By Lana Abdullayeva, MD Strategy, CB Investment Growth Holdings
Digital disruption is reshaping many industries. Take for example, the music industry, which has constantly evolved to keep up with the world we live in today. From vinyl (currently back for retro-fans), cassettes, CDs, MiniDiscs and the once ubiquitous MP3 player today, music has moved to digital platforms. That move has allowed us all to listen to music on any device, anytime and anywhere we want – driven by the needs of customers to match the way we all live in today’s digital era.
Financial services, on the other hand, has struggled to keep up. It’s been slow to change, and as a result have fallen short of customers’ expectations.
The fact that its foundations and principal methods haven’t changed in centuries is a huge challenge for innovators in this space. The way money is held and transferred hasn’t changed for decades, and the way equities are traded has only slightly improved with automation in recent years. In some parts of the financial services industry, it’s fair to say we are still using gramophones in the age of Spotify.
The roots of innovation in financial services haven’t changed
The issue is the infrastructure of today’s financial system is fragmented, lacks interoperability and is expensive to run. In fact, maintaining legacy systems in financial services can be incredibly costly, in some cases consuming more than 80% of a business’s IT budget. It hasn’t been updated since its creation decades ago and therefore not surviving the test of time. The systems were developed with technologies that are no longer widely supported and today’s talent lack training to keep up the legacy system’s maintenance. What’s more, the cost of its maintenance increases the longer it is left without being updated. Further, the existing business models of traditional banking are not designed for the fast-evolving digital world.
However, it would be unfair to say we haven’t seen huge digital disruption in some areas of financial services. This has largely been driven by strong government backing for fintechs in the UK. The Bank of England encourages a culture of competition with policies that ensure they are fair to both big banks, but also to the upstart banks who are pushing for investments in a new market infrastructure in areas including real-time gross settlements, open banking and digital assets. From this, we’ve seen successful fintechs like Monzo, Starling and Revolut emerge.
What we haven’t seen is the drive to transform the aging infrastructure from incumbents. We can keep reinventing digital services, but if these services rely on the same ageing components, we won’t see the real results that a full digital transformation in financial services can bring. Going back to our analogy of the music industry – rather than keep trying to make the records look more flashy, it’s time to ditch the gramophone.
This impact on financial services also holds back the potential of industries that rely on it – whether it’s utilities, telco, music or entertainment – any business that is becoming digitally native. Digital transformation in the financial system will drive change beyond immediate financial players by changing the way we exchange value and how we move money around for the better. This opens up a whole new world of finance for businesses and consumers. It enables wider financial inclusion and opportunities for businesses to open up new revenue streams and offerings for its customers.
Uber is an example of successful digital transformation. It pushed forward an otherwise lumbering industry. In the days before Uber, you had to physically hail or call a cab. Now, you can get a ride in minutes with the click of a button. Financial services need to see the same level of innovation and digitisation.
An urgent need for a mentality shift
The outdated system even makes the basic function of holding and moving money cumbersome and inefficient. It is challenging domestically, and even worse internationally. Did you know that globally, sending remittances costs an average of 6.38% of the amount sent? These high fees are inexcusable given the technology we have today that connects us to different parts of the world. Can you imagine a mobile phone that couldn’t contact someone on another network or even roam internationally? This would be unthinkable today. Unlike financial services, the mobile network industry adapted its systems becoming increasingly interoperable with other networks and jurisdictions to enable customers to seamlessly contact others across the globe.
These changes will not happen overnight. At present, innovators must deal with a legacy of complexity, built upon over years of looking for short-term fixes to age-old problems such as high customer fees and slow product launches. This change needs to be led by a shift in mindset with innovation, interoperability and sustainability front of mind. By and large, traditional financial institutions have rarely been incentivised to innovate. The cost is high, the margins are comfortable and there’s not always a good understanding of the additional revenue to be made when you fix the systems ‘behind the scenes’ compared with a new product or service offer.
It’s vital that innovation takes many forms, beyond the new services that get people excited. It’s the infrastructure innovation that will have the longest-lasting impact on the sector. While Open Banking developments started to bring a mind-set shift to the market, redesigning the ecosystem and traditional value chains, this is hardly enough to address the fundamental problem of cumbersome and outdated foundation. Things like faster settlements and adaptable business models that enable connectivity with different markets will be transformative. In some cases, we need to go move away from patching the flaws in our legacy systems, and instead rebuild and invent a new way of thinking and doing.
It’s time we empower innovators to create long-lasting services
If we compare the ‘Uber moment’ with what’s going on in financial services, the similarities are strikingly familiar. Both industries had been digitally isolated and didn’t feel the need to listen to customer wants. This is exactly why Uber was able to make its market presence felt so quickly. It came along with an app-based digital taxi experience that forced an industry that was stuck in the 20th century to digitally transform and meet the needs of our tech-forward world. By expanding their reach through the borderless digital-native platform , driven by a clear forward looking vision to serve customers in the digital world, it stated its position in the market, built long-lasting relationships with its customers and has been a true innovator since then, expanding its offerings beyond ride-hailing to food delivery.
Banking is no different. Anyone looking to innovate in financial services must rely on the banks that clear with the Central Banks, and the existing infrastructure they provide. With no incentive to change, fundamental services like clearing haven’t moved to fit the needs of today’s businesses and the customers it serves –as a result, many payments still cannot be settled in real-time, cost effectively and free of unnecessary risk.
Growing digital players need 21st century foundations
The financial services industry is in desperate need of a new model to allow innovators and consumers to take full advantage of technology advancements that is becoming prevalent in many industries. Much like we’ve seen in the telco and music industry, it needs to continually evolve at its core to fully provide digital services to keep pace with today’s world.
The time has come to re-design banking foundation for digital economy. Only when the constrains of traditional banking models are removed, can the industry see huge strides being made from innovators in finance’s core services such as cross-border payments, clearing and instant settlements, as well as in newer areas like DeFi and crypto. It’s the opposite of what existing banking model currently designed to do – but it’s the only way we can unshackle businesses from the grips of 20th century barriers.
Global Banking & Finance Review
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