In June 1967, a crucial change for the world of finance unfolded as the first ATM was installed in the city of London. At that time, credit cards hadn’t been invented, so the ATM would accept only checks and people could withdraw only 10 pounds at a time. Nevertheless, it was one of the first instances when a machine could replace a person – a teller in a bank. This was the turning point for the way people interact with financial institutions, for this day marked the beginning of technological intervention in an industry that is as old as checks seem nowadays.
Since then, each technological breakthrough has somehow – directly or indirectly – affected the banking industry, and shaped it into the industry we know today. It soon became clear that the reason technology would attempt to disrupt the industry was that the way banking had operated for over a century could hardly be dubbed ‘effective and convenient’, but rather ‘bureaucratic and heavy’.
The idea of disrupting the bank might have implied good intentions, but it was a very naïve idea. Banks exist for a reason, and they’re not going anywhere. They act as a regulated mediator between businesses and consumers, and without this sort of regulation, the financial system would collapse. The key word here is regulation, because no matter how much effort is put into the attempt to scatter the financial industry, it would still need some sort of supervision. It just doesn’t work the other way around, and the proof lies in the fact that this still hasn’t happened.
This understanding was pivotal for the FinTech community because they realized it’s no good trying to replace the bank. The only win-win solution would be to work with them. The banks, for their part, understood that FinTech companies were doing something interesting, so they started to work with them, support them, and promote them.
This so-called partnership period began in the mid-2010s’ and is still going on. The collaborative relationships between banks and FinTech companies, among other things, have influenced the sort of challenges that both are facing nowadays.
The New Challenges for the Banking Industry
Accessibility and affordability used to be the biggest challenges for banks. The main question was “How can we attract the most people to our services?” Now, the question is, “How can we keep the most people using our services?” Today, it’s all about pleasing the customers. So, with that in mind, here are the three biggest challenges for well-established and emerging banks.
If previously the banks would restrain Fintech startups by any means possible, today the struggle has shifted towards satisfying the customer’s expectations. Technological advancements are deemed a norm in our everyday life, so to keep a customer happy, banks are expected to take advantage of the latest trends in software development, design and usability while remaining compliant with numerous regulations and security standards. But banks can’t just become fun-to-use apps, and this imposes certain constraints that we’re still not sure how to deal with. Many customers, on the other hand, are willing to go fully digital. As CB Insights 2019 reports, 43% of the respondents said Yes when asked if they would consider moving to an independent digital-bank only.
Customer expectations may range from an easy-to-use interface and reduced transaction costs, to more extravagant ones like an ATM locator and chatbot instead of a personal assistant. Once a customer learns that a banking app features Apple Pay, they expect every banking app to feature it. It’s just how humans work — we get accustomed to new things very fast, and we learn to take them for granted even faster.
“Technologies are replacing personnel”. It’s a phrase that scares every clerk who does routine paperwork. As it did in London in 1967, the banking industry is using process automation wherever possible, revamping organizational structures and setting up digital infrastructures that result in more cost-effective service provision.
It’s the core idea behind many FinTech startups — to use technology to provide easier access to financial services for customers. Now that there are lots of individual players in the market who offer specific financial services for a smaller price, banks are struggling to keep up with the competition. But it’s still too hard for them to catch up, because it takes many separate cogwheels to move this bureaucratic machine.
Security and authentication
When news about data leaks are more widely discussed than a revolution in Venezuela, it’s clear that people are more concerned about the security of their data than ever. This results in an increased demand for extra security measures to ensure that no one but the owner has access to their banking account. Security has been regulated since the very beginning of the banking industry, and the standards have not changed significantly.
What has changed, though, is people’s desire to feel safe each time they make a transaction, deposit, or withdrawal of funds, or even sign up for a loan. This, of course, affects the design features because, as I said, customer expectations are what usually drives the decision to move from a traditional bank to a startup. The feeling of security doesn’t have to do anything with the security itself. It’s more of a feeling that can be achieved through various means, most notably the design. The banks, however, cannot afford to provide seamless user experience if their top priority is to deliver top-notch security — a dilemma still worth discussing.
