By Peter Heywood, Regional Director, BFSI at ISG
Interest rates are low, consumers are demanding digital delivery of banking products, employees need to access data from anywhere, and cybercrime is on the rise. The challenges facing banks are complex, and the market in which they operate is shifting. For many traditional banks, these challenges are made harder by a historic lack of investment in technology other than addressing regulatory issues.
Despite this, European banks — primarily driven by outperformance of the investment banking and asset management arms and simplification via divestitures — have proven their resilience in the face of severe economic downturn brought about by the pandemic. They are making increasingly focused on strategic technology investment and on reimagining their businesses to face these new challenges.
Post-pandemic, the success of these banks will depend on how effectively they’ve managed the structural challenges that plagued them before the pandemic started. Traditional banks need to continue to invest in digitalisation projects to streamline their operations and give customers the control, apps and services they want.
In 2022, banks will focus their investment in nine core areas.
- Banks will look beyond lending for growth and revenue
European banks have seen their net interest margins squeezed by low-interest rates and demand for loans — this is forcing banks to explore new ways to drive revenue (including investing in emerging markets, increased bank charges, and exploring new product lines).
For example, Australia’s Commonwealth Bank is adding crypto to its retail banking app – allowing customers to buy and sell the digital currency, while Fidelity Investments launched a bitcoin exchange-traded fund.
We’re also seeing retail banks start to offer more advice around managing money (such as NatWest’s Financial Health Check) and looking to move into wealth management, which we can see with Lloyd’s takeover of Embark Group.
Another thing some banks are starting to explore is a subscription model. Revolut, for example, has launched standard, premium and “metal” levels of subscriptions for digital banking, offering things like access to cryptocurrencies, priority customer service and a higher interest rate on savings.
As they move away from legacy IT systems, we’ll see more banks will start to reshape their businesses and business models to maximise efficiency and make the most of the new technology at their disposal. It’ll be an essential part of regaining profitability.
- Driving cost efficiencies through cloud and technology investment
Banks will focus heavily on reducing their cost-to-income ratio in 2022 through a slow recovery. Closing branches and reducing headcount will play a part here, but the bigger opportunity lies in rethinking operating models.
For example, the ten-year deal between foreign exchange company CME Group and Google announced in November 2021. Google will make a $1bn investment in CME Group, and in exchange, the group will move all of its markets to Google’s cloud services to increase efficiencies and scale while optimising costs.
HSBC announced a multi-year, global agreement with Amazon Web Services back in 2020 to move functions from legacy systems to the cloud, with “customer-facing applications” and the global wealth divisions being the first areas they wanted to move over. Then there’s Deutsche Bank, which has partnered with Google to deliver things like a “fully-managed environment for applications”.
Other banks, like Wells Fargo, are implementing multi-cloud strategies (in this case with Microsoft and Google) to ensure they have more choice when selecting the best platform for particular tasks or processes. Multi-cloud lets organisations make the most of each platform’s expertise – deriving maximum benefit for the bank and its customers.
As more banks start exploring what they can do with cloud technology, we’ll see an increasing number of them focus on cloud financial operations (FinOps) to ensure cost optimisation and management of these new services.
- Higher investment in the prevention of cybercrime
Cybercrime has evolved quickly during the pandemic as consumers demand digital communication over social media and live chat or messaging. UK losses to fraud alone total £52bn a year, according to a report in City AM.
Cybercrime incidents have increased, and the risk of incorporating third-party platforms into core banking services has increased banks’ vulnerability to attack. As a result, we expect the cybercrime prevention market to increase by 40% by 2024. We’re also expecting to see the regulatory technology market be worth $33.1bn by 2026 as organisations strive to simplify compliance processes and minimise risk.
While retail banks have long been able to manage card fraud, this new wave of cybercrime sets new risk parameters and increases exposure to fines under data protection regulations. It’s not enough to simply budget for these fines (as banks have done in the past), as shareholders and regulators pressure banks to de-risk and avoid repeated fines.
We are also seeing an increase in ‘hacktivism’ attacks on banks, something they must consider in 2022.
- Growth in digital platforms and new business models
As banks digitalise their front and back-end processes, they’ve started using more third-party services and technology (this will increase through 2022).
We’re already seeing several banks starting to offer banking-as-a-service (BaaS) – fintech, Dozens, partnered with Clearbank in 2019. The Financial wellness platform, Douugh, partnered with Railsbank in November and Solarisbank has bolstered its BaaS offering by purchasing Contis in July.
