Complex Made Simple

The Future of Banking: Will retail banks trip over?

Could increased transparency and further commoditization of retail banking services will likely reduce banks' traditional revenue potential?

Four technologies may alter global retail banking sectors over the next few years: mobile banking, cloud computing, artificial intelligence, and blockchain Banks' ability to respond will depend on their digital readiness The authorities should act swiftly to protect banking systems from disruption that may reduce the quality of banking services or result in vulnerable banking systems

By: S&P Global Ratings

We believe today's traditional banks have no other option than to digitize their business models. If they execute that well, they can better defend and potentially expand their franchises, and possibly offer new products or services. If not, their market positions and profitability could shrink. Digital solutions will not only allow banks to attract more clients and open up new revenue channels, but also become more efficient, all keys to succeeding in tomorrow's digital environment. Such considerations form part of our assessment of banks' business positions. In our view, the increased transparency and further commoditization of retail banking services will likely reduce banks' traditional revenue potential by more than 20%, with more servicers competing for the same client pool. We think revenues might be even more at risk in markets with high-margin consumers, where mortgage lending is being commoditized faster. This situation represents a challenge for banks' business models, since retail banking generates on average about 50% of total banking revenues.

What's more, technology is a leveler. We believe the barriers to entering the banking market have reduced materially and are structurally altering the competitive landscape. The cost of launching a digital retail banking product for a fintech company is now marginal compared with that for a traditional bank operating from a brick-and-mortar branch network. It is against this backdrop that we carried out our tech disruption survey to show where banking systems stand with respect to four broad areas: mobile banking, cloud computing, artificial intelligence, and blockchain.

Change Has Already Begun

Traditional banks are already bracing themselves for disruption. According to KPMG, 73% of the $100 billion poured into fintech investments over 2012-2017 were for innovation in banking services for retail and small and midsize enterprise (SME) clients. Fintech and Big Tech companies have already spotted the weaknesses of traditional banks, many handicapped by complex legacy systems, limited capacity to invest, and low customer confidence. On the other hand, some tech players are using their readily available know-how and material budgets to enter the financial services market.

Although the environment for banking systems varies across the globe, we believe banks will increasingly adopt new technologies, and all will eventually go digital. In our view, new technologies will enable currently unbanked or underbanked individuals and SMEs to better access banking services, particularly in emerging markets. This trend is already visible in China and many developing economies, where smartphones are spurring greater financial inclusion, opening up access routes for bank service providers, and for society as a whole by serving residents that previously had no access to banking services. At the same time, we expect banks in Europe and North America to first seek to reduce costs and only then increasingly invest in digital banking solutions to create additional revenue streams.

Technologies At The Forefront

We believe the availability and fast development of technology will lead to a structural shift in the banking industry. We expect four technology types will gain in importance and represent important considerations in determining the winners and losers in retail banking over the next few years.

Mobile banking

Fully digitized and convenient ways to offer and execute services and products will enable banks to onboard and retain existing clients. Simultaneously, banking will be more easily available to the unbanked or underbanked population and to SMEs, facilitating greater financial inclusion. The comparably lower incremental investment versus running a large branch network will further lower barriers to entry for new competitors.

Cloud computing

This is a prerequisite for the storage and processing of vast amounts of information to improve capacity for innovative products. Cloud computing provides the power needed to commoditize unstructured data, allows banks the flexibility to scale their IT infrastructure up or down, and reinforces the resilience of cybersecurity because of simpler update solutions.

Artificial intelligence (AI), machine learning, automation, and robotics

Thanks to their information-rich client data, banks, with the help of AI and related technology, will be better able to offer tailored services. We believe this technology will allow banks to expand revenues by better understanding client behavior and preferences. At the same time, AI-based solutions will enable banks to establish state-of-the-art "know-your-client" processes and compliance systems to better prevent reputation and financial risks stemming from criminal activity.

Distributed ledger technologies and blockchain

We expect this technology to allow banks to transact business more efficiently and securely. Although we still believe current use cases to be marginal, blockchain application might result in a leaner way to execute structured transactions. Banking regulation will also need to adapt, and the digital literacy of potential product users must improve for banks to fully leverage blockchain solutions.