Nevertheless, new challenges always produce new opportunities for businesses. Since the accent has shifted from just doing the financial work to satisfying everything listed above, the new FinTech companies usually aim to deliver a specific type of service.
This table is only the tip of the iceberg. Each service can be split into ten narrower services, and those can be split into another ten, and so on. That’s the structure of the banking industry, simplified. But even without studying it thoroughly, it’s already clear that the notion of Bank and FinTech are merging. Banks are utilizing technology, and tech startups work with banks. When did this become possible? And what technologies are driving these innovations? The next section provides the answers.
Five technologies that make innovation possible
Technology has allowed financial companies to see their customers from a different perspective. Now, by applying a different set of technologies – more advanced ones – we can reinterpret how people consume financial services. The technologies I’m going to talk about in this section are: open-banking APIs, blockchain, artificial intelligence, mobile banking and payments and microservices. Not all of them are customer-facing (the ones that customers interact with). But it’s certain that all of them are influencing the new standards in banking.
1. Open Banking
Open banking is the practice of using APIs to enable third parties to access customer banking data (with their consent) to create new applications and services based on this data. What does it mean? Here’s a simplified example: assume there’s a company who has access to somebody’s spending habits and financial history. This data can be analyzed to draw conclusions about their customer profile which, in turn, can be used to create more customer-centric services (now that they know their customers better). So in part, it means the transition from hypotheses-based to data-based product development.
On a larger scale, open banking doesn’t just mean that banks are becoming open. It’s more of a change in their operational and business model. In their annual report, the Open Bank Project pointed out the main benefits of using APIs for businesses. Apart from improved customer service – the example I used in the previous paragraph – it will promote rapid prototyping and new revenue streams — offering APIs with access to a certain type of data to third parties.
There are multiple benefits for customers as well. When there is a platform for, say, transactions, that features different APIs from different banks, customers will be able to choose among the payment providers and choose the one that offers the best deal. Utilizing the APIs in the financial app development will also mean fewer activities involving intermediaries to whom we’re currently paying service fees.
When is it going to happen?
The adoption of API was initiated by the European Parliament in 2015 with the introduction of legislation known as the European Union Payment Services Directive 2, or PSD2. To comply with the legislation, European banks have to move from bulky and obsolete software in favor of API-based infrastructure that includes robust security features. The PSD2 will come into full effect on 14 September, 2019.
What are the challenges?
In the same survey, the Open Bank Project found out that the biggest challenge for the universal use of APIs is corporate culture and bureaucracy. These two are followed by a lack of understanding of the technology. I believe there’s a certain degree of uncertainty and skepticism from banks regarding open banking. It’s partly because PSD2 is one of the most groundbreaking pieces of legislation ever imposed on all European banks, so it’s easy to see why banks aren’t very happy about it.
The next technology needs no introduction. A simple explanation is that blockchain uses distributed databases and cryptographic encryption of data to store the history of transactions. The recorded history is called a ledger. All parties have access to the ledger, which cannot be edited or deleted because all records are interlinked and synchronized with the same information, which provides transparency for all transactions. Where can we apply it in the banking industry? And if it’s so powerful, why not use it in other industries? This section answers these questions.
Applying blockchain in banking
Transferring money from card A to card B boils down to a few taps. Transfers between different bank accounts are a bit more complex, but still a no-brainer, while international transactions are still time-consuming and often include intermediaries who charge extra fees for the services. Blockchain can reduce the number of involved parties, thus reducing the costs by millions. Apart from the hidden costs for the customer, blockchain can help optimize operational processes. Whenever it comes to referring to past information, like when a clerk needs to create a report about payments based on country, age or the spending habits of customers, it requires them to dig into the archives and juxtapose tables with complex numerical data. The chances of making a mistake are high, and the time it takes to complete this routine task could be used more efficiently. Blockchain simplifies data extraction so the task gets done faster and the clerk is less likely to err.
If you think this sounds too far-fetched, here are the statistics for the U.S. blockchain market. You see that the Financial Services sector is growing each year. And this graph is not a projection of what we expect it to be. There are already working applications that use blockchain for everything described in this section.
