Innovation and transformation in banking

Fintech has undoubtedly transformed the customer experience – for the better – over the past 10 years or so. Thanks to its advances, we can complete a whole range of banking tasks online, from checking our account balances to making payments, in a matter of seconds.

Some of the key technologies behind this digital revolution have been generative artificial intelligence (AI), mobile banking and digital wallets. But further exciting developments are likely to shape the future of the financial services sector.

One of the most significant of these in recent times has been the rise of AI-powered advanced predictive analytics. This technology is helping millions of customers to access affordable finance and manage their money better. Banks worldwide are planning to spend an extra $31bn (£25bn) on AI embedded in existing systems by 2025, according to Jones Lang LaSalle’s 2023 Banking and Finance Outlook report. 

“AI is game-changing in enabling banks to improve lending inclusivity, arm their customers with precise spending insights and build hyper-personalised money management tools,” says George Dunning, co-founder and COO of Bud Financial. “By using real-time analysis and insights from transaction AI across their entire portfolio, banks and other financial institutions can better understand their customers and serve them accurately and immediately.”

Taking generative AI a step further, virtual assistants and chatbots are being used across the sector to answer customers’ queries around the clock. The technology is also being used to pre-empt the impact of inflation on customers and equip them to budget more effectively. 

It’s making life easier for lenders too, aiding processes ranging from income verification and affordability assessments to the provision of support for struggling borrowers. When combined with open banking, AI models can examine an applicant’s financial history by looking at much broader data sets than those used by most traditional credit-scoring algorithms, meaning that lending decisions are based on richer information. In this way, many customers who couldn’t previously obtain bank loans because lenders only had data from credit reference agencies to go on – part-time workers in the gig economy, for instance – have been granted access to affordable finance.

Financial management tools

Banks have been offering customers ever more control over their financial affairs in recent years through the provision of self-service tools such as saving pots and in-app budgeting functionality. 

“Consumers always want to feel that their bank has their back, but that’s especially true during times of economic uncertainty,” says John Goodale, executive director of operations at Ubiquity in EMEA. “To build trust and loyalty among them, an increasing number of banks and fintechs are providing resources such as personal finance management tools that offer their customers a more holistic view so that they can make smarter financial decisions.”

In addition, digital wallets and ecards have simplified the payment process and rendered it frictionless. Meanwhile, apps are enabling users to complete a whole host of transactions on their smartphones, including ordering and activating physical and virtual cards, transferring money and viewing transactions in real time. 

The rise of embedded finance and open application programming interfaces has also been a game-changer. This has enabled many non-financial businesses to offer financial products via smartphone apps – for instance, a taxi-booking app that also allows the user to pay for that service.

All these technologies must be fed with sufficient volumes of high-quality data if they’re to work effectively, of course. By scrutinising material extracted from all parts of the payment process, AI can suggest what customers will want, enabling finance providers to build their offerings around those requirements.

“Consumers are becoming more willing to share their data as they see the benefits of their overall payment experience,” notes Mike Peplow, CEO of Paynetics UK. “This has meant that there’s more data enabling businesses to deliver a hyper-personalised and enriched payment experience for each customer.”

While all these data-driven advances have the potential to take the financial services sector to a new level, Amit Dua, president at SunTec Business Solutions, does suggest another key task that banks would be well advised to focus on next.   

“Using technology to address consumers’ needs and preferences”, he says, “will be crucial to ensuring their continued loyalty. For banks to remain relevant in the long run, they must also start thinking about unifying the customer journey across the physical and digital channels.”

It’s difficult to gauge the health of the banking sector as a whole. On the one hand, the failure of Silicon Valley Bank and near collapse of Credit Suisse have sent tremors through the industry. On the other, UK banks have profited handsomely on the back of rising interest rates.

But the increasing cost of borrowing represents a double-edged sword. Even as its Q1 figures surpassed analysts’ predictions, Lloyds recently warned of stresses ahead. The bank predicts a significant growth in the number of customers defaulting on their loan repayments.

