Banking’s Digital Moment
By: Mit Ide
Tags: Mobile Apps, Digital Banking, Fintech

Banking’s Digital Moment

Spurred by young users, mobile apps, and pressure from China, the online banking revolution has arrived

By Irving Wladawsky-Berger

Digital transformation has generally followed three distinct stages. First comes the use of IT to improve the productivity and quality of back- and front-end processes. Distribution is next, leveraging the universal reach and connectivity of the Internet for online transactions and disruption of the industry. Finally, the transformation reaches a tipping point when technologies radically change the business model and user experience, leading to a fundamental disruption of the industry.

While such a digital journey is ultimately inevitable, the pace varies widely across industries. The IT industry has been the most disrupted — often by its own digital creations in a kind of sorcerer’s apprentice scenario. I’ve seen many once-powerful IT companies done in by technology and market changes, and either disappear altogether or become shadows of their former selves.

Beyond IT, few industries have felt the impact of digital forces as much as media. In less than two decades, the global recorded music industry has lost over half its revenue, while the drop in newspaper advertising revenue in the U.S. has been even steeper. Retail has also undergone major changes with the rise of e-commerce, as has telecommunications with the transition to mobile phones. The banking industry, long a leading user of information technologies, has taken a more circuitous route.

Digital Payments Rule

A May 4 issue of The Economist examined digital banking in a special report and claimed that “technology is at last shaking up banking.” Two major forces are driving this shake-up: the dramatic growth of digital payments in China and other Asian countries; and the rise of mobile banking in the West, especially among young digital natives.

In the U.S. and other advance economies, payments for e-commerce, online music and ride-hailing services have been mostly based on widely available credit and debit cards. But, given the relatively low penetration of credit/debit cards in China and other Asian countries, e-commerce, social media, and ride-hailing services have had to bundle digital payments into their apps. Such payment apps are now a way of life for over one billion users in Asia. While linked to banks in the back end, payment app companies control the customer relationship and the vast amounts of data that give them insights into their customers’ preferences and behaviors.

In China, AliPay and WeChat Pay have transformed commerce, social media, and everyday life. Alipay was started in 2004 by Alibaba, with the goal of making online payments easier for its new e-commerce website. Since its inception, Alipay has grown remarkably fast while adding new services like person-to-person payments and the ability to pay for a wide variety of purchases both online and in physical establishments. Renamed Ant Financial in 2014, it’s now one of the world’s biggest financial firms. WeChat Pay, Ant Financial’s main rival, was started in 2013 by WeChat, China’s dominant social-media app.

Together, they’ve made it possible for China to bypass credit and debit cards and leapfrog straight to mobile payments. Their remarkable growth “is both a cause and a consequence of big changes in Chinese life: development, urbanization, and the emergence of a vast middle class ready to spend.” But, it also exemplifies the radical shift that’s been taking place in the provision of financial services since the advent of the iPhone and App Store in 2007, a shift that goes well beyond China’s borders.

In the West, banking has been late to the smartphone age, partly because entrepreneurs have been put off by increasing regulations, and partly because banks have been preoccupied with repairing their balance-sheets and cutting costs since the financial crisis — which incidentally, pretty much coincided with the advent of the smartphone.

But, mobile banking is now reaching critical mass. Nearly half, 49%, of Americans bank on their phones.

In addition, U.S. tech giants might well decide to follow China’s example and integrate digital payments into their apps, as Facebook recently announced with Libra, while relegating incumbent banks to providing back-end financial services.

Though people of every age use mobile phones, the best way to understand the future of banking is through the eyes of smartphone’s most devoted users, digital natives. “The main reason people choose a bank is convenience…For older people that means a nearby branch; for younger ones it means an excellent app.” Fully 85% of American millennials — those born between 1981 and 1996 — use mobile banking, with the share expected to be higher for Generation Z — those born after 1996.

Digital natives are demanding customers, with expectations for speedy, convenient service. They use their mobile phones “to read, chat and play, stream music and videos, hail taxis, order food, and search for dates and jobs.” They’ve cooled on cash. “Half of American millennials use peer-to-peer payment services such as Venmo or Zelle at least once a week… just one in three American millennials has a credit or debit card, a much lower share than for previous generations at the same age.”

Fintechs Move In, Customers Win

Switching banks has long been rare . In a given year, only 8% do so in America and 4% in Britain. But, younger people no longer stay with the same bank as their parents. An increasing number are using mobile-only. Not bearing the cost of branches or the maintenance of legacy systems, neobanks can concentrate ton providing the kind of digital customer experience that their demanding users expect. Innovative financial services from FinTech startups are also adding to the pressure felt by banks.

“The biggest four American banks are spending a total of over $25 billion a year on perfecting better customer applications and learning to mine data more cleverly. Venture-capital firms invested $37 billion in upstart financial firms last year.”

The shake-up of banking should be great for customers. “The benefits of technological change are likely to be vast. Costs should tumble as branches are shut, creaking mainframe systems retired and bureaucracy culled… Rotten service will improve — it is easier to get money to a friend using a chat app than it is to ask your bank to transfer cash. The system will get better at its vital job of allocating capital. Richer data will allow banks to take risks that currently baffle underwriters. Fraud should be easier to spot… A smartphone revolution in finance offers one of the best ways to boost the economy and spread the benefits.”

But change also poses risks. “The implications are profound because banks are not ordinary firms. It is one thing for Blockbuster Video to be wiped out by a technological shift, but quite another if the victim is Bank of America…Because the financial system is embedded in the economy, innovation tends to create turbulence.”

Will incumbent banks embrace the necessary transformations before neobanks and FinTech startups gain scale and distribution? Will we see further concentration as banks become as adept at leveraging data as technology giants, or will technology giants move into banking, as has happened in China and might happen with Facebook ?The digital revolution seems to be finally reaching banking, but there are so many factors at play it’s unclear how it will all turn out.