined dynamics driving this fintech revolution. In particular, I argued how disruptive technologies and new business models are testing conventional wisdom in a number of areas.
In a nutshell, innovating on digital capabilities enables banks to create more efficient business models. In turn, that allows them to scale faster, service customers better, and increase margins in the long term. Cutting-edge technologies, when leveraged successfully, have the power to turn old business models on their heads and generate new sources of profitability. Blockchain, for example, which has the power to make legacy costs associated with foreign exchange transactions nearly obsolete.
At the same time, high compliance costs and regulatory scrutiny have become the norm in the banking industry. Conventional wisdom suggests that these regulatory forces are in some way inhibiting banks from jumping into the future. And to some degree, yes, firms’ risk-taking ability is limited by regulations, especially in the post-crisis environment, while costs of compliance are weighing down margins.
But, regulation, if anything, can be a catalyst for change: costs put pressure on banks to innovate on sources of profit, while banks’ longstanding relationship with regulatory bodies put them in a far better position to proactively work with regulators in shaping the standards and protocols around new technologies as they work toward becoming digital leaders.
Against this backdrop, an inflection point is beginning to materialize in the fintech revolution, with banks starting to respond to these dynamics and capitalize on them. And many, having recognized the need to speed up innovation cycles and tap into the R&D capabilities startups provide, are increasingly looking for ways to align with, adapt to, or partner with fintechs in order to propel themselves into the future of banking. The convergence of banks and fintechs is the next inevitable chapter. From my standpoint, banks are adjusting to digital pressures in a number of ways, but two models of innovation are really starting to stand out.
First, the extended enterprise model — or the leveraging of an ecosystem — is emerging among banks as the most popular approach to innovation. Rather than going it alone, many banks are increasingly tapping into the expertise of a consortium of partners, each with a different capability, in order to bring next-generation services to their customers. It’s easy to understand why: digital projects are complex and often require the collaboration of a tech firm, a telecom provider, a cloud service, and even an integrator before anything makes it to market.
In fact, we are already seeing this form of strategic partnership play out among big banking stalwarts. One bank announced earlier this year that it has eliminated legacy costs and built an entirely new virtual bank through an extended enterprise model. And just this month, HSBC’s retail banking and wealth management CEO announced the bank had set aside $200 million to invest in tech startups.
Another trend is the emergence of the hybrid legacy-digital model, which I expect will continue to take root as banks grapple with how best to reinvent themselves as old infrastructure weighs them down. As clunky and outdated as legacy systems might be, one of the common mistakes firms make is to treat legacy and digital as two different models. This “out with the old, in with the new” mindset tends to foster resistance, since it is often not possible to fully retire legacy architecture given the complex interconnections of systems and processes. As a result, many banks are building new digital systems alongside the old, battle-worn infrastructure, with a plan, over time, to overhaul their entire architecture in pieces rather than wholesale restructuring at once.
It will certainly be interesting to see these trends play out in the coming years as more banks ramp up their efforts to innovate and boost their “digital DNA” by collaborating further with fintechs. Industry dynamics, some of which are very fluid, will undoubtedly continue to propel the digital revolution, while new approaches to becoming the “bank of the future” will continue to emerge and be fine-tuned over time.
Kenny Smith is Deloitte’s financial services industry leader, responsible for overseeing a team that works with 90% of the largest financial institutions across Deloitte’s audit, tax, consulting, and advisory businesses.