Digital Impasse

As going digital becomes a byword for banks, it can and should only be a means to an end


7 Mar 2018


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ON a humid, warm day, a queue forms outside Leopold’s ice-cream parlour along Broughton Street in historic Savannah. While the crowd waits patiently for their turn to order a single or a double-scoop of the signature flavours of tutti frutti or butter pecan (with locally harvested nuts from Georgia), a server comes out with a jug to offer cups of water.

It is not just the attention to guests that is quite refreshing at Leopold’s. The charm and the novelty have stood the test of time; next year the ice-cream parlour celebrates a century in the business. As the relentless march of globalization transforms cities to look identical with Starbucks and McDonald’s at every other corner, it has also spawned a growing movement that provides an alternative to the conventional and the commonplace; from artisanal cheese to organic wine to craft beer, and yes, homemade ice cream.

The financial industry is facing a similar challenge. With financial technology (fintech) advancing rapidly, banks face considerable pressure to adjust to how clients’ buying behaviour is evolving as a result. This reality is no more acute than in payments with the emergence of third-party payment/e-wallet providers such as Alipay in China and Paytm in India.

To give a perspective on a scale of the disruption, it is predicted that by 2020 the number of non-cash transactions in the Asia-Pacific will reach 276.8 billion, an increase of almost three times the total recorded in 2015, according to the forecast from the World Payments Report 2017. China’s mobile payment market alone was valued at US$5.5 trillion in 2016 according to internet consulting firm iResearch, more than 50 times that of the United States. Even governments around the region are encouraging cashless payments with the introduction of PayNow in Singapore and PromptPay in Thailand.

As in Joseph Campbell’s The Hero with a Thousand Faces the same story is rarely told for the first time. Campbell argues that the same narrative patterns repeat time and time again throughout the mythologies of separate traditions. So the story of a young disrupter, in this case the fintechs, challenging the old for power, the banks, is not new. One only need look to the recent story of craft beer and its disruption of the beer industry.

Craft beer offered a locally produced, honest product that resonated with the endemic consumer malaise at pervasive and boring big brand beer. Why was it successful? It gave a homely, exciting, start-up coolness, and a level of care and attention lacking from production-line manufactured alcohol; something which big beer was unable to replicate. But more importantly, it got the basics right. Branding, customer care, loyalty, much like Leopold’s. People wanted to support something they cared about.

Banks find themselves in a similar predicament as industry dinosaurs, outmanoeuvred by new market participants. As such, for most banks, accelerating the adoption of digital is imperative as a pillar for future growth. The data show that 85% of senior banking executives globally cite the implementation of a digital transformation programme as a business priority for 2018, according to EY’s Global Banking Outlook 2018. Moreover, Asia has some catching up to do. Only 4% of Asian banking executives felt that their institution was digitally mature. This compares with 27% of executives in North America and 15% in Europe, according to the report.

For now, however, most view the benefit of digitalization as a cost-saving exercise. As the strain to meet tougher standards on regulatory capital increases and competition intensifies, international banks’ return on equity (ROE) has been in the doldrums since the global financial crisis nearly a decade ago.

Banks around the world on average saw revenue margins decline by 4% from 2014-2016 lowering ROE by 1.5 percentage points, according to a recent report from consultancy firm McKinsey. Currently, banks’ ROE is stuck around 8% to 10% but is predicted to fall to 5.2% by 2025 if banks don’t evolve.

Adopting digital technology – automation – holds the promise of trimming cost while achieving greater operational efficiency. DBS Bank in Singapore, for example, operates DBS Digibank, a mobile banking platform for both India and Indonesia that uses an AI-based virtual assistant. Among Asian banks, DBS is perhaps the most digitally committed. And it is for good financial reason. DBS found that it generates an ROE of 27% from its digital customers compared to just 19% for traditional customers.

In Canada, also looking to leverage cost savings, TD Bank has signed an agreement to use conversational AI technology to replicate a chat-style customer support experience. Similarly, Ulster Bank, a unit of the Royal Bank of Scotland, has announced plans to work with an AI vendor to better understand its customers.

Increased regulation requires banks to also fork out a tidy sum for compliance in order to avoid major fines. The estimated cost of navigating the regulatory environment was around 10% of all operational spending for major banks, about US$270 billion per year, according to the McKinsey study. Digital may help offset this increasing cost.

