Few sectors reflect just how much our lifestyles and way of relating have changed in recent decades as well as the banking sector. The traditional image of banks as monolithic institutions afraid of change has been shattered. Banks were even pioneers of using the internet to digitize. In fact, we have colleagues at SNGULAR who have been working on bringing banking processes online since the 90s. Since then, we’ve developed more than a dozen digital banking channels.
In all this time, we’ve noticed so many changes in the financial sector that few processes remain the same. Although it may seem like the regulations haven’t changed, they’ve modernized too. Take the EU’s Payment Services Directive PSD2 as one example. But what’s change the most dramatically are the business models, the spirit under which they’ve been developed and, most importantly, the clients.
A company like Nokia has gone from a pulp mill to a cell phone manufacturer to one of the key players in the telecommunications space. Can banks really make such radical changes? What could a similar transformation look like in the banking sector?
Starting from scratch
Starting from zero isn’t an option in most cases. The products and services that banks offer are so wide-ranging and complex that reconstructing them from the ground up would be a long, slow and expensive process. Faced with this reality, the clearest route is transformation, rethinking the business model, customer relations and the products. Financial companies must adapt or anticipate market needs, they cannot expect the market to adapt to them. Education experts say now is the time to unlearn everything that no longer serves us. But un-learning isn’t as easy as it sounds. It requires hard work to start fresh and change horizons.
The market is ready. Technology has ushered in an era of abundance. But although some social problems have been resolved, new ones are surging in their place. The financial sector must be able to offer new solutions to address the challenges of modern society, helping their clients with one of their main problems – money management. They can assess financial situations, help clients save money, plan for the future and use debt correctly. At the same time, banks can help address their own problems – retraining their staff, dealing with lower profits due to low interest rates and confront the competition posed by startups and big tech.
The client comes first
Digital transformation isn’t the same as adapting products to the clients’ needs – that was digitization. What we’ve learned through startups is that there is an advantage in starting from scratch, and that is being able to build a client-centered business model. That means empathizing with the client, observing their aspirations and worries, and constructing hypotheses and value propositions for the clients. Only then do companies look fits within the market. With all the competition coming from fintech companies that are small, agile and able to take on more risk and the big tech companies with massive budgets and mind-boggling amounts of user data, banks are at a critical moment. Now is the time to demonstrate that they understand the financial business better than anyone else and take advantage of that unique strength to sharpen their position.
Traditional businesses can make the mistake of using agile methodologies to adapt their products to clients’ needs before taking the time to understand the problems they face. Some banks have used people-centered design thinking to figure out the best way to help clients. They’ve used this process to successfully design new products and services that get ahead of what clients are already demanding. When it comes to finances and money, clients need to trust that their banks can help them. The financial sector has a major opportunity to help people with these new challenges:
- Saving: It isn’t easy to save money. It wasn’t taught in school and can become a major source of conflict and tension in people’s lives. This is a huge opportunity for banks. In the past, people saved money through a house and a mortgage. It was almost obligatory to use part of their income to pay the mortgage, but when it was paid off, they’d have a house to show for it. Now that younger people are much more likely to rent, we need to find alternatives to help them save part of their money so that they can eventually achieve financial freedom. Knowing you have a nest egg that will help you face unforeseen problems can provide an unmatched sense of stability and tranquility.
- Investing: This goes hand-in-hand with saving. People should understand that they can make their money work for them so they don’t lose buying power through inflation. But many banks have viewed this more as a problem than an opportunity. They keep selling investment funds that aren’t very attractive due to high commission fees. In the meantime, low-commission index funds have been booming. Although investments are very complex and no one can be 100% sure how profitable they will be, it's key to give clients more options and more information regarding risk and reward. Many banks have taken note of the success that these investment models have brought to fintechs and are adding similar services so their clients don’t have to look elsewhere for a good place to invest.
- Taxes: This is another major worry for people, especially those who are saving and investing but aren’t very aware of taxes. If banks have historically helped clients with their finances, and now these clients are facing tax issues, that opens another interesting opportunity for banks. We’ve also noticed that a lot of problems derive from unprofessional accountants or financial advisers, giving banks the space to step up with their knowledge and experience to offer services in this area. To do so, banks can use AI data and models to offer personalized tax services to millions of people.
