All of the UK's banks have passed the European Banking Authority's latest round of stress tests, suggesting that financial institutions in the region havethus far been successful in shoring up their finances in the wake of the economic crisis. With confidence in the sector increasing and balance sheets holding up under pressure, will the institutions increase investment in overhauling legacy systems and move towards a digital-first environment?
With the major banks releasing their third-quarter results over the next week or so, we should gain some better insight into how the institutions are holding up against increasing digital stress. Not only are traditional banks facing competition from online-only services springing up, such as the soon-to-launch digital-only Atom bank, which claims to have a substantially lower income ratio compared to high street banks, but they are also facing competition from digital companies in completely different sectors.
For example, Apple has just launched its new payment service in the US, Apple Pay, which will no doubt make its way to UK shores in the coming months. Although this might not appear to be direct competition, it indicates how companies operating outside of the sector are vying for a slice of the pie. The retail banks in the UK are currently in the process of launching their own digital wallet – Zapp – but how well will this compete against Apple Pay, which when launched this side of the Atlantic could have the advantage of already sitting in the pockets of millions of consumers across the nation? I know what I'd be putting my money on.
Accenture recently released some research on this subject, which outlined that by 2020 up to 35 percent of traditional banks' market share could be up for grabs, thanks to the emergence of digital banking and new competition. The research also found that there was a 50 percent increase in mobile banking activity during 2013, up to triple-digit growth in online sales of traditional banking products, and a strong trend of customers looking outside their primary banks for new products.
Wayne Bush, Accenture's managing director of North America Banking Practice, said:
Digital technology and rapid changes in customer preferences are threatening full-service banks that do business primarily through branches. Given the scale of these disruptions, traditional full-service banks, as a group, could lose significant market share by 2020 -- to banks that reorient around digital technologies and to new entrants from the retail and technology sectors. Our research shows signs of this already occurring.
This is certainly evident at Lloyds Banking Group, which is the largest bank in the UK, and the first of the major banks to release its results this week. The chairman of the bank warned its staff and investors that the industry faces more change in the next 10 years than there has been in the past 200 – thanks to the digital revolution. These comments come as Lloyds has cut a tenth of its workforce and is expected to close a number of its branches, as it responds to changes in how consumers interact with their banks.
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Global management consultants ATKearney recently released some research that supports this view that the banking industry is facing significant disruption from digital and that in order to keep up with the changes, financial institutions need to reassess how they operate internally to support digital services. The following infographic from ATKearney shows the benefits of getting to grips with digital banking, both for financial institutions and consumers:
The benefits for consumers are obvious – fair prices with increased transparency, high-quality interactions, security, speed, rich spectrum of new services, peer comparisons etc. However, given that banks are typically still operating on outdated legacy infrastructure that is struggling under the pressure from digital interactions (take a look at a number of the high-profile outages in recent years), financial institutions need to get their IT house in order, in order to compete. The research states:
Making all of this possible will require support from the inside. The underlying operating model will need reshaping, with lean channel and organization structures in place to allow for fast processing. Decision and governance processes will need to be streamlined, with a new more-agile culture that has the right spirit to support a superior customer experience.
An integrated IT infrastructure will be needed to meet all requirements, with fast computing to allow for super-fast processing. Last but not least, digital banking will change the way revenue is generated. As customer centricity becomes more important, deep customer insights will open up new sources of revenue, such as third-party advertising and customers paying for value-added services.
This is a long way from how banks have traditionally operated, with upwards of 60% of IT budgets typically having gone on maintaining legacy systems and a significant chunk of the rest being spent on small, incremental changes. But with the stress tests suggesting that UK banks are becoming increasingly stable (the latest stress tests were the harshest yet), can we expect an increase in budgets for financial institution CIOs and CTOs?
TechMarketView's research director Peter Rose doesn't think so. He believes that progress could be slow. He said:
Certainly passing these tests is good news for the UK banks, but it does not mean that we can now expect a move to a more expansive strategy or a major acceleration in investment. Third-quarter results from the major banks (due over the next week or so) will show that they are only part-way through some serious long term restructuring of their cost base, a focusing of their product portfolio and a multi-faceted renewal of how they interact with customers. All these changes will take many years to embed into the complex and labyrinthine organisational structures and system stacks of the established banks.
But will more money be available for these renewal projects? We expect a slight easing of budget discipline in 2015, but CTOs and suppliers should not get too excited as most “change the bank” projects will still have to be funded from savings in “run-the-bank” programmes. Nevertheless we see an expansion in spending across the wider sector, to 4.2% growth in 2015.
And for CTOs more onerous stress tests still have to be overcome. Established banks still face massive legacy issues, with rising volumes of customer interactions (mobile presenting the biggest change) mounting customer expectations and aggressive competition from agile newcomers. Bank CTOs will be looking to accelerate the rate of change and this should mean a greater use of private and hybrid cloud, shared services and more standardised software. These are the areas where CTOs will need to focus their attention – and build convincing business cases.
Some recent research from IBM generally supported this view, which found that banking technology leaders in Western Europe neither embrace fundamental transformation of core banking systems as a strategy nor see the need for it. It states that no one is contemplating the complete replacement of core banking systems (understandable), but also that strategies are only perceived as possible if they can be achieved through incremental steps. For instance, most bank leaders are engaged in investments for which payback is expected in the same year for highly-targeted modernisation initiatives.
IBM said that most budgets are tight and businesses cases are typically generalised, high level, or in some cases, non-existent. You can read the full reporthere.
Thanks to new regulation, it is now easier for consumers to switch between banking providers than has been the case in previous years. Not only this, but customer service from digital providers, where actually not a lot of service is needed thanks to the ease at which digital makes transactions possible, is raising the bar of what is expected from banking providers.
Combine this with increased competition from all angles and consumer confidence in traditional institutions being dented since the 2008 financial crisis, banks face a huge challenge in hanging on to their customers. Traditional banks need to be able to operate like the new start-ups, but figure out how to do so with huge legacy mainframes and systems dragging them down – no easy task.
With budgets tight and investments only being made if they deliver a return within one year, legacy banks will struggle to keep up with online institutions that have been built to suit the needs of a consumer in the digital-age.