At its core, digital banking essentially entails the leveraging of technology to deliver banking products. Some believe that digital banking essentially means an online or mobile banking platform but true digital has to go far beyond that.
Going digital implies embracing the latest technologies at all functional levels and on all service delivery platforms. A digital bank would behave similarly at the branch, at the head office, on an online service delivery platform, at the ATMs and at the point of sale machines.
The issue with thinking of digital banking as existing only on a mobile or online platform is that it ignores the use of digital at the other functional areas of the bank. The online or mobile platform is only the front end of the banking service delivery platform. There are hundreds of banking functions like risk management, treasury, product development, marketing, relationship based sales teams and so on at the middle and back end. All of these functions also have to digitize in order for the bank to be truly considered a digital bank.
What does Digital Banking mean for the Banks?
So, if going digital means more than just having a fancy front end Android or iOS app, is it really worth the effort for the banks? As per a survey of banking executives, almost half believe that going digital is critical to improving customer relationships and it is also the most compelling reason to do so. Here are just some of the ways banks can benefit from a digital transformation.
Efficiency – For an industry which has such an enormous volume of interaction with retail customers, banking has remained surprisingly reluctant to leap at every technological opportunity. Of course, many banking systems are digitized but the entire organism is still not functioning like a single digital entity, as is the case in many other customer facing entities. Industries like airlines or logistics, for example, derive their efficiency from technology, while most banks are yet to reach that level. Most banks right now think of digital as a useful tool, rather than the core around which their systems ought to be built.
Cost savings – A McKinsey report estimated that banks can increase their EBITDA margins by as much as 40% by going digital. The cost savings come from automation of functions, removing redundancies and so on. However, there are even greater benefits to be had, like the synergies from having access to more qualitative data and faster response times to market changes.
Increased Competitiveness – Going digital allows banks to reach a broader customer base and build a closer relationship with the tech savvy generations. If the banks hope to compete with the new age tech giants and innovative new fintech start-ups, they have to offer services at the same quality level.
Agility – Digital banks are nimbler by design. Their automated functions can easily be trained to perform differently and react to changes in the market environment. As an example, the 2008 financial crisis saw an increased focus on risk management, but it was years before banks could train and recruit enough risk professionals which were needed to manage their assets properly. Even today, banks take years to adapt to any new regulatory changes and the biggest challenge is always on the technology side.
Survival – With mounting pressure from technology companies and fintech players, banks are finally giving serious thought to a true digital transformation. Most of the banks had so far only applied a veneer of digital technologies to their front end, customer facing platforms but that has not been enough. In order to survive, and compete on costs as well as usability, commercial banks will have to transform completely.
What is Digital Banking to the Customers?
For customers, the benefits of digital banking services are more obvious. Consumers today are used to consuming products and services online and they would only be so happy if more of their banking work could be digitized and automated.
More choices – As banks become truly digital, customers would gain the advantage of having the choice to switch easily between them. This does not mean that banking would become commoditized, as there are still enough differentiators to set apart one service provider from another. It would just allow customer to switch without artificial barriers which exist right now – like physical documentation or manual approvals.
Ease of use – Digital products are obviously easier to use as well. There is no need to physically visit a branch and submit documents or put your signatures on applications forms and mail them across. Everything can be done online, much like booking an airline ticket.
Cost advantages – Since the digital transformation would be saving the banks a significant amount of money, they would be expected to share some of those saving with their customer base as well.
Digital Banking Enablers and Technologies
In order to adapt to the environment of the digital age, banks are using one or more of the below technologies and enablers. This is just the tip of the iceberg though. Every day novel ideas and innovations are coming to light and radically altering the way customers consume financial products. Most of these enables are already prevalent in other industries and banks are finally taking notice and making progress towards their digital transformation by using such enablers.
Banking as a Service
Banking as a Service or BaaS allows for banks and their systems to be treated a sort of middleware over which the actual products and services are built and marketed. BaaS allows for a third party company to use the core banking systems of a bank and build their own new and unique product offerings over it. It would use the bank’s underlying system as the base on which it builds new products.
In order to visualize how this would work, think of a digital wallet. The customer simply has to download the app, upload some KYC (Know-Your-Customer) documents on the app itself, transfer some money into the app and he is ready to transact. At the back end, however, there might be an actual bank which opens an account and goes through all the normal regulatory processes but the customer doesn’t have to bother with any of that. Such systems are already operational in certain countries and here the bank is providing BaaS to the app developer who is using the bank’s core systems and capabilities to offer their own services.
