The financial services' ecosystem is changing rapidly.
A collaborative multi-year study by the World Economic Forum and Deloitte looks at how these changes are manifesting, and the implications for Incumbents, FinTechs, and Regulators.
In just a few short years, FinTech companies have defined the direction, shape, and pace of change across almost every financial services subsector. Customers now expect seamless digital onboarding, rapid loan approvals, and free person-to-person payments — all innovations that FinTechs made popular. Although not yet dominant in the industry, FinTechs have succeeded as both standalone businesses and vital links in the financial services value chain. They have laid the foundation for future disruption.
FinTechs represent a great opportunity for smart incumbents. They provide a chance to see which new offerings show promise. The FinTech ecosystem is also a veritable supermarket of capabilities, allowing incumbents to rapidly deploy new offerings via acquisitions and partnerships.
However, accelerating change could be a serious threat. It means that an incumbent's success is predicated on business model agility and the ability to rapidly deploy partnerships. Neither of these is a mainstay of established financial institutions. What's more, upstart firms can shop the FinTech landscape too - and they face significantly lower barriers to entry.
Since 2014, Deloitte has partnered with the World Economic Forum (the Forum) to study disruptive innovation in financial services (the Study). Bob Contri, Deloitte's Global Leader of Financial Services, sat on the Steering Committee and Rob Galaski, Deloitte leader for The Forum Future of FSI, formed a part of the working group. The most recent publication of the Study in August 2017 distilled eight insightful disruptive forces that have the potential to shift the landscape of financial services.
Recognised as the world's premier financial hub, the Cayman Islands has a unique blend of international institutional and local retail services. As such, these forces affect the jurisdiction as a whole and its many independent financial service providers uniquely and likely on slightly different timeframes than the rest of the world. These forces and their implications are touched on briefly here.
DISRUPTIVE FORCE #1: COST COMMODITISATION
Facing enormous pressure to reduce their cost base, incumbent financial institutions are embracing new technologies, as well as working with long-time competitors and new entrants alike, to commodify cost drivers that do not provide competitive differentiation. One approach is to create a new utility that standardises processes and avoids duplication of work among the companies it serves. Other approaches include expanding the range of outsourced activities and increasing automation to streamline processes such as loan origination, audit compliance, and account reconciliation.
In digital banking, banks are increasingly working in concert with regulators to set up trials of utilities focusing on mission-critical but non-core tasks such as KYC (Know Your Customer) and AML (Anti-Money Laundering).
For example, the Monetary Authority of Singapore is working with several banks to build a national KYC utility, which will reduce duplication and lower costs for all financial institutions operating in the jurisdiction. At the time of writing, Cayman clearing banks are collaborating to establish an electronic automated clearinghouse that will reduce local transaction times and related costs.
As a result of Cost Commoditisation, the financial services value chain will flatten and firms will step up their protection of user data as they share more information with external organisations. Incumbent firms will be freed (or forced) to focus on differentiating their customer-facing processes as their middle and back offices become indistinguishable from those of competitors. Regulators will stay busy tracking utilities and business service providers for potential risk.
DISRUPTIVE FORCE #2: PROFIT REDISTRIBUTION
Technology is shaking up the financial services value chain. Investment firms are using exchange-traded funds (ETFs) to entice customers away from savings deposits. Online sellers are accepting payments via web applications, leading to the dominance of online, cashless solutions for transactions and precluding the need for a traditional merchant bank account. Incumbent institutions are pairing with startups in ways that put them in competition with their traditional partners. The result of all this activity? An industry-wide redistribution of profits.
Intermediaries will feel the pinch from both sides. As technology reduces the cost of bypassing them to reach the end customer, intermediaries will need to find other opportunities to profitably add value.
Meanwhile, FinTech companies will gain an expanding pool of potential partners that offer scale and customer reach. Up-and-coming technologies will encourage both incumbents and FinTechs to bypass traditional value chains, creating vigorous competition for both adjacent and new areas of profit.
Insurers and reinsurers increasingly partner with outside organisations (such as insurtech and large technology firms) to acquire expertise and hedge against disruption. At least one large reinsurer is partnering with product start-ups – including Bought By Many and Trōv – to directly compete with its traditional insurance partners.
