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WHAT BANKS CAN LEARN FROM SILICON VALLEY

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Bertrand Lavayssiere, managing partner at international financial management consultancy, zeb

 

Five success factors which explain why Europe’s most digitalised banks outperform their peers

More than a decade after the global financial crash, most of Europe’s banks are profitable. It is therefore tempting to assume that the region’s banking sector has almost fully recovered from the 2007-08 meltdown, but this is to miss a crucial point. Overall, Europe’s top 50 banks earnings are insufficient to cover their cost of capital, meaning that their core banking services might lead to long-term stagnation and decline.

 

There is, however, a promising escape route from this grim fate for banks with sufficient foresight, as revealed in zeb’s latest annual European Banking Study. Digitalisation—the hottest topic across the whole industry—could be the “silver bullet” that delivers long-term profits. Research by zeb reveals that banks which are digitalisation pioneers outperform less digitalised peers across all significant banking and capital market KPIs.

 

Further analysis shows that these pioneers have absorbed the example set by Big Tech giants such as Google and Amazon and focused on five key success factors that are equally applicable to the banking industry: a consistent customer focus, a simple, flexible product portfolio, an innovation-led operating model, an expandable infrastructure and omnipresence in their customers’ daily lives.

 

Bertrand Lavayssiere

Look at the earnings profile of many European banks and one can see immediately why it is no longer an option to rely on traditional, pre-digital solutions to restore long-term profitability. Based on data compiled by zeb, average post-tax return on equity (RoE) among Europe’s top 50 banks reached 7.2% in 2018, 0.6 percentage points higher than in 2017. On paper, the region’s leading banks look like they are moving closer to delivering the returns expected by investors, with a current cost of equity of around 8.0%. However, appearances are deceptive.

 

When we drilled deeper into these numbers, we found that the incremental increase in the top 50’s RoE over the last five years was solely due to non-operational factors: principally, reduced loan loss provisions, lower litigation costs and lower taxes. In stark terms, Europe’s largest banks are making less money from their core banking services than five years ago.

 

How, then, can Europe’s leading banks boost their earnings in a stagnant market with a host of new competitors, from digital start-ups and personal finance portals to online brokerages? In this difficult market, we believe banks have four strategic options. They can consolidate and gain economies of scale through M&A; specialise by focusing on certain products, customers and sales channels; break up the value chain by outsourcing and concentrating on core banking products and services; or go “beyond banking” by building or joining ecosystems. For all four options, digitalisation is the key enabler.

 

The next question is how far Europe’s top 50 banks have pursued digitalisation and it is not easy to answer this in the absence of external benchmarks. In our study, we measured the degree of digitalisation across all banks using a proprietary zeb algorithm which determined how often these financial institutions referred to digitalisation in their annual reports, not an exact measure but something which revealed very stark results. This enabled us to cluster banks into three groups: 13 digitalisation “pioneers”, which emphasised digitalisation very early and continue to stress it strongly; 14 digitalisation “challengers”, which took longer to start communicating on the subject and still do not emphasise it greatly; and lastly, 23 banks that we classified as digitalisation “followers”. Of course, the bias is the potential discrepancy between the intensity of the communication and the reality on the ground.

 

Meanwhile, the difference between the performances of these three groups in recent years is striking. On average, digitalisation pioneers outperformed challengers and followers according to every significant banking KPI: for example, pioneers registered an average post-tax RoE of 8.7% between 2013 and 2018, compared with 6.0% for challengers and just 2.1% for followers. In the same period, pioneers increased their average operating profit by 5.1%, while the average returns of challengers and followers shrank by 10.1% and 9.6 % respectively. Digital pioneers were also clearly ahead of the other two groups when comparing efficiency ratios and especially the cost-income ratio. Given this performance gap, it is hardly surprising that digital pioneers generally performed better on capital markets than challengers and followers. Indeed, pioneers were the only group that achieved a price-to-book ratio of more than 1.0x (while BigTechs are largely above 10).

 

It is not enough, however, for banks simply to entrench digitalisation across all operations for profits to follow. Digitalisation will only work for banks which understand its implications for their businesses. In this regard, there is no better role model for Europe’s profit-starved banks than US technology giants like Google, Amazon and Apple, the original digitalisation pioneers. To complete our study, we looked in depth at these tech giants’ business models and identified the five key success factors, based on digitalisation, which banks need to adopt.

 

Arguably the most important lesson for banks to learn from the tech giants is that digitalisation is not an end in itself. A banking app on a smart phone is not automatically a profit generator any more than the latest back office banking software. Instead, banks need to see digitalisation as a means to achieving sharper, value-adding customer focus and engagement, combined with efficient, scalable delivery of offerings.

