The Transformation Imperative - Jon Davies Banking White Paper v1

Digital Bank Transformation

“Banking is at a crossroads and decisions taken today about the pace and direction of travel may

ultimately decide the future of institutions!”

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Digital Bank Transformation Whitepaper The imperative for digital transformation in banking.

“The banking industry is at a crossroads and technology is driving unprecedented change. Mobile and online in particular will completely revolutionise the banking landscape. Innovations in payments have led the way, but ultimately the entire banking value chain will be impacted. Adoption of mobile banking has shown phenomenal growth in some territories, demonstrating how new technologies can change the face of banking almost overnight. Barriers to market entry have been greatly diminished by technology, reducing the ability of the traditional banks to fend off competitive threats, whilst simultaneously dealing with the almost overwhelming burden of regulation. In the face of digital disruption, many banks are poorly equipped for the future. Despite many other strategic priorities, it is essential that banks act now to transform their structures, processes and mindset for the digital future.” Jon C Davies, Banking Strategist. Many banks are not well equipped for a rapidly changing marketplace or the digital future that lies ahead. Most of these institutions would not look like they do, if they were being designed today. A multitude of complex interwoven processes have grown organically within the back office, often exacerbated by previous M&A activity and a subsequent failure to integrate. Meanwhile the existing technology estate is an enormous cost burden and acts as an inhibitor of business agility and change. On average, more than 76% of all bank IT spend currently goes on ‘keeping the lights on’! The established banking brands are currently facing unprecedented competitive threats from a variety of new entrants and tech. savvy rivals. Whether or not they realise it yet, many are engaged in what is potentially a battle for survival. As banking becomes increasingly mobile and virtual, new digital technologies will be at the heart of the entire business model. These technologies offer new entrants the ability to create a lean, efficient, virtual banking organisation that is not burdened by its legacy. As investment in mobile, digital and online banking has increased, so the decline of the old style retail branch network has accelerated. Today these physical estates are looking increasingly anachronistic. Whilst some banks have been trialling experimental branch formats, these have tended to show a limited return on investment to date.

In some markets ’challenger banks’ with full mobile and online functionality are targeting the many disaffected customers of the established banking brands. Ironically, as a direct result of the financial crisis, banking with a new entrant or non-traditional player is far less risky these days in light of the deposit guarantees offered by many governments. It remains to be seen just how much leaner, customer focused and efficient these new entrants will be in the long run. However, the ’challenger banks’ are not weighed down by enormous overheads. Many are already trusted ‘mega-brands’ with potent CRM and analytic capabilities facilitating effective cross sell/up sell and customer service. The established banks must respond to the threat as a priority as many of the agile new entrants may potentially have the competitive edge over the traditional banks.




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The banking industry has fended off competitive threats in the past. However, many of the advantages that have protected banks in the past have since been lost. Furthermore digital technologies have significantly leveled the playing field. Customer acquisition, servicing and retention can all be facilitated via digital online and increasingly mobile means. Recent failures and scandals also mean that the reputations of the banks have no real currency. Payments innovation by non-banks has greatly enhanced the customer experience and given these players access to customers of the traditional banks. ATM and branch networks are no longer differentiators, with the growth of cashless, mobile and online transactions having greatly diminished the value of these assets.

Meanwhile the extra demands imposed as a result of new regulation have placed a massive additional burden on the banks. In the face of heightened regulatory scrutiny the banks, their back office processes and their technology are potentially under more pressure than ever before. Regulatory compliance is not optional! The volume of regulatory traffic affecting the banking industry is extreme. Whilst regulatory priorities vary from region to region, there is a multitude of new rules and regulatory structures impacting banks worldwide. Regulation is at the very top of the major risks impacting the industry. These regulatory demands are currently expected to keep rising. A significant portion of IT maintenance spend is driven in part

by regulatory compliance, whilst up to 50% of discretionary IT spend has a compliance implication. Despite the many other priorities facing them, banks must not ignore the imperative to take action on digital transformation. To be able to compete effectively in the digital future that lies ahead, institutions should embrace enterprise wide change to their structures, processes and mindset. Digital banking investments are bearing fruit across the value chain. Online is now the most frequently accessed channel on a monthly basis and one of the fastest growing channels. Projections show that the majority of customers will soon prefer online and mobile channels for routine access. Digital banking has already shown extraordinary growth and is now an established part of the service model and the client experience. In the UK there were 19 million transactions a week via apps in 2013, up from just 9 million in 2012. Spanish bank BBVA recently revealed that 90% of financial transactions are now completed outside of its branches thanks to service digitisation and the new branch model. That statistic speaks for itself and provides further evidence that the traditional high street branch is unlikely to play a significant role in the future of banking. There is considerable scope in other regions for banks that embrace digital transformation to attract new clients. In emerging markets digital methods provide the opportunity to tap the vast unbanked segment. Widespread mobile payments adoption took less than seven years in Kenya as a result of enthusiastic support for the M-Pesa system. In a country without a significant physical branch network, this demonstrates the potential of digital to change the face of banking almost overnight. Full scale mobile banking adoption is already following a similar path in Kenya via M-Shwari. In the face of the heightened competitive threat from new entrants the established banks must




