By Ben Robinson, Chief Strategy and Marketing Officer, Temenos
The banking industry used to enjoy strong barriers to entry, such as low customer switching, which protected it from the threat of new entrants and, in turn, allowed it to earn high returns on capital over extended periods. In the years 1980 to 2006, for instance, annual global banking return on equity (RoE) averaged 16 percent.
Now, digitization is changing the industry’s dynamics. Cloud computing is lowering the cost of doing business. Improvements in mobile technology are rendering banking possible anytime, anywhere and accessible over any device. Big data is making it possible for firms to draw major insights into customers’ lives from their transaction and other data. And social media is providing the opportunity to inject a social context into banking services.
Disruptive new business models
We recently interviewed 11 disruptive new entrants to the banking industry to understand how they are taking advantage of digitization to launch disruptive new business models. We uncovered many interesting findings, including that:
- banking provision is stratifying, with new entrants offering discrete banking services at lower costs and with better rates than large incumbents,
- business models built around offering transparency and helping customers to manage their finances can be highly successful,
- leveraging social media and big data can help firms to get a clearer picture of their customers’ lives as well as help them to determine customers’ creditworthiness,
- digital-only banks can be truly viable,
- transplanting a retailing model and mindset into the banking industry can work,
- embedding financial services within a social network, where peers share information and advice, can produce impressive results,
- many gaps still exist in either the types of financial services that customers would like to consume or in the way they are delivered.
But, perhaps the biggest finding was that traditional banks can succeed in the digital age. They have great assets, such as large customer bases, access to rich transactional data and the ability to offer integrated financial services. However, they must find a way to leverage them. In particular, they should concentrate on ridding themselves of legacy (legacy technology and processes), on developing a balanced multichannel delivery model, on deepening their data analysis capabilities and, lastly, on playing a larger role in their customers’ lives.
While much of the fatalistic talk about banks’ futures is overdone, in our view, the threat from new disruptive, digitally-enabled business models is real and banks need to act quickly if they are to succeed in the digital age.
Banking’s moat is disappearing
Warren Buffett once said, “in business, I look for economic castles protected by unbreachable moats”. The banking industry used to be protected by an unbreachable moat. High barriers to entry meant that few new banks or other market entrants were created and, together with other factors such as high leverage, created the conditions for sustained periods of very high returns on capital. In the period of 1980 to 2006, for instance, the average annual Return on Equity (RoE) for the global banking sector was 16 percent.
However, the situation is now changing and the historical barriers to entry are being stripped away. While this due to a smaller extent to factors like changing customer behaviour and a regulatory agenda that seeks to introduce new competition to contain the problem of banks that are “too big to fail”, the role of technology change is absolutely critical.
The four principal technology trends driving the digitization of financial services (and other industries), putting at risk existing business models and threatening industry profitability are cloud, big data, mobile and social media. These are what Gartner, the US information technology research and advisory firm, has termed the “Nexus of Forces”.
Leveraging social media and big data
Lenddo, a financial services provider started in 2011 and focused on emerging markets, uses social media and big data to help it to develop deeper relationships with its customers, as well as build a picture of their credit risk.
Its goal for customer relationships is to go “back to basics”. In the same way that a traditional community banker knew their customers personally and so could offer the best advice, Lenddo analyses customers’ social media activity to piece together a detailed picture of their lives.
As Jeff Stewart, CEO, says, “we are looking at who the person is rather than their transaction history. In these [emerging] markets there is not a lot of transaction history to work with.”
Lenddo also uses social media to inform its credit scoring. It has determined that the behaviour of people is influenced by the people they are connected to, even on social media. “We can map back to see how connected they are to good payers and bad payers. It is very, very powerful,” says Stewart.
Lenddo’s business model is made possible by the amount of data that customers share, but also by the capabilities that now exist to analyse this data. As Jeff Stewart puts it, “we have more computing power in our smartphones than Citi had in its world headquarters in 1980. And then you connect that to the cloud and it’s more power than all the banks in the world in 1980 – the power is there.”
