In late 2013, delivering on its election commitment to hold a root and branch examination of Australia’s financial system, the Government established a Financial System Inquiry. The subsequent report in 2015 provided a blueprint to achieve an efficient and resilient financial system over the next 10 to 20 years, with both the fair treatment of customers and support for innovation.
This year has proven the folly of long range forecasts in an increasingly disruptive environment, competition is rife in all aspects of banking, and customers are rapidly losing trust in these major institutions.
The Banking Environment in Australia
While banks in Australia have remained highly profitable, they are under increasing pressure as the levels of bad and doubtful debt, as well as the costs of funds continue to rise, while measures such as net interest margins, dividends, return on equity, and ratings decline. Domestic customers are no longer willing to tolerate bad behaviour, as demonstrated by this year’s Banking Inquiry and the volume of international litigation currently proceeding through the courts. There is competition from fintech start-ups and global platforms including Apple, Facebook, and Google who seek to challenge banks in core markets. Further, there is no foreseeable respite from regulatory demands and compliance costs, and a continuing need to invest in technology to replace legacy systems and enhance service delivery.
KPMG recently concluded these cumulative pressures will compel banks to revisit their business models – quickly.
The acceleration of innovation and an exponential rate of change
Across all industries, there is clear evidence that the technologies that underpin the Fourth Industrial Revolution are having a major impact on all businesses, including banking.
On the supply side, technology is allowing jobs to be done for customers in new ways that disrupt existing industry value chains. Both agile, new competitors and existing global platforms can oust well-established incumbents with their focus on delivering customer value through the savvy use of technology including ubiquitous high-speed internet, supercomputing, Artificial Intelligence (AI) and big data. Also, blockchain offers the prospect of replacing third-party institutions through formalising the trust that is essential for financial, contract, and voting activities.
These changes herald the coming impacts of Bitcoin, and other digital currencies which could fundamentally transform all aspects of banking. The World Economic Forum predicts that, within a decade, 10% of global gross domestic product (GDP) will be on blockchain technology, disintermediating financial institutions, as new services and value exchanges are created directly on a blockchain, removing the need for transaction costs, escrow and other guarantees. Gartner predicts by 2022 a blockchain-based business will be worth $10 billion and Australia is moving to become one of the first countries to regulate e-currencies.
On the demand side, customers are increasingly powerful. Power relationships which were once asymmetrical are increasingly shared and controlled by millions of market participants. Technology supports higher levels of transparency as seen with the rise of service comparison and rate checker sites, and the impact of customer reviews using social media. At the same time customer behaviour, driven by both demographics and ready access to mobile networks and data, are forcing banks to change the way they deliver products and services, collaborate, and organise themselves.
Customer Sentiment and Behaviour
Conflicted bonus payments, large-scale credit card fraud, rogue traders, hard-charging sales, possible cartel behaviour and serious data breaches such as the 2014 incident where JPMorgan Chase is believed to have compromised data associated with over 83 million accounts, has led to a collapse in confidence. Customers are ready to make a leap of trust, to stop trusting institutions and start trusting the recommendations of strangers or new providers.
The Millennial Disruption Index ranks banking at the highest risk of disruption with 73% of those surveys more excited about a new offering in financial services from Google, Amazon, Apple, PayPal, or Square than from banks.
Similarly, a recent survey by UBS confirmed an increasing number of customers from ANZ, CBA, NAB, and Westpac are considering switching to rival banks in increasing numbers up from 7% to 12% in the last year due to poor service, fees, and interest rates.
While Federal Treasury implemented a paper-based scheme to support customer switching banks in 2012, adoption remains slow. Overseas, adoption has been far more rapid for a system such as the UK developed Midata, which allows consumers to access data held by private companies electronically and share it, and also the work by the UK Competitions and Markets Authority to support comparison shopping through mobile banking apps.
Competitors and Collaborators
Gartner predicts by 2021 20% of all the activities an individual engages in will involve at least one of the top-seven digital giants Google, Apple, Facebook, Amazon, Baidu, Alibaba, and Tencent. These global platforms will increasingly dominate our digital world “web search, mobile, social networking, messaging and music streaming…Mobile apps and payments, smart agents (such as Amazon Alexa), and digital ecosystems (such as Apple HomeKit, WeChat Utility and City Services) will make the digital giants part of many more of our activities”. Their depth of capability and resources is driving disruption across all industries and is particularly relevant to information intensive industries including banking.
Fintech startups are also proliferating. PwC has revealed that 95% of bankers believe at least some part of their business is at risk from fintechs with up to 28% of banking and payments at risk by 2020. According to Accenture, global investment in fintech ventures tripled from $4.05 billion in 2013 to $12.2 billion in 2014 in an environment where “the vast majority [of banks]…lack the skills and culture needed to succeed in the digital age”. Little wonder new entrants are seizing the opportunity to provide banking services. Finovate has estimated the number of fintech unicorns i.e. those valued at $1 billion, or more was 46 in 2015 up from just 11 in 2014.
