Finance
Transformation of the traditional financing system – millennials and gen Z
Global Banking & Finance Review®
Company
By Raymond Hsu, CEO and founder of Cabital
Over the last decade, and increasingly so over the past two years, fintech startup technology providers along with blockchain companies have disrupted financial businesses in the most innovative ways and have fundamentally changed the way in which a financial services institution’s products and services are created.
While traditional financial institutions continually face major revenue losses because of the fierce competition from fintechs and blockchain firms, understanding the pros and cons of fintech and traditional banking systems can help IT leaders determine the future evolution of the banking and fintech worlds, and figure out the best strategy to face it.
Most importantly, cryptocurrency and blockchain technology is a direct challenge to banks, and they will have to embrace them like never before if they want to keep millennial and Gen Z customers. There will be no choice in the near future and that is why we are already seeing banks, asset management companies and even pension funds beginning to embrace crypto.
Fintech and blockchain are leading the change of finance
Fintech platforms are characterized by their agility, customer friendliness and innovative strength. And they have taken the traditional finance world by storm, forcing the traditional banking industry to adapt quickly by either buying them out or by also hiring software developers to ramp up their digital services.
They use innovative technologies (e.g. blockchain or artificial intelligence) and until recently were only partially subject to regulatory restrictions. Their services are always simple, convenient, fast, user-friendly and available from practically any device. Above all, “millennials”, “digital natives” and customers in rural areas where there aren’t any bank branches nearby want to carry out their banking transactions digitally. Cryptocurrency has become a great way to send money amongst digital nomads who want to maintain their privacy yet also use their digital currencies to earn up to 12% a year, far exceeding what a checking and savings account would earn them.
Fintech platforms focus on a selected customer group and have a better understanding of customers through big data.
By using large amounts of data, fintech firms can provide their customers with personalized offers that are tailored to their interests. They establish intuitive functions for mobile and online user guidance and replace personal relationships with classic banks by offering aggregation services. This allows them to provide customers with more personalized services, forcing traditional finance firms to also reevaluate the way they view the customer journey and their own propositions.
Fintech firms do not require a lot of staff or a large branch network with expensive IT networks. By establishing digital marketplaces, they increase transparency. Their processes are automated, which means that customers can use their services quickly and cost-effectively.
For small companies, fintech platforms are often the only way to get a loan, since most traditional banks do not pay for loans for the self-employed or small companies and have completely removed them from the portfolio.
Low income earners, the unemployed and students fall through the cracks of many banks (too high risk) and use the offers of fintech platforms instead. Automation also leads to cost savings that they pass on to customers.
Many fintech services are therefore free of charge, unlike many banks that charge sometimes high interest for cash withdrawals and loans. Thanks to cost transparency, customer trust increases and new customer groups are created. But fintech platforms not only offer old products in a different way, but also develop disruptive new services, such as peer-to-peer (P2P) payments, robo-investment platforms or secure fiat on-ramp and off-ramp solutions for businesses, in which almost all processes are based on algorithms and human intervention is hardly used any more. This is bringing huge savings and investment opportunities to the end user not known before.
In doing so, they eliminate established offers from banks and reduce banks’ earnings through cutting commissions. But fintech platforms also have some disadvantages. A recent study found that 85% of respondents said the biggest barrier to using fintech services is a lack of awareness. In addition, fintech platforms mainly need investors in the early days because, unlike established banks, they do not have large capital reserves. There is also a risk that a start-up will not survive the early days and will file for bankruptcy.
Customers should therefore think carefully about which fintech platforms they want to work with. Fintech platforms are also at greater risk of expanding attempts to attack the economy as a whole, since they connect more systems and thus offer more targets for cybercriminals. If fintech platforms only deal with some parts of the value chain, they also do not need a banking license. A small percentage of fintech companies have a license. The security of customer data is therefore often not guaranteed.
Advantages and disadvantages of banks
Banks are financial intermediaries between investors and lenders. They also help investors and lenders/savers to invest and obtain their funds efficiently. Especially for complex products (e.g. trade financing), banks offer an important and necessary advisory service. Furthermore, banks have access to cheap financing (due to their banking license) which they can use for their profitable refinancing.
Banks also score with their privileged access to customers due to their bank branch networks and also have a proven sales structure and a corresponding customer trust. In addition, classic banks offer security and in-person customer service. But since a lot of information can now be called up in a user-friendly manner via the Internet at any time and from any place, there is a risk for banks that their function as information intermediaries will no longer be used to the extent that it was in the last few decades. This applies primarily to products or services that do not require much consultation.