What’s interesting is that while regulators have their eyes peeled on compliance by banks to stricter capital standards, they have also embraced fintech. The collision of these two worlds is much like the paradox of the unstoppable force (fintech) meeting an immovable object (traditional banks) – the result is unclear and unpredictable. The way to deal with fintech therefore should be under their watch.

Asia’s regulators are among the most progressive. In 2016, the Hong Kong Monetary Authority (HKMA) launched the Fintech Supervisory Sandbox, which allows banks and their technology partners to conduct pilot trials of new initiatives to meet compliance standards before eventually going live. The Monetary Authority of Singapore also operates a similar fintech regulatory sandbox, although its approach is somewhat more nuanced and some say much more agile than that of HKMA.

Although some argue that such initiatives help propel experimentation in fintech, the primary purpose of the sandbox model is for new fintech solutions to meet compliance standards, and therefore may act as a barrier to launch. China has taken a bolder approach, which enabled its fintechs such as Alipay, WeChat pay

and UnionPay to flourish, arguably because no such sandbox requirements hindered innovation. Of late, however, it too has stepped in setting up a national clearing house for online payment services to be routed to this platform operated by the People’s Bank of China starting June 30 2018.

Novel fintech
As fintechs come up with novel ways to interact and engage, the fear is this: they are able to offer financial services, such as retail payments, cross-border cash transfers, and others, with low cost and high volume due to their specialized use of automation. In doing so, they receive the visibility and branding, and banks, as well as lower margin, lose relevance and engagement with their customer base. It is no longer just payments. Banks are seeing fintechs creep into what they do best: lending. Rather than go to a bank, small and medium-sized enterprises are able to tap alternative financing platforms for funding such as peer-to-peer lenders. A joint study by the University of Cambridge, the Australian Centre for Financial Studies and Tsinghua University reports that more than US$245 billion of funding was raised via online alternative platforms. Southeast Asia in particular has experienced significant usage growth in alternative financing with the market estimated to be US$215.94 million in size in 2016 compared to just US$46.65 million in 2015.

Robo-advisers are also threatening to take clients from banks’ wealth management business providing cheaper automated services. IDC Financial predicts that by 2021 the total assets managed by Asia-Pacific based robo- advisers will reach US$500 billion. The research firm also states that although robo-advisers only represent 0.2% of overall wealth assets under management (AUM) globally, they are likely to gain ground growing at 100% annually to become 1% of the wealth management market by 2021.

However, in Asia, robo-advisers have generally adopted a different business model from their counterparts in the US. While most digital wealth managers in the US such as Betterment and Wealthfront have opted for a business-to- consumer model, Asian firms on the other hand have decided to focus on the business-to-business model due to the high cost of retail-investor acquisition.

Nutmeg, one of the largest robo-advisers in the UK, for example, has yet to make a profit even though it has US$800 million in AUM.

Cognizant of the potential lost revenue on that last mile, banks are fighting fire with fire with many now regularly enabling APIs (application programming interfaces) and engaging directly with technology partners to create that visibility to clients. DBS and Citi have opened up their systems to support various APIs.

In the case of Citi, the development of APIs has enabled the bank to embed itself with the likes of Uber and Airbnb. Other institutions have opted to go for a fully digital strategy forgoing the traditional brick and mortar. Banks such as CBD Now in the United Arab Emirates and WeBank in China have been some of the leaders in this new type of banking.

To strengthen the adoption of innovation and embed digital thinking, especially within their organizations, banks have set up innovation labs, including ones that are open to third-party entities. From Silicon Valley to Singapore, Hong Kong and Shenzhen, these labs have rapidly sprouted up offering a space to experiment and form collaborations with fintech players. A few years ago, Standard Chartered Bank opened its eXellerator innovation lab as a way to allow business units of the bank to work with emerging technologies such as blockchain. More recently, the bank set up SC Ventures to lead digital innovation across the group including investing in fintechs and other start-up companies.

In addition to setting up labs, other banks such as Citi have created competitions, including hackathons to engage and potentially form partnerships with fintech players. In 2016, the bank announced that its mobile challenge winner Mtel had been incorporated into its official CreditCheck app.

Digitalization is a double-edged sword. Although it improves efficiency and may achieve cost savings through automation, it also opens up a bank to added risks. Recent cyberattacks on companies such as Equifax, Uber and Swift indicate that the risk faced especially by financial institutions is a real and present danger. In the case of Equifax, one of the largest credit bureaus in the world, personal data from 145 million accounts were leaked publicly.

