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‘THE RISE OF THE DIGITAL-ONLY BANK’ A CHALLENGE OR AN OPPORTUNITY FOR EXISTING BANKS?

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‘The rise of the digital-only bank’ A challenge or an opportunity for existing banks? 3

CONTENTS:

pg 04: Introductionpg 07: What is a ‘digital-only’ bank?pg 10: Are consumers ready for digital-only?pg 14: What challenges does digital-only present?pg 16: How can traditional banks compete?pg 18: Conclusion: digital-centric over digital-only

In an environment of increasing reliance on consumer technology, is a move to digital-only banks the next logical step for the retail banking industry?

How willing would customers be to switch to branchless banking?

And how could traditional banks and financial institutions implement a digi-tal- only strategy without alienating their traditional customer base?

In this Pathway Paper we investigate the rise of the digital-only bank and its prospects for success in the current banking climate.

Who is this Pathway Paper for?

Senior strategic and technological decision makers in retail banking.

Key takeaways:

• An analysis of the benefits of digital-only banking - for consumers and the banks themselves

• The impact a move to digital-only could have on traditional retail banking

• Lessons early adopters can teach the industry

• The advantages traditional banks have over their digital-only competitors and how they can quickly implement digital only services

Adoption figures for mobile banking are on the rise. Consumers are demanding a seamless banking experience via their mobiles and branch visits are on the decline.

Introduction

5‘The rise of the digital-only bank’ A challenge or an opportunity for existing banks?

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71% of those whouse mobile banking sayonline or mobile bankingis sufficient for their needs1

1 Javelin Strategy & Research, Prepaid with Mobile is the Underbanked’s Killer App, August 20142 Forrester Report: Disrupting Finance: Digital Banks, June 2014

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‘The rise of the digital-only bank’ A challenge or an opportunity for existing banks? 7

At its simplest level, a digital-only bank provides end-to-end banking services primarily or entirely through digital platforms.

Primary of these platforms is mobile; according to Forrester in its 2014 report ‘Disrupting Finance: Digital Banks’, ‘Instead of mobile being a channel, mobile is the channel’2 and the ultimate aim is convenience – an alternative to branch-based banking for consumers who demand ease of use and anywhere, anytime access to a comprehensive range of banking services.

For consumers who are increasingly digital-savvy and used to the frictionless and contextual experiences provided by Amazon, Google and the social networks, digital-only banks aim to provide a similar, simplified experience, with a range of basic banking products such as current and savings accounts, combining with quick transactions, automated processes and electronic documentation.

Still in its relative infancy as a concept, contenders are beginning to emerge across the globe and they are winning small, but growing numbers of customers – customers in a desirable demographic; younger, more affluent, better educated and representing a higher potential lifetime value.

What is a ‘digital-only’ bank?

For an industry eager to tap into a rich seam of revenue opportunity it’s a compelling proposition, but it’s not just potential customer value that makes digital-only desirable from a financial stand-point; there’s also a powerful case around cost to serve.

3 Javelin Strategy and Research: Leveraging an omnichannel approach to drive $1.5bn in mobile banking cost savings 2013

Digital-only services are currently established in a number of ways:

1 As subsidiaries of existing banks – like some of the earlier direct banks, many digital-only banks are subsidiaries of existing banks

2 Independents with a banking licence – a rarer, but growing segment, these are entirely new banks, set up independently to provide digital-only services

3 Start-ups acting as a front-end to an existing bank – these operations provide a branded digital service layer for deposits held at an existing regulated bank

4 Traditional banks developing digital- only services – existing operators investing in a strategic shift towards digital

Importantly, digital-only banking does not require the heritage or infrastructure of a full bank to get off the ground. Just as we’ve seen the Internet innovators entering the banking space, tech companies can establish themselves as digital-only specialists quickly and relatively cost-effectively by leveraging existing technology and open architecture to offer streamlined banking services.

With regulators across territories lowering barriers to entry in an effort to encourage greater competition, it could be said that for the ambitious digital start-up, there’s no better time to strike.

The estimated cost per transaction to a bank is $0.10 via mobile, while a face to face transaction in branch costs an estimated $4.25 – around 40 times higher.3 Removing the branch means removing much of the overhead.

It’s also well aligned to the vision for consumer-centric, next generation banking, in which banks take the data created via mobile and social interactions and use it to provide more intelligent, real-time support and personalised offers and services. The emphasis is ‘connectivity’ - creating stronger, longer lasting relationships through continuous connection with the consumer.

For the ambitious digital start-up, there’s no better time to strike.