Thanks to increasing cost transparency, customers can quickly and easily compare offers on the Internet. However, the outdated corporate structure causes a lot of costs, because the operation of the branches costs, i.e. staff, rent. In addition, the banks’ outdated IT infrastructure is very expensive. They pass these costs on to their customers. In addition to the costs, the quick and uncomplicated conclusion is a decisive factor for customers and the long-standing close relationship with the local bank hardly plays a role anymore (primarily for private customers). The willingness to pay decreases and individualized offers are required. By completing banking transactions via multimedia channels, bank customers use peer experiences and recommendations and are becoming increasingly critical. Many banks have not yet reacted to the new customer needs. Their anti-innovation attitude is partially due to their very complex internal structures and their opaque processes. Their key focus is mainly on compliance and internet security.
The banking policy orientation slows down innovative approaches rather than promoting them. Banks are faced with two major challenges today: on the one hand, banks have to “keep up” e.g. come up with smart services. On the other hand, they have to “react” with new ideas that didn’t exist in banking before. With these two measures in place, they can meet the new requirements of their customers and improve their antiquated image.
Recommendation for action for conventional banks
As shown above, banks still have considerable potential for optimization, especially in online business. It is therefore advisable to set up a new business model and not to further develop the outdated business model. To do this, they must, among other things, take out and shut down their legacy systems and invest the budget in a modern IT infrastructure. It is also advisable to integrate all existing sales channels and implement an omnichannel approach. As a result, all service offerings can be networked with one another, making holistic advisory offerings possible (online and offline).
Customers can then decide for themselves which channel they want to use. The branch is still important for bank customers and is not an obsolete model in the mix of sales channels. But, the branch has to reinvent itself and should face the requirements of digitization. It is also advisable to question outdated sales structures and, if necessary, to abandon them. But this involves both personnel and organizational changes. In addition, banks have to transform into an agile, customer-oriented, fast and innovative organization in order to be able to develop new ideas. Often, trial-and-error approaches are not common banking practices. Banks therefore need cooperation partners, such as fintech platforms, for which they have to adapt and open up their processes to work with them together. There are countless opportunities for banks to work with fintech platforms (e.g. creating new products for a new generation of consumers or developing scalable business models), which banks implement either alone or together with several banks. While it is better for banks to work alone with the respective fintech for new digital front-end solutions in order to generate competitive advantages, new platforms for e.g. lending partnerships between several banks and fintech platforms, which massively increases customer acceptance.
Crypto comes into play
Banks are now embracing cryptocurrency – setting up trading desks and have launched research arms to follow the markets. Asset management companies, and other traditional finance companies such as pension funds, are also looking into how to incorporate crypto into their business.
The problem is that they are now considered to be behind the curve when it comes to crypto. Fintech firms are leading in this effort and control all the major exchanges, DeFi exchanges, and in bringing crypto into the real world through on and off ramp solutions. Banks will have to move quicker in bringing crypto into their business if they want to continue to stay relevant in their customers’ lives.
Conclusion
As stated in the present opinion, digitization has already arrived in the banking sector and offers tremendous new business opportunities and new usage options. But digitization is also intensifying competition, as fintech platforms are increasingly entering the market with innovative digital business models and are transforming the banking sector in the long term.
This op-ed compares banks and fintech business models and derives advantages and disadvantages for each. It is important for banks to understand that business models are only successful if they satisfy demanding customer needs and have an attractive offer. They therefore have to rethink their business model and, among other things, build a modern IT infrastructure.
This allows them to automate their internal processes, outsource support processes to third parties and digitize the customer interface, e.g. through internet banking or personal finance tools. In addition, banks should integrate the existing sales channels and implement an omnichannel approach. Through cooperation with fintech platforms, banks can e.g. increase their customer experience. This also has advantages for fintech platforms, because banks contribute their knowledge (e.g. financial know-how) and their banking license.
To summarize, an alliance between banks and fintech offers advantages for both parties: Banks combine their well-known attributes of security and data security for the customer with the ‘shopping experience’ that is being developed by fintech platforms.
With all the measures/changes, banks must remember that these take place during ongoing business. A system can therefore not simply be shut down and replaced, but old and new systems should run in parallel until the new systems are stable and secure. It can be assumed that there will still be banks in the future. However, digitization will lead to far-reaching changes that can already be observed today. Crypto is also changing the game, forcing banks to completely reconsider their business models, or face the problem of losing a new generation of consumers.
The classic bank is therefore required to reinvent itself. And cryptocurrency will play a leading role in this transformation of the traditional financing system, where we will see a hybrid of decentralized finance and centralized finance merging.
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