How composable banking allows incumbents to take on challengers
Photo credit: magico110 / Shutterstock.com
Eugene Danilkis, CEO & Co-Founder of Mambu, draws comparisons between Lego and the new innovative methods to succeed and compete within banking, even against the wave of challenger banks.
Banking has undergone more change in the past 20 years than in the previous 900 thanks to digitisation. And while that change has already transformed the sector, make no mistake, there is much more to come.
The speed of change is accelerating, driven by challenger and neo banks, fintechs and the big platform companies such as Ant Financial, Apple and Amazon, and telcos such as Globe Telecom and Safaricom. For most established banks, the challenge to keep up is formidable.
The strategic threat
Here is what incumbents are up against. New entrants are backed by venture capital; platform companies have deep cash reserves and loyal customers; and fintechs are on the good side of regulators. The media and industry influencers love disruptors. And all use the latest technology to fulfill their business goals.
Unlike the incumbents, the disruptors are lean, agile, provide a best-in-class customer experience and are able to grow and scale up rapidly – attributes that are increasingly important to consumers and shareholders, and which represent a strategic threat to incumbent banks.
McKinsey estimates that legacy financial institutions will see profits decline by up to 60% by 2025 if they fail to evolve. Threats like this are pushing incumbents to look beyond their traditional boundaries in search of growth and sustainability.
Incumbents that are adapting successfully have something in common: they have set up or even composed a digital bank that operates independently of their parent organisation. The new digital banks have their own identity and culture. They are more Silicon Valley than Wall Street, and central to each is an ability to use the latest technology and provide a best-in-class customer experience.
Growth opportunities
With many domestic markets essentially at saturation, long-term growth lies in geographic expansion, improving the customer experience and focusing on underserved areas such as SMEs.
Millennials and digital natives have turned away from traditional banks in search of mobile alternatives. They are drawn to the best products and experience and banks offering the right level of service are winning over this large market. Mobile-only banks such as N26 are leading the way. Their strategy is simple: offer customers the best digitised products on one platform. This has allowed the bank to grow at an impressive rate.
Open for business in 2016, today N26 has more than 5 million customers across 25 countries. Much of the expansion has been based on referrals from existing customers, underlining the importance of a positive experience.
SME lending also offers a significant opportunity for growth. Historically underserved due to relatively high costs, SMEs nevertheless account for 90 per cent of all businesses worldwide, according to the World Bank, and already generate some $850 billion in annual revenues for banks, according to McKinsey. But in its IFC MEME Gap Assessment, the World Bank estimates that the funding gap for SMEs is $5.2 trillion globally.
Some incumbents are focusing on this potentially lucrative market, launching new digital banks with lower costs and that are better able to manage risk. ABN-Amro’s New10 is one.
New10 works within its own ecosystem to offer a modern mobile banking service to SMEs. Launched in less than 12 months a little over two years ago with a small project team of just 10 people, today it has more than 2,000 customers and has helped put its parent, ABN-Amro, into the top three SME lenders in the Netherlands.
Banks willing to change their thinking and take a digital approach can benefit from the same opportunities and expect similar rewards. With the ability to leverage their balance sheets, they also have a distinct advantage over neo and challenger banks when it comes to navigating a rapidly evolving market.
Routes to success
One route to go digital is acquisition, pursued by BBVA with the neo banks Holvi and Simple. But this option is expensive and made more complicated by the need to find targets with the right fit. In addition, the risk of botching the integration in terms of culture and technology can erode value.
Another option is to rip out legacy systems and replace them with digital platforms. An expensive, risky and long undertaking, this route has many detractors. Here, the challenge lies in finding the right vendor that can deliver exactly what is needed not just today, but into the long term.
Given the technology available, a cleaner option would be to build a digital banking spinoff which can operate like a fintech. If we look at established banks as cruise ships: large, expensive to operate, process heavy and slow to maneuver, the spinoff can be seen as a speedboat: independent, cost-effective, agile and lean. It can be launched within 12 months of inception and be unrestricted by geography making it easy to enter new markets.
A spinoff has to be seen as an investment in an innovation arm, created to address a specific market need and unimpeded by traditional organisational processes. Given the freedom, it could leap ahead technologically by prioritising APIs, automation, cloud and mobile first thinking and be able to demonstrate results and customer impact in a short period of time.
Banks can derive value by leveraging technology to streamline operations, automate processes and significantly reduce the overall cost of doing business. By accessing the very technology used by the new players allows them more focus externally on clients and service instead of internal systems and processes.
Compose your own spinoff
Today, it is possible to compose exactly the right bank for the right market. Think Lego, not picture puzzle. Where the picture puzzle can only be assembled and reassembled successfully one way, Lego bricks can be built and rebuilt into anything. When it comes to digital banking, the bricks are the independent third parties that provide the best in their field – be that Mambu with our cloud banking platform and service-enabling software, white-labeled products and services, and back office services. The parent bank works with these third parties to design and build its own challenger. We call this composable banking.
The advantages of this approach are manifold. By starting with a blank sheet and using non-proprietary software and the cloud, the new bank will be unimpeded by legacy organisational processes; it can pick and choose its partners to ensure it works with the best; it will be nimble and agile making it far easier and quicker to adapt to changing market conditions and consumer demands; and it will be able to scale up and down as required.
Meanwhile, automation, artificial intelligence and big data will cut costs.
New people, thinking and processes
But technology is just one cog in the machine. Real transformation is only possible with a change of people, thinking and processes. The leadership must drive success without creating conflicts with the parent bank – and the best way to do this is to instill a culture of innovation and continuous change from the start.
As change accelerates across banking, the successful players will be those that lead. This requires a whole new paradigm, one where business goals are enabled by cutting-edge technology and where that technology doesn’t limit a bank’s options.
Early mover advantage
The speedboat approach is gathering ground. Established institutions are moving early to grow outside their traditional structures: ABN Amro is one; Santander another. What these banks have in common is their pick-and-mix approach to suppliers and services. They are not locked into a particular vendor and are not reliant on that vendor’s product pipeline.
Instead, they use open banking and plug-and-play connectivity to quickly and efficiently add technology that enables them to deliver their business goals and the best possible customer experience.
Learn from the market
Banks and lenders cannot carry on as if nothing has changed. Everything has changed. To stay relevant so must they. They need a long-term strategy not a tactical fix. They need to innovate. By composing their own spinoff bank, those currently wedded to legacy will get the flexibility to play at the same speed as a startup. They will be able to change products, launch new ones, enter new markets and adapt to new regulations quickly and efficiently. They can create their own bank to their own design. Remember Lego, not picture puzzle.
This is what innovation is about – the ability to explore, learn and quickly develop what works in the market. Those that practice innovation like this are composing banking for the 21st century.