The challenge for regulators will be to understand how shifting fortunes are reshaping the value chain, with long-regulated companies giving ground to new ones.
DISRUPTIVE FORCE #3: EXPERIENCE OWNERSHIP
The rise of distribution platforms allows product distributors to leverage control of their customer experience and place pressure on manufacturers. This means incumbents can no longer rely on controlling both product manufacturing and distribution. Power will transfer to the owner of the customer experience. Pure manufacturers must therefore become hyper-scaled, or hyper-focused.
Current examples offer an early glimpse of this post-integrated world. Customers buy ETFs from a wide range of companies that offer robo-advisory services. They download apps from providers that stringently control which products to display. If trends like these take hold, customers will interact with increasingly fewer distributors as the market consolidates. Large technology firms and incumbent financial institutions have the advantage, the former due to their rich customer data and the latter because of their brand and existing customer base.
DISRUPTIVE FORCE #4: PLATFORMS RISING
In close tandem with the force of Experience Ownership, customers are demanding more choices in financial services—and, increasingly, they expect one-stop shopping. True to capitalist principles, this provides opportunities, and the shift to multiple-provider platforms as a channel to distribute and trade is gradually emerging across geographies and throughout a wide range of financial products.
The Study predicts that platforms offering the ability to engage with different financial institutions from a single channel will become the dominant model for the delivery of financial services. Business and retail customers, for example, will be able to purchase credit and asset management services from an online storefront of competing vendors. Buyers and sellers in the capital markets will be matched through platforms that accommodate a wide range of trades.
This trends toward fewer, bigger winners in the long term. Platforms will offer customers far more choice around what they are buying, significantly increasing the advantage for the best products, which might otherwise have limited reach. We expect first movers to take the early advantage, and are watching with interest to see how adoption plays out on the Cayman economy among banks, insurers, fund administrators and other financial service players.
DISRUPTIVE FORCE #5: DATA MONETISATION
Financial institutions know a lot about their customers. However, when it comes to monetising this knowledge — or, more precisely, the data beneath it — technology companies have the lead. The reason? They've moved beyond static datasets to combine rich, differentiated data from multiple sources - and they use it in real time.
The potential of this approach is not lost on the financial services industry. Facing a future where data is increasingly important, firms are starting to collect it in flows rather than in snapshots - for instance Visa Mobile Location Confirmation, which is optional and offered through participating financial institutions' mobile banking apps, uses real-time mobile geo-location information as an addition to Visa's predictive fraud analytics.
Firms are also looking to expand their customer datasets using a more engaging digital experience as a platform, or teaming up with other companies, offering customers additional value as a market differentiator in exchange for their data.
Naturally, ownership and control of data are a key issue for all stakeholders. Data security will be crucial to establishing and maintaining customer trust. New partnerships will be evaluated for the data they can provide. Incumbent institutions will have to decide whether it is worth keeping data in legacy systems as opposed to new systems where it can be easier and possibly safer to maintain. As for regulators, the concerns will include not only hacking, but also the ways banks use the additional data and how well customers understand the implications of sharing it.
DISRUPTIVE FORCE #6: BIONIC WORKFORCE
Artificial intelligence (AI) isn't coming. It's already here, and it's not simply a smart chatbot. People are working alongside AI to boost their efforts, greatly reducing the time and personnel required to complete major projects that involve well-defined, repetitive tasks. Don't read that to mean simple tasks only. Machine intelligence firm Ayasdi worked with a major bank to improve its stress testing, from a nine-month process requiring hundreds of employees to a three-month process using less than 100 specialists. AI is a scalable product that is becoming commercially viable for smaller institutions as it matures. Going forward, AI risk management will become an industry-wide priority. For regulators, AI will require new strategies, including ones for enforcement and punishment of non-compliant actions. The intersection of AI and human resources has been the subject of much discussion, but so far, the debate has raised more questions than answers. One clear take away: AI will remove friction from front and back office processes, sending people into roles that emphasise innovation, engagement, and emotional intelligence.
