As a resurgent world economy lifts itself into a new dawn of 2023, it is pertinent to note that we are almost three years into the pandemic and emerging from the longest period of flux in this century. Financial institutions of all shapes and sizes are rubbing their eyes and staring at a new year that is full of potential but, at the same time, presenting a challenging environment never seen before.

Expect financial institutions to be busy dealing with the following areas:

The continuous disruption in the operating environment is expected to intensify and keep all functions busy. Growth in P2P payments, BNPL, the rise of the digital native customers, and evolving digital transformation means the banking industry, along with Fintechs, is going to be in a permanent state of disruption. Disrupting the disruptors of the previous years is likely to be the primordial theme.

The world is now reeling from two major shocks – the COVID pandemic and the Russian invasion of Ukraine with the accompanying economic devastation. The financial crisis has reduced global economic resilience while increasing social concerns where governments and societies struggle to cope with these challenges.

The specter of a rapid global contagion through increasingly connected systems and the threat of disastrous impacts have now repeatedly come true. Banks have no choice but to keep an eye on the next big event – even a climate change-related event cannot be ruled out. Black Swan events are now more prominent and part of our daily existence than what was thought before.

Growing perceptions of economic disparity and failures in healthcare and climate change – both influence the ability of the financial services industry to manage other risks and inhibit their capacity to exploit the opportunities that the new digital reality is throwing up. As the effects of the pandemic settle down, the financial services industry finds itself defined by a 21st-century paradox: as the world grows together with digital, it is also growing apart.

The march of digitalization has opened a new front for sustained economic growth. It has shrunk and reshaped the world, making it far more interconnected and interdependent. However, it has made it immensely more challenging to manage the perceptions of society and consumers. As the adage goes – perceptions often become a reality, and perceptions cannot be managed with just hard numbers.

The Great Resignation of 2022 has shaken the financial services industry to the core. What started off as the convenience of working from home and operating flexibility has now turned into a mass seismic shift in the operating rhythm of the industry. Even the looming threat of an impending recession is not making any dent in the bargaining power of the workers.

A key leverage point for employees is that the interactions with customers and their employers are on digital channels. This leads to additional considerations to be managed and poses an added challenge for employees to feel a sense of lack of ownership – with high dependence on technology tools. As more and more seasoned bankers ride into the sunset, the inevitable trade-off between investment in automation versus investment in developing people becomes a prominent bone of contention.

The entire ecosystem of digital operations and online interactions means that banks are reliant on accelerated delivery of services, where the ripple effects from the speed of transactions, payment, and settlement are of paramount importance.

The top metrics in this area are:

• Reliability
• Agility
• Scalability

All this means it is back to the basics of Asset Liability Management and Loans vs. Deposits balancing acts. Since 2008, most banks have been engaged in building fortress balance sheets. However, the continual demand for a rapidly evolving transformation brings to the fore the importance of skillful balance sheet management.

The degree to which the financial services industry has changed in the last three years is off the scale. We have witnessed the arrival of cryptocurrencies, digital technologies, business models, and forms of transactions, all within an environment of global economic upheavals and increasingly comprehensive regulation.

The most significant change has been the arrival of well-funded new players, fintech, and neo-banks that bring a groundswell of innovation and are turning market models on their heads. The financial services industry has entered a new phase in the evolution of rapidly disruptive products like cryptocurrencies which threaten to shake the foundations of banking and financial services.

As banks face unprecedented pressures from a combination of tough economic conditions and pervasive consumer behavior, we are seeing the emergence of a new paradigm of fintech and digital banks. Banks have seen a bigger impact from fintech and neobanks, who have indulged in a culture of ‘race to be a unicorn’ with scant regard to building a sustainably profitable business generating continuous revenues.

This runs contrary to the bulwark of the banking system – stable, sustainable, and profitable growth at minimal risk. Banks will continue to see many of their business models crumbling but also see many new areas of opportunity emerging. It will be critical for banks to keep their focus and stick to their core competencies.

To have a meaningful effect across the customer base, banks and processors must adapt their processing infrastructure to cater to the demands of online commerce as well as traditional channels. The underlying platforms become a significant factor in the profitability of operations. The rise of digital commerce is shifting the focus from a commoditized base to one that is weighed more heavily toward resiliency, scalability, and performance.