Propy, a real estate platform, has two successful cases of payment transactions for housing in California using blockchain. A house in Daly City sold for $917,000, and although the payment was in US dollars, the transfer was made using Ethereum smart contracts. All the information about the transfer — who, to whom, for what, when and so on — is now forever stored in the platform’s ledger. The whole purchasing process took 30 days, which is the same as normal deals.
There are reasons why blockchain is still not as fast as the media usually claim.
Challenges for Blockchain
Although there are even step-by-step articles on how to build your own blockchain for a financial product, there are several roadblocks for blockchain to tackle before it’s universally adopted in the Financial Sector.
- Lack of regulation. Blockchain doesn’t have rules or laws. It’s difficult to get under government control. And it totally contradicts the GDPR, because once somebody’s personal information is in the ledger, it can’t be removed.
- Lack of knowledge. Although blockchain’s tagline is ‘cost reduction’, setting up a blockchain network is expensive. It requires the best software developers. Most engineers can’t comprehend the complexity of its architecture, so they make mistakes – and those mistakes cost us a considerable sum.
- Public image. Like all new stuff, blockchain will take time for people to get used to and move away from the idea that it’s used by crypto-miners to get rich. Also, because of the attention from the media in 2017-2018, it has become a buzzword among the professional community and is often used sarcastically.
- Tech constraints. Until we know more about the technology itself, it will impose certain constraints on the design of interfaces and technical performance. Usually, setting up a blockchain wallet (account) requires more steps than an ordinary login on a website, and problems with scalability decrease performance and transaction speed.
3. Mobile banking (a.k.a. Neobanks)
The banks that are fully digital – that have no physical branches – are called neobanks. The first popular neobanks were Simple and Moven, both American. In Europe, the leaders are Monzo and N26, from the UK and Germany respectively. The perks of signing up for a digital account is that you never need to go visit a bank to get service. You do all the financial activities through an app interface. Banks, in turn, reduce the cost of maintaining physical branches and service staff, so the focus is on delivering cost-efficient and user-friendly applications and services.
What’s so appealing about using a digital bank? Let’s find out.
In the UK, 9% of adults have opened an account with neobanks, Finder reports. If you take a look at the table on banking services for individuals, you’ll see that what banks are offering is not what customers do on a regular basis. Neobanks understand current customer needs, and so they shape their functionality accordingly.
What do neobanks offer?
Neobanks can’t help you manage your investments, nor do they offer various savings, checking, and credit options. Here’s what they do instead:
- Convenience. When you deposit funds, or share a bill for lunch with a friend, the transaction information will update instantly, and thanks to great interface, all operations that used to include queues, form, banks and approvals are now replaced with a few taps.
- Spending analytics. One downside of using cards is that you send more compared to paying in cash, since you don’t notice how you give the money away. Because of that, lots of apps emerged to help to keep track of expenses. These app required users to write down each time they pay for something which was very inconvenient. Neobanks have built-in expense analytics linked to the holder’s card, so it’s clear where your money is going.
- Lower fees. Neobanks don’t have branches and therefore need fewer employees, hence reduced costs. The saved money later transforms into lower fee rates for their customers. They also tend to have low-to-none ATM withdrawal fees which makes it extremely useful as you don’t need to run through the neighborhood to find you bank’s ATM.
Despite all the benefits, what may stop a customer from going fully digital is that neobanks might not meet all their needs.
Challenges for Neobanks
I mentioned the absence of investment management and different account options. Let me elaborate on that and other roadblocks.
- Limited services. Neobanks provide many services for day-to-day financial operations, but due to being digital, they can’t help you with investments advice or mortgages, so for the time being, it’s still impossible to go fully digital.
Read more: How to Build an Investment Platform
- Client support & protection. If a problem occurs, mobile banks can’t give you a manager who will be leading your case until it gets solved. For most requests, an online chat would do, but what if the problem escalates? Not all regulations and standards apply to mobile banks so there might be cases when customers don’t have a working procedure to follow.
