Finance faces its ‘uber’ moment
If you can't beat them, then you might as well join them is probably not a bad philosophy for banks swamped with new rules whilst fending off still nascent, but increasingly competitive technology-driven up-starts. By Jagdev Kenth, Director of Risk and Regulatory Strategy, Financial Institutions Group, Willis Towers Watson
Soon after former Barclays CEO, Anthony Jenkins, announced his new business venture, 10X Future Technologies, he said that traditional banking is facing an “uber moment”.
“Uberisation” has become shorthand to describe the disruptive force of technology-enabled innovation on traditional services, institutions, business models and delivery. Uber is an online transport service enabling people to hail cabs and pay for their rides using a smartphone app and has considerably disrupted the taxi market.
For many, the uberisation of financial services started some time ago. The convergence of regulatory pressures, technological advances and availability of capital created a sector ripe for disruption. Since the financial crisis, regulators have redefined risk and reward. Banks must hold increased levels of regulatory capital and have been “derisking”; involving reduced lending to SMEs through to curbing activities, such as proprietary trading.
Regulatory demands have increased stress and pressure within the City making it less attractive for talent. When Jenkins was Barclays’ CEO, he spoke of the need to increase bonuses to senior staff to avoid a “death spiral” as attrition rates doubled. The financial sector has seen some senior executives leave for more lightly regulated private equity or hedge funds just when traditional banks need them most.
In contrast to traditional finance, the tech sector seems a haven of innovation. The Harvard Business School reports that 20% of graduating students from the class of 2015 said they were taking jobs in the tech sector, up from 11% in 2011. Demographics also plays a role, with graduates increasingly comfortable with social media and online platforms.
Within this environment, the retrenchment of traditional finance has enabled fin-tech disruption to flourish and enjoy lighter regulatory requirements. For example, peer-to-peer lending and crowdfunding sites have united borrowers with new or alternative sources of capital. The US P2P platform service, Lending Club raised $1bn in its IPO in December 2014. Lending Club describes itself as “the world’s largest online credit marketplace”, which is “transforming the banking system to make credit more affordable and investing more rewarding.” Whilst it refers to banking, it is not a bank and not subject to those regulatory burdens.
Unburdened by legacies
Traditional UK banks have seen challenger banks, such as Virgin Money and Metro flourish as viable alternatives. They’re unburdened by legacy IT systems or trust and misconduct issues and have used technology to provide a distinctive and innovative approach to their customers. Virgin Money has even partnered with Jenkins’ new fintech company to build a core banking platform. Other challenger banks such as Aldermore, Shawbrook, and OakNorth Bank have targeted under-served sectors, such as the “buy-to-let” market or SMEs. Although market share remains relatively small, analysts state that challenger banks provide a higher ROE than the big five UK banks. Internet-based challengers, such as Atom, Monzo, Tandem and Starling may fare even better as they appeal to a new wave of customers with an app-based 24-hour service, promoting ease of use, transparency and clarity.
The regulatory burden is generally lighter for fin-techs firms than traditional banks. Meeting these soaring regulatory, which have soared since the financial crisis, has triggered a hiring spree: JP Morgan alone recruited 3,000 more compliance staff in 2013, but this has not stopped investigations or problems emerging. Meanwhile, the Thompson Reuters “Cost of Compliance 2016” report notes that over two-thirds of firms are expecting skilled staff to cost more, 22% of the larger globally systemically important financial institutions expect the cost of senior compliance professionals to be significantly more, and 69% of firms are expecting an increase in their compliance budget this year with 15% expecting significantly more. Firms are tackling compliance issues across the board, from updating Know Your Customer (KYC) and Anti Money Laundering (AML) controls, improving compliance, reporting and analysis, to ensuring compliance officers are appropriately skilled and trained.
Paradoxically, the banks’ response to regulatory pressures and fin-tech competition may well lie within the technology sector. Technology firms have begun to provide technological solutions to regulatory pressures, creating innovative technologies to facilitate the delivery of regulatory requirements and help banks make up some of the ground lost to fin-tech. Some tech firms, or RegTechs offer KYC solutions, using online platforms which collect and compile data from across countries and multiple sources, helping to verify customer identities. Others have created digital solutions to securely manage and share customer data and identity information. One firm offers cognitive computing and behavioural algorithms to monitor, detect and investigate suspicious trading.
Regtech firms can aggregate and analyse vast amounts of information from numerous data feeds, cheaply, swiftly and efficiently. The UK’s Financial Conduct Authority (FCA) also recognises the potential of technology for the world of compliance. In its feedback statement about RegTech, the FCA articulated the outcome it was looking for: “To improve compliance and reducing the cost of regulation for both firms and the regulator by encouraging innovation development and helping to identify opportunities for the adoption of new technologies that support the improvement of regulatory compliance and the interface between the regulator and regulated firms.”