Banking’s prophet of doom?
Technology that transformed the way people relate to each other and the world around them– like the wheel and the internal combustion engine that sped up travel, the printed book that profoundly broadened our minds and paper money as a means of exchange – were all disruptive.
In the 21st century, these were joined by Internet-connected gadgets that can be carried in the pocket. The most popular form today is the smartphone. One by one, Internet businesses accessible on smartphones are bringing down incumbents in areas like retail, communications, entertainment and even taxi booking.
Banks, the bluest of blue-blooded industries, are now wondering what’s in store for them. For decades, well-dressed men occupying formal offices in important downtown buildings have controlled the nation’s financial plumbing. Their image isn’t veneer but aimed at gaining customer trust and raising the level of dealings with them way above the village moneylender or the local mob boss.
Upstarts can somehow challenge banks, if trust, which took incumbents decades to earn, can be garnered quickly. In emerging markets like China and India, financial sector startups have been able to do just that – win the trust of customers. In these countries, bank managers break into a sweat when the discussion turns to financial digital startups offering services overlapping investment and commercial banking. Nowhere have such firms (commonly referred to as fintech companies) run a bank out of business. But that’s little comfort for bankers.
Dilshan Rodrigo, a banker who is Chief Operating Officer at HNB, fits the profile perfectly – astute, regal and diplomatic. However, few bankers are as forthright about the great challenges posed to incumbents by technology and fintech.
“This is a global change in lifestyle,” he says about people using smartphones for everything, including purchases, instead of cards or cash. A disruption to banking similar to the one that hit bookstores and video rental outlets in many countries is now underway, he warns. Bankers here don’t realise the gravity of the situation. And they are suspicious of those crying wolf because incidents like the feared Y2K problem proved to be overblown. When regulators haven’t blocked them, fintech companies have collaborated, making finance more inclusive. The banks have no issue with this.
However, a successful fintech company can also grab banking market share. Through smartphone app-based payments, they can cut off the lucrative commissions banks earn on credit card transactions. And, if they are able to raise deposits or channel savings to mutual funds, it will be at the expense of those held by banks. In some countries, fintech companies also lend, in competition with banks. How fintech evolves depends largely on local circumstances, traditions and consumer preferences.
Rodrigo says telcos moving into financial services and payments is a cause for concern. “If a customer is not happy, he will switch. The HNB relationship won’t count for anything if they can’t get the job done fast.”
For HNB, its existing tech platform, invested in eight years ago, is now a barrier. Fintech (short for ‘financial technology’, referring to internet-based payments, banking and investment), as these services are now known, are spreading worldwide. They are mostly accessed on smartphones.
Smartphones are no longer just yuppie playthings. Over the last decade, they have empowered millions of the rural poor, compensating for deficient public transport and difficulty obtaining services, while facilitating growth of small businesses.
SRI LANKA’S LARGE banks have digitised their business (core banking systems), centralised the back office and offer Internet banking to customers. Some of these costly investments test the resolve of century-old banks in a low-wage economy like Sri Lanka where demand for digital services is limited. Banks struggle to challenge fintech companies because they are unconvinced of the short-term shareholder returns on these investments. Being somewhat uptight, bank managers aren’t used to leading agile teams and testing risky assumptions necessary for successful startups. These cultural barriers are at the core of the challenge for large banks.
When a bank does overcome cultural blocks, the results are awe-inspiring.
“They are not a bank doing IT, but an IT company doing banking,” says Rodrigo about his recent visit to DBS – Singapore’s largest bank and a giant even by global standards. He concludes that DBS is turning its culture on its head.
Process maps, customer journey maps and targets covered many walls in a hall occupied by some 60 to 70 young people at DBS. They called it ‘digital to the core’, he says.
“It was like a startup. They basically want to change the entire organisation’s culture to digital,” explains Rodrigo, a mild-mannered accountant who has been part of HNB’s corporate management for some years. Earlier, he held positions at accounting firm KPMG, Standard Chartered Bank and readymade garment maker Brandix.
Fintech companies’ promise, however, extends beyond shaking up stuffy banks. Their lower costs will reduce economy-wide waste, inject efficiency into small businesses, bring convenience and boost e-commerce.
Few bankers in Sri Lanka are stirred as deeply as Rodrigo by the potential of digital disruption to the industry. Most have a vague idea about how digital technology is changing customer behaviour, but few can envision what to do next. For big banks, argues Rodrigo, the challenges are not just about the technology. “To deliver around the customer journey, we need an environment encouraging cross- functional collaboration rather than working in silos,” he says. It takes HNB a few days to process a new credit card application and up to ten days for a mortgage application. We need to change this, says Rodrigo. “We should be able to approve a new card in a matter of hours and take no more than two days for a new mortgage approval.”
With its own IT teams, Singapore’s DBS – a $53 billion market cap company – is able to respond nimbly to market change without external IT vendor assistance, enabling it to better manage the customer experience.
FACING THE PARKING lot of HNB’s imposing headquarters building, which merges a rectangular structure with trilateral sections, is a four-storey building with the slogan ‘Centre of Aspiration.’ Debt collection – previously the responsibility of its over 250 branches island-wide – is now managed here.
There is a similar centre for back office operations in Colombo, where 350 people work. It has centralised general operations and credit operations, freeing branch staff to pursue business growth by engaging more new and existing customers.