Creating social platforms
Other models focus not on using social media to inform banking, but rather on creating a social community in which to embed the financial products. This is the model that players like Fidor Bank and eToro are using. The concept is simple but impactful: a network of people who share common interests and goals, who give each other advice and share information.
eToro, a social investment network with three and a half million users across 170 countries, says that its users are very happy to help each other out. What is more, it observes that, unlike dealing with professionals, financial advice given by peers is typically given in language and at the level of complexity that is appropriate to each user. The network, which refers to itself informally as the “Financial Facebook”, has as its goal removing the barriers to investing. Part of this lies in de-mystifying the jargon, but it also uses Contracts For Difference (CFDs) to allow its customers to lower the financial barriers (allowing customers to acquire parts of securities, like half a share in Google).
The eToro platform has one especially unique and defining feature: it allows users to see the portfolios of all other traders and to copy the best-performing ones. In return for letting other users copy their portfolio, the traders will gain followers and also a financial reward – with the best traders earning as much as $100,000 per month. As Nadav Avidan, a company spokesperson puts it, this copy-trading makes for much better goal congruence than giving money to a professional portfolio manager:
“If you copy me, I am working on my own portfolio trying to make money for myself. If you go to a bank or broker, your interests aren’t aligned at all. You want a good portfolio; he wants to make money from his job. In eToro, if I say you should buy Apple, you can check my portfolio to see if I have bought it – that’s how you can see who is walking the walk and who is just talking the talk.”
According to research commissioned by the company, copy-trading delivers better results: a 10 percent higher return than individual discretionary trading.
Lowering fees through unbundling
Many of the models we have seen are predicated on simply lowering fees (and giving better service), typically leveraging cloud infrastructure and typically through concentrating on discrete financial services. This is certainly true in the cases of Currency Cloud and Traxpay.
For Currency Cloud, which aims to give individuals and small businesses a better deal on foreign exchange transactions, the model is based on specialisation, coupled with low infrastructure costs. Because Currency Cloud just does FX transactions and because it handles large volumes, it can get good rates from the banks it deals with. And, because it operates on the cloud, its infrastructure overheads are minimal. It thus secures good rates and charges a very low spread on top; in fact, it offers full transparency on its margins, providing customers with the wholesale rate and showing its own markup.
Mike Laven, Currency Cloud CEO likens the model to the unbundling that has taken place in other industries, such as tourism. An intermediary sits between the consumer and the producer and helps to get the consumer a better deal. As he puts it, “the Currency Cloud specializes and doesn’t use one type of transaction to subsidise our other costs, we can take a lot of cost out of international payments.”
Traxpay has a similar model, but for business-to-business payments. According to the company, its competitive advantage stems from its cloud-based platform that brings together secure, flexible, real-time, 24/7/365 electronic payments with structured and unstructured data related to the transaction. By reducing complexity, freeing companies of the need to set aside large amounts of working capital, giving faster access to funds and providing better data to help reconciliations, the company claims to be able to save its customers significant amounts of money.
Filling gaps left by banks
The peer-to-peer lending model is assumed to disintermediate banks, by removing them as intermediaries between lenders and borrowers and, by extension, offering more attractive rates to both parties by cutting out the banks’ margins.
What is interesting about Lending Club, the peer-to-peer lender based out of San Francisco, is that banks form a significant part of its lending base. According to Scott Sanborn, COO, banks have been lending through Lending Club because it allows them to outsource unsecured lending while still holding onto their customers. Unsecured lending, along with small business lending which Lending Club launched in March of this year, is an area that is under-served by traditional banks.
This tends to be because banks have simplified their businesses in the wake of new regulations, such as Basel III, or because they lack the know-how and technology to manage risk well – or at least profitably. “We aren’t competing with the bank for deposit services,” says Sanborn.
The bank keeps the relationships and has delivered the customers a service. If Lending Club can help a bank deliver more services to its customers, because Lending Club has a highly automated solution to underwrite the borrower and determine income. As such, the bank can provide a financial service while retaining the customer.”
