by KPMG
Does banking's future outweigh its past?
On the surface, at least, it’s a conundrum. How do banks face profound industry changes driven by rapidly evolving customer expectations, emerging technology and new digital challengers when millions of dollars are invested in inflexible, though robust, legacy systems that served them in the past but are not fit for future needs? Given the dominant market share of incumbent banks and the relatively small inroads made by digital challengers, how quickly do traditional banks need do move? Should changes be piecemeal, transformational or totally greenfield?
To companies in the banking industry, the story is a familiar one. Customers with connectivity at their fingertips are demanding cheaper, faster, and better banking experiences. A plethora of challenger banks and new market entrants are emerging to meet these demands — armed with innovative technologies and unencumbered by the legacy infrastructure that restricts traditional financial institutions. Yet, traditional banks still have the lion’s share of the business, enviably strong brands, large customer bases and high visibility.
In the face of this many banks are investing heavily to drive innovation, enhance agility, and become more customer centric. For the majority, these investments comprise patchwork upgrades to legacy systems and incremental change. Organizations are reluctant, indeed, to walk completely from these systems owing to substantial investments in them, concerns for relia
bility, and the simple fact that these systems have been so central to past successes. Other financial institutions are taking different paths to reposition themselves.One thing is clear. Traditional banks cannot afford to apply patchwork upgrades to their legacy systems. Nor can they assume that system upgrades, even bold and ambitious ones, will translate to a sustainable competitive advantage over the long term. While the pace of technology change in financial services has been more gradual than in other industries, in part due to regulatory restrictions on new market entrants in many jurisdictions, the ability of companies to rapidly adapt will only become more critical over time.
The degree of industry change is such that banks ne
ed to think more radically about what they want to become and how they want to get there if they expect to thrive.
What will the banking industry look like in 2030? Business models, just like the industry as a whole, will be transformed by technology. New models will emerge in the years ahead putting a halt to the band-aid approach to legacy systems. Banks will look to new architecture that is digital to the core, and, more will choose to build and migrate to new systems.
Under pressure: digital banks making inroads
Challenger banks — such as Starling Bank, Atom Bank and Tandem — have existed in the UK for a number of years. Fidor and N26 were the first of the European digital banks. The model is now emerging in other parts of the world. Indeed, there are approximately
100 challenger banks worldwide, including:
— SolarisBank and N26 in Germany — MyBank, WeBank and Kakao in Asia — Nubank in Brazil
— Chime in the US — 86400, Volt and Xinja in Australia.
In March, 2019 the Hong Kong Monetary Autho
rity announced that banking licences had been granted to no less than three digital banks in the territory. These entities are expected to go live later this year.Though still dwarfed by their traditional counterparts, digital banks are growing fast, leveraging their adaptability, customer-focus, and ability to make data- driven decisions. While they might not, as yet, have customer bases to rival traditional players, they are star
ting to make inroads. Traditional financial institutions should not overlook the growth potential of new digital challengers who could, over time, win share of market segments, in particular the growing cohort of millennials.
Responding to a new reality
Over the past five years, many financial institutions have invested millions in innovation programs focused on enhancing their technological capabilities, as well as trying to become more agile. The approaches they’ve taken to make these changes have varied based on their existing strengths, business strategy,and identified gaps.
Legacy system updates
Numerous traditional banks, as noted, have invested heavily in updating their legacy technology in order to remain competitive. These investments include upgrading credit systems in order to approve loans more swiftly, making systems compatible with application programming interfaces (APIs) and open banking regimes, or finding ways to integrate more robust data analytics. While good, these incremental changes are unlikely to give traditional institutions the competitive edge they need to stave off new competitors. Purchasing a digital bank
A number of traditional banks have purchased digital banks as a way to make rapid changes. Canada-based Scotiabank acquired digital bank ING Direct (Canada) back in 20122. This trend has become much more pronounced in recent times. For example, Nordic bank, Nordea reported in March, 2019 that it had acquired Gjensidige Bank3 and the Royal Bank of Scotland (RBS) recently purchased a 25 percent equity stake in digital start-up Loot4. RBS made the investment through its digital bank, Bó, which is currently under development.