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For an industry eagerto tap into a rich seam of revenue opportunity it’s a compelling proposition

It costs $0.10 to serve a customer via mobile - and an estimated $4.25 to serve them in branch1

Are consumers ready for digital-only?From a world in which switching was a rare occurrence, banks now face a situation where they are unable to keep up with innovation and lose customers and market share as a result

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‘The rise of the digital-only bank’ A challenge or an opportunity for existing banks? 11

In the new banking environment, consumer demand is driving service delivery. Digital – and mobile in particular - are very much at the top of their agenda.

There’s no doubt that the market for mobile innovation is moving rapidly. At first mobile banking was a ‘nice to have’, but swiftly moved on to become a mandatory requirement for all retail banks. Now it has evolved to the point that the availability of individual mobile banking services can be the deciding factor in retaining customer loyalty.

In AlixPartners’ most recent Mobile Financial Services Tracking Study, 28% of consumers between 26 and 34 said that they would be likely to change banks to gain access to mobile photo bill pay. From a world in which switching was a rare occurrence, banks now face a situation where they are unable to keep up with innovation and lose customers and market share as a result.

The timing certainly seems right for the model to grow. In AlixPartners’ survey, mobile banking users reported visiting a branch 39% fewer times per month after adopting mobile banking services. The advent of mobile banking, like Internet banking before it, has removed much of the need for human interaction.

Services too, are evolving to fit the mobile lifestyle. Online banks have already proven that the bigger ticket items traditionally served by the branch; new accounts, mortgages, business banking, are readily available and relatively easy to arrange remotely. The more transactional counter services are also becoming commonplace; adoption of mobile remote deposit capture (RDC) is growing fast, with up to 22% of smartphone and tablet owners in the US now using the facility1, while photo upload technology and passport scanning are also becoming commonplace as part of the identity authentication process.

So was the British Bankers’ Association Chief Executive Anthony Browne right when he recently asserted: ‘Make no mistake; the branch will remain integral to banking services in the 21st Century’?2

The statistics and experience of the first digital-only players would seem to suggest, no.

But it’s important to understand the role that consumer demographics play within these startling figures. It’s no surprise that the Millennial generation is the most likely to embrace digital-only. Around 66% of Generation Y (born since the early 80s) already use mobile banking weekly or more3. Additionally, 40% see mobile banking as a must have – and these numbers are growing4.

It’s also true that digital banking adoption amongst older generations is on the rise; mobile banking amongst the over 55s is up by five per cent over the past year alone, but this still only represents around 13% of the total population in that age range - meaning a massive 87% are yet to embrace this new way of banking.

It’s clear that digital banking is very much here to stay. But will we ever see it become the only type of banking?

1 AlixPartners Mobile Financial Services Tracking Study March 20142 BBA March 2014 3,4 Novantas Bank Choice Monitor, June 20145 PWC, October 2014

But does it follow that a desire for improved digital services means we’re ready to move to digital-only?

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The advent of mobile banking, like Internet banking before it, has removed much of the need for human interaction.

67% of UK Gen Y customerssay mobile is their preferredmethod of digital banking,88% say it is online banking5

For the traditional banks who are already under pressure to improve their mobile banking services, there appears to be some breathing space before digital-only really takes hold – Forrester’s recent report; ‘Disrupting Finance: Digital Banks’ suggests that this new type of bank currently poses a low level threat to established operators.

But the success of the first digital-only banks demonstrates a growing appetite for the concept – and it’s an appetite any bank looking to the future should take seriously. A great deal has already been made of the threat of disintermediation from Google, PayPal and other Internet innovators; with this new concept coming over the hill, alongside the forthcoming XS2A legislation in Europe which will open up account access to third party providers, there’s growing pressure on incumbents to act quickly in order to protect their interests.

But it’s not just about protection – the meteoric rise of ‘cool’ and progressive digital brands is a compelling argument for traditional banks battling with a conservative image. Those who move first are likely to benefit from a boost to their brand reputation.

What challenges does digital-only present?

The experience must be seamless and pleasurable, with excellent customer service back up.

1 Accenture, The Everyday Bank, March 2014

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Service provisionDirect banks, which first launched in the late 1980s with telephone banking, proved that a remote approach could work. Their focus on ‘a different way to bank’ enticed many customers jaded with existing offerings and eager for greater convenience – and proved that arranging a mortgage or financing a new purchase no longer required a trip to the branch.

Ironically, it was some of the ‘easier’, transactional processes that caused some of the direct banks problems – and it’s a challenge that many of the more successful operators from that era still struggle with.

First Direct, for example, the UK’s first telephone bank moved latterly into Internet and mobile banking, but still offers cheque pay-in and cash withdrawal through its owner HSBC and the Post Office.

