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Disruption Down the Road: What Banks Are Facing And What Can They Do About It

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By Jonee C. Bilasano

So much chatter has been going around regarding the state of the banking industry. Some say it is about to undergo radical change; others opine that disruption will come with the force of a tidal wave and leave things unrecognizable.

If the banking industry is about to be hit with a tidal wave of disruption, then concerned stakeholders should not look away but instead stand their ground.

What is Disruption?

Disruption owes its roots to Harvard Business School professor Clayton Christensen. He defined disruption as “a process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves up market, eventually displacing established competitors.”

Examples of these include personal computers, which disrupted mainframes, and cellular phones which disrupted fixed lines.

These examples also showed how established products gave way to new offerings. I can still remember when people relied on landline phones to make calls; now, that mode of communication has become almost dispensable.

Does this mean that any new offering can cause a disruption? Not necessarily. Professor Christensen says that disruption occurs “when the incumbents are so focused on pleasing their most profitable customers that they neglect or misjudge the needs of their other segments.”

Therefore, disruption doesn’t necessarily come with every new product; it’s the novel process involved that causes the disruption. Netflix’s entrance to the market is an apt case in point.

“When Netflix entered the market, it didn’t make a dent in Blockbuster’s market share, because the former’s DVDs-via-mail service ‘didn’t satisfy customers who wanted to get new releases at once.” But, when Netflix changed to an “on-demand streaming model,” Blockbuster began to lose its clients.

Now, that we’ve reviewed the concept of disruption, we shift the discussion to the banking industry. We now survey the most compelling and apparent technology that can disrupt banks.

Disrupting Technology

First on the list is Blockchain, “a decentralized and distributed public digital ledger used to record transactions across many computers so that the record cannot be altered retroactively without the alteration of all subsequent blocks and the collusion of the network.” The definition admittedly can be a mouthful.

To simplify, just remember that Blockchain is a ledger in the Internet, supposedly secure that everyone can access. How does it work? The public records and confirms their transactions in the ledger. Blockchain, in that sense, works as a record of events, shared by numerous parties. And once entries have been made, they cannot be altered. It is that feature that makes Blockchain a probable game changer for the banking industry.

The banking industry, especially here in the Philippines, rely on a lot of documentation. Forms, certificates, photocopies, and the like occupy the vaults and desks of bankers. The same paperwork can even be found stashed underneath tables. So, it isn’t surprising to see piles upon piles of files occupying the offices of the banks in this country.

With the use of Blockchain, banks wouldn’t have to rely too much on paper. For example, Know-Your-Customer (KYC) documentation, in theory, can be recorded using Blockchain technology. This already dispenses with a lot of paperwork.

But, the benefit of Blockchain doesn’t end with reducing the use of paper, it can, for KYC purposes, provide a shared digital record that will store customers’ identities.

This is a big deal since the same record can be continually be updated and be accessed by those that need it.

Now, any discussion about Blockchain includes leads to a related conversation. This is none other than cryptocurrency.

Cryptocurrency functions as “a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.” It is known as a “a peer-to-peer, decentralized and digital currency system that furnish online users with the capability of processing transactions using digital exchange units known as virtual currency.”

So, what’s the connection between cryptocurrency and Blockchain?

“All the transactions made on cryptocurrencies are registered on the Blockchains that are updated by users instead of a centralized authority.” Blockchain technology, in simple terms, makes it possible to use and transact cryptocurrency.

There are a lot of cryptocurrencies around like Ethereum, Ripple, Litecoin, and etc.

But, for brevity purposes this essay will focus on Bitcoin — arguably considered as the first cryptocurrency.

Bitcoin owes its genesis to Satoshi Nakamoto. He wanted Bitcoin, ironically, to act as a Peer-to-Peer Electronic Cash System. But, when the Bitcoin network came into existence, Satoshi Nakamoto “mined the first block of Bitcoins.” A certain programmer named Hal Finney subsequently downloaded the Bitcoin software and received 10 Bitcoins from Nakamoto on 12 January 2009. The rest as they say is history.

Bitcoin nowadays has achieved a degree of acceptance. Paypal, Microsoft, Dell, and Newegg have reportedly accepted payments in Bitcoin. It has also been used for investments. Bitinfocharts.com says that in 2017, there were 9,272 bitcoin wallets in existence. This translated to $ 1 million worth of Bitcoins.

