how technology and
regulation will team
up to radically change
banks’ business models.
FinTech Thought Leader for IBM
Watson Financial Services
Regulation is a fundamental engine for innovation in Financial Services. Regulation not only creates the incentive for traditional institutions to invest and transform their business model through technology, but it also creates the necessary playing field for new technologies to be adopted and deployed within a clear legal and regulatory framework – technologies like blockchain for instance. European regulators seem to be making a self-defeating attempt to change the business model of Financial Services. Since clients must take centre stage, their data should be used openly (PSD2), but must be protected (GDPR); and banks and FinTech compensation should be free of conflicts of interest (MIFID2), while manufacturers language should be clearer (PRIIPS).
Disruption has been distilled into the industry since the global financial crisis. This is due to a progressive squeeze of intermediation margins as a consequence of low interest rates; higher cost of capital forcing banks to restructure their credit portfolios towards less risky, and thus less remunerative exposures; and sky rocketing costs of compliance which are caused by the deepness Banks started to adapt to this uneasy landscape by reducing investment banking operations and proprietary trading; and by deleveraging credit risk taking and focusing on wealth management (investment and insurance). The consequence has been to turn commission based revenues into the biggest contribution of their profitability. Unfortunately, however, even these revenues are not a safe haven because of the rise of passive investing at a time when clients have become more informed and price conscious. Furthermore, digital solutions (eg, Robo-Advisors) are accelerating a process of potential disintermediation, which opens the door for technology giants like Amazon and Facebook; while MiFID2 regulation, which fosters transparency on all costs and charges, targets the asymmetry of information between banks and private clients.
Banks are left with a strategic choice to survive. One option is to accept disruptive innovation. In this case banks will become volume businesses through M&A and digital enablement; they will accept current level of conflicts of interest and high compliance costs; they will be forced to simplify their products on offer; and they will reduce the distance between manufacturers (eg, asset managers) and distributors (eg, retail and private banks) to cut costs. The alternative option is to search for sustaining innovation. In this scenario, banks can change their business model in order to transform from transactions (in which money comes from distributing products with embedded fees) to services (in which money comes from packaging products into a mechanism called financial advice, which investors are willing to pay for transparently).
This transformation would be truly r-evolutionary, and it is the heart and soul of my latest book “Financial Advice R-Evolution”, which extends on the content of my recent bestseller “FinTech Innovation”. For the first time, clients would take real centre stage of the investment relationship, steering the discussion away from payoffs and financial market trends (so called in-boarding of the investment solution) and granting much higher relevance to the activities of clients’ on-boarding, which focus on the analysis of risk profiles, goals, preferences, tax implications, and life events. This evolution of the banking model, towards an Amazon Prime type of mechanism, would be truly r-evolutionary and cannot be achieved successfully without the use of FinTech innovation. Only technology can institutionalise all banking relationships with households and SME clients. It will augment bankers to explain the added value of their services, and help clients to understand the new language through a digitally enabled customer experience.
Human beings will take centre stage in banking, and technology will empower them.