By helping banks to fill the gap in unsecured lending, Lending Club is enjoying strong growth. It has facilitated over $4 billion in loans since it was started in 2006 and, underlining the rate of growth over that period, $2 billion of the loans were made in 2013.
Solving practical issues
Like so many successful start-up companies, most of the companies we interviewed were founded to solve a practical, everyday problem. In the case of Square, a company which makes it simpler and easier for merchants to take card payments, the product was born out of a lost sale. As Jim McKelvey explains:
“I was trying to sell a piece of glass to a lady who only had an American Express card, which I can’t take in my studio. So, I lost the sale. And that afternoon, I was holding an iPhone in my hand and I was like, this device could have saved my sale if only we’d had this system. And that was the inception of Square.”
For nD bancgroup, a bank that intends to make real the promise of real-time mobile banking, the realisation of the size of the opportunity came on a visit to a local restaurant. Gordon Baird, CEO and founder, found that he had forgotten his wallet. He did have his mobile phone, however, but it wasn’t equipped with any sort of payment service. People are more apt to carry their cell phone than their wallet was his insight. His conclusion was that he should build a bank that could deliver the sufficiently differentiated mobile banking experience that would see customers adopt mobile banking in much greater numbers.
In Lenddo’s case, the idea to create a financial services company came from observing how difficult it was for people to get credit in the Philippines. As Jeff Stewart, CEO, says:
“It didn’t make a lot of sense. These were super-educated, hard-working people whose incomes were going up and they couldn’t get credit. Or if they could, it was very expensive or cumbersome. After many requests, the idea hit us that maybe there is a problem beyond the places we have done business, maybe it is broader. What drew us to start a business was the magnitude of the problem.”
Helping customers to manage their finances
Another common theme we noted across this group of disruptors is a desire to help customers to manage their money better. Take Simple, for example. It offers very basic tools to its customers: a mobile phone app, a debit card, a relationship with a bank, and some easy-to-understand money managing software. But, that is the point. The service is designed to work the way people live. One of most interesting features, is a “safe to spend” balance: that is, instead of just showing a bank balance, Simple monitors a customer’s income and spending. So it can see when a customer gets paid and how much she pays out for rent or a mortgage, phone bills, groceries and medical bills, for example. It uses machine learning to register the patterns without requiring the customer to key in a lot of information and track every receipt, the way most personal financial management programs do. Simple prides itself on its transparency. As its website says, “Simple never profits from fees. That’s not who we are,” and as John Reich explains, the concept was created as very much an antithesis to how he perceives traditional banks operate: “Large banks seemed to make money by keeping their customers confused. I thought there might be an opportunity to fix it.”
Simple’s other goal is to help its customers to save, which people are typically not very good at doing. The “safe to spend” reflects not just anticipated outgoings but also takes into account the customer’s savings goals, such as paying off student debt, retiring credit cards or putting money aside for a vacation or a down payment.
As Reich puts it, “people didn’t understand the connection between their spending habits and their ability to save. At the end of month they would get a statement and try to internalise the information – how did buying shoes impact my vacation plans? With Simple, you swipe your debit card and your phone knows. It closes the feedback loop between swiping your card and being aware of your goals. Obviously mobile and real-time are critical for us.”
Leveraging mobile technology
Mobile banking interactions are growing extremely rapidly, but they still account for a small share of overall banking interactions and an even smaller share of revenue-generating transactions.
Believing that mobile banking can play a much larger role in overall transactions, Gordon Baird founded nD bancgroup. Part of the issue with mobile banking, says Aditya Khurjekar, executive vice president at nD bancgroup, is that “consumers have not yet been offered a ten times better experience in mobile payments for them to change their current habits. The industry needs to invest in platforms and infrastructure that will enable many compelling value propositions to be easily created and adopted at scale.”
This is exactly what nD bancgroup is doing. It is building a state-of-the-art secure, cloud-based infrastructure to realise the promise of mobile banking. As Mr Baird puts it, “we have real-time processing, real-time analytics and real-time business rules running on highly fault tolerant systems with in-memory data models. Our analytics and reporting can monitor payments and accounts on a real-time basis and set financial and compliance limits on an account by account, and transaction by transaction basis.”