White Label Banking
White labelling essentially allows a service provider to market and distribute a product without the need to build the product from the ground up. The best example of white label banking is a co-branded credit card. The technology behind the card and the entire payment, authentication and processing mechanisms as well as the communication infrastructure is already built and in place. The co-branding partner, let’s say a department store chain, is just putting their brand on the credit card, adding a few features like reward points for shopping with them and then selling these to their customers.
White labelling is a great tool for banks and new entrants in the financial services sector to quickly ramp up their product base and start selling. Some companies are doing this in the financial services sector but the potential exists to do a lot more. Banks have access to a treasure trove of risk management data and experience with financial products which can be leveraged by other companies to sell more.
Banking as a Platform
The Banking as a Platform paradigm allows for using bank’s existing core banking systems as a base or platform upon which new and innovative banking products or services are built. The best and most practical example of BaaP is perhaps the Open Banking Project. It allows for third party developers to connect to a bank’s core banking platform using open APIs and build apps which use the bank’s data and information but provide something which is more useful or entirely new.
For example, you could download an app on your phone which connects to all your saving accounts, loan accounts, credit cards, trading accounts etc. and provides a single view of everything. You can then transact right there on that app and juggle all your finances from a single application. The core data is still residing with the respective banks, but the front end is this third party application.
Cloud Based Infrastructure and Infrastructure as a Platform
Most users would only ever see the visible front end of a banking or payment platform while transacting or using a financial service. At the back end, however, there are mountains of servers and data banks and streams of communication lines. The banking industry has always been very adaptive of new computation technologies, mostly because it relies very heavily on statistics and data in order to remain profitable. Unfortunately, this reliance on technology means that most banks are bloated with enormous IT departments which not only handle the hardware but in some cases even the software to run all those banking products.
At the back end of a bank, there are servers which calculate the daily interest on hundreds of millions of loans every day, systems which calculate counter party risks on thousands of securities which are inter-linked, algorithms which predict the probability of default, expected losses, economic revenue etc. on a real time basis. All of this requires considerable hardware and banks usually prefer to maintain their own systems. This has made them slower to change and less cost effective as well.
In contrast, companies in other sectors are already using cloud based IT infrastructure to optimize their hardware use. For example, let’s say a web based company wants to launch their product in South East Asia. Rather than having to invest in local web servers, the company can simply tap into a cloud based service like Amazon Web Services and get going the next day. It would have the advantage of locally hosted systems and it can increase and decrease the allocated servers based on daily demand.
Companies in the financial services sector can also use this to their advantage. Why pay for hosting a massive server farm all year round when you only need to calculate some things on an ad-hoc basis? Cloud based infrastructure or IaaS allows companies to rent the computing power as and when required.
The Role of Fintech Companies
Fintech companies have a key role to play in the digital transformation of the financial services industry. They have the advantage of being deep rooted in technology and the agility to quickly move from one direction to a more optimum one almost overnight.
A few banks view fintech companies, especially in the payment sector, as direct competition. From the customer’s point of view these companies are providing a faster, easier or cheaper way to transact and what’s good for the customer, is eventually good for the industry as a whole. Most banks however are choosing to partner with these fintech companies. Fintech companies can provide specialized services of modules or even easier access to a new customer base.
Some of the more advanced players in the fintech field are indeed creating new and innovating products which are transforming the way financial products and services are distributed and consumed. It might be true that large banks, despite their deep wallets, are finding it difficult to transform themselves at the rate at which their customers expect. However, they do have access to certain key competitive advantages, like customer data, risk management data, product expertise etc. Therefore, banks and fintech companies have a lot to gain by working closely to optimize financial product creation, distribution and maintenance.
The Digital Era of Banking
With such a litany of powerful tools like white label banking, banking as a service, cloud based infrastructure and new allies in the tech savvy fintech firms, banks are perfectly positioned to leap into the digital era. With even the financial regulators supporting the digital transformation of banking, it is indeed time for banks to stop creating small “tech-demos” and truly embrace all that technology has to offer.
-  What really is digital banking (2015), Banking Exchange, by John Ginovsky
-  The rise of the digital bank (2014), McKinsey & Company, by Tunde Olanrewaju
- Read more articles on FinTechs in VentureSkies' blog section.
- Read more on the services and packaged solutions which VentureSkies offers for FinTechs.
- PSD2 Directive - DIRECTIVE (EU) 2015/2366 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC (2015), The European Parliament and the Council of the European Union.
- DIRECTIVE 2007/64/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 13 November 2007 on payment services in the internal market amending Directives 97/7/EC, 2002/65/EC, 2005/60/EC and 2006/48/EC and repealing Directive 97/5/EC (2007), The European Parliament and the Council of the European Union.
Image: "Piggy Bank" courtesy of 401kCalculator.org, Flickr (License: CC by 2.0)