- Sustainability: This is going to be the trend of the coming years, both in the social and economic sense. Banks can play an important role here too, especially in terms of helping ESG companies. Starting sustainable businesses or making sustainable transformations requires investment. On the other hand, people are more and more enthusiastic to invest in ESG funds or green energy/tech. The financial sector has an opportunity to help facilitate these changes.
Fintech and DeFi are marking the rhythm of innovation
It’s fascinating to consider how innovations over the last 15 years have resulted in fintech startups presenting major challenges to certain aspects of the traditional banking sector. On the other hand, there have been success stories of banks teaming up with these startups to obtain great benefits. BBVA’s collaboration with Coinbase is a great example.
In fintech, we’ve seen thousands of hyper-specialized products coming onto the market in response to the needs of people and businesses. This has meant that the big tech companies like Amazon and Google still haven’t become major players, but they are taking their first steps in this direction. But so far, most of the competition has been between smaller startups that have tried to compete vertically, centering their focus on payments, accounts or investment. Neobanks are one exception to this, as they’ve been directly going up against traditional banks. In any case, the market has to adapt to this new competitive landscape.
We still haven’t seen DeFi, or decentralized finance, which is based on blockchain technology like cryptocoins, pose a major threat to the traditional financial sector. For the moment, only a small minority of the population is participating and the coins are more centered around investment than traditional currencies. But that’s beginning to change. There are already interesting initiatives around loans, payment and even insurance. It’s definitely worth knowing that in the long-term, some businesses could become increasing threats. At the moment, one of most developed areas around peer-to-peer lending, especially where crowdlending becomes based in cryptocurrencies.
Making the most of exponential technologies
Digital technologies have been a major driving force for the financial sector’s transformation. This is particularly due to new consumer habits (like using smartphones) and the way that businesses can relate to these changes. But not every company has used these technologies to their full potential. Sometimes, that’s because they haven’t fully committed to these new technologies. Other times, new technologies can cause market leaders to fail due to the type of decision-making explained in The Innovator’s Dilemma.
There’s no denying that technological advances in the financial sector have been massive in recent years. For the most part, they’ve helped companies adapt to clients' needs, become more efficient, propose new business models and improve their existing ones. Here are a few examples:
- Cloud Computing: Migrating data storage and processing to private and, increasingly, public clouds. It also facilitates the development of digital fronts based on multilayer architecture.
- APIfication: How banks have opened innovative ecosystems around finance, especially through connecting with other companies and fintech startups. The EU’s PSD2 regulation was created to deal with this. Its goal is to make the payment market more open and collaborative to improve customer experience. At the same time, it regulates the access to information that third parties can receive about payment transactions, implementing prior consent and boosting security. On the other hand, banks like BBVA have developed new initiatives like the API Market as part of its strategy to become a software company alongside a financial institution.
- Biometrics: This is a very specific technology that is useful in areas like security. It’s also a great example of how technology can be used to improve relationships between businesses and clients. In this case, it's particularly useful for opening new accounts, which has been hugely simplified thanks to the possibility of being able to sign up for an account online without having to worry about identity theft. Veridas is a great example of a company that works in this area.
- Artificial Intelligence: Experts agree that AI is likely the technology that is going to have the biggest impact over the next few years. This applies across the board but it could become particularly relevant in the financial sector. On the client’s end, AI could help financial platforms offer services that help make better decisions around saving, spending and investing. It can help companies offer more personalized services to clients, get to know them more deeply and improve the management of key areas like credit risk, creating investment portfolios, fraud detection, automating customer service and behavior prediction. This could be possible since banks have one of the most complete data streams. They know a lot about clients’ lives and how they make economic decisions, and this information can be used to train deep learning systems.
- Blockchain: Since its beginnings, this technology has been used mainly in the financial system with coins like BitCoin and Ethereum. Since then, the technology has found many applications like managing international payments and granting loans through smart contracts. This brings us to the current moment, where we’re speaking of the Internet of Value, which envisions the internet as a place where value is transferred as easily, cheaply and reliably as data is now. It would make it possible to optimize the management of digital assets, which is a great opportunity for companies in the financial sector. For instance, the tokenization of financial assets could be extremely interesting.
- Quantum computing: This is the latest technology to make its appearance in the financial world. Even though it still is in the very early stages of development, we’re already seeing important use cases like how it could be used to enhance security, risk management and investments. This is a new type of computation that requires the construction of new computers, so it’s still not being widely applied. Still, many financial institutions are working on its development. They are especially interested in how quantum computing could guarantee the security of all communications and transactions through new models of encryption.