Neobanks are having a great start, and I hope there won’t be many obstacles of their way to universal acceptance.
4. Artificial Intelligence
Artificial Intelligence – AI – is a high-level term for different technologies, most notable being machine learning (ML), natural language processing (NLP) and natural language generation (NLG). These technologies are based on learning algorithms that self improve by gathering and analyzing mountains of data. Here’s the brief description of each technology:
- ML is a method of analyzing data correlations and anomalies augmented with human involvement. This allows machines to process much more data than a person could so that it can detect patterns to draw new insights.
- NLP is the ability of a machine to process and use human languages as an input for certain activities. NLP has been used mostly for spell checking, voice commands like for Siri or Google assistant. In banking, it’s widely used for chatbots and sentiment analysis. More on that below.
- NLG, on the other hand, refers to the ability to produce human-like communication in written or verbal form. In finance, it’s used for generating news and reports. Now, there’s no need for a human study multiple pie charts, figure out what they show and then write a report on it.
Read more: 6 Examples of AI in Financial Services
The banking industry is the leading area that currently focuses on developing and integrating AI for numerous tasks — to increase the accuracy of data. Autonomous Research, an independent research provider in the financial sector, has reported that AI is expected to save the banking industry around $1 trillion by the year 2030.
I have mentioned a few use cases for AI in the banking industry. In the following section, I will elaborate that and will provide a few examples of how the industry can benefit from implementing AI.
AI use cases in banking
Reports like the one by Autonomous Research suggest clear evidence for the advantages of integrating AI in the daily routine in finance. Banks, like JPMorgan and Bank of America, have already invested into developing AI algorithms to solve certain problems. I’d like to single out three most notable areas of application for AI in banking.
- Chatbots. Erica is an AI-powered chatbot developed by Bank of America that offers its customers help services by voice and text messages. Erica’s capabilities include:
- Checking customer’s card info (activity, bills, funds)
- Money transfers
- Appointment scheduling with a manager
- Locating the nearest branch or ATM
- Advice about money management
In March 2019, Bank of America reported that Erica has over 6 million active users and the number is growing. Chatbots have switched from being a small number of commands to a human-like support manager, who knows exactly what to do.
- RPA. Robotic Process Automation uses various algorithms to reproduce human activities with computer precision. Such tools can analyze data inputs (documents or reports) and produce results based on the given task. JPMorgan has already invested in RPA development. The result is CoiN, a platform that analyzes and extracts critical information from legal documents much quicker that a team of analysts can.
- Reporting. NLG can transform mountains of data into a comprehensible and coherent piece of text. This technology can summarize a huge analytical report in a 3-page narrative with key highlights. Given that the accuracy and the time to create the report is exceeds human performance, we can predict that within a couple of years, reporting will become a fully digitized process.
Out of these practical applications, we can assume the following benefits for the industry. Like the previous 3 technologies — Open API, blockchain and mobile banking — AI aims to increase the speed and accuracy of operations, reduce costs and please customers with improved personalization.
Benefits for the industry
Cost reduction occurs by switching from human-packed departments to AI-based tools. When tens of hundreds or such tools work simultaneously, tasks like validating money transfer requests (checking whether the input data is correct) are carried out much faster and with less human involvement. Therefore, the speed of transactions improves dramatically. Since machines don’t need to rest, they operate 24/7. And not only institutions benefit from it – customers do as well. The days when you had to stand in line in a branch to get service are no more. As AI continues to teach itself, the accuracy of the outputs increases as well, to such a degree that it’s getting harder to tell whether man or machine performed the task. And finally, the more data an algorithm collects about a customer, the more personalization occurs. AI can analyze your spending history and offer you a credit loan for a specific good. All these benefits continue the trend of shifting towards more human-centric operation by replacing people with machines.
5. Microservice Architecture
In order to implement open APIs, blockchain, neobanking or AI, banks would have to either completely transform their technical infrastructure or create it from scratch. Either way, it’s expensive and lengthy. This short section is a sort of conclusion. It’s about the idea of microservice architecture.