That being said, ultimately, IT and technology management have to be designed to support business functions. The primary perspective of the effect of technology within the rapidly evolving space is reliant on its ability to influence key business metrics.

The key metrics continue to be:

• Cost
• Transaction risk (security, resiliency, etc.)
• Agility
• Customer satisfaction

Despite banks’ efforts to improve their customer relationships via digital channels over the last couple of years, overall satisfaction levels have remained almost unchanged or even gotten worse. Satisfaction levels among customers of large banks were under significant strain due to the onset of fintech offering social media-like customer experiences.

Customers have been quite receptive to new services that encouraged loyalty and personalization. However, customers have seen little change in their banks’ management of their data and improvement in their customer experience cycle. Historically, there has been strong customer inertia in retail banking, with many remaining loyal for lengthy periods even though they might not be completely satisfied.

As banks respond to the environment by changing their services and prices and migrating more of their offerings to digital channels, consumers will force financial institutions to revamp the way structure of the data fabric. As the traditional sources of revenue come under pressure, the ability to pull the levers of revenue generation will be hampered if banks do not manage to get the best out of the vast mass of data that is now available to them.

Digitalization has come in overwhelming waves, driven by the growth of e-commerce – first in the B2C and now the B2B space – and the proliferation of mobile apps and cryptocurrencies. With it has come continuous innovation to meet the demand for technologies that drive efficiency, lower transaction costs, and boost convenience.

Innovative and nimble new players – fintech and digital ecosystems – have entered the payments and lending arena, creating increased competition for already-pressured banks. But without access to a profitable client base, the expertise to navigate the regulations and licensing of the finance industry, client confidence, and robust global infrastructure, these new entrants are now finding that their business models can only go so far on their own. Fintechs are suddenly finding their ‘cash burn’ strategies to garner market share, leading to a ‘scorched earth’ marketplace.

It is in this area that banks have an edge – managing risk effectively. The overwhelming deluge of macroeconomic pressures means that a bulk of 2023 will be spent on risk management, which is aligned with all the other areas mentioned here.

With a scorching inflation rate burning a hole for customers, banks will continue to see a steady draining of deposits and balances in accounts. This means the traditional source of low-cost funds is going to recede – making it tougher for banks to manage the squeeze of seeking alternate sources of funding for loans.

The rise in credit card receivables to over a trillion dollars is a clear sign of stressed customers. Less available cash in the bank will lead to a spiral of less spend, less borrowing by ‘good’ customers due to high-interest rates, and less creditworthy customers getting more leveraged on debt.

Disruption in the industry will continue, with ongoing innovation shaping customer behaviors, business models, and the structure of the industry. The time has come for a shift in mindset from one of innovation as a standalone function to that of collaboration across all functions.

By exploring strategic partnerships for digital lending, legacy bank providers and new innovators can together create a business model for long-term success and revolutionize the credit market and widen the digital financial sector for the benefit of all. Going forward, the distinction between the laggards and innovators will be more obvious. Financial institutions will have to create a fuller, more customer-driven digital experience and, in doing so, may well alter the role of primary account providers.

The sudden fall in customer demand and lack of trust in fintech may enable traditional banks to excel in creating digital customer experiences to assume control of the customer relationship while fintech facilitates the plumbing for front-end interactions.

Clearly, after the pandemic, regulators are now driven by the philosophy that ‘smooth user experience’ and ‘safety and security’ are not mutually exclusive. In fact, they must go hand in hand as the ‘digital native’ customers expect nothing less than utmost safety combined with a ‘social media’ like user experience. Mobile wallets and other digital service providers have made enormous progress in access to finance, particularly through a slew of new start-ups.

They have been fairly successful in exploiting the gaps in legacy systems and establishing traditional financial institutions. However, as these newer players drive increased adoption of digital financial services (including but not limited to online credit), the regulators are upping their investments in digital platforms and data infrastructure and ensuring services are affordable and secure.

Latest trends show that legal and regulatory changes will endeavor to catch up with the rapid growth of digital channels, where an increasing number of access points to digital financial services will facilitate faster growth of online commerce.

– by Sriram Natarajan
President
Quinte Financial Technologies