The digital revolution has arrived in the financial services sector. In this article we examine the most important points set out by McKinsey in the light of their latest research, and we ask the question: What radical action is needed for banks to survive in this digital age?
According to McKinsey, fintech start-ups numbered 2000 in February 2016, compared with 800 in April 2015. In addition, the past five years has seen $23billion of venture capital and growth equity deployed to fintechs globally, with $12.2 billion deployed in 2014 alone.
This is a sector renowned for its resistance to disruption by technology (fewer than 5 of the original 450 financial challengers during the dotcom boom survived into adulthood) and a customer base with high levels of resistance to change.
So what is different this time around? Is resistance futile and if so what actions should the banks be considering to secure their (digital) futures?
Dotcom vs the rise of fintech – this time it’s different
In their February 2016 article Cutting through the noise around financial technology, McKinsey recognises that although ‘banks remain uniquely and systemically important to the economy’ some things have changed compared to the dotcom era, providing a unique opportunity for fintech disruption. These include:
- A lack of intrinsic trust in the banking sector since the financial crisis
- The rise of mobile and the effect this has had on payments and services
- The demographic shift from Gen X of the dotcom era to Millennials
These digital natives are far more open to consider new financial service providers than their parents ever were – and more open to relationships that are focused on origination and sales (eg Airbnb and Uber), that are personalised and offer an additional service layer separate to the underlying product.
McKinsey cites this as a significant and attractive opportunity for fintech attackers – estimating that banks earn as much as 22% return on equity (ROE) from origination and sales in contrast to credit provision at only 6% ROE.* (McKinsey 2015 Global Banking Annual Review).
Fintech start-ups – Six markers of success
Despite the differences with the dotcom era, failure rates amongst fintech attackers may still be high. However, according to McKinsey, some fintechs that focus on retail banking may manage to forge long term, sustainable businesses, significantly changing areas of financial services as they go. These winners are likely to be more successful and scalable than their disparate dotcom predecessors.
McKinsey predicts that between 10 and 40% of retail bank revenues may be at risk by 2025, from attackers forcing price reductions and compressing margins. The successful fintechs may be characterised by the presence of the following markers:
- They have advantaged modes of customer acquisition – attracting and building a customer base cost- effectively
- They create a step-function reduction in the cost to serve –a lack of physical distribution costs enables fintech business to pass on cost and time benefits to customers
- They use data innovatively – to drive new products and services, delivered in new ways
- They segment specific propositions – targeting only the most receptive audiences for their offerings
- They leveraging the existing infrastructure – embracing the concept of ‘coopetition’ to work with existing ecosystems
- They managing risk and regulatory stakeholders effectively.
Banks – six digital imperative
McKinsey’s advice for banks is not to panic and over-react to the increasing levels of noise about fintechs, but instead to take a middle ground. This means not concentrating on individual threats but instead taking a view of what attackers represent – then to build or buy the capabilities needed to secure their digital futures. This means focusing on the following:
- Use data-driven insights and analytics – to create a 360 degree view of customers and drive scientific decision making
- Create segmented customer experiences – not a one size fits all, to raise service levels and expectations
- Build digital marketing capabilities to equal e-commerce giants – to make best use of big data available and drive more effective marketing operations
- Mitigate potential cost advantage of attackers through process digitisation and streamlining Rapidly leverage and deploy next generation technologies – one of the biggest challenges is for banks to keep pace with the speed of innovation.
- Rethink legacy organisational structures and decision rights to support a digital organisation – how will banks most effectively support a data and insight driven business model?
It‘s clear that there is a challenging time ahead. Whilst the sector has quietly been dealing with the fall-out of the banking crisis concentrating on cost reduction and the lengthening shadows of regulation, digital attackers have been getting in position. These disruptors threaten to significantly change the shape of the financial services sector, undermining profits and traditional ways of doing business.
McKinsey’s research may be based around retail banking, but that does not exclude the threat posed by fintech disruption for investment banks. The difference in pace between retail and investment banking almost inevitably indicates that similar changes and challenges will be experienced by investment banks in the not too distant future.
Banks now need to change up a gear to reposition their business models and cultures. Underlying this is an urgency to modernise technology infrastructures, quickly retire legacy systems and increase the speed of software delivery using agile methodologies.
One final note of attention: McKinsey’s research may be based around retail banking, but that does not exclude the threat posed by fintech disruption for investment banks. The difference in pace between retail and investment banking almost inevitably indicates that similar changes and challenges will be experienced by investment banks in the not too distant future.
As McKinsey concludes: There is no time to lose.
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