But, nD bancgroup isn’t doing this purely for its own sake. Its view is that, encumbered by decades-old legacy systems, other banks will choose to white-label nD’s infrastructure so that they can give customers what they want and so retain them. “We want to service other banks and companies that have existing customer bases with better payment and banking solutions.”
A look at the Kenyan banking market illustrates just how pervasive mobile banking adoption can be. The M-Pesa mobile payment service is used by a staggering 70 percent of the country’s adult population.
To build on the success of M-Pesa and to increase access to not just payments but a full banking service, Safaricom entered into partnership with Commercial Bank of Africa to create M-Shwari, a mobile-only banking service. From account opening to savings and lending, customers initiate their accounts from their phones, triggering automated processes to verify KYC information in a few seconds. Customers can access their M-Shwari interest-earning accounts and apply for 30-day loans without ever stepping into a branch or filling out paperwork.
One of the key success factors for M-Shwari was speed to market. The bank went from conception to three million customers in under 10 months, a feat most banks would struggle to replicate, given the prevalence of legacy systems in the industry.
By dint of being the first mover, M-Shwari has enjoyed massive success. It has so far collected more than Ksh66 billion (~$730 million) in deposits and dispersed more than Ksh10.6 billion (~$120 million) in loans. Further, its default rate, at 3.1 percent, is materially below the national average of 5 percent. At the time of writing, M-Shwari, started at the end of 2012, had more than 7 million customers.
Bringing a retailing ethos
Vernon Hill, who owns several Burger King restaurants, has a retailer’s mindset. He successfully built Commerce Bank from a single branch in 1973 to become one of the largest banking groups in the US (before its sale to Toronto-Dominion Bank for $8.5 billion in 2007).
Now Vernon Hill has brought his distinctive model of customer-centric banking to the UK with Metro Bank, which when it opened in 2009 was first new retail banking entrant for over 100 years.
The concept is built around great customer service (turning customers into fans) and convenience. Like retailers, Metro’s branches (or stores in its parlance) are open seven days a week: “You don’t have to think about what time a Home Depot, a McDonald’s or a Starbucks is open,” Hill says. “They’re open. You just go.”
In terms of great customer service, Metro opens new customer accounts and issues customers with their debit card in 15 minutes; it is dog friendly, with dog bowls of fresh water in the lobby; it has free coin counters in every store; cyclists can ride in, lean against the counter and make a transaction, no need to chain the bike outside; and, the bank has zero tolerance for unnecessary complexity or silly rules (“If we can’t explain it to our 18-year-old team members, it’s too complicated”).
Could such a model be successful in the UK? “Metro Bank is growing at three times the rate Commerce did when it went into New York City,” says Hill, and now has £1.6 billion in deposits.
Banks fighting back
Contrary to the impression that may have been given up to this point, the ability to be innovative and potentially disruptive is not the sole preserve of new entrants, whether they be created as banks or not.
BforBank is a new banking concept created by Credit Agricole. Like many of the disruptors we have reviewed in this report, it was created to fill a gap left by other financial services providers. An online bank, BforBank caters for the demographic of people who have money, but want to take a more active role in managing it themselves. This is a demographic that typically isn’t well served by traditional retail banks and falls under the radar of traditional private banks.
Also, like many other disruptors, it is a model which is predicated on advanced technology. As André Coisne, CEO, says, “Technology is key for BforBank. Without technology we don’t exist.”
The BforBank concept is based on giving consumers the tools to become their own asset managers (as the bank’s slogan puts it, “Mon Banquier, C’est Moi”). Its website has many interactive tools to track investments, run simulations, set risk parameters and check the tax efficiency of investments. It includes more than 50 videos with expert advice, and over 1,000 articles with financial advice and planning and has data feeds from the Paris Bourse.
BforBank has proved to be a big hit. In the past four years, it has taken more than €3 billion in deposits and despite greater competition – from rival internet banks beginning to offer similar money management tools and from the financing arms of major car companies competing for deposits – it continues to grow strongly.
It may just be that there is still a place for traditional banks in the digital age.
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