So, where do banks fit in relative to Bitcoin? At this point, banks in general are not yet dealing or handling Bitcoin since it has yet to achieve universal acceptance. Most central banks are either on the fence or do not believe in its viability as a form of money or currency. It has yet to fully satisfy what economists call as the three-fold test in order for Bitcoin to be considered as money: a store of value, a medium of exchange, and a unit of account.

Still, Bitcoin, according to some pundits, pose as a threat to banks. For instance, a certain Rainer Michael Preiss, an executive director at Taurus Wealth Advisors, says that cryptocurrencies such as Bitcoin “are attractive given the banking system’s supposed lack of transparency.”

Vanity Fair’s Nick Bilton, on the other hand, believs that banks are fearful of Bitcoin because they can supposedly be displaced when it comes to intermediate transactions. To open a Bitcoin account, there is no need to present a driver’s license or pay account fees. Banks cannot, so far, provide those privileges.

Aside from Blockchain and Bitcoin, there is another field of technology that can disrupt the banking industry as well. And that is artificial intelligence (AI).

Artificial Intelligence boasts of three major technologies: cognitive computing, machine learning, and natural language processing. AI, as shown in the next paragraphs, can fundamentally change banking in five ways.

Fraud Prevention. With machine learning, it will be possible to detect suspicious activities based on the transaction history and behavior of individual clients. Machines, for example, can at once withhold a huge transaction when there is something dubious; say the initiating bank account historically issues minimal checks and then suddenly does the opposite. Machines can do this in real time.

Chatbots. Simply put, “they are artificially intelligent software that can stimulate a human conversation.” In banking, chatbots can help address critical customer issues. “One popular use case of such bot is the recent initiative by HDFC Bank to launch its very first chatbot, ‘Eva’. This effort gained tremendous media coverage and helped HDFC serve many of its clients.”

Risk Management. With machine learning, analysis of real-time data arising from recent transactions is possible. The same technology can also evaluate market conditions and latest news that in turn can unearth potential risks relative to the offering of credit. Finally, with the help of predictive analytics, “a machine learning algorithm can analyze petabytes of data to understand micro activities and assess the behavior of parties to identify a possible fraud.” Humans unfortunately can only do this manually.

Marketing and Support. Machine learning has the ability to analyze past behavior and map out present or future campaigns. This will lead to designing targeted and responsive programs. Customer experience will in turn improve since the approach won’t be scattershot.

Algorithmic Trading. Studying macro forces and market forces is integral and indispensable to a trader. With the use of AI, it will be easier to churn and process all these pieces of information. The trader then can make real time-decisions since the gap between evaluation and data collection will be virtually be non-existent.

And finally, the most evident source of disruption comes from the emergence of financial technology or more popularly called as fintech. If there is a piece of innovation or a model that seems to have the strongest chance of rocking the banking industry to its foundation, then look no further. Fintech, as pundits say, has the probable potential of making various banking services unnecessary and outdated.

Fintech is defined as a “business that aims at providing financial services by making use of software and modern technology.” Fintechs threaten banks because the former can provide substitutes to the latters’ services. For instance, banks used to dominate the payments business. Now, fintechs offer other alternatives like digital channels or mobile payments. For the first time, end consumers can choose between traditional banking payment methods and the ones that fintechs provide.

What Now?

Due to emerging disruptive technologies, the banking industry is now facing hard questions. Should existing banks immediately shift to new practices and adapt to new technologies? Should they close more branches? Which existing services should be discarded? These are the queries that both foreign and local banks face.

While there are no easy answers to the questions above, one thing remains certain: banks have to decide. They have to determine whether they should retain the status quo for the time being or change altogether. My instincts tell me that it should be the latter. Some of the biggest foreign banks have the same viewpoint.

DBS, according to Treasurytoday.com, has established different innovation project teams all throughout its organization with the purpose of evaluating current products and processes. The bank has to do this because it knows that it is going up against companies in garages that are nimble and daring enough to take risks. But, this isn’t what DBS is doing.

The same website reports that DBS knows that it has to “digitize its organization from end-to-end in order to compete.”

Nordea, a Nordic financial services group operating in Northern Europe, has also embarked on a different path. It is now hiring people with varying skillsets. Erik Zingmark, Nordea’s co-head of Transaction Banking, says that the organization is now empowering its personnel to work differently and not be burdened by institutionalized reporting processes. Bureaucracy shouldn’t hamper innovation.

In the Philippines, local banks are already taking steps to deal with the onslaught of disruption and change.

