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As early-stage investors in multi-sector technology-focused businesses, Breega has a unique insight into how the application of cutting-edge technology is disrupting traditional ways of doing business. One of the biggest impacts has been to the financial sector. Up until very recently, Banks enjoyed an uninterrupted control of the financial services value chain, escaping the first tech wave that hit a majority of sectors and holding onto to their monopoly status as others strove to adopt and adapt to new technologies.
The arrival of Financial technology or ‘Fintech’ changed this. And, as with all sectors disrupted by new technologies, the change began with the introduction and development of customer-facing interfaces. Facilitated by regulatory changes aiming to stimulate competition, encourage innovation and strengthen security, these new interfaces have turned the traditional bank- client relationship on its head.
Fintech is one of the fastest-growing tech sectors with world-wide investment reaching $55 billion in 2018 and growth remaining strong in 2019. Regulation, in the form of the Open Banking directive, has seen a step-up in sector growth, with Fintech and data aggregator companies finding new ways to securely link an individual's account and transaction details with third parties, to streamline business processes and enhance the user experience.
So what are the impacts of developing financial technology services on the banking industry today?
Fintech developments have resulted in the rise of challenger banks and traditional banks, subjected to tighter regulation and capital requirements, are losing ground to these younger, more flexible structures. The take-off of digital marketing and the take-up of internet banking services in the early-2000s saw an increase in competition between banks, and a move away from the traditional high-street banking. It became necessary for the banks to differentiate themselves and consumers and businesses were now able to search for services and better interest rates on a far wider scale than was previously possible by walking down the local high-street.
In more recent times, competition has increased still further with the growth in new technologies and the advent of the Open Banking directive. This has given rise to challenger or ‘neo’ banks such as N26, Revolut or Starling. Challenger banks provide traditional banking services such as savings accounts, mortgages and business loans coupled with a “digital-first approach” that allows for easy access to banking services from any part of the world on a smartphone or computer. The comparatively low corporate overheads of these, branchless, online banks have allowed them to offer a fully interactive customer experience. Their ability to gather, analyse and exploit customer data also means that they can propose personalised value-adding services and loans to their customers structure, therefore generating revenue for themselves.
“Blockchain will disrupt back-end operational processes in the financial sector in the same way that front-end customer-facing technology has reshaped financial services”
Neo banks are attracting new clients at a rapid rate and traditional banks are losing ground, especially amongst the younger smartphone savvy generation. According to a recent study by global management consulting firm McKinsey, by 2025 between 10 and 40 percent of bank profits may be under threat due to the expansion of fintech companies. Adding to this phenomenon are providers of over-the-top banking solutions such as Curve, one of Breega’s portfolio companies. Although not strictly speaking direct banking competitors, these Fintechs are weakening the customer-bank bond by offering clients easy-to-use high-level financial management solutions that allow them, among other things, to regroup all of their bank accounts on a single card and manage them in real time. This effectively removes the need for customers to interact directly with their banks.
Customer-facing financial services are also changing customer requirements which are, in turn, shaping the banking landscape. Fintech, with its capacity to offer a high level of customised and personalised services at relatively low cost, is changing consumer requirements. Customers and businesses are now expecting the same user-friendly high-level experience offered by payment and other financial ‘smartphone apps’ from their traditional banks. In order to respond, traditional banks are making digital transformation a business priority and investing large amounts into digital infrastructure and software innovation to improve customer experience, transfer and payment services, replace outdated back and middle-office systems and cut costs. To speed up the process, they are also teaming up with established Fintechs. According to a recent PWC study, 60 percent of traditional banks will team up with a fintech startup and 82 percent expect these partnerships to expand within the next five years.
As digital channels continue to dominate the way customers behave and businesses interact, banks have progressively moved away from traditional procedures and branch-based activities, to operating almost entirely digitally. This shift is one of the greatest ever experienced by the banking industry. But the transformation does not end there; in fact, it may just be the beginning as the second tech wave in the form of the blockchain prepares to hit the financial world. Blockchain will disrupt back-end operational processes in the financial sector in the same way that front-end customer-facing technology has reshaped financial services.
It is estimated that this year, a third of all banks will start using blockchain technologies. Until now, they have mostly relied on middlemen to facilitate transactions such as accepting deposits, lending money and processing payments. This has meant that moving money can be a time consuming, costly and, in the advent of online fraud, a risky process. Blockchain technology is already disrupting the banking industry in a number of ways. It is facilitating cross-border payments and reducing payment costs and processing time. Transfers that traditionally took three days can now take a few seconds and traditional payment fees no longer apply.
Blockchain technology also allows for the instant clearance and settlement of transactions instead of having to rely on SWIFT payments as banks can now track and keep their decentralised ledgers in their public network rather than relying on custodial services and correspondent banks, and, as a result, significantly reduce their settlement fee costs. The manual purchasing and selling of securities is coming to an end as blockchain technology will lead to the elimination of all intermediaries, reducing error margins and broker costs. These are just some of the ways in which blockchain technology is transforming the banking sector, bringing with it greater transparency for customers, efficiency and cost-effectiveness. Its full potential, however, remains as yet largely unexplored. And change in the form of technological process will not stop here. The onset of AI-driven predictive banking, cryptocurrencies and other digital developments will undoubtedly lead to further shifts and changes in the banking landscape.
Faced with technical debt, increasing competition and depleting revenues exacerbated by historically low interest rates as well as the probability of further technological disruption, traditional banks are being forced to adapt, anticipate, rethink and restructure their business models on an unprecedented level. The digital revolution is well and truly underway and the impact on the business environment of the banking sector is total. There can be no turning back.