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THE TECH ATTACK– How Banks Can React to Avoid Losing Huge Margins

A look at strategic options and tactics for banks in the event of a real incursion by big tech firms into financial services.

Banks have been under pressure from tech firms for some time. However, there’s a strong chance that this pressure will intensify as big tech firms increasingly leverage their strong consumer franchises and digital expertise to compete with banks. As such, there are needs to consider the strategies and tactics available to banks, and how they might emerge stronger and more profitable from the big tech incursion.

Big techs have not yet taken significant market share outside China in financial services, and tend to avoid regulated markets; and when they do look to enter banking, they usually start by partnering with banks.

But big tech firms are making headway in ways that might not be measurable in terms of traditional market share. Consider big tech’s approach as disintermediation rather than direct entry into the regulated domain of financial services, or of their focus on the most capital-light and digitizable areas of business that are closest to their core. Take Amazon’s foray into small business lending, Apple’s entry into payments and consumer finance, or Facebook’s announced launch of Libra, a cryptocurrency.

It is imperative that banks respond to this potential now, as once big tech firms achieve scale it will become near impossible to compete on price, or with their ability to offer a distinctive client experience that builds consumer loyalty and trust. Ultimately, if not resisted, the tech attack will destroy the financial services industry’s margins—by taking some themselves and returning the rest to consumers.

So how to react? Banks can use a 2x2 matrix (Exhibit) to structure possible responses depending on the likelihood of required action and its incremental cost.

Exh. 1

No brainers are actions that are necessary but do not incur significant incremental costs. Banks should make a detailed scenario analysis—establishing the value at risk, understanding the motivations and capabilities of potential attackers (both global and domestic), and positing potential strategies for a counter-attack. An effective tool here is a “black hat” strategy exercise that helps banks understand what an attacking player would do; or traditional war-gaming. Banks should also consider engaging with regulators early on, and educating their board members about the threat so that they are prepared for possibly radical and costly action. They should also closely monitor the market for emerging “star” companies in their target client segments and track partnerships that other financial firms are pursuing. 

Banks should also continue to forge ahead with the efforts they are—or should be—making to stay ahead of the competition. For example, digitizing processes to ensure a great customer experience and to keep costs down will also reinforce a bank’s defenses at the most common attack points for tech firms. The same goes for advances in digital marketing, which reduce the cost of acquisition and improve consumer engagement. Banks should also continue to work on building customer loyalty through loyalty programs and explore how to turn their local presence and customer-specific knowledge into bulwarks against tech incursion.

Insurance policies are actions with relatively low incremental costs that address risks with small but non-zero probability of occurrence. They can be thought of as ways to future-proof the business.

Raising barriers is an example. Monoline financial services firms should consider diversifying into adjacent financial businesses—these areas don’t have to be profitable for the banks if they address a broader set of customer needs; for example, expanding from consumer finance to retail banking. By bundling products in a simple, transparent way, banks can make an attacker’s niche proposition look inferior. Banks with a narrow product set may need to find new partners to make this tactic work, expanding to, say, insurance or wealth management, or adding features like analytics, personal financial management, or peer-to-peer payments. Banks should also consider experimenting with new technology; for example, advanced payments schemes.

Another way to secure a stronger position in the market is through pre-emptive partnerships; for example, teaming up with local players (e.g., to share data to the extent permitted by regulation), with government (e.g., to provide payments infrastructure), or with large e-commerce players (e.g., to provide point-of-sale lending or joint loyalty programs). Making such partnerships work at scale would likely require the skill to build APIs related to some of the bank’s core functions, and having a dedicated partnership unit/venture fund.

A proactive regulatory stance also fits with this strategy. Regulators are interested in supporting a healthy, profitable, banking sector. Issues to address in this context could include: how opening banking to big tech might impact industry profitability in the long term; what kind of regulatory framework would ensure a sustainable competitive landscape (e.g., degree of open banking; requirements for data protection and on-shore data storage).

Big pre-emptive bets are the most important of the higher-cost actions, but success can be elusive. For a bank, the most critical decision is whether and how to significantly raise up your local game in payments, focusing on value-added services to merchants, and pushing hard to deliver new technology in payments, such as biometrics. Moves of this kind are costly, but could secure access for a bank to a unique and valuable set of customer data. Banks could also enter the data management space, as Australia’s Data Republic did by building an industry-wide data aggregation infrastructure. Or banks could focus on a client-data-protection agenda; in this latter case, banks can justifiably claim superior capabilities than their tech counterparts. 