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adapt their products and services and significantly enhance the customer experience in order to engage and retain their customer base. In particular, banks must fight hard to retain their younger customers who will be the high net worth individuals of tomorrow. There are considerable demographic differences in customer perceptions. Many 18 to 34 year olds no longer value the traditional bank branch and would be happy to rely on a purely mobile/digital relationship. The proportion favouring mobile/digital will inevitably grow over time, just as online commerce has itself seen inexorable growth. Many of these ‘Millenials’ view their relationship with their bank as purely transactional. Analytics is as fundamental part of any digital strategy and a vital investment area for banks. The effective capture and utilisation of the wealth of customer and transactional data at their disposal will be key to the long term prosperity of the banks. Analytics offers the potential to extract significant value from customer data via improved customer, acquisition, retention, experience and lifetime value. Used in tandem, digital methods and effective analytics help to inform and accelerate the product development process and significantly enhance the relevance of service offerings. In turn, this facilitates the effective marketing of products and services. The business case for this type of initiative is well established and analysis shows that, 70% of financial services firms, with established analytics initiatives, have justified their business case. Whilst the drivers for digital transformation are not primarily focused on efficiency, embracing digital offers banks the opportunity to radically reduce their cost base. By implementing swift, consistent, automated processes as part of a comprehensive digital strategy, banks can begin to transform the multiple processes throughout the organisation and rapidly improve the cost of sale.

Those banks that have been early adopters of digital transformation have demonstrated the potential cost benefits of this approach. Many have yielded significant improvements in their underlying efficiency ratios, with the ‘best in class’ occupying the 30% to 40%nt range. Whilst most banks are already highly vigilant with regards to the threat posed by cyber-crime, a comprehensive digital transformation strategy can also provide a holistic approach to effectively managing that threat. Whilst many of the outdated back office technologies present within banks today are vulnerable to cyber- crime, to a certain extent digital transformation introduces a different set of risks. However, the good news is that, by its very nature, digital transformation provides the facility to integrate preventative techniques. As a result, these safeguards become embedded in the processes, rather than occurring in a disconnected manner, typical of many institutions today.

As the banking industry seeks to prioritise resources whilst juggling a multitude of priorities and competitive threats, the agility offered by the cloud model presents an increasingly compelling business case. Indeed, the flexible, efficient approaches offered by infrastructure virtualisation and the cloud are key elements of a comprehensive digital transformation programme. A great example of this approach comes from Australia’s forward looking banking industry.




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Commonwealth Bank of Australia (CBA) has had a pragmatic cloud strategy in place for around five years as part of its own digital transformation programme. The original vision of the then CIO who instigated the change was to “get out of infrastructure” and into “components and highly granular data” so the bank could more readily develop new services for its customers.” CBA has been successful in leveraging cloud to shift focus towards customer engagement. However, the cost savings alone appear to provide ample justification for the bank’s shift to cloud, in support of its digital transformation. CBA recently revealed that it had been able to cut its overall IT infrastructure spend by two-thirds. A comprehensive digital transformation strategy incorporates many techniques in addition to those briefly detailed in this document. Moreover, a major part of the journey is the adoption of a digital mindset. Key to success is the appreciation that such a programme will involve a fundamental change of approach, a remodeling of the banking process map, and potentially, the overall value chain. In the face of the digital disruption that is already occurring in the industry, many banks are faced with a stark choice. Furthermore, the decisions taken today about the pace and direction of travel may ultimately decide the future of many of the established institutions. Success or failure, prosperity, or ultimate decline?

About the author. Having started his career in the 1980’s in investment banking, Jon has spent more than 25 years in a variety of research, planning and strategy roles focusing on the financial services industry. Based at CSC’s Royal Pavilion, Aldershot, UK, Jon is responsible for Banking Strategy within CSC’s ResearchNetwork (part of the Office of the Chief Technology Officer).

Documents

The Transformation Imperative - Jon Davies Banking White Paper v1