Disruption – can traditional banks fight back?

Philippe De Backer

Juan Gonzalez

By Philippe De Backer, Global Leader, Financial Services Practice, Arthur D. Little

Juan Gonzalez, Partner, Financial Services Practice, Arthur D. Little

The disruptive rise of fintechs leads many to believe that the traditional, universal bank is doomed. Through their digital-first model, lower cost structure, lower capital requirements and greater flexibility, the new breed of fintech firms have been able to outmaneuver less agile universal bank competitors. These strengths are reflected in higher stock market valuations and growing customer numbers. By contrast, in most markets, price to book ratios for major retail banks are consistently below one.

The scale of the challenge is enormous. For example, Ant, the financial arm of Chinese marketplace Alibaba can handle 120,000 transactions every second and reach a decision on granting a loan within just three minutes. Fintechs don’t have to support aging, legacy technology and can focus instead on innovation and customer centricity.

So, is it all over for the universal bank? Despite the challenges there is still hope for their survival, particularly as fintechs face greater competition from their peers and come to terms with the costs of becoming a recognizable, mature bank brand. However, for traditional players to strike back they will need to act quickly and decisively, focusing on transformation around six key priorities:

1. Take a focused, ecosystem approach

Universal banks are stretched too thin, aiming to provide all things to all people. They need to slim down and focus, starting by developing a clear picture of the future. What will the industry look like in three to five years’ time – and what do they want their role to be?

To achieve that position, they need to learn from the new ways of doing business that fintechs have introduced. For example, look at the ‘triangular strategies’ that allow fintechs to leverage assets and channels that banks don’t have; or embedded finance which offers opportunities for exponential growth.

Search out the right niches within the emerging financial ecosystem. That means moving away from the old business model of recycling customer deposits into loans to embrace a balance-sheet-light structure that revolves around selling third party products from across a wider range of partners. This requires a very different set of capabilities, and different operational structures.

While every bank will create its own vision of the future, the common factor underpinning each one is that it should probably be far away from where the bank is now. If it isn’t, then the senior leadership team haven’t been thinking big enough. It is about more than simply digitalization, which is a means to an end, not a business model on its own. Essentially banks will need to shed long-established activities, re-evaluate acceptable levels of risk, restructure systems and processes, and invest fully in new technology.

2. Move customer-centricity from a slogan to reality

Every bank claims to focus on its customers – but the reality is normally very different. At best universal banks have used broad demographic segmentation to target customers, while consistently underperforming at delivering the right experience. In many cases customer service was seen as a cost to be minimized rather than a core process that drives loyalty.

This must change. For the future, the customer should be everything. Banks need to embrace technology to acquire a much greater understanding of those they do business with and then use this to personalize every interaction with them, through chatbots, AI, and data analytics, for example.

In most cases traditional banks need to rebuild trust with their customers, who now understand that they have a choice and won’t be taken for granted. That means building processes and experiences that consistently meet their needs on a personalized level. For example, banks need to become seamless problem solvers, offering ‘one call resolution’ to save customers’ time and effort,

Customer-centric mindsets and data-first models need to be adopted quickly. After all, open banking now means disruptive third parties can access customer data held with another financial institution, so banks have to monetize their wealth of customer knowledge, before rivals do. Again, this comes down to investing in the right technology and top-notch analysis. This creates opportunities, but generally only for early movers as they capture and retain customers. Life is then harder for those that come afterwards.

3. Embrace technology as a key enabler

As fintechs are demonstrating, the bank of the future is digital-first and built on technology. However, over time traditional banks have acquired huge estates of complex, expensive to maintain systems that they now struggle to manage, let alone innovate through. Essentially, technological obsolescence is rife in today’s banking environment. Banks therefore need to effectively adopt and use next-generation technology to drive greater customer engagement, faster product development, better operational management, and improved compliance, efficiency, and growth. New systems will also enrich the customer experience through stellar, hyper-personalized service.

