Stop me if you’ve heard this one: Banking is changing and may never look the same. While that may have been true at many points in the past decade (or century), there is a growing sense in Europe and other developed markets that the next few years will see a more profound change in the financial services landscape than at perhaps any time in the past. Less certain is whether these changes will spread to emerging markets and developing economies (EMDEs) and what the implications will be for the banked or the unbanked, for regulators or incumbents.
The underlying drivers of change are fairly well understood. One is technological innovation, including the internet, smartphones and cloud computing, as well as things like artificial intelligence, biometric identification and distributed ledgers. These technologies are dramatically altering cost structures, revenue models, scalability, user experiences and perhaps the very nature of financial services.
Another is regulatory change, including tighter requirements on traditional financial service providers (FSPs) in the wake of the global financial crisis and competition-enhancing measures like regulatory sandboxes and open banking. These changes are breaking down barriers to entry for challengers, reducing switching costs for consumers and weakening the customer lock-in advantages that incumbent FSPs have historically enjoyed.
The combination of these two broad forces has unleashed an explosion of start-ups in the fintech space and considerable amounts of hyperbole around the impending disruption of incumbents. But what is less well understood is the degree to which these forces are changing the fundamental business models of FSPs and the value chains in which they operate, let alone how these winds of change will buffet EMDEs, where financial services have also been undergoing substantial change. While it is not yet clear how rapid or dramatic these changes will be or how incumbents and regulators will respond, there is increasing agreement on the broad outlines.
- There will be a growing disaggregation of how people consume financial services, as customers increasingly use different providers for different products, use cases and contexts. We can already see this in the ways many people make payments today: using different methods to engage in e-commerce (e.g., PayPal), buy groceries (Apple Pay), have lunch (LevelUp), split a bill (Venmo) or remit to another country (TransferWise). In this increasingly “modular” demand, customers assemble their own portfolios of products that suit their preferences and circumstances just right. Each provider commands a shrinking portion of the whole and may see fortunes change quickly as better value propositions emerge. Marketplace facilitators that use artificial intelligence to match customers with the most compelling products, irrespective of provider, will also contribute to this trend.
- We will see increasing disaggregation of the value chains through which financial services are produced. FSPs will increasingly leverage highly specialized, technologically sophisticated third-party providers focused on offering best-in-class, end-to-end solutions for narrow links in the chain, often on a plug-and-play, pay-per-use basis. This will enable unparalleled levels of service but also make it difficult for banks relying only on in-house solutions to keep up. The range of functions that can be provided in this way is wide, including origination, customer due diligence and onboarding; analytics, compliance and risk management; and customer support, advisory and personal finance management. Such “modular" value chains allow each FSP to assemble a bespoke suite of solutions to fit their strategy and customer demands and to continually evolve it in a nimble, cost-effective manner. But they may also bring about considerable changes in the fortunes of value chain participants, as most of the revenue is captured by the players who generate unique value — which could increasingly be a question of having the deepest analytics, most reliable facial recognition or smartest chatbot. Meanwhile, the actual underwriting of risk — the core of traditional banking — could become an increasingly commoditized, less profitable part of the larger whole.
- There will be fierce competition for the customer relationship, as incumbents, fintechs and potentially the big platform businesses like Google, Facebook and Amazon all fight to be the primary interface between people and their money. Here, banks may face an uphill struggle to match their competitors on user experience design, access to data and artificial intelligence, all of which will be essential in creating the frictionless, engaging, smart and relevant services that modern consumers increasingly take for granted.
What does all this mean for the future of financial services? The UK Financial Conduct Authority (FCA), regulating one of the most dynamic financial sectors in the world, has been asking itself that very question. In December, it issued its final report from an 18-month strategic review of how business models in retail banking are evolving. Its conclusion was that those business models may be on the cusp of unprecedented change, as financial services become unbundled, digital challengers produce innovative, data-driven solutions and incumbents could be sidestepped and grow increasingly distant from their customer base. The FCA sees potential advantages for customers from such a development, including expanding financial inclusion, but it also notes several risks to track as it continues to monitor developments through a business model lens.
For CGAP, the main question is what implications, if any, this will have for financial inclusion at the bottom of the global pyramid. In principle, an increasingly modular financial services sector has many apparent advantages. First of all, increased competition tends to drive down end-user prices, and the far lower costs of new technology-enabled business models means there should be plenty of room for that. Second, the new technological capabilities and intense customer centricity of many challengers should lead to better experiences, with simpler uptake and greater ease of use. Third, the growing range of increasingly specialized providers should result in products that are better tailored to the varying needs of different customers. Fourth, the emergence of entirely new products and services — and the ability to bundle them seamlessly in novel combinations — should create entirely new sources of value. All of these are things that speak directly to key barriers for financial inclusion: cost, complexity, relevance and value.
Will this potential actually be realized? Will these forces play out differently in EDMEs, taking other forms and having other implications? Or will they not play out there at all, due to gaps in cutting-edge technology, progressive regulation, connectivity, smartphone uptake, financial literacy, digital savvy, customer incomes, entrepreneurs or investor capital?
We don’t yet have the answers but will continue to explore these questions. In the meantime, we would love to hear your views. Please leave your comments below or reach out to us through the website.
Thought-provoking. Thanks Peter
1. The term disaggregation feels inadequate. How about “disaggregation plus”? This brings in your point of the emergence of novel bundles of products and services. It's not just the old pieces being taken apart, there are a LOT of cool new parts.
2. I love that you mention underwriting of risk. Speed eliminates costly risks associated with slowness so there is less there financially. Holding no future as a profit center, it’s a commodity.
3. How Google, Facebook, Paypal and Amazon will dominate, or not — and drive scale, or not — in the markets about which CGAP cares is anybody’s guess.