Purchasing an existing digital bank gives the incumbent the flexibility to change or retain the purchased brand name. They can also either migrate existing customers over or grow the offering’s existing customer base organically and through cross promotion. Banks that elect to migrate customers, however, run the risk of incurring significant expenses as a result of a need to write off aging legacy systems more quickly than they might have otherwise.Establishing a digital bank
A number of traditional banks have established their own digital banks. As mentioned above, RBS, in addition to investing in an existing digital bank (Loot), is developing retail bank Bó and just last year launched Mettle5, a digital bank targeting small and medium enterprises (SMEs). Other well-known examples range from Marcus (Goldman Sachs) to Finn by Chase (JPMorgan Chase) in the US to Pepper (Leumi Bank) in Israel.
Establishing a digital bank provides legacy banks with similar flexibility in regards to branding and building a customer base. The time and investment required, however, to develop a new business model and build the brand can be exorbitant. Significant resources are needed to erect the five pillars of any digital bank: senior management, licensing, funding, technology, and customers. To deal with this, some banks are turning to digital banks for assistance. RBS for example have partnered with Starling Bank for help with their digital foray.
Starting a bank can provide a successful defense against new challengers with improved services and open capabilities. The new, more competitive business model provides for lower costs, greater agility and greater modularity. New technology stacks put incumbents on a level playing field with upstarts and customers can be readily migrated over.
Digital banks are also often referred to as “lifeboat” banks. Should the digital bank prove operationally resilient, traditional banks will consider migrating their legacy customer books to the new entity. This helps replace legacy infrastructure with new technology, and helps solve the agility and customer experience issues that banks struggle with.The elephant in the room: change isn’t all about technology
If banks are to successfully face the challenges posed by new digital competitors and changing customer expectations, they need to think beyond technology. Whatever path of change a bank undertakes, whether organic or inorganic, it must be partnered with a willingness to entirely rethink their strategy and business processes in order for their transformation to be successful. This means objectively considering the use of mobile apps, the cloud, customer accessibility, the use of big data — and defining how any decisions will contribute to the organization’s overarching business strategy.To be successful long-term, a major cultural shift is required, one in which employees at all levels come to appreciate and even value a company’s transformation. While many financial institutions know they need to change, few recognize the magnitude of change required or the degree of internal resistance they might face to change. To manage this resistance, change management needs to be an upfront, ongoing and persistent component of any bank transformation initiative. Additionally, any associated communications program should be aimed at attracting converts, even evangelists, to the effort right from the get-go.Forging a path forward: Questions to ask
There is no one path to success for financial institutions that want to increase their competitiveness and better respond to the needs of their stakeholders or the dynamic changes expected to continue to reshape the financial services industry in the years ahead. Companies need to determine their path based on a strong understanding of where they are today and what they want to become in the future.Defining a digital banking strategy starts with a clear business model
As a starting point, companies should consider a number of pivotal questions that can help them define what they need to do. These questions include:
— How will you create and monetize value in the future? — What changes are required to bridge the gap between where you are today and where you want to be? — What is the cost-benefit associated with making necessary upgrades? — Will modifications to legacy systems be sufficient to give you the flexibility to compete in the future? — If not, how might brand new technology stacks be built at the bank?— What are your time constraints and how long will different options take? — What systems, structures or partners can you leverage as part of your transformation?
Acting today to thrive tomorrow
Banks that recognize the profound shift required and act now to transform their organizations to keep pace will emerge more competitive and successful than ever. It is our belief that although patchwork upgrades may seem like enough to stem the tide in the short term, companies willing to make more radical changes will be better positioned to lead the financial services industry in the years ahead. Those that adopt new business models and build and migrate to new technology stacks will be best prepared for digital competitors.
How can businesses tackle financial crime? The answer doesn’t lie in quick fixes or ‘one-size-fits-all’ solutions.
Costly, complex and increasingly brazen, financial crime is a huge headache for the banking sector. Banks must stay one step ahead of a constantly evolving legislative, regulatory, political landscape. Whether it’s identity theft, credit card fraud, money laundering or another systemic illegal activity, financial services firms are now suffering significant commercial losses – with digital technology simply fuelling the ingenuity of the crimes. There is also societal and government pressure on banks to tackle financial crime in order to protect our communities and national security.
How can businesses tackle this constantly-evolving industry challenge? The answer doesn’t lie in quick fixes or ‘one-size-fits-all’ solutions. It is not about placing responsibility solely at the doors of the compliance function and risk management teams. Nor is it about relying entirely on tighter controls and monitoring.