 

Our research indicates that even Europe’s digitalisation pioneer banks have yet to absorb this lesson fully. For instance, pioneers have to become faster and more dynamic in expanding their offering and in using customer data to tailor products and services to individual needs, without increased complexity. Meanwhile, followers and challengers are in a catch-up race where they must still address such basic issues as developing authentically customer-centric businesses and automating back office systems.

 

The hopeful conclusion from our study therefore comes with a cautionary note. Digitalisation can indeed be the “silver bullet” that enables Europe’s banks to return to stable profits. As with any bullet, though, one must aim accurately and pull the trigger at the right time, because banks need to apply digitalisation in line with their own digital maturity. Above all, they must make sure not to mistake the means for the end.

 

 

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Banking

Will ‘Britcoin’ change the way we bank?

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The Treasury and Bank of England recently announced a state-backed digital pound is likely to be launched in the UK later this decade, following the popularity of cryptocurrencies. However, the ‘Britcoin’ will be backed by the central bank, ensuring the digital pound will be much less volatile than its sister, cryptocurrency. Could a digital pound backed by the central bank be the answer to utilising technological developments in the finance system for the better?

Ross Thompson, Accountancy and Finance Lecturer at Arden University, considers what we can expect from ‘Britcoin’, how this will impact consumers, businesses, and the economy, and whether ‘Britcoin’ could be the revolution to restore our confidence in the banking system.

Trust in our financial system hit an all-time low post the 2008 financial crash. Even ten years on from the collapse of Lehman Brothers, a survey found 66% of adults in Britain still don’t trust banks to work in the best interests of society.

This means there remains to be apprehension for people to sign up to and use a bank to help manage their money. The UK doesn’t seem to struggle too much in this arena, however, as according to the Financial Conduct Authority (FCA), most UK consumers (96%) have a current account from a bank or building society. Regardless, there is still a significant number of adults who do not have a bank account or are what is known as ‘unbanked’.

The lack of trust plays a big part here. More people want better control over their money and to cut out the middleman, hence why cryptocurrencies and blockchain became a tempting option, as it can potentially remove the need for banks for any transactions. However, the volatility of these currencies has been a cause for concern for many investors and regulators.

Blockchain and cryptocurrency are gaining more traction and are becoming more of a viable option for businesses, especially due to talks of regulations coming into fruition. This is especially true with cryptocurrency, with the government announcing crypto assets will be subject to FCA rules in line with the same high standards that other financial promotions such as stocks, shares, and insurance products are held to.

The “Britcoin” aims to solve the issues traditional Bitcoin presents. It would be backed by the central bank, which would ensure its stability and reduce its volatility, making it a more attractive option for investors and providing greater confidence in the stability of the financial system. Britcoin will be as stable as the inherent stability of the British economy and political system. It would also provide an opportunity for the UK to stay at the forefront of technological developments in the finance system – a system in which it can sometimes be slow to react.

One of the key benefits of a digital pound is that it would be much faster and more efficient than traditional banking systems. Transactions could be completed almost instantly, regardless of where the parties involved are located. This would make cross-border transactions much easier and could even help to boost international trade.

The Bank of England’s Governor, Andrew Bailey, stated: “a digital pound would provide a new way to pay, help businesses, maintain trust in money and better protect financial stability”, pointing toward the other advantage of a digital pound. It would offer more security as transactions would be recorded on a distributed ledger, which would make it much more difficult for hackers to tamper with the system. It would also provide greater transparency, as all transactions would be recorded on the ledger and could be easily traced if needed.

However, there are also some potential drawbacks. One concern is that it could lead to a reduction in the use of cash, which could have implications for those who do not have access to digital technologies or who prefer to use cash for privacy reasons. There are also concerns that a digital pound could be used for illicit activities, such as money laundering or terrorism financing. On top of this, more details are required in relation to the levels of personal account privacy; the potential to usher in ‘big brother’ banking systems is a growing a concern regarding state digital currencies.

Around 85 central banks are currently engaged in projects to create digital currencies, according to figures from the Bank for International Settlements. But as it stands, many feel there is probably little need for a digital pound; with a growing amount of people using their debit cards, phones and watches to fulfil the same function, a digital pound is deemed unnecessary. On top of this, many of the public fear that a government digital currency could potentially infringe on their privacy – despite the BoE stating the currency would be subject to rigorous standards of privacy and data protection.

