Building digital capabilities takes time – it’s an organisation-wide, multi-year technology change. Some banks are prioritising innovation, some user experience, some cost-cutting, and some a combination of all three. Regardless of approach, the key challenge amid Covid-19 is digitising at sufficient pace and scale so as to protect the most at-risk customers while not impairing the ability to make more long-term strategic changes around underlying technology capabilities.
Listed below are the key macroeconomic trends impacting the digital transformation theme, as identified by GlobalData.
Heightened political and economic support for digital transformation
Investors are looking for predictable, consistent, and stable returns from banks. However, Covid-19 has created heightened alignment among investors, employees, and consumers alike around the imperative for technology change. As such, Covid has become a unique opportunity for forward-looking providers to push through long overdue business model changes, cutting deeply into bloated branch networks and building new digital capabilities. As ever, while some banks will be mobilised by crisis others will be paralysed by it.
Declining private investment for new entrants creates a buyer’s market
Covid-19 is directly analogous to previous economic shocks, such as the credit crisis and the dot.com crash, insofar as private investment has fallen sharply. Funding in Q1 2020 was down nearly 46% against Q3 2019. Investors are becoming more cautious and focusing on later-stage fintech’s – a trend that pre-dates Covid but has now been accelerated by it.
For smaller, less-established fintech’s, funding rounds will become harder, fewer, and smaller. Larger pre-revenue fintech’s, meanwhile, will find less sympathetic investors and more difficult market conditions. Conversely, incumbent banks are not only more able to weather the storm from a balance sheet perspective, they benefit from less competition and perfect opportunities to acquire distressed firms at knocked-down prices.
Rising non-performing loans creates sustainability minefield for incumbents
The International Monetary Fund (IMF) has already warned of a global recession unlike anything we’ve seen since the Great Depression. Furlough schemes have postponed confrontation with the worst economic dislocations in the form of widespread redundancies and business closures.
How banks handle the collection process – and deal with distressed customers – presents significant reputational risk. This will be a unique opportunity to forge sustainability credentials by proactively engaging digitally with customers in moments of truth. But savage cost pressures and the need to rebuild balance sheets will make this a minefield, particularly once government support programmes are wound down.
Inevitably banks will be backed into corners in which it will be impossible to keep everyone happy all of the time. Unlike previous crises, the response of banks will be carefully contrasted with big tech and other players encroaching on financial services.
Acute economic stress for gig economy workers
Gig economy workers, numbering more than 50 million in the US alone, typically have unstable and unpredictable income streams, making them especially vulnerable to Covid-19. To date they are also underserved by banks. There are already a number of fintech’s and challenger banks that serve the gig economy, including Green Dot, Salaryo, Joust, Qwil, Steady, and Cogni.
Some provide features such as advances against unpaid invoices and the ability to find gig jobs on the app itself. Likewise, fintech’s in the UK have formed a consortium and created a new concept called Covid Credit to cater to freelancers affected by the Covid-19 crisis.
Perfect storm of cost pressures
Already cost-cutting pressures have seen widespread branch closures. Having to remove cost while information technology (IT) demands escalate in the short term will see providers try to offset cost increases with productivity gains. We also expect more focus on reducing third-party expenditures by working more efficiently with vendors, moving vendors to alternative pricing models, renegotiating prices, and consolidating relationships. These efforts typically deliver 5% to 10% savings within six to 12 months.
Search for new revenue streams and business models
As part of transformation efforts, incumbents and new entrants alike are looking to disaggregate fixed assets – whether in the form of data, regulatory entitlements, security credentials, etc. – and white label them to third parties, drawing on the inspiration of large tech firms. This is a way to monetise sunk costs and diversify revenue streams to offset the capital outlay of transformation costs.
Likewise, we expect more banks to partner with third-party platforms to protect against disintermediation and/or expand reach. This creates new strategic questions around how to optimise a bank’s products and services for a third-party environment it cannot fully control, and the extent that third-party distribution dilutes or enhances a bank’s brand.
Meanwhile, the changing economics of adjacent verticals could evolve plans regarding direct entry in banking. For example, many social media firms are discouraged from competing directly with banks so as not to cannibalise their advertising revenue from banks. However, advertising budgets are expected to fall significantly as the economic downturn caused by Covid-19 begins to bite.
This is an edited extract from the Digital Transformation in Banking – Thematic Research report produced by GlobalData Thematic Research.