Another type of a big bet would be to build an ecosystem—either focusing narrowly (like Hungary’s OTP in B2B and real estate) or pursuing a multitude of directions, like Ping An and Sberbank. Or simply scale linkups with tech companies themselves. For example, tech firms often lack non-digital distribution. In addition to risk management capabilities and a balance sheet, a bank can provide the physical network to complement an attacker’s digital channels, as well as contributing knowledge of local markets and customers. These capabilities are valuable to tech firms, for client onboarding, customer engagement, troubleshooting, and logistics. Consider Amazon’s venture into physical retail in India.

Finally, Plan Bs are actions banks should consider to deal with “nuclear scenarios”—only to be used as last resorts. Here’s one: temporarily slashing margins to the point where an attacker is dissuaded by the potential cost of investment. If a bank drops fees on payments to close to zero, it will be very difficult to create incentives for merchants to switch to a different provider. Banks can supplement this move with a carrot-and-stick approach—offering generous rewards, or disincentives, to prevent clients switching to new entrants. Other Plan B options could include:

  • Becoming the back-office of choice for the tech entrants into financial space—which would require a distinctive cost position; risk, cyber-security and operational capabilities; and a superior technological infrastructure
  • Building a digital bank adjacent to the main franchise that would match the customer experience and positioning of tech attackers; the risk of cannibalization may be outweighed by the overall defense of market share.

Size is a clear advantage in all four scenarios. Players with dominant market shares can invest to keep up with techs’ innovation, and have a better chance of fending off attack, especially where regulators provide something of a barrier to entry. Medium-size players have some options; they may be able to build a niche offering, or partner with tech giants. It is the smaller players who are most exposed. From the shareholder perspective, divesting such an asset—especially in challenged markets—might be the right strategy. If market exit is out of question, smaller banks can mount defenses based on local knowledge, or try to grow their client base through partnerships. But in the longer run their prospects are grim.

For banks of all sizes, the first imperative is to understand the threat of big tech incursion, and the new competitive landscape, build an objective assessment of your own capabilities and market strengths, and develop a plan of response. It is important for banks to take action on all these fronts if they wish to maintain their position in the face of a big tech move into financial services.

Renewing Confidence in Ghana’s Banking Sector by Adopting Transformational Strategies for Wholesale Banking Operation and Technology

Renewing Confidence in Ghana’s Banking Sector by Adopting Transformational Strategies for Wholesale Banking Operation and Technology

With Banks gaining progressive evolvement in Operation and Technology, there is the need to acknowledge the more tremendous value that can be ascertained in the industry.

The role of banks in providing appropriate financial channels and services for businesses and consumers is in the midst of nothing less than a fundamental transformation. At a time when banks are looking to significantly improve returns, it can sometimes seem that everything that can be done, has been done, particularly on the operations and technology side. But there are a lot more banks can do. The opportunities may be more complex, but they could drive the next step-change in productivity and efficiency.

Notable among wholesale banks worldwide is a significant progress in transforming operations and technology over the last few years. A general move to agile, and technology teams have been upskilled, and platforms rationalized. There is a record of witnessing improvement in operation teams in their partnership with the business; much clearer exception drivers; and a scale-up growth in the use of new technologies, such as robotic process automation and natural language processing. The results have been significant. For example, in capital markets, trade volumes rose by an average of ten percent a year from 2014 to 2017, while industry-wide cost levels declined. Overall, banks have now broadly settled on a global operating model across trading hubs, and on their nearshore and offshore locations.

However, the search for new opportunities for most operation and technology functions to achieve greater delivery speed and outcomes, increase efficiency, and ensure regulatory and compliance deadlines are met is never-ending. This reflects an urgent need for firms suffering from critical scale deficiency in the wholesale business, and are struggling to make the investments required to continue to increase automation levels, consolidate platforms, and transform to a more modern environment. In reality, some firms spend more than 25 percent of revenues on operations and technology, making profitability a challenge.

Other forms of downsides that almost always emerge from the discussion of wholesale banking are: the “golden source” of data; an absence of holistic financial resources; limited access to real-time pre-trade insights (such as compliance checks); Platform fragmentation across asset classes and geographies and; Lengthy, inefficient and cumbersome client onboarding/updating processes (for example, 90 percent of time spent collecting documents and only 10 percent analyzing data).

In Ghana, several reforms and emerging trends seen in the banking sector over the last couple of years, specifically; the capital requirement directive; the full implementation of the minimum capital directive; and issues relating to digitization have had the most impact on the banking business. The central Bank of Ghana (BoG) stated that these decisions were taken to “further develop, strengthen and modernize the financial sector to support the Government’s economic vision and transformational agenda”.

The subject of an increased minimum stated capital issued on 11th September 2017 from GHS120 million to GHS400 million, set off a rather charged conversation in bank boardrooms, the regulator’s and shareholders’ offices, bank Executive Committee meetings, bank personnel huddles, key customers and depositors’ homes. The conversation has carried on for a while on traditional media and social media platforms as well. Among the myriad of questions asked is; what are firms doing to get the most out of their spending and improve efficiency?