What it is needed is far more radical: a holistic response to risk embedded in the people across your entire organisation. In other words, everyone from the front line onwards feeling motivated, skilled – and confident – enough to play a key practical role in stamping out financial crime.
Creating a can-do culture
For many businesses, that adds up to a major shift in corporate mind-set. That’s why, drawing on our extensive experience of supporting clients across the sector, KPMG has developed an innovative portfolio of learning programmes to achieve precisely that community-based transformation.
We realised that in order to achieve the right confidence, skill, and motivation in people to help bring about that shift in mind-set we needed to bring together everything we know about learning and about risk. These new programmes combine insights from not only KPMG’s in-house financial crime experts, external risk firms, but also our deep learning and behavioural science subject matter experts.
The result? Highly tailored learning programmes, delivered using immersion techniques designed to get real results in terms of immediate and long-lasting behaviours. Not just for the top table, but primed to reach every single corner of the organisation and create a comprehensive and lasting capability framework.
Making the difference, fast
With the backdrop of increasing regulation, complexity and new ways of doing business, we are working with firms to lead the way in creating and embedding financial crime learning throughout the ranks with agile, interactive and micro learning, accessed on the go, 24 7 says Karen Briggs.
What sets this approach apart? It’s an interactive learning solution within financial services, highly practical, immediate and anchored in real-life scenarios: as far away from a traditional dusty classroom set-up as it’s possible to be.
Digital
Micro learning – bite size elements, compressed into 10 to 12 minutes, using game mechanics and techniques to drive engagement such as scoring, and highly graphical interfaces. This gives the experience of an interactive movie or mobile game.
Each individual employee is directly in charge of their own experience, they make decisions and choose their own path, learning from the consequences of their decisions. Our research tells us that encouraging learners to make those decisions for themselves stimulates higher cognitive load in the brain, providing a far higher rate of information retention, compared to a retention rate of as low as 10% from more standard learning techniques.*
Real-life risk
We take the same approach to classroom content. Using fully immersive scenarios created to be as closely as possible related to the individual’s day to day role within the organisation. By providing an experience instead of passive, lecture-style learning, we see increases in confidence and a willingness to engage.
The training modules can be adapted from frontline staff all the way up to leadership and senior management, to ensure that the cultural change genuinely embraces the entire business from one end to the other.
Happy clients, tried-and-tested result
Just how well this approach works in practice was illustrated recently by the positive response we received from one of our major banking clients, after we created and implemented a large-scale customised financial crime transformation programme within the business.
The project involved a total of 18 different training modules across 20,000 staff across the UK, with six modules prioritised to focus on specific areas within the organisation. The design of the training products took just six weeks from conception to deliver and we used agile storyboarding techniques to develop the training and test it in real time, to ensure it achieved its objectives.
Employees within the bank gave the training process a score of nine out of ten after they had participated, reporting that they felt far more comfortable asking questions than within a classroom set-up – and gained a much better understanding of how to deal with the issues they faced.
KPMG can transform your financial crime programme to improve resilience and unlock opportunities. Click here for more perspective from KPMG on the future of financial crime and how to fight it.
by Karim Haji, Head of Banking at KPMG in the UK
In this article, Karim Haji, Head of Banking at KPMG in the UK, looks at why is culture change important for banks to meet customer expectations.
In this era of digital disruption, it would be easy to assume that technology is the key to unlocking the transformation that the banking industry so badly needs. But while innovation has a role to play, it is another imperative that will ultimately determine the success or otherwise of banks seeking to transform. Only those banks that manage to persuade all their people of the need for a new culture, from senior management to the most junior member of staff, will make a convincing shift to the customer-centric model now required.
It is people, after all, whose behaviours each day determine the outcomes enjoyed by the bank’s customers. Their actions and decisions either support the bank’s claims to have shifted to a model built around the customer or undermine its credibility. And in a bank that has yet to embed the right culture at every level of the organisation, it is the latter that is more likely.
Talk is cheap
How, then, to change the culture of the bank for the better? Well, step one is to recognise that simply having senior leaders talking about cultural change is unlikely to be enough. KPMG’s own research suggests that all too often, banking executives have a much higher opinion of their organisation’s culture than the rest of the workforce.