Against this uncertain backdrop, it may not seem like the most opportune moment to consider significant investments in new technology. But some experts believe that this is exactly what banks should be doing.

“Any good financial institution is taking advantage of the economic downturn by performing two important activities: creating products that serve customers better and seeking opportunities to improve operational efficiency,” argues Andrea de Gottardo, CEO of digital bank Kroo.

The rationale here is that, in straitened times, banks need to be fitter and more agile than ever. The right tech, carefully implemented, can improve their efficiency, reduce their costs and help them to stay profitable even if their revenues decline.

The challenge of legacy technology

Achieving that goal that is nowhere near as simple as it sounds, of course. Traditional banks often struggle to make the best use of new tech. For instance, 38% of banking transformation leaders surveyed by EY at the start of this year reported that their companies’ digital transformations had failed to deliver the benefits expected of them.

The emergence of digital-first challenger banks and the fintech sector over the past decade forced them to modernise customer-facing services and embrace a world of apps, open banking and digital customer experiences. But in many cases their internal systems remain relics of a pre-internet age.

Igor Pejic, author of Big Tech in Finance (Kogan Page, 2023), is an experienced senior manager at one of the largest banking groups in Europe. He compares the task of upgrading these core systems to “swapping a jet engine while 10,000ft above the ground”. 

He continues: “Starting in the mid-20th century, banks were among the first to invest in computers and build overarching and highly specific computing infrastructure. These systems are at the very core of their business and have thus been tricky to upgrade, let alone exchange.”

Professor Lily Fang is dean of research and Axa chair in financial market risk at Insead business school. She points out that some bank software is still based on systems that were developed 50 to 60 years ago. And that isn’t the only obstacle.

“Banks are heavily regulated, so any system upgrades need to be very carefully thought out,” Fang observes.

For some financial institutions, there may be further complexities to deal with, such as mergers and the existence of localised and fragmented IT decision-making. These factors have left many large players with divergent and overly complex back-end infrastructure.

Creating efficiency

While all this shows the scale of the challenge facing banks that want to modernise their systems, it also hints at the potential rewards. If they could replace their legacy tech, that should vastly improve the efficiency of their processes. A digital transformation has the power to automate numerous basic tasks, accelerate the gathering and analysis of data and enable people to focus on more value-adding work.

Some progress has been made in recent years, often by banks working with (or buying out) fintech firms and absorbing their technology. Pejic talks in particular about the adoption of application programming interfaces (APIs) and microservices, which allow one application to access another’s functionality.

APIs enable internal systems to speak to each other, letting disparate applications share data. This is incredibly useful, which is why every bank will be deploying them to some extent.

The promise of emerging technologies 

The ability to extract value from data will be key to the sector’s further digital transformation.  With more integrated systems, the use of data-gathering and analytics tools can grant a bank a competitive edge – if it can use them well.

After that, numerous emerging technologies show considerable promise, according to Pejic.

“I see the most potential in centralised blockchain and artificial intelligence,” he says. “Both are ground-breaking general-purpose technologies that will improve and automate processes across the organisation.”

AI can enhance the efficiency of software development, as well as automating processes ranging from conducting credit checks to answering customer queries. Centralised blockchains, meanwhile, remove the middleman from digital transactions, increasing efficiency and slashing costs in areas such as payments and settlements.

Integration or bust

Replacing or upgrading internal systems will succeed only as part of a carefully planned transformation strategy, says Fang, who stresses that none of this work should be done in silos.

“These cannot be isolated pieces, as they all need to fit together and be well integrated,” she says. “The software and hardware capabilities are all parts of the overall system – and they need to operate as such.”

A digital transformation requires strong leadership, meticulous planning and full commitment from all involved if it’s to deliver all that’s expected of it, then. It also needs significant investment. A bank may be understandably reluctant to dedicate all these resources in uncertain times, but the ROI for properly replacing legacy systems could be immense.