Gaining a holistic understanding of wholesale banks across the globe, Ghana inclusive, five thematic approaches to effective banking operations and technology remain manifest.

Capitalizing on Focus-Based Investments

This means making at-scale investments in the next generation of re-platforming, and automation in one or two product processes. Some firms have invested at-scale in multi-year trade-finance re-platforming. Some have targeted investing in cross-asset trading risk management. The most successful initiatives are always the ones linked closest to the strategy of the business.

According to the Banking Sector Report that was released in 2018 by Bank of Ghana (BoG), earnings from investments constituted the major source of income for the banks in June 2018. Approximately 83% of respondents of the 2019 Banking Survey mentioned that they expect to invest significantly in technology and create agile businesses over the medium term, which will be crucial to meet customer demands and grow profitability.

Tapping into the Growing Trends of New Technology

There are opportunities to be seized from taking a “greenfield” approach which indicates undertaking a project from a blank slate, with no restrictions or constraints imposed by previous work. This is particularly important for businesses where the bar for client experience has been raised dramatically. This means investing in new technology often in partnership with a fintech firm. Undoubtedly, many bank executives in Ghana have come to appreciate and view FinTechs as partners rather than competitors

Technological innovation or electronic delivery channels have contributed positively to the provision of banking services and the growth of the Ghanaian banking industry. These developments include new delivery channels for banking products and services such as Automated Teller Machines (ATMs), Telephone Banking, PC-Banking, and Electronic Funds Transfer at Point of Sale (EFTPoS). Areas, where this is equally prudent, are lending for small business clients, foreign exchange execution, and trade processing. New tech firms have built end-to-end stacks, in less than eighteen months, with small, high-caliber product and development teams.

Developing New Income Generating Operation and Technology from Existing Processes

Ghana’s Banking Survey report 2019 revealed that an appreciable number of banks had generated income specifically to secure the minimum capital through a hybrid of reserves and injection of fresh capital. Others admitted to having secured it through fresh capital injection only. In total, GHS1.5 billion was injected as fresh capital into the banking sector in 2018. Sources of fresh capital injection included equity from parent companies as well as funds from other private investors. Some banks also refrained from paying their shareholders dividends for the year to shore up their reserves to meet the GHS400 million requirement.

However, another great source for productivity gains that banks can adopt to also generate more income is the carving out and “mutualizing” processes. If a bank decides it does not have a differentiating business area or one that it is not able to invest in, success can come from working with private equity, information technology, and business process firms to carve out operations and technology. This can also mean transforming operations and technology into a new business to provide services to multiple wholesale banks. This works particularly well in areas like post-trade processing in capital markets, reference data management, and lending operations.

Combining New and Innovative Methods to Improve Customer Experience

Innovation is critical in this rapidly changing banking landscape. The customer of the future has a choice and is not afraid to exercise this choice, causing banks to invent new approaches to meet their demands. Banks are experimenting and scaling the use of a multi-lever approach to improve end-to-end client journeys, and processes. Firms have been able to improve throughput and productivity by more than 40 percent in product control and operations by merging client channel migration to electronic portals, automated workflows, optical character recognition, and natural language processing process improvements.

75% of Ghanaian bank executives, per the Banking Survey 2019 report, expressed to have already achieved profitable revenue growth by encouraging customers to migrate to electronic channels. In effect, traditional “brick and mortar” branches are expected to significantly reduce going forward, which is consistent with the banks' stated objective to migrate more customers to electronic channels.

Generating and Tailoring Daring Goals Towards High-Level Achievement

The final theme reflects the power of setting bold aspirations. For a few critical topics, firms are striving for a dramatic improvement. Examples are captured in the proportion of technology, staff engineers delivering codes, the proportion of workloads (applications and data) in modern infrastructure, and reductions in exception rates.

There are different implications for the different actors in this ecosystem. For wholesale banks, bolder actions are required to drive costs down. For business processing outsourcing and information technology outsourcing firms, platform partnerships will be critical to driving “mutualization.” For private equity firms, a deep understanding of transformation in this space (for example the ability to automate smaller, more specialist teams) will be crucial to making carve-outs successful.

The overall picture of wholesale banking has a huge value potential for the trading banks, and this can be found where they may least suspect—in their operations and technology teams. These aspects must be treated as businesses in themselves, and their professionals as “business people.” To get an idea of how big the opportunity is, careful consideration must be given to in sell-side capital markets alone where banks spend some huge sums on middle- and back-office operations and technology.

In light of structural changes and reforms in the wider financial services industry in Ghana, a renewed confidence in the sector following recapitalization, good corporate governance practices, sanitization of the non-bank financial institutions among others can only position the sector for growth and profitability in the coming years.

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