Indeed, senior management may talk the talk, but the middle managers and more junior staff charged with actually implementing transformation often don’t truly believe in the sincerity of the message from the top. Their behaviours reflect what they think senior leaders are really looking for – increased sales, perhaps, or greater profitability - rather than what those executives say they want.
Shifting those perceptions therefore represents a crucial step forward in changing the culture of the whole organisation. And here, action will speak louder than words.
One part of the solution will be to provide employees with access to the facilities they need in order to shift to the more customer-centric model to which executives aspire. Unless the bank’s processes have been reconfigured around customer outcomes, with new tools and technologies introduced to facilitate change where necessary, the bank’s staff simply won’t be able to deliver what is required. And unless staff are supported through this change process, with easy access to ongoing advice, they will struggle to exploit the potential of the new operating model.
Rewarding good behaviour
Banks that make it possible for staff to focus on the customer can then encourage them to do so through a shift in performance management and incentivisation processes. Changing the way that staff are appraised, and the metrics used to calculate their remuneration, sends out a powerful message about the bank’s intent. Cascading this new approach down through the organisation will support cultural change throughout and will help bolster the messaging coming from senior leadership.
In practice, this shift may require the bank to think again about the key performance indicators it monitors – and how these are measured. To what extent, for example, is the bank measuring its customer outcomes performance – whether it’s general satisfaction with service levels or a more specific metric such as the quality of investment advice – rather than depending on traditional yardsticks such as sales and profitability?
Subtle changes can be important. For example, while banks may penalise employees whose behaviours have fallen below the required standard in some way, do they reward those who go above and beyond? Incentivising outperformance may be more difficult than penalising failures, but it is likely to be more productive.
This is not to underplay the importance of holding people to account. Indeed, encouraging individuals to take greater personal responsibility throughout the bank will pay dividends. While the Senior Managers and Certification Regime (SMCR) has embedded greater accountability at the top of banks, it now makes sense to apply similar principles in middle management and beyond.
However, this isn’t about implementing a blame culture. Indeed, one problem facing many banks is that staff shy away from taking decisions for fear of punishment if there are adverse consequences. Empowering people to focus on the customer without having to worry about a backlash is not the same as ensuring people know they will be held to account for poor behaviour.
Enduring change
Get these changes right and the potential to finally move towards truly customer-centric banking is exciting. But cultural shifts don’t happen by accident – it requires deliberate and considered action to drive transformation that is authentic and deep-rooted.
One final thought. Banks that want to better understand their customer bases will stand a better chance of doing so if their own staff look more like the customers they serve. In this regard, the importance of building greater diversity into the banking workforce cannot be over-stated.
Indeed, this may be the final piece on the cultural change jigsaw. To shed the ‘them and us’ culture that has defined the relationship between banks and their customers for far too long, helping existing staff to change may be only half the battle. New members of the workforce, recruited from the ‘them’ to join the ‘us’, will complete the transformation and help ensure the change is enduring.
Click here for more insights from KPMG on the transformation of the banking industry.
The general playbook that large Banks have used to generate returns is being challenged at every turn. Efficiencies from centralisation are being offset by the new regulatory focus, while savings from capital models are being eroded by increased use of standardised models, systemic risk buffers and the rising costs of compliance.
In the aftermath of the global financial crisis, we saw Banks retrench around global, universal services to varying degrees, but 10 years on, many are now looking to get back on the front foot. Most can no longer rely on economies of scale to drive strong returns, and need to reacquaint themselves with an old truism: “You can’t be all things to all people.”
Specialise to optimise
It may seem obvious that Banks need to focus on the markets, client segments and product categories where they have genuine pricing power and points of differentiation. Nevertheless, such fundamentals were often overlooked, or at least eschewed, in the benign pre-crisis market conditions that incentivised firms to chase scale while any associated inefficiencies were masked. It is these inefficiencies that are now resurfacing amid today’s more onerous regulatory requirements and a more challenging interest rate environment. Many successful banking strategies now involve a renewed focus on “the core.” Naturally, this means different things to different institutions. For some it means a core client segment, for others a core product set or capability, others still a core geography. It is a trend gaining traction in Europe, with many creating non-core divisions. Even the largest global players are shifting focus and investment spend to markets where they have scale in their chosen products and customer segments.