The banking sector has changed beyond recognition over the past decade. Driven by consumers’ ever-increasing demand for online services, its traditional high-street players have been forced to adopt an omnichannel approach with technology at its heart. Yet they have been slow on the uptake compared with neobanks and other fintech businesses, which have seized the opportunity to win a new generation of digital-native customers. 

The big beasts of banking were initially reluctant to engage with these disruptive newcomers. This was perfectly understandable, given that several startups had arrived on the scene fully formed as challengers to their dominance. But, acknowledging their relative lack of technological know-how, they have since adopted the ‘if you can’t beat ’em, join ’em’ approach, forming partnerships to provide their own digital offerings. Several have used money services provider Wise to offer non-core services such as foreign exchange, for instance.

At the same time, fintech companies have moved into the traditional banking space. This trend has been accelerated by the increasing use of apps and other open banking services. Even before the Covid pandemic, 64% of consumers worldwide were using fintech applications, according to a survey published in EY’s Global FinTech Adoption Index 2019.

“There are enormous benefits arising on both sides from collaborations between traditional banks and fintechs,” observes Henning Holter, business development director at Star. “Fintechs can lean on the trust and experience of established banks, while banks can use the technology to improve and accelerate the delivery of their services.”

The biggest hurdle that banks face in making the most of this tech is the task of adopting the new culture and skills required to give their customers the best possible digital user experience. But they can overcome this by harnessing fintech expertise and thereby providing end users with the high-quality digital solutions they’ve come to expect.

The other advantage of using fintech firms is that their systems are easier to integrate than traditional software, which has often proved cumbersome. This has enabled banks to pick and choose the most suitable tech to support various processes. For instance, credit decisioning and card issuing can reside in the cloud and doesn’t have to be built into their systems.

“The biggest challenge for traditional banks over the next 10 years is to achieve an effective tech stack,” notes Olivier Bessi, managing director of Star’s fintech practice. “They have got disparate systems that are hard to maintain, making it more difficult and expensive for them to launch new products.”

Tapping new revenue streams

Smaller banks can also use fintech firms to build new marketplaces where they can provide a wider offering and cross-sell other services, such as insurance and investment products. As well as adding another income stream, it also enables them to compete with their larger rivals on a fairer footing.

By joining forces, the more established banks, which have typically focused on building a strong presence in their domestic markets, can also reach a wider customer base through fintech firms, many of which operate in several countries. For example, UK-based fintech Revolut has recently launched multi-currency accounts in Brazil.

“Combining the core strengths of the incumbent and the innovator in this way, banks can create an extremely compelling proposition,” Holter says. “In forming these multinational entities, there’s an opportunity to create national champions for the banking industry.”

Credit card providers are also starting to benefit from the power of fintech. Mastercard, for instance, recently signed up six fintech firms to its Start Path Digital Assets programme to develop innovative solutions such as cryptocurrency wallets using blockchain technology.

Despite all the potential benefits, a big concern remains as to how banks can maintain trust and security as they innovate apace. While customers want the convenience of accessing their bank accounts wherever and whenever they please, many are worried about how secure the technology is and how their personal data is being used. But, rather than making processes less secure, the most efficient tech can actually be an enabler because of the seamless way in which it works. It can also be used to monitor transactions for potential cases of fraud.

On the other side, a big problem for neobanks has been securing banking licences and adhering to the many and varied regulations governing the industry. That’s where traditional banks can help, because risk management and compliance is embedded in their culture.

“It’s a matter of striking the right balance between the two,” Holter says. “The fintechs can continue to provide the excellent user experience, while the banks bring the skills and expertise needed to navigate large amounts of often complex regulation.”

Banks might not seem like the most obvious of ecological superheroes, but they could be. Beyond governments, few institutions have as much clout as those behind the world’s financial systems to power initiatives promising environmental benefits.

Banks can wield great authority at both ends of the financial pipeline. They control huge outflows of capital, with their loans and investments capable of making a huge difference to projects with environmental goals. They also have huge numbers of customers – almost all adults in the developed world have a bank account. That gives banks a potentially unique role in encouraging responsible spending. In this respect, they can be important educators and influencers. 

Banks therefore have a key part to play in the environmental, social and corporate governance (ESG) arena, and could even help to save the planet. The question is, will they rise to the challenge?

Compliance and customer demand

The short answer is that they must. Banks have as much to gain from a healthy planet and a cohesive society as any other entity.

But there are other motivations. Compliance is one, as industry regulators set ever more stringent ESG targets. Customer demand is another.

“This is a matter of survival, transparency and relevance,” says Mathias Wikström, co-founder and CEO of Doconomy, a provider of climate impact tools for consumers and businesses. “A bank can address the responsibilities that come with the climate crisis and the societal divide as opportunities. In doing so, it can change itself from a commoditised platform for transactions to a relationship hub.”

In other words, the ever-increasing importance of ESG is giving the sector a chance to fulfil a new and more engaging role, especially in the eyes of younger, greener consumers.

This is an opportunity it can’t afford to miss. In one recent study of UK consumers, 67% of respondents said that they wanted their banks to become more sustainable. 

There are both reputational and financial rewards to be gained by doing so. The provision of so-called green finance appears to be a future-proof new line of business, notes Dr Mansoor Soomro, senior lecturer in sustainability and international business at Teesside University.  

“In terms of opportunities, institutions that offer green finance can benefit from a sustainable revenue stream, all while fulfilling their ESG objectives,” he says.

How banks are stepping up

There’s plenty of evidence to suggest that banks are becoming increasingly aware of ESG-related responsibilities and rewards. In 2021 a group of global banks formed the Net-Zero Banking Alliance, a pact to align their strategies with UN net-zero targets.

The alliance represents 40% of the world’s banking assets, but even outside it many financial institutions are prioritising ESG-related goals. 

In some ways, banks are in a unique position to implement impactful ESG strategies. They already operate in a heavily regulated market and are therefore accustomed to implementing new processes to meet legislators’ demands. The sector’s intense focus on anti-money-laundering and know-your-customer regulations is a recent case in point. 

Similarly, the industry’s established players have spent considerable time, effort and money over the past few years on digitalisation in response to the new generation of disruptive challenger banks.

Driven by increasing competition, banks have become familiar with agile innovation, especially when applied to the collection and analysis of data.

Technology is the key to ESG

But there is more for them to do – and strong leadership is required. Banks need to create ESG strategies that both span their own operations and support their customers’ decarbonisation efforts.

They must set ambitious goals and map out how to reach them. They must also invest in the technology and expertise that will get them there. 

David Lais is the co-founder and chief product officer of ecolytiq, a company that provides digital infrastructure for green finance. He predicts that climate tech will “play a very important role in the coming years. This will require banks to have a strategic rethink to understand how to use these technologies, not only to facilitate the goals of net zero and create technological efficiencies, but to also add value to their customers.”

That technology will be multifaceted. Depending on the strategy, it might equip banks to offer customers environmental footprinting, ESG investment opportunities and impact offsetting plans. It should help banks to refine their own approaches to investment.

It will do it all by gathering data and measuring it against ESG benchmarks.

Wikström says: “With comparable data and continuous improvements, the trinity of data, tech and behavioural science can be a solid handrail for the implementation process.” 

None of this is easy and there is no time to lose. Banks need to act now and understand that any unsupported sustainability claims will be exposed as greenwashing. Their ESG strategies need to be serious, accountable and transparent.

If these are, banks will be rewarded with regulator approval, customer loyalty and new revenue streams. 

“Banks have successfully digitised banking in the past decade, benefiting millions of customers around the world,” Lais says. “The next decade should be dedicated to making banking sustainable.”