When complex digital systems, like a bank, were developed, all its internal parts were interdependent. Changing one thing affects the rest. Nowadays, banks are spending 73 percent of their IT budgets on maintenance of legacy software. Often, because of incompatible architecture, the software stays in place rather than being merged with new technologies, which results in several systems with duplicate functions that aren’t consolidated. This limits their usefulness. The solution is to build up systems that are easy to change. The design of such systems is called microservice architecture.
Simply put, microservice architecture is a system comprised of small, independent services, each focusing on a certain function, that are easy to change, remove or upgrade without much negative impact on the system as a whole. It may sound like it makes a product simpler, but in fact it makes it more complicated. How come? Since each service is an independent unit, it’s harder to maintain, manage and update all of them. It would require more people involved into the project, each assigned to a single microservice. Also, you can take an old-school system, and add one or several microservices. It’s a game of All or Nothing. The entire bank must use a microservice architecture so that it works as expected.
The benefits and challenges
Microservices is a complex solution that largely depends on the expertise of the team members, but on the other hand, it allows more agility in the future development and utilization of innovative technologies.
The five technologies described in the previous section are a hallmark of the cutting-edge companies trying to change the financial industry for the better. Note that I say “change”, not “disrupt”. Both parties – fintech and banks – are attempting to extend their market shares and so cooperate to engage displeased customers. Fintech companies can offer more agility by adopting the new technologies and cost-efficient solutions. Banks, in turn, have trusted brands, infrastructure in place, and risk management experience. Together, they can establish a working partnership that will achieve the following goals:
- Access new market segments
- Create new offerings for existing customers
- Collect, store, and analyze data
- Deepen customer engagement and product usage
Relationships between FinTech and banks may follow different roads, and there will be cases of both collaboration and separation. There are still many opportunities for fintech startup to succeed on their own. Take money transactions, for example. What strategies can make transactions faster, cheaper and more transparent for individuals and small-to-midsize businesses?
Here are four tips based on the example of N26.
- Remove the complexity and provide a simple interface. It’s frustrating when an action as simple as transferring money from account A to account B takes more than 3 steps and requires users to fill out unnecessary input fields. The solution would be a simplified interface focused on the successful completion of the action. You can also change the interface copy. Instead of jargon, try simpler words, so instead of ‘Make a transaction’ it reads ‘Send money’.
- Make transactions more transparent. By transparency, I mean revealing all the extra fees and showing the real transaction numbers up front. N26 has nailed their international transaction feature. They show their customers real-time exchange rates and make clear how much you send and how much the recipient will get. More on that in #4.
- Streamline a frustrating experience. At some point, each user flow has a frustrating point. It might be either an error message or a task that requires many small steps to complete. Now, what information is usually required to send somebody a few dollars for movie tickets? The minimum is: full name, address, card number, and a phone number. Then it can get weird. Some may require a bank account number, IBAN, email address, and other things we don’t understand why we need to provide.
…or, you can just select a contact from the list.
- Exclude third parties when possible. Many banking apps offer services that aren’t their own, but involve third parties. They may use intermediary banks for certain operations – and that’s where the hidden fees are. The most notable example is international transactions. If a bank doesn’t have its own IBAN, it will use an intermediate. Luckily, as open API expands, it’s getting easier for bank to exclude third parties, at least to the degree that they don’t affect the customer experience. N26 has partnered with TransferWise to allow quick money transfers in international currencies. As a result, customers enjoy seamless design and no hidden costs.
Although many blame the financial industry for being bureaucratic and inconvenient, it’s actually the best system the world has seen in the last 400 years. Banks have accepted the fact that others are doing some amazing things to improve the industry. Luckily, instead of trying to oppress them, they’re cooperating to promote innovation.
The five technologies we’ve just explored — Open API, Blockchain, Mobile banking, Artificial Intelligence and Microservices — are the future of the industry. It’s not a guess, but a fact, and there’s plenty of evidence to support this claim. Due to the shift from bulky and monolithic system architectures to agile and human-centered system design, we can make international transactions in seconds and have our data stored securely. So let’s take all the steps required to make using financial services a pleasant experience for good.