For a new service to work, all the sophistication in the world is meaningless if the basics aren’t in place – and it’s the reason the mobile banking industry has worked hard over recent months to introduce facilities such as remote deposit capture in the US.

For any traditional banks looking to introduce or move to digital-only, service provision and delivery should be the number one priority. Evidence shows that a poor digital experience is a trigger for switching – if services customers are used to suddenly become unavailable, or worse, if the process is left wanting, previously strong relationships could soon be at risk. As a result any tran-sition would have to be very carefully managed and offer benefits above and beyond existing provision.

Customer relationshipsA key lesson we can take from the direct banks is that protecting relationships with no physical presence requires work. The experience must be seamless and pleasurable, with excellent customer service back up.

It certainly seems to be an ethos that the pioneers of digital-only have taken to heart. Trust, in the digital-only world, is a valued currency, and many of the market leaders are typified by their commitment to transparency and customer interaction.

Simple in the US states; “Customer service isn’t an afterthought, it’s at the core of everything we do. Simple gives you tools to help yourself, while still making sure knowledgeable, friendly people are there to help when you need them.” Its website backs up this sentiment with an array of pictures of smiling faces from the Simple team.

There’s also a clear aim across the board to counteract the remoteness of digital- only banking by fostering a sense of belonging. Germany’s Fidor Bank encourages its 250,000 customers to share their opinions and advice on everyday finance via its online forums, while Hello Bank, SmartyPig and Moven run active social networks and enable savings contributions and payments via Facebook.

A further characteristic of digital-only banks is their emphasis on money management. Helping customers to track their spending and budget carefully is a common element of the digital-only proposition. With safe spending notifications, money management features and cashflow tools, the banks are stating clearly ‘we care’, resulting in strong relationships and brand loyalty.

TechnologyStart-ups and newer entrants to digital-only banking are better equipped to react to market need quickly and efficiently. They have the luxury of designing their infrastructures from the ground up and as a result can exemplify best practice for digital and multi-touchpoint marketing and services from the outset – building agility into their architecture to add in new services as required.

For many traditional banks wrestling with legacy architecture and bolted-on Internet and mobile banking services, a move to digital-only may appear a technological step too far.

And it’s in this regard that they must start to think laterally and look beyond their own walls.

1 2 3Should they decide to implement a digital-only strategy, the challenges are three-fold:

By 2020, more than 30

percent of banking revenues

could be at risk thanks to

new competitors and new trends1

New market entrants will continue to emerge, but despite the doubtless cost efficiencies that digital processes deliver, they face a tough challenge in reaching profitability. Direct banks, by their nature, operate on low margins and require rapid growth to remain viable; a situation which led to many more of the first direct operators failing than succeeding.

In this context, the traditional banks hold a trump card over their start-up competitors; the established relationships, brand equity and IP around corporate governance that has been built up over many years’ trading.

They are starting from a stand-point of trust with their customers, so if they can implement the digital services the consumer requires at a pace to match the market, there’s a good chance they’ll stand firm, and grow their digital customer base.

The issue lies in achieving this pace of innovation. There’s no doubt that a start-up, with the agility and digital expertise to set up in response to demand is better equipped to offer a digital-only service than an incumbent who is tied to traditional operational, technological and physical structures.

For some, acquisition is the easiest route to market. Spanish bank BBVA, which has already shown great commitment to mobile banking, recently purchased Simple and as a result can now boast a robust and successful digital-only offer within its armoury.

For others, partnerships with digital innovators and Mobile Money specialists are the most efficient way to introduce a strengthened mobile offer. By opening up their APIs and subscribing to efficient mobile services, banks are able to cost-effectively implement much of the innovation their consumers demand and meet the ‘metabolic rate’ of mobile. Digital-only in this context becomes a very viable option.

The good news for banks looking to shift to digital is that there’s plenty of help and support to enable them to do so. Fintech is at the top of many governments’ agendas, and organisations like Innovate Finance in the UK and the Open Transaction Alliance in Europe have been set up specifically to foster collaboration, facilitate dialogue and encourage innovation within the financial services sector.

In this environment, and with access to an ecosystem of Mobile Money specialists with whom to develop new services, digital-only needn’t be an insurmountable challenge.

1 ING survey July 2013

How can traditional banks compete?

The winning formulafor traditional banksit seems is a middle ground

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So should existing banks take the brave step of becoming entirely digital?

To do so would require a seismic shift in approach. It’s not just a bank’s infrastructure that would need transitioning, the bricks and mortar of its branch network would need repurposing or closing.

And this is without considering the impact on customers. It’s doubtless that a wholesale move to mobile would alienate a proportion of many banks’ existing customers; ING recently revealed an apathy towards mobile banking in a sizable section of UK consumers – 33% of those who don’t currently use mobile banking said that they made that choice because they don’t trust the security, while 37% simply didn’t have a smartphone or tablet.1 Any appetite for digital-only should always be viewed in this counter-context.