While some fintech’s claim to be constrained by regulations e.g. Firstmac, these can and do change, sometimes quickly, as demonstrated by the regulatory response to both Uber and Airbnb. Other new entrants have been limited by a lack of funds or their depth of reserves banks. Despite these limitation, banks will need to collaborate with both global platforms and fintech startups to address cultural and capability gaps and cater to customers demands.
GE says they have restructured their operations to collaborate with emerging technology companies to avoid potential extinction.
The GE Global Barometer 2016 reports new investments and partnerships have been rapidly pursued by business to secure new skills including e.g. data analyse. There is general agreement (90%), among executives and citizens alike, that the most innovative companies not only launch new products and services but also create a new market that didn’t previously exist.
Financial Advice and Wealth Management
For most individual investors, the days of calling a stockbroker or adviser to trade stock, options, and other investments is over. AI and increasing computer power support growing sophistication in stock software platforms, many of which are accessible with mobile apps.
According to Deloitte, there are over 50 wealth management startups in Australia. These firms are Business-to-Consumer (B2C) focused and primarily serve retail investors to connect investors with their peers, provide advice and providing access to investment opportunities.
These same trends are leading to the rise of quantitative fund managers in banks, the application of sentiment analysis to investment decisions at Blackrock, and companies such as Kensho creating algorithms to analyse how real world events influence financial markets.
Gartner reports JPMorgan Chase, which has racked up more than $36 billion in legal bills, use advanced algorithms to forecast and positively influence the behaviour of thousands of investment bank and asset management employees to minimise mistaken or ethically wrong decisions.
While bankers in the USA positively self-assess both their growth outlook and success in digital transformation, the rate of technology innovation has been comparatively low. Providing the opportunity for new entrants like PayPal and Square to reduce friction in payments.
Certainly, the supremacy of mobile banking is undeniable. In August APRA reported banks having shut more than 300 branches in the past year. UBS has reported fewer customers are using bank branches, ATM, or desktop online banking websites each week. CBA has seen annual deposits and withdrawals at branches more than halve from 2003 to the last financial year, and BoQ says branch usage has declined across all generations and that a quarter of millennials in Australia, Britain and China choose to use a bank app daily.
Customers in Australia have also adopted new types of services such as contactless payments enthusiastically due to its ease of use. This is leading banks to the well-founded fear people will begin to pay for things by tapping phones rather than tapping cards with the announcement that Facebook is ready to make payments possible with its Messenger app, much like Apple Pay or Android Pay.
Real-time payments between financial institutions have been mandated and implemented throughout Europe and Asia and are in use in Africa and South America, and the USA may not be too far behind. In Australia, the New Payments Platform is a major industry initiative to develop new national infrastructure for fast, flexible, data-rich payments in Australia is on track to being operational in the second half of 2017.
In addition to the proliferation of payment options including contactless and cardless, regulators including the European Commission are pushing for an increasingly pan-European Commission to form part of its Payment Services Directive 2. Those rules aim to open up the payments system so that banks no longer dominate it.
Consumer & Business Banking
While banks currently manage consumer and business banking by segmentation, customised services and lifecycle marketing based on insights from AI’s are emerging. NAB, for example, has recently deployed an AI to help employees identify customer needs faster and to offer a more customised service. Banks already invest significantly in AIs for fraud analysis and investigation, automated threat intelligence and prevention, and for smarter financial advice. IDC has estimated that by 2019 banks will account for 20% of the $41.b global AI budget.
Online banks including the subsidiaries of more established banks e.g. ubank and ING DIRECT use AI to replace traditional high operating cost models. AI is also used by peer-to-peer services like Lending Club, Zopa, SocietyOne, Ratesetter, and MoneyPlace who provide simple, investor funded personal loans with lower rates, based on the customer’s unique profile.
The UK Government has been urged to consider guaranteeing qualifying consumer investments made through peer-to-peer platforms when investments benefit the “real economy”.
Small businesses are using the increasing breadth of solutions from tyro and also experimenting with loans from alternate online providers including e.g. TruePillars, and other crowd-funding ventures.
Transformation and innovation in banks requires a culture that fully understands the new operating environment, where customers rule, technology changes are rapid, and competition is intense. Banks will only survive if they build new digital capabilities, focus on their customers in all their portfolio of offerings, and deliver distinctive service.
Barriers to entry are low. The primary role of a bank has been to quantify and manage risk, and for this, they received a margin on their funds. Supercomputing, Artificial Intelligence, and big data allow new entrants to manage risk better and provide more highly valued banking services.
Banks can no longer rely on their scale, depth of financial reserves, the shield of regulatory barriers or the lethargy of customer to hold off competition.