Becoming more focused is a logical response to the environment that Banks now find themselves in, but it does raise its own set of problems. In particular, it makes Banks more vulnerable to changes in their own market segment.
Embracing agility
As the pace of change increases, whether due to innovation, regulation or competition, a bank’s vulnerability increases. In the absence of a crystal ball, the only way that Banks can manage this risk is by embedding flexibility into their operating models to enable them to adjust rapidly to the way they serve their chosen market. In short, more agility is required to ensure that fears about being "too big to respond” are not simply replaced with being “too concentrated to survive”. In exploring how Banks can make their operating models more agile, it is necessary to disaggregate banking into its two core components, “production” and “distribution” since each brings different opportunities and challenges.
Disruption to distribution
Distribution was once an area where size was an unequivocal advantage; a large physical footprint and broad customer reach have acted as barriers to entry supporting entrenched participants. However, this model is being challenged from two sides. Firstly, technology is challenging the volume of bricks and mortar required. Secondly, and particularly in the Retail market, regulatory initiatives such as open banking and PSD 2, which require sharing of data across Banks, challenge the incumbents.
These changes present a threat of intermediation, since they enable new entrants to “own the layer” between the bank and its customers, with solutions containing customisable algorithms. These cater for changing customer behaviours; increasingly focused on quicker, more digital and more personalised service which can only be met through technology. In short, new entrants provide the potential for better service at a lower cost.
Faced with these challenges, Banks could choose to retreat from distribution entirely or, in our view, more likely compete with those providers; by upscaling their own technology options to meet changing customer demand. However, with Fintech and technology behemoths alike showing interest in banking services (if not Banks), partnership may offer a more agile route so distribution may effectively be co-sourced or outsourced.
This could provide a cost effective and scalable distribution model allowing Banks to focus on production, which is more highly regulated and therefore less susceptible to threats from new entrants.
Driving performance from production
Performance in production is driven by three inputs: innovation, price and flexibility. The first two are self-evident; offering innovative products that suit customer needs at the best price will always be a prerequisite to success. However, in our view, it is equally important for Banks to be able to allocate resources flexibly between products and markets to those that offer the most favourable returns within the context of their long term strategy.
Banks have traditionally been better at innovation than at pricing or flexibility. But as product innovation cycles are shortening (and leaders’ advantages are swiftly eroded), the ability to deploy and redeploy balance sheet resources to the next best option is critical.
Banks need to design an operating model that supports efficiency in pricing and flexibility of resource utilisation. In doing so, they have to move away from the distribution led operating model, where business lines follow customer groups and balance sheet management is an after thought.
Such a model too often leads to short term profits that turn into long term drags on profitability, which can tie up capital years after origination, eroding long-term returns.
Banks need to be savvier in how they manage the key constraint on growth and returns: balance sheet resources and capacity. This can be done by rebalancing the power between demand functions (the business lines) and supply functions (treasury and legal entity management). Too often business lines make demands on financial resources to drive promised growth, but are not adequately held accountable if the demand does not materialise, resulting in surplus supply. This inevitably results in feast and famine, where certain business lines have surplus capital while others are starved of the resources for growth. This is caused by scarce balance sheet resources being locked up in the wrong areas, leading to waste and inefficiency.In our view, Banks should put in place multi-disciplinary balance sheet management functions with a mandate to reduce balance sheet inefficiency and put more tension in the supply and demand process. This allows a more dynamic allocation of resources in the short to medium term whilst ensuring a longer term perspective on balance sheet management beyond the first year of the financial plan. This is already happening in certain Banks, and we can see this developing in an even more radical direction.
We are not suggesting a complete reversal of the current state of affairs to a balance sheet first, business unit second approach. Merely a much greater balance between supply and demand of resources. Otherwise there will be neither the ability nor the political will to reallocate and rebalance between products and business lines in the way we think will be required. Unlike distribution, where one path to agility is decentralisation, agility in production must be achieved through increasing centralisation and power to supply functions.
The path to agility: What Banks can do now
We have has put forward two linked propositions: that Banks should realign around their "core", and that this must go hand in glove with embedding more agility into the operating model to ensure long term sustainability. To date there has been more concern on the former than the latter, but the true power play comes from investing in and enacting both together. In our view, Banks have the opportunity to refocus their resources at pace to deliver long term, sustainable returns in the future.
Performance in production is driven by three inputs: