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Challenger finance firms will kill only those banks that fail to evolve

It’s not doom and gloom for the UK’s traditional banks – as long as they can learn from fintech and transform themselves

The loss of business to challenger banks with easy to use digital products and services rather than because of a distrust of the big banks could be a blessing in disguise for the UK’s traditional banks.

Recent research for EY has concluded that challenger banks may not replace traditional banks but could help them grow if the traditional banks emulate some of the technology developments their challenger rivals are implementing.

The EY study, which polled 10,000 people globally, found that ease of use was given as the reason for using fintech products and services by 43.4% of respondents who already use them. Only 1.8% said they used fintech because they distrusted traditional banks.

The EY survey also makes it clear that consumers are taking up products and services from fledgling finance firms that are using technology to connect to a digital generation. It found that about 3,000 had used fintech. Among the fintech users, a total of 25.2% of 25 to 34-year-olds used two or more fintech services; the figure is expected to reach 47.8% in the foreseeable future, said EY.

If this were not enough encouragement for setting up a new bank in the UK, the government is actively encouraging businesses to set up challenger banks. The Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) have even launched a unit with the sole purpose of supporting startup banks. Starling Bank, Fidor Bank, Atom Bank and Aldermore Bank are some of the new players in the sector, and there are also businesses offering niche products such as peer-to-peer loans and savings accounts. The UK government has been eager to stimulate competition in the retail banking sector following the financial crisis that began in 2008.

Trust not an issue

The reason consumers are using fintech services is not through lack of trust in traditional banks, or better products and services from challengers, but because fintech is easy to use, according to the EY study.

Traditional banks in the UK accordingly need only improve the customer experience to retain market share. While this is easier said than done, given the complex IT legacies of the big banks, it does mean that their future lies in their own hands.

Nor is the big banks’ decline as rapid as some might think. While they might be losing customers in certain product areas to the fintech industry, recent figures for the number of people switching bank account providers show a decline last year, which means the banks are doing better at retaining account holders. According to the latest figures from the Current Account Switching Service (Cass), which was designed to make it easier to change bank, the number of people switching bank accounts fell again in 2015. Cass enables a seven-day switch, rather than the 30 days it used to take.

A total of 1.03 million current account switches were made in 2015, down from 1.15 million in 2014. The number of switches in both years was lower than the 1.2 million current account switches made in 2012 – before Cass was launched. 

But – and it is a big but – traditional banks should not take solace from these figures. While they may be holding on to their customers, they could lose profitable product lines such as loans to more focused, agile, tech-savvy competitors that have easy to use services. The rise of peer-to-peer (P2P) lending is a loud warning shot. According to figures from the Peer-to-Peer Finance Association (P2PFA) in February 2015, P2P lending in the UK had doubled by value since the end of 2013, with more than £2.1bn lent in total. It also revealed the number of borrowers rose by 90% and lenders by a third.

Legacy problem

For the traditional banks to create products as easy to use as those from fintech companies, IT transformation is essential, and legacy systems need to be addressed. While they have huge IT budgets and access to the best IT skills available, the big banks are complex organisations and their IT follows suit. Thousands of different products rely on thousands of interdependent systems. The failure of one can bring down a bank service. Today’s digital consumers get irate if they can’t access an online service for minutes, so if services regularly collapse and sometimes for long periods, as RBS’s did for weeks in 2012 when its CA-7 batch process scheduler froze 12 million accounts, then anger is widespread and the attractions of the fintech challengers are heightened.

There are options, although none is easy when it comes to replacing legacy systems. Yet even if the big banks can’t stomach a multi-year, multibillion-pound project, they could try to remove the complexity instead. They could buy a modern core banking platform off the shelf, get it working, connect it and migrate everything from legacy systems onto it. They could even acquire a new bank with state-of-the-art IT, and move everything onto its modern systems.

It is only then that traditional banks will really be able to copy the fintech businesses and match them for ease of use.

One senior IT professional in the UK banking sector said he has believed for years that financial services can be automated and provided online. “There is very little need for branches, retail staff, junk mail and so on.

“I think the banks can do it, they just need to be cooler about how they design and deliver internet products. The banks are old school and being cool is outside their comfort zone. The new starters can be as cool as they like and don’t have an existing reputation to damage if they get it wrong. The banks design products by committee involving risk, compliance, legal, finance, marketing, HR and so on, which can dilute a great idea.”

Challenger finance firms will kill laggard banks only

He added that if customers trust regulation and security to work properly, then the barriers for new starters in financial services are lowered. “If a provider meets recognised regulation and security standards, it should provide enough reassurance for people to use the service.”

He went on: “In 10 years I see almost no high street branches as they are high cost and low value. I see numerous online providers of specific products, with the current big banks focusing on bespoke corporate services rather than retail, and many more peer-to-peer platforms enabling lenders, borrowers, buyers and sellers to deal directly without a bank involved. A bank is really just a trusted intermediary between people, and that can be done by IT given the right controls.”

Lawrence Freeborn, financial services analyst at IDC, said traditional banks are in a great position to improve their ease of use. “They can simply appropriate innovations from fintech to keep their market share. The existing customer relationships between banks and their customers act as a huge barrier to entry to new players, in practice far outweighing any perceived lack of trust: this is demonstrated by the continued low current account switching rates.”

He added that the average consumer might not understand what is being offered, so the new banks’ technology advantage might not translate to more customers. “I expect that the most common unprompted response to the question ‘which bank is the biggest innovator?’ would be more likely to be Barclays or Santander than, say, Fidor Bank.”

The two big IT challenges

But he said traditional banks face two big IT challenges: “The first is the data challenge and the second is legacy IT.

“Their data, which has built up over years, must be viewed as a powerful competitive advantage which new banks will not be able to replicate. Good analytics of data should contribute to a single, rich view of the customer, allowing much more relevant personalisation of service. Even if challengers have up-to-date analytics, they will not have the quantity raw material to analyse, compared with incumbents.”

On legacy IT, he explained that banks need to be “continually hacking away at old, obsolete or inflexible systems. The key to this is the idea of the digital ecosystem. Banks need to get used to plugging in third-party services as the easiest way of innovating.”

Gareth Lodge, analyst at Celent, said banks are essential in financial services, and fintech companies need them. “The ecosystem can’t work without the banks. There are activities that are regulated – giving consumer protection – that the fintechs not only can’t do but wouldn’t want to.”

He added that few fintechs have truly disrupted the banks. “Fintechs exist because they can use modern new technology in an agile way. Which means that once one fintech has created something, they’re rapidly followed to market by many others.

“Yes, traditional banks need to make their products and services easier to use. But equally, I think we’ll see agile banks working much more closely with fintechs. To achieve this, it’s likely to be about culture and more practically, APIs. The technology is key, but without the right mentality, it’s likely to limit some of the success.”

Dominance curtailed

However, Jean-Louis Bravard, IT outsourcing consultant and former CIO at JP Morgan, expects banks will eventually lose significant market share.

He predicted that the most probable successful banking services providers in 10 years will be retailers like Tesco or Amazon or internet players like Apple or Google.

“I think that the only reason people stay with their current banks is a mixture of passivity and also that it is so bloody hard to open a bank account that doing nothing is very attractive. On the trust front, I think that trust and bank are two words that do not work well together.  People hate banks!  They are clumsy, increasingly expensive and do not have any sense of what client service is about.

The only protection for banks, besides apathy, is regulation.”

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