Replacing legacy systems is challenging, both technically and in terms of budget. It means writing off old systems and software, but this is a price that must be accepted. Again, banks can learn from fintechs by embracing the cloud to cut infrastructure costs and becoming technology agnostic, using architectures that allow for easy integration with third-party solutions and facilitate migration from legacy IT solutions.

They also need to look strategically at future, breakthrough technologies and operating IT in new ways. Banks need to become proactive in innovation management, continually identifying emerging technologies and then using them to lever advantage. This includes working with partners and start-ups across the ecosystem, incubating promising technology and potentially scaling it externally. They need to become truly agile, adopting digital development models such as running parallel improvement sprints, seeking fast feedback, doubling down on winners and killing losers.

4. Leaders must be ambidextrous, backed by strong governance

Traditional banks clearly have to meet two, radically different challenges. They must deliver significant growth and productivity improvements in the short term, while simultaneously redesigning their business model and moving it to the new point of arrival in the future. The right leader is key to a legacy bank’s survival and future success. They must be ambidextrous – able to innovate for the future while still optimizing productivity from existing operations.

Being ambidextrous is not the same as merely being ‘forward-looking’, which involves doing little more than identifying a few industry trends and responding with possible options. The truly ambidextrous CEO must also be adept at peering through the blizzard of largely irrelevant information, slicing into the complexity of other’s opinions and be willing to back their decisions even when they are based on incomplete information.

Banks also look at their boards and overall governance – after all, the board appoints the CEO. Do the board members have the right skills, capabilities, and foresight to understand the radical nature of the transformation needed? Or will they choose candidates who promise to focus on the status quo? Banks therefore need to look at potentially refreshing their boards by bringing in a more diverse mix of open-minded individuals, representing a range of different gender, race, and experience profiles. This should include a strong awareness of such things as artificial intelligence, machine learning, robotic process automation and augmented reality.

5. Build a culture that supports transformation

Traditional banks have grown and created specific types of culture – focused on acting and thinking in specific ways and minimizing risk. While this may have worked in the past, customers, the market and employees now demand something different.

Transforming culture is vital – and starts with the CEO. A forward-looking ambidextrous leader should be able to convince the organization that the old days of banking are gone, and that a different way of thinking is needed. It isn’t just about becoming more digital and agile, but also meeting changing customer and staff requirements. For example, just over half of Generation Z (those born between 1995 and 2010) say they trust their primary financial institution – a bank – most with their money.

Culture is at the heart of employee engagement, satisfaction and retention. However, the cultural values and day-to-day behaviors of banks are often out of sync with the types of individuals they need to recruit and retain. For example, younger generations have different, and often stronger, beliefs and expectations regarding an organization’s values and culture. For example, the need to truly embrace Environmental, Social, and Corporate Governance (ESG), reflecting a firm’s collective consciousness beyond the purely commercial, is now a key priority for growing numbers of employees, as well as consumers, and investors.

6. Be humbler and take an ecosystem approach

The world of monolithic banks that can meet every one of their customer’s needs alone are gone. For banks to deliver exceptional value to their customers they have to be willing to work in partnership with fintechs, accessing their skills and capabilities to fill gaps in their offering.

Taking an ecosystem approach centered on the customer is vital. However, in this type of environment, banks need to put their egos aside – it simply isn’t possible for a financial brand to stand out as it did before. Instead, banks need to manage the process of developing their partner ecosystem strategically and purposefully, if they want to remain relevant and profitable.

The need to embrace radical change

Reading what needs to be done to transform, many banks might be daunted and feel that business as usual is a safer option. That misses the point – the traditional world of the universal bank is becoming history, and those that fail to change are doomed to fail. What is needed is to embrace radical change now, with a clear starting point, strong, ambidextrous leadership, and a digital, customer-focused ecosystem approach. Only then will traditional banks have a fighting chance of a successful future.