DISRUPTIVE FORCE #7: SYSTEMICALLY IMPORTANT TECHS
Financial institutions increasingly resemble, and are dependent on, large tech firms to acquire critical infrastructure and differentiating technologies. For example, Amazon Web Services (AWS) is forming the backbone of the financial services ecosystem, with a diverse set of firms – from JP Morgan to start-ups such as Xignite – adopting AWS for data storage and processing.
Financial institutions have also used the example of large techs successfully unlocking data and revenues from customer platforms to guide and shape their own efforts. JP Morgan is investing in the collection and analysis of its customers' data with a new customer management and analytics tool, enabling cross-selling – "a little bit like how Amazon suggests what you might like to buy next."
So far, major technology companies have shown little interest in offering financial services. However, the implication is that financial services faces a balancing act: On one hand, they risk becoming dependent on large techs, but on the other, they risk falling behind their competitors. To avoid either outcome, financial institutions will need to find ways to partner with technology companies and potentially each other without losing their core value proposition, and accept some loss of control over their costs and data. They'll also have to compete with large techs for talent, forcing them to redefine their talent model. Regulators will have to figure out how to treat large techs under a traditional regulatory framework.
DISRUPTIVE FORCE #8: FINANCIAL REGIONALISATION
Differing regulatory priorities, technological capabilities and customer conditions are challenging the narrative of increasing financial globalisation.
In Europe, for instance, regulations to bolster data transparency and consumer protection is driving the development of platform ecosystems and putting pressure on incumbents. In China, the popularity of mobile solutions – combined with an absence of major consumer-focused bank offerings and a largely innovation-friendly regulator – has left significant market share in the hands of large technology companies.
In the United States, unclear regulatory direction plus a mature financial services industry means that any change is likely to be incremental. The US Automated Clearing House Network, for example, is moving to same-day payments, but progress remains slow compared to other countries (such as the United Kingdom, which adopted real-time payments over a decade ago).
Under these conditions, regional FinTech hubs could crop up, creating breeding grounds for companies with geographic-specific offerings. For incumbent firms, even global ones, financial regionalisation will mean cultivating locally competitive advantages and integrating with local economies. FinTech companies may prove eager partners as they seek opportunities to scale and enter new markets. For their part, FinTechs will be challenged to establish themselves in multiple jurisdictions, despite the potential of technology to lower barriers to entry.
In a climate of regulatory uncertainty, financial institutions will have to develop an ability to swiftly adapt to large-scale regulatory changes as well as to regionally disparate regulatory treatment of emerging market infrastructure technologies.
As large incumbents push for global convergence and their smaller rivals campaign for localised regulations, regulators will have to find the right balance for their jurisdictions.
In conclusion, disruption has become the norm in a traditionally stable industry. For incumbents to face the mire of competition and rapid change, some helpful themes have emerged:
Proactively seek change. This includes finding ways to innovate and create different value, especially as intermediaries lose their customary place in the value chain. A sense of urgency must be present at the top of the organisation.
Prepare to be agile. Regulatory jurisdictions are moving apart, and technology is upending processes in both front and back offices. In some cases, the only way forward may be with a partner, requiring firms to develop skills in managing peer-to-peer business relationships.
Choose a strategy and pursue it aggressively. Institutions may not be able to own both product manufacturing and product distribution. Rich datasets will be required to stand out either way – and there will be fewer, bigger wins.
This article is adapted from the World Economic Forum report, Beyond FinTech: A pragmatic assessment of disruptive potential in financial services and the Deloitte publication, Beyond FinTech: Eight forces that are shifting the competitive landscape, available for download at www.deloitte.com.
ABOUT THE AUTHOR
Tristan Relly is a Director in the Financial Advisory team at Deloitte with over seventeen years' experience in business analytics, business modelling, strategy, liquidations, and financial and forensic audits. Tristan has provided a leadership role on a number of significant projects across the financial services industry for both mid-size and large financial institutions domiciled in the Cayman Islands and internationally. Tristan is regarded as an innovative and versatile leader in the Deloitte team. Deloitte in the Cayman Island boasts a Technology Consulting squad of over 18 specialists.
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