Through technology, HNB’s seeks twin benefits – higher customer engagement and reduced costs. Costs as a percentage of income at HNB was 47.1% in 2017 due to investments for growth and high financial service taxes.
HNB, founded over a century ago, scaled before the arrival of tech, linking branches to centralised operations. Banks starting business later benefited from technology more, as they were not constrained as incumbents with more staff than the new systems required and the challenges of transformation. HNB’s last core IT system update eight years ago and its digitisation of other processes four years ago are generating results. “The inbox is empty,” motions Rodrigo with his head to a clutter-free desk. “We are a paperless office. All our credit approvals, memos, operations, everything is on the system. I can approve credit papers from home.”
HNB’s back office units for operations, credit approvals and debt collections centralised tasks managed by branches like housekeeping, accounting, reconciliations, credit documentation and collections.
“In our previous model, 80% of a branch office’s was back office-related while 20% related to customer service. We have now flipped this equation.”
The existing technology of banks is inadequate to compete against fintech companies. “To be honest, we are already late,” says Rodrigo. “But fortunately, nobody is ahead of us.”
FOR CENTURIES, success in the banking business model of financial intermediation has accrued to the most trusted, efficient, best managed and well capitalised institutions.
While technology is rapidly evolving, banking, as the adage goes, is the art of passing money from hand to hand until it finally disappears. Any client of a bank who has sent cash overseas can attest to how fees, commissions and disadvantageous exchange rates has whittled away his remittances. Shopkeepers pay 3% on sales made by credit card, which they must absorb into gross profit-eroding cost of sales.
However, various financial sector institutions, including global credit card companies, whittling away customers’ money expose banks to competition from fintech offering mobile payments, lending and investment.
Fintech firms – without infrastructure like high street branches and imposing downtown headquarters buildings – have a cost advantage. Even their technology is less costly than the multimillion-dollar systems banks use. One of two broad approaches is available for Sri Lanka to spark fintech growth by financial disintermediation.
The first is the route India’s central bank, the Reserve Bank of India, has taken with its 2015 guidelines, under its existing Banking Regulation Act of 1949, to license 11 so-called ‘payment banks’. These light-touch licenses are designed to appeal to mobile phone companies and fintechs. For now, this new breed of financial institutions will not lend money and will only accept deposits up to 100,000 Indian rupees from a single customer.
Besides lending and limited deposits, payment banks can do most other things a commercial bank can, like offering current and savings accounts, issuing ATM cards and providing Internet and mobile banking services.
Indian telco Bharti Airtel was the first payment bank to go live. The Indian model made it possible for any payment bank to create a “digital wallet” by linking a bank account to a smartphone app that enabled customers to make payments. This makes commercial banks uncomfortable as anyone with a digital wallet can bypass the credit cards they issue, resulting in the loss of fees and customer data.
The smartphone apps of HNB and other commercial banks allow customers to undertake transactions they can also manage though online banking, like paying bills and transferring money to other banks. But, the apps can’t make third-party payments.
Fintech firms – without infrastructure like high street branches and imposing downtown headquarters buildings – have a cost advantage
Fintech firms – without infrastructure like high street branches and imposing downtown headquarters buildings – have a cost advantage
People will want to have a ‘wallet’ from a bank, rather than trust their money with a little-known fintech, Rodrigo contends. But he says, should an exciting fintech emerge, “I might push to buy that company for their superior software and market position.”
HNB has used its acquisition-led growth to reach, with great effect, market segments that its core banking business isn’t able to. In 2014, it acquired control of Prime Grameen Micro Finance, which lends to small businesses in rural areas. Rodrigo explains the argument for synergy: “For instance, we don’t know how to do three or two-wheeler financing, but there are companies doing this brilliantly. So we finance those companies. Even though it’s a good business we don’t get into it ourselves but still benefit from the growth.”
Despite high taxation in 2017, large commercial banks were very profitable. In the 2017 financial year, HNB’s return on equity (ROE) of 17.8% was a seven percent premium on that year’s risk-free rate for shareholders. HNB’s market cap of Rs114 billion (around $735 million) makes it the second most valuable private bank in the country.
REMOVING REGULATORY speed bumps along the path to allow fintechs to connect to banks directly is the second approach, and one that floundered here when the government agency leading the digitization agenda clashed with the central bank.
If fintechs don’t hold customer deposits, they have little chance of losing other peoples’ money.
In some countries, like the UK for example, banks have been mandated to allow fintechs to link into their systems. This way, customers transact though apps, which allow fintechs access to their money in the bank accounts. Sri Lanka’s Information and Communication Technology Agency (ICTA), implementing a government policy on digitisation, proposed a platform that would allow fintech firms to connect to banks securely. The advantage is that it eliminates the need for fintech companies to negotiate access individually with banks.
Either outcome will open the competitive landscape as it will then be possible for fintech companies to get between banks and customers by introducing online ‘wallets’ and spend from there. This will make banks very uncomfortable.
“I’m not saying this is a fad or passing fancy and ‘let’s not get too excited about it’. We have to be fully engaged to the point of paranoia because this threat can become serious, ”warns Rodrigo.
However, banks have strengths like branch networks, solid reputations and risk management expertise that fintech companies lack. But Rodrigo says the battle needn’t pit upstarts against incumbents, for there is scope for banks to work together with fintech companies. “We believe they need us as much as we need them,” he says. “The solution is to collaborate with them.”