Author: Mihály Medovarszki, Software Developer at ApPello
Banking Industry has already faced several challenges of digitalization in the past few years but most advisors and sector experts agree that only fully digital banks will be able to survive the next decade. COVID-19 has only accelerated digitization as pointed out my colleague Gergely Ambrovics in his blog recently. Expanding on that here are my thoughts on how Banking & FinTech world will be impacted post COVID-19.
COVID-19 has put environment top on the agenda globally, making Millennials’ environmental agenda stronger. Environmental consciousness in banks can go beyond paper-less offices. And it’s not only a nice-to-have, but it’s a must if financial institutions want to attract their youngest customers. The millennial generation act for different values than their parents. Currently most of the available retail and investment products are composed according to the older generation’s taste, simply because they dispose of the greatest wealth. However, this will change in the future so the banks have to prepare for the new generation of clients and their fundamentally different approach to finances.
This shift can be observed on the investment field, where more and more so called ESG products appear. ESG stands for environmental, social and governance, and it’s a kind of scoring framework which can be used for ranking a company’s social and environmental responsibility and attitude. It’s just a matter of time banks start following these trends. Actually, green banks are already out there, but most of them are still smaller than average.
Impact can be achieved through the banks investments, for example by financing environmentally positive projects, and avoiding sectors such as oil & gas or defence. Social responsibility (CSR) is another important tool which can be used inside the organization of the bank to shift the corporate mindset into a positive direction – and alongside with smart marketing, it’s really good for the brand too.
A study published by Augustin Landier of HEC Paris Business School, Jean-François Bonnefon of Toulouse School of Economics, and Parinitha Sastry & David Thesmar of MIT Sloan, showed that investors are willing to pay $0.7 more for a share in a company giving one more dollar per share to charity. The study also revealed that firms exercising a negative social impact were valued at $0.9 less per share than those considered socially “neutral.” It seems the time has come when we can express the “greenness” in dollars, so banks have to adapt to this trend as it become more popular.
Decentralized finance (or just DeFi) is currently a niche but more and more important topic in fintech. This relatively new term is connected mainly to blockchain-based distributed services. By DeFi we are talking about the new generation of financial services where there is no central counterpart in the process. Every transaction happens in a distributed way on the network typically by using so-called smart contracts. These smart contracts are small code snippets with a specific purpose (eg.: booking a transaction) where the execution of the transaction is validated by the participants on the network.
Only a few of these solutions have been commercially proven, but the technology is proved its benefits in certain areas and many new solutions are under development. Decentralized solutions can substitute the middle-man in many areas such as clearing houses or can be used for security purposes by preserving data integrity. Though the technology is still not in the spotlight of decision-makers, large financial institutions, like JP Morgan are investing heavily in the research on this field, so we should take it seriously.
“Blockchain is the financial challenge of our time. It is going to change the way that our financial world operates.” – Blythe Masters
Interest rates are the cornerstone of the profitability of the banking industry. As the classic approach of a retail bank operates: Bank collects money from their depositors and lends it back to other clients. Both sides of this core business highly depend on the interest rate environment the bank operates in. There is a small margin on both sides, so the bank earns a yield on this interest rate spread during its operation. In a constantly low interest rate environment this spread is shrinking while the operating costs remain on the same level which negatively affect the cash flows of the firms.
As a result of the 2008-2009 financial crisis the world’s central banks had no other option than lowering the base rates to the floor and pumping money to the financial system to keep the economy alive. But with this move they also reduced the profitability of the core businesses of these institutions. After a decade of low interests and ample liquidity the FED started to hike the base rates a few years ago and it seemed the world for the banking industry will return to the normal. Then came COVID-19 and with the necessary bailout programs practically erased the possibility of rate hikes in the foreseeable future.
” We’re not even thinking about thinking about raising rates.” – Jerome Powell, 2020 June 10.
So what? Winter is coming onto the banking industry? Kind of. As everything in life, low rates have their positive impact as well, mainly on banks’ balance sheets. Reduction of the rate environment means increased valuations on the asset side of the books which has a positive effect on the income statement. Lower rates also decrease the probability of credit quality deterioration which leads to lower loan loss provisions.
Beyond the accounting part of the game, banks can do something more important: reduces operating costs by digitalization. Transforming their operations fit for future can increase customer experience and satisfaction while their costs per client lower significantly. On the other hand, digitalization is still an easier way on a dense market than increasing substantially the number of profitable bank customers.
Nowadays every traditional bank has an on-line e-bank interface and/or at least one mobile app. Some of them are practical and fancy, but most look outdated and modest in features next to a start-up’s freemium mobile application. With open banking gaining traction, these traditional banks are in pressure to getting their API strategy and execution right. Open banking fintechs like Cake from Belgium are exposing the poor state of APIs traditional banks have. It is only one side of the coin. In the back-office, there are still many areas in almost all institution where the levels of digitalization is – let’s say – natural sloth. The systems are hardly and partly integrated with each other, every business area has its own rote, and the different systems are not working together in a standardized way. This leads to complicated workflows in some cases and this complexity means drag and costs for institutions. Meanwhile each poorly integrated satellite system is a potential killer of any progressive feature on the fancy front-end. Nowadays the divided and legacy layers of banking back-end can’t affiliate the full potential of an up-to-date client portal or application. By using customized 360 degree, microservice -based solution from a vendor for a specific business process, this complexity can be reduced, and the goals of bank customers, back office staff and IT operation can meet.
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