The Philippine Star reported on 12 September 2017 that the Bankers Association of the Philippines (BAP) and the Association of Banks of Singapore (ABS) convened technology experts, financial institutions and regulators to discuss the plan of the International Finance Corp (IFC) and Monetary Authority of Singapore in establishing the industry sandbox platform. In relation to this, the country’s Bangko Sentral ng Pilipinas, according to Businessworld in January 2018, has begun talks “with other Southeast Asian central banks to adopt regional standards in testing latest financial technology (fintech) products.”

Based on the accounts above, a lot are going on. It is easy to get lost in all the details and happenings. To manage all the changes, some banks have embarked on programs centering on evolution and the administration of the status quo. This is what PricewaterhouseCoopers (PWC) says in its latest paper on the subject.

The PWC recently released a paper entitled Financial Services Technology 2020 & Beyond: Embracing Disruption. And in that treatise, PWC outlined the changes to come.

Among the insights in that paper is the need to “change the bank.” This of course is necessitated by the various technological developments happening in the financial services industry.

The same treatise also alludes to the concept of “run the bank.” This notion pertains to the running of day-to-day activities.

So, for PWC banks must ensure that it allots resources in change the bank initiatives, but at the same time manage their respective status quo. But, to me, there is another task being left unattended. There must be people focused on preparing the bank.

Most of the time, organizations focus on preparing for tomorrow. And when this happens, companies force their current realities to change without assessing whether their systems, infrastructure, and people are ready. This is exactly the gap that should be addressed. Banks caught between change the bank and run the bank initiatives should take note of this chasm.

Those that will be assigned to the preparing the bank team must consider the following:

(1) communicate all throughout the organization the changes that the change the bank team is spearheading;

(2) identify pockets or possible areas of resistance relative to the coming changes;

(3) ensure that both the change the bank and run the bank groups are not at odds with each other;

(4) win the buy-in of everyone in the organization with regard to change the bank initiatives; and

(5) determine if all the bank’s personnel have roles to play in its vision for tomorrow.

There are of course other considerations, but the idea is that while banks are looking towards the future and are at the same time managing their day-to-day activities, they should also ensure that their organizations, from systems to personnel perspectives, are ready to embark on their deliberate evolutions.

But, contending against new technology isn’t the only issue that banks must face.
The World Economic Forum in its paper entitled “Beyond Fintech: A Pragmatic Assessment of Disruptive Potential in Financial Services (August 2017) state that: “Banks no longer define customer expectations of the banking experience; instead, fintechs and large technology companies set the standard.” For the first time, banks do not have a solid hold on their customers anymore.

To ensure that clients remain loyal, banks must embark on bold customer experience initiatives. If end consumers have a pleasant time dealing with their banks, then chances are they will repeat their transactions and not leave.
For banks to succeed with their customer experience initiatives, they can do the following:

• Conduct an audit — determine what works and doesn’t work. This entails an organization wide effort. Processes should be evaluated; customers must be interviewed; employees should be consulted. No stone must be left unturned.

• Study how competitors are doing their customer experience initiatives. Benchmark the best practices and then improve on them.

• Look at how other players in various industries are trying to win and keep their customers. Sometimes insights can be gathered from seemingly unrelated markets. Who knows there might be a lesson or two to be learned from the endeavor?

• Make client and bank interface pain free. Simply put, when customers access banking portals, the experience must be enjoyable. If a person wants to get a loan, then the corresponding manner of getting the information, either via navigating through the bank’s website or accessing the organization’s app, must be comfortable.

• Revisit their value chains. This is what Royal Bank of Canada’s Dave Mckay said in a recent Boston Consulting Group interview. “Banks must redefine the relevant problems and pain points they’re trying to solve for their customers and create value, create connectivity to their brands and franchises.” He feels that banks do not step out of their comfort zones and rely on their model that has existed for hundreds of years, “they can expect that someone’s going to step between them and their customers. Someone with a broader value chain will squeeze the margin, if not take them out completely.”

Banks, as this piece shows, face unprecedented threats to their existence. This is the first time in history that they do not have a monopoly anymore with the way they do things. It is only a matter time before they are taken out provided that they do not take action.

But, when there is a crisis, there is also an opportunity. Banks can look at the looming disruption as an impetus to evolve. Adapting this mindset and doing the necessary action, ensures that they will remain relevant in the coming future.

Jonee C. Bilasano is a banker by profession and considers writing, corporate strategy, and basketball as his passions.