The winning formula for traditional banks it seems is a middle ground; an offering which wholly embraces digital, providing superior mobile banking to attract and retain new segments and drive unprecedented levels of Net Promoter Score, alongside streamlined and refined standard banking services to satisfy their core customer base.

Turkish bank, Yapı Kredi, recently realised the demand for a digital-only service with the launch of Nuvo, a ‘branchless banking’ service which combines transactional banking with m-commerce services, exclusive offers and loyalty benefits. Long recognised for its pioneering stance on mobile innovation, Yapı Kredi worked with Monitise to bring Nuvo to market and estimates that the new bank will reach 300,000 customers in its first year alone.

Its CIO, Cahit Erdogan, is highly aware of the generational influence on digital banking adoption. He says: “Today’s younger generation will one day become income earners. As income levels grow, consumerism of IT does too… When we first introduced Internet banking, we got 100,000 customers in three years. When we introduced mobile banking we got 100,000 customers in three months.”

Santander recently revealed that the peak time for customers using its banking app is 6.55 in the morning. There’s clearly an appetite for easy banking that complements the consumer lifestyle – and mobile so neatly fits this criteria.

The growing success of the early pioneers of digital-only banking provides proof that this new category serves a welcome purpose for a particular sector of the market – and that the removal of face-to-face banking doesn’t necessarily mean the death knell for customer relationships. By striking a balance between digital ease of use with effective human back up, these new market entrants are already gaining plaudits for their approach to customer service.

They’re beginning to disrupt the market and it’s vital that traditional banks take this threat on board.

But as the market shows, digital-only is very much a matter of taste. Yes, mobile banking and a desire for improved digital banking services are on a rapid rise, but for every digital native, there is a traditional banking customer who is quite happy with the status quo.

Digital-only then, offers a unique opportunity to the traditional banks. If they can provide a wholly-mobile service as an option to

customers, they can not only deliver the same innovation and user experience as the digital-only banks, but can also continue to service the needs of customers who prefer traditional banking. Digital- centric, rather than digital-only is the key.

Digital-centricity of course brings its own rewards. Advocacy, loyalty and brand affinity tend to be higher for digital services, while the cross-marketing opportunities afforded by digital platforms open up new revenue streams.

But to deliver on the digital promise requires agility. In order to provide the experience consumers demand, traditional banks must be in a position to launch new services quickly and efficiently. Those who are working collaboratively with digital innovators and Mobile Money specialists are typically the quickest to market with these robust and scalable new services.

Is it the case then, that banks should continue to operate their in-branch services in isolation from mobile and online banking?

The more visionary and proactive banks would suggest it isn’t a case of either/or. The most effective long term strategy, they say, lies in rationalisation; blending online, offline and digital operations in the most effective way for the customer.

Far from closing branches, some are in fact reversing the decline in high street banking by opening more outlets of a new style of ‘lite’ branch, in which face-to-face counter services take a back seat to self-serve computer terminals and personal banking advice on tap.

By evolving retail banking itself, to a point where the branch becomes a customer- service function with a focus on quality consultation and cross and up-selling other services, traditional banks may be able to transform their current fragmented service offer into a streamlined, catch-all proposition – where every customer is served in the way that suits them best, and every channel is profitable.

However the world of banking changes, one thing is clear; to dismiss the rise of the digital-only bank would be to dismiss consumer demand. There’s an inevitability to digital-centricity and the banks who jump quickest will be best placed to profit – financially and via improved customer relationships. As one of Simple Bank’s customers proclaims online; ‘I am in love with this bank!’ – and who can argue with that level of loyalty?

Conclusion: digital-centric over digital-only

1 Accenture, The Everyday Bank, March 2014

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For banks that can exploit theirdigital levers to build these newcapabilities, the rewards are immense.These banks can increase customerinteractions by up to 250 percent1

Monitise designs, develops and implements Mobile Money products for some of the world’s leading banks and financial institutions.

By simplifying the complexity of Mobile Money and providing a single point of connection to an ecosystem of technology partners, content providers and financial institutions, Monitise helps its clients to identify and maximise revenue opportunities and improve customer engagement.

Interrogate your Mobile Money strategy and explore the issues covered in this Pathway Paper via a no cost, no obligation Discovery Workshop with a Monitise product specialist.

Visit monitise.com/workshop to find out more.

Monitise Insights brings clarity to the world of Mobile Money.Opinion, insights and pragmatic guidance on the global mobile banking, payments and commerce opportunity, delivered by the Monitise experts.

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