What keeps the banks up at night?

In April, we welcomed 6 of our bank clients to Barcelona as some in the financial industry face a potential ‘Kodak moment’. In the face of industry disruption, there is a need for fundamental change or they will go the way of Kodak after digital cameras, newspapers after digital media, and telecoms after digital communication. Banking is positioned as the next big victim of the ‘digital revolution’, and it’s happening fast; according to Accenture, 25% of today’s banks will disappear within in the next 5 years. We look at why the changes brought by digital are keeping the banks up at night.

Death of the middleman

Traditionally the banks’ role has been the middleman between people lending and sending money to each other. However as digital makes peer-to-peer networks scalable, people are connected to deal directly with one another. Just as taxi ranks are superseded by Uber, money transfer operators are cut-out by Transferwise, and credit providers by Lending Club. These platforms are reducing the need for so many middlemen, and so the challenge for incumbents is to find their value-add in this networked business ecosystem. This is not about creating a new app, but fundamentally changing the role of the bank.

Fragmentation of services

The banks’ business model used to offer end-to-end solutions, spanning current accounts, borrowing, mortgages and investments. Now, this model is under pressure on both the customer side and business side. For customers, the bank is no longer the centre of their financial ecosystem; they are used to mixing-and-matching the services which make most sense for their specific circumstances.

From the business side, each area of the bank is being replaced by fragmented services that offer that one function, and offer it better than anyone else. Transferring money abroad? Transferwise allows you to do so with minimal fees. Looking to invest but don’t know where to start? eToro lets you invest based on the successful behaviours of your network. These single value proposition startups are thriving; FinTech investments globally grew three-fold in 2014, up from $4 billion in 2013 to over $12 billion last year.

Shifting customer expectations

Digital services have created new consumer behaviours, expectations and lifestyles, and exploring these has been one focus of our shared Always in Beta consortium. We’ve seen through our fieldwork that the next generation of bank customers, ‘Digital Natives’, have different attitudes to concepts such as loyalty, trust, and planning.
One class of new competitors speak this same language and understand these new behaviours, and are successfully taking the customer relationship away from banks. As digital banks such as Moven outperform traditional institutions on user experience, some (but not all) banks are growing concerned that they are sinking into the background as an infrastructure provider, rather than a customer-facing business.

Organisational structure

The success of FinTech startups owes much to their capacity to offer a specific service and be agile enough to adapt to evolving needs. Paraphrasing Klaus Schwab at this year’s World Economic Forum, in this new financial landscape, it is not the big fish that eats the small fish, but the fast that eats the slow. The traditional bank model is strained to accommodate this. Their legacy, size, and perceived bureaucratic stability, where previously seen as a strength is now their weakness and perhaps their undoing.

Adjusting organisational structure for innovation is notoriously difficult in banks, and a highlight of our financial services workshop was seeing the exchange of lessons learned and best practices by the six participating banks.

Banks are under pressure from all sides: startups focus on providing one function better than anyone else; tech giants cutting out the need for a middleman; customers new expectations and needs; and internal structures that are not best suited to react quickly. Digital is at the root of these challenges, but the solution is not to simply be ‘more digital’. These questions go deeper than creating a new app or Facebook campaign; they require a fundamental rethinking of what the bank is positioned to provide better than anyone else. For the banking industry the only way to catch up on sleep is to dream big.

This is the first of a series of articles related to our consortium into disruption in financial services which will be published in the coming months. If you’re interested in learning more about our ongoing Always in Beta initiative, please email aib@claropartners.com.

Written by Akash Radia and Harry Wilson.

May 12, 2015