We’ll see BaaS become more widespread as banks look to partner with platforms, challengers and other non-banking firms to reach a broader market and deliver the kinds of mobile banking and payments services that consumers are demanding – this includes embedding finance into other apps and platforms, and offering customers financial services. For example, Amazon offers a credit card that gives users extra discounts on Amazon products. We could also see more examples of things like being able to apply for a mortgage while searching on a property website.
We can already see retailers getting more involved in BaaS. Back in January 2021, Walmart announced it was partnering with Ribbit Capital to provide its customers with more financial services and reach the unbanked and underbanked. Ikea is also making moves to start offering more consumer banking services.
While banks are clearly becoming more open to partnering with fintechs, this does raise the question of how much additional risk is involved, particularly around shared data.
- Increased pressure from regulators to strengthen technological and operational capabilities
The European Commission’s Digital Operational Resilience Act (DORA) is tasking EU banks with adhering to a comprehensive risk framework and upgrading ICT risk requirements. The UK’s PRA PS 22/21 is putting similar pressure on UK banks — this means investing in the right technology to address risk and modernise IT systems. ISG’s GovernX, for example, automates third-party risk management with artificial intelligence, robotic process automation and workflows.
Banks are using AI to proactively manage risk and have a good grasp of their position before submitting annual reports to regulators. American bank, Cross River Bank ramped up investment in AI in 2019 and now uses it to gain a better understanding of loan documents – helping it identify risk. It helped it spot inconsistencies and was much more efficient than the manual process it had in place.
Investment in advanced analytics, artificial intelligence and machine learning will help banks increase their agility, reduce costs and upgrade their technological, operational and reporting capabilities.
- Investment in ESG
In the wake of COP26, banks– like other organisations – will come under pressure to commit to reducing their environmental impact, social impact and governance. Some European banks are already exploring ways to tie executive pay to ESG targets, for example. We’ve also seen the launch of the MSCI ESG index, HSBC introducing EFT ESG bonds and Credit Agricole CIB (CACIB) launching a Socially focused structured product.
While the European Commission’s Basel III regulations set clear goals for the banking sector, NGO, Finance Watch, is sceptical about the implementation time-frame and a lack of climate-related risks being addressed. So, we could see current regulations amended to become more stringent and pressure put on banks to improve their ESG reporting.
- The return to the office and the workplace of the future in a post-pandemic world
CIPD research found that while 65% of UK employers didn’t allow regular virtual working before the pandemic, only 37% are expected to take the same stance after the pandemic is over.
The pandemic has resulted in fast-paced changes to the workplace, and traditional banks have struggled to keep up with the digital-native competitors. Increased employee flexibility, new working models and banks will need to keep up with these changes to continue recruiting and retaining the best talent (and so remain competitive). Offering increased flexibility, such as hybrid working environments, will be especially important for traditional banks as challenger banks are likely to be much more agile in this regard.
For example, ISG’s 2021 Provider Lens™ – Future of Work found that many German businesses listed in the DAX stock exchange allowed some senior managers to work three days at home and two in the office per week.
Remote working has traditionally been seen as a managerial perk, but more businesses will start providing these opportunities to office-based employees at all levels as the ability to work from home becomes a basic expectation of employees.
Investment in collaborative working technology, improved customer and employee experience will continue through 2022, as flexible and remote working becomes the norm.
- Mergers and acquisitions will continue but at a slower rate
We’re seeing some of the highest levels of consolidation that we’ve seen for a long time. Interest rates are low, and money is cheap to fund acquisitions. Banks are building capability through acquisitions of fintechs and startups to use in their own operations to avoid stranded capital in regional or branch level acquisitions. In the short-term, we’ll see more firms looking at joint-venture and partnership transactions to boost their ecosystem strategies.
However, we’ll likely see these deals slow down as investors of all kinds want to see proof of profits before investing and are less prepared to take risks. For example, in the US, it’s expected that regional lenders may slow or pause their M&A activities until regulators provide more guidance.
While M&A activity will continue, it probably won’t be at the rapid pace we’ve seen in recent years.
- Simplification of service lines
Banks are seeking to simplify their product and service lines, reducing complexity and consolidating offerings; for example, Credit Suisse exited prime services and brokerage to focus on wealth management. That means they are divesting some less profitable product lines and offerings (such as current accounts and debit cards) and doubling down on more profitable offerings (like credit cards, loans and international money transfers). We’ll see this reduce the complexity of legacy systems used to support these services, making banks more agile and nimble.
It’s a time of real change for banks, streamlining services, increasing digital capabilities and refocusing investment into the technology to enable them to thrive into the future. The banking landscape could look very different indeed at the end of 2022.