Technology advances have disrupted and changed multiple industries, and banking is no exception. Strict regulation, competitors and changes to business models are all topics that contributed to that disruption in the banking sector in recent years.
In the last few years, he banking sector, partly due to the pandemic, has seen major improvements on the digitalization however, new competitors such as Fintechs, and the growth of the Crypto market do pose the question: “Can traditional banking remain competitive and not fall behind?”.
Traditional Banking: Risks and Challenges
The traditional banking sector already has risks associated with it, even without considering new ones brought by technological advances. The risks of the banking area can be divided in two main groups: the systematic risks, who cannot be controlled by the organizations, such as interest rate risks, market risks and purchasing power risks, and the unsystematic risks, being examples liquidity risks, the credit risks, cybersecurity risks due to the acceleration of the digital transformation of services provided and the operational risks, having grown significantly due to tighter supervision by central banks in matters such as KYC and AML.
These new challenges show that digital transformation and the additions of new technologies based on AI and ML is not enough for traditional banking to get a competitive advantage in relation to Fintechs, it is imperative to rethink the outdated business model that has always characterised traditional banking.
The Traditional Banking Business Model
The traditional bank business models are linear, inflexible and vertically integrated, mostly due to tight regulation from the supervisors. The new players arriving to the Banking sector showed that by changing the business model to something more flexible and personalized they can choose more carefully which layers of the value chain they wish to interact with, allowing them to innovate the products and services that are offered to clients.
A study conducted by Accenture on the value of non-linear business models between 2018 and 2020 revealed big differences in annual revenue growth of banks and other players in the financial market: digital-only players with non-linear models saw a 76% increase, contrasting with traditional banks with vertically integrated models, who only saw less than 2% growth (The Future of Banking, 2021)
McKinsey suggests that banks must shift their focus to outside the banking business to increase their revenues, since interest rates have been historically low for almost a decade, sometimes even negative. Integrating other services and focusing on the UX/UI in their digital banking platforms might be a good way to produce a more personalized and overall better experience for their customers. Using AI and ML to analyse data and provide better services seem to be a focus point for the future of traditional banking, although many managers feel like they can’t compete with current Fintechs and Big Techs on that regard.
The World Retail Banking Report 2022 revealed that 95% of managers in the banking sector believe that their current technological resources are outdated, when compared to Fintechs. This discrepancy in technological resources ends up resulting on traditional banks not being able to process or analyse the huge amount of client’s data in their possession and losing potential business opportunities to their competitors. Data science tools as AIML present an opportunity for banks to have a closer interaction with their clients anticipating their needs and expectations.
This possibility is supported on the same study, revealing that 75% of clients feel more captivated by Fintechs due to their approach to banking as a 100% online service as one of the main reasons.
What Approaches can be taken?
However, there is still hope for traditional banking as there are multiple possible approaches that can be taken. Banks can shift their focus to what really distinguishes them from the financial technology services: the people. Both the wide and loyal customer-portfolio that traditional banks produce and the ability to have real in-person human interactions with their clients. All without discarding technology, investing especially in Data Science to provide better data analysis resources, to improve the overall experience for each client.
An alternative approach is one that some traditional banks have already taken to innovate the current state of traditional banking: partnerships with Fintechs. While the bank gain access to the technology and the business model, the Fintech gains access to a mostly loyal customer-portfolio. This allows better and more innovative services to be offered to a wider range of customers, making it a win-win-win situation.