By nature, financial institutions are conservative, constrained by regulation as well as by internal risk and control. As the troubles nearly a decade ago have shown, non-compliance can cost more than a pretty penny. From 2008 to 2016, international banks paid around US$321 billion in regulatory fines, according to data from the Boston Consulting Group. The Chinese Banking Regulatory Commission revealed that it had issued 3,452 penalties and confiscations of funds involving 1,877 financial institutions amounting to 2.93 billion yuan (US$465 million) in 2017 alone.

More recently off the back of the bitcoin buzz, Japanese cryptocurrency exchange Coincheck was hacked resulting in the loss of US$534 million worth of funds.

Following the attack, the Japanese Financial Services Agency (FSA) ordered all cryptocurrency exchanges based in the country to submit a report on their risk management systems.

Information from cybersecurity firm Gemalto’s breach level index shows that there were 918 data breaches in the first half of 2017, resulting in 1.9 billion data records being compromised – equivalent to 10 million records exposed a day.
This represents an increase of 164% compared to the last six months of 2016.

Increasing spending is inevitable, as underspending on cyberattack prevention – like underspending on compliance – could cost more in the long run. A report from A.T Kearney predicts that the Asean (Association of Southeast Nations) needs to collectively spend about US$171 billion on cybersecurity between 2017 and 2025. Not doing so could cost the top 1,000 companies in the region about US$750 billion in market capitalization, the report predicts. Globally, cybercrime will cost businesses US$2.1 trillion by 2019, Juniper Research forecasts.

Several financial regulators including the HKMA have looked to tackle cybersecurity via education and collaboration. In 2016, HKMA kicked off its Cybersecurity Fortification Initiative, which provides banks a standard set of guidelines to assess their cybersecurity readiness. Last summer, the HKMA’s sister regulatory entity, the Securities and Futures Commission, released new requirements for brokers involved in internet trading. These requirements include encryption of client login passwords and monitoring/surveillance mechanisms.

“As a regulator, we have to encourage trust and confidence in the financial market, because without trust and confidence, financial markets would not work,” explains Ashley Alder, CEO of Hong Kong’s SFC, at the recent Asian Financial Forum.

What is interesting is how digitalization presents banks with an impasse. Banks can choose to remain traditional banks, maintaining the community reach and touch through physical bank branches. The risk is that they cede ground to digital players, which offer the latest banking apps for account management, stock trading, lending, payments, and so on. This would arguably push traditional banks further into the background, losing visibility to customers engaged in a digital world, becoming slow and outdated, with higher headcount and rent.

The other option is to become like the fintechs, by becoming a heavily or purely digitized bank like DBS Digibank, CBD Now or WeBank. The digital path represents high automation, offering cool apps, a cool brand, and services traditional banks may be unable to provide: payments, robo advisory, API integration with vendors, and other yet-developed technological offerings. Yet, they risk losing the traditional local branding of a bank, of the bank manager as a family friend, instead offering a mostly or fully online offering, with faceless chatbots rather than real people, and apps instead of bricks and mortar branches. For some, such an entity is unrecognisable as a bank, and more like a technology company. For traditionalists, such change would be act of self- destruction, challenging the existential nature of the bank as the trusted friend. A third vector is at play, and follows in the footsteps of the big beer story. In the same structural narrative as big beer and craft beer, the incumbents, big banks, are failing to reproduce the results of the disrupters, the fintechs. But it should be noted that nowadays if you buy craft beer, especially in a supermarket, you’re likely to find that the craft beer brand is now owned by AB InBev or Miller.

Similarly, banks are likely to continue following the same narrative arc by simply acquiring the new disrupters: when an immovable object meets an unstoppable force, they merge. Like Campbell’s Hero, it’s the same story with new faces.

It is at this point the means-ends principle comes to mind. Philosopher Immanuel Kant held that people should never be treated as a tool (a means) to achieve an outcome (an end). Treat people as an end in themselves, and never a means. In other words, don’t use people, and don’t confuse a means with an end. This category distinction has been applied in various fields, including in economics and AI, providing the form for means-ends analyses. Here, it should be reminded that digitalization is a means to an end, and not an end in itself.

And so what is the end? The traits that will distinguish the winning banks of tomorrow are likely to be what has made Leopold’s a Savannah tradition the past 99 years. It is about great attention to detail, delivering the service in a seamless and custom-made manner and being able to intuitively discern what clients need. That breeds loyalty, recognition, differentiation and coolness, and makes every scoop of ice cream a delightful experience. Artisanal banking, anyone? 


7 Mar 2018


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