And in countries where a digital currency has already been established, there has been little uptake – widely due to the lack of trust between central banks and citizens. It seems gaining users’ confidence should be the Bank’s first priority. The House of Lords economic affairs committee stated last year that a digital pound would pose “significant risks” such as state surveillance, financial instability as people convert bank deposits to CBDC during periods of economic stress, an increase in central bank power without sufficient scrutiny and could be exploited by hostile states and criminals; it is safe to say that the nation’s ‘Britcoin’ will need to be very well thought out.

It has the potential to revolutionize the finance system, however, and could provide significant benefits to investors and consumers alike. However, the potential risks and drawbacks must be carefully considered before any decision is made to launch such a currency. Having said that, if it is implemented correctly, a digital pound could be a powerful tool for utilising technological developments in the finance system for the better.

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Banking

Why the future is phygital

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By Eric Megret-Dorne, Head of Card Issuance Services and Service Operations at Giesecke + Devrient

 

Digital banking has become increasingly ingrained in people’s everyday lives. Today, 73% of people globally use online banking at least once a month. Traditional bricks-and-mortar banks, which have long relied on the in-person experience with customers, are now having to step up their offering. With new ways of working blurring the work-home boundary, banks must ensure a fast, seamless connection between face-to-face processes and virtual customer experiences.

However, this does not mean that physical and digital banking are in competition with each other. In fact, many continue to use physical bank cards, with 1.12 billion in circulation in 2021, which provides the basis for digital payments and offerings. As a result, the benefits of digitalisation should converge with the comfort of physical touchpoints to create a holistic, “phygital” experience.

The path to phygital

Banks are accelerating their digital transformation strategies to keep up with the fast pace of fintech innovations. To meet the changing needs and preferences of customers, the payment world is leveraging new technologies to create personalised experiences through a range of different channels.

While the digitalisation of banking has been underway for quite some time – particularly for younger generations – events such as the Covid-19 crisis forced banks and customers of all ages to use digital tools and processes to compensate for branch, office, and call centre closures. With branches worldwide typically operating at reduced capacity due to social distancing requirements, consumers embraced online banking to avoid both the virus and potentially long queues.

However, some consumers still enjoy physical touchpoints, meaning a digital-only approach won’t suit everyone.

Striking a balance

It’s all about options – consumers now want to freely switch between traditional and digital channels without being forced into one. But how can banks achieve this phygital balance? One way is to equip physical channels with digital capabilities, so that online tools can augment the physical experience. For example, personalised bank cards with a bespoke design can be activated digitally, offering customers an extra layer of convenience. Having to wait for a new PIN to arrive in the mail is a common bugbear for consumers, so bringing card activation processes into the digital ecosystem will ensure a more seamless experience.

Greater automation in the card issuance and activation process enables the benefits of digital to be integrated into the physical banking experience without being intrusive. For instance, self-service kiosks empower customers to print their own cards, reducing the time between acquisition and card issuance, while still allowing for in-branch expertise if needed.

The personal touch

Phygital strategies also give banks a range of valuable data insights that can help them better serve their customers. This includes data on purchasing behaviours and habits, which can then be utilised to improve banks’ offerings and unify the physical and digital brand experience. Using omnichannel data helps to build a hyperpersonalisation strategy to provide real-time services.

In this way, digital solutions help banks maximise their user experience. Whenever a consumer interact with a bank, it creates data and behaviours. With fragmented databases, legacy systems and real-time data created by interactions with third-party partners through Application Programming Interfaces (APIs), it is not always easy for banks to streamline this data from different sources. By understanding patterns in that data and behaviours, banks can tailor and personalise unique experiences for each and every user.

Where security meets innovation

With big data opportunities abound, banks should be mindful of their consumers’ security concerns. Customers are now demanding much more transparency when it comes to how information is stored and collected. At the same time, they still desire greater personalisation via digital methods. Therefore, any successful phygital strategy requires a robust digital security to ensure customers have the same peace of mind as when they complete physical transactions.

To close the gap between innovation and security, banks should utilise tokenised infrastructure, which ensures the safe provision of payment credentials and securing of customer payments across all touchpoints. This is particularly important as regulations such as PSD2 and SCA demand strong authentication requirements.

The use of a token greatly enhances the consumer experience. For example, it allows for card details to be automatically updated for subscription services upon the expiry of an existing one, avoiding any service disruption.  Multi-factor authentication can also ensure an additional layer of security, as it combines a password with verifiable human biometrics such as fingerprints or facial recognition.

Best of both worlds

Every consumer has unique preferences when it comes to banking. Therefore, banks must evolve by bringing both physical and virtual touchpoints into a ‘phygital’ world. Only a phygital approach can meet the needs of all end users – whether they favour an in-person experience, an online one, or a blend of the two. The holistic data insights, personalisation opportunities, and optimised security ensured at every touchpoint are also critical in building future-ready banks.

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