Banks Are Preparing for the Digital Revolution

Yesterday the Australian Financial Review Banking & Wealth Summit kicked off. The two-day event includes attendees such as bank executives, financial regulators and financial leaders. With the first day out of the way, day two kicked off with ASIC chief Greg Medcraft, who took the stage stating that we are witnessing a new revolution. He rattled off the past three:

  • The First Industrial Revolution used water and steam power to mechanise production;
  • The Second used electric power to create mass production;
  • The Third used electronics and information technology to automate production.

Now Klaus Schwab, Executive Chairman of the World Economic Forum postures that we are in the middle of the Fourth Industrial Revolution – the digital revolution,’ Medcraft said.

It makes sense when you just look around. More of us are now using internet banking. In Australia, bank customers were among the world’s fastest adopters of mobile banking. A Bain survey showed 38% of Australian customers interacted with their bank via a smart phone or tablet in 2014. This was up 22% from a year prior.

Banking interactions 06Apr16

Source: Bain Research

Early last year McKinsey & Company published an article surrounding this very topic. McKinsey looked at the digital trend as both an opportunity, and a threat. McKinsey states that incumbents only have a short period to adjust. Failing to do so would put them at risk of becoming obsolete.

And it’s not just for the customer experience that banks are adopting a digital environment. Banks have been using digital technology to automate processes and create new products, among other various enhancements. However, there are those banking institutions that resist change.

For those that do, McKinsey believes customers will punish them for it. As seen in the graph below, the digital potential could increase banks net profits by up to 45%. Yet the potential threat of getting left behind could erode net profits by as much as 35%.

digital innovation in banking 06Apr16

Source: McKinsey Analysis

But these stubborn banks not adopting digital innovation are few and far between. Many banks have already heavily invested in transaction migration. But there needs to be a cultural change across bank as well. They must adopt the habits and culture of digital-native companies.

By 2018, McKinsey estimates digital-disrupted revenues to be around 50% or more. But the pattern of disruption will vary significantly by country and product category. The two graphs below show the difference between nations and products for digital disruption revenues.

digital disruption in banking 06Apr16

Source: McKinsey Panorama

Medcraft went on to say at the summit that the digital revolution was rapidly changing the industry. And customers are the ones who are winning.

The evolution of ‘fintech’ is being embraced by consumers. And they are clearly seeing the benefits. The ease of payments, improved speed and convenience are the driving forces for a better customer experience.

These benefits are also lowering the costs for banks too. So it seems like a win-win for banks that latch on to the digital revolution.

But, as the ASIC chief, Medcraft didn’t leave out how regulators would need to respond to this change. He said the key for ASIC’s response boiled down to four things:

  • The first being the promotion of cyber resilience — identifying potential cyber-attacks in markets through real time market monitoring;
  • The second is to ensure compliance with licensing obligations;
  • The third is to be proactive and forward looking. Steps need to be taken to help industry take advantage of the opportunities on offer. But to ensure that investor and financial consumer trust and confidence is not compromised;
  • And the fourth is to monitor overseas developments on regulating fintech. An example could be the proportional approach evolving in many jurisdictions, such as China.

But how can we use this information as investors? Easy, let’s just look at the first point that Medcraft makes. He says there is a need for banks and regulators to be more cyber resilient.

Could this mean that cyber security services will be needed more in the future? I believe it does. Why? Because we are hurtling towards an ever more immersive world. It’s not just customers who need to be protected online, either, but banks as well.

For anyone interested in finding out more about the industry, here are some notable ASX-listed companies operating in the field of cyber-security: Senetas Corporation [ASX:SEN], Covata Ltd [ASX:CVT] and Future Fibre Technology [ASX:FFT].

Härje Ronngard,
Junior Analyst, Money Morning

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