By Jason Bell
How innovation is fundamentally reshaping the Financial Services industry
Business has always been fuelled by innovation. But in the digital era, the pace of innovation – and the extent to which it has permeated business models in all sectors and geographies – has unquestionably picked up.
As more and more of the physical world is replicated in digital format, constraints of time, space and scale have melted away, enabling agile, digital-native start-ups to carve out profitable niches in markets and industries traditionally protected by high barriers to entry.
Nowhere is this more obvious than in Financial Services. The financial services industry lends itself so easily to the benefits of digital transformation because it is, to all intents and purposes, already a virtual industry. Since the earliest financial innovations of credit, paper currency and capital markets, the core purpose of the financial industry has been to decouple the value of things from the physical things themselves, in order to make the trade in these easier, faster and more efficient.
With the development of digital technology, the flow of information, and the ability to process, analyse and distribute it at volume, has increased exponentially, making the industry more productive and profitable for incumbents. But while the speed and volume of transactions have increased exponentially, digital technology hasn’t drastically changed the fundamental structures of Financial Services. At least, not until now.
Now, a cluster of new innovations, made possible by digital technology, are setting in motion a period of change that will reshape customer behaviours, business models, and the long-term structure of the Financial Services industry.
Broadly, these innovations fall into three main categories: externalisation, decentralisationand connectivity.
The end of the middleman
One of the core functions of the Financial Services industry has been to act as a trusted intermediary for value transfers between parties. With digitisation, the speed and efficiency of this service category has increased, but the system has remained largely unchanged.
Now, with widespread consumer access to digital communication, and technologies such as Blockchain removing the need for a trusted intermediary, the role of the financial institution is surely on the cusp of a major paradigm shift.
The obvious first mover in this development has been Bitcoin, but many competing technologies have launched in recent years. Whilst these are built on the same underlying concepts they employ different encryption technologies or focus on niche use cases.
These new currencies are not without their problems. High levels of volatility are hampering their development as a reliable form of payment or store of value, and risk turning them into an instrument of pure speculation. Lately, it seems, barely a week goes by without a new cryptocurrency launching, but most disappear without trace leaving early adopters out of pocket. A lack of transparency into the workings of the system expose it to fraud and manipulation; and the very decentralisation that gives cryptocurrencies their advantage over traditional counterparts also signal a disadvantage, which is the anonymity of the counterparty in a transaction.
How will established FS providers adapt to incorporate this shift into their business models? There are a few possible responses.
Already, some providers are starting to develop their own services around Bitcoin and other crypto-currencies, including trading services, Bitcoin denominated bank accounts and exchange facilities.
Some are developing their own decentralised solutions – their own currencies, in a way. With proprietary cryptocurrencies, Financial Services providers could offset the long-term loss of intermediation revenues by enabling them to create an entire value ecosystem, offering value-added services as a means to generate revenues and build customer loyalty.
While Blockchain and similar decentralised payment models are still in the relatively early stages of development, and with widespread adoption and adaptation hampered by a shortage of suitably qualified talent, these new ways of conducting, tracking and verifying transactions in the digital space could be as transformative to the Financial Services industry as the creation of the limited stock corporation in the 17th Century.
Inside out
Over the past few decades, there has been a trend for Financial Services businesses to outsource (or externalise) aspects of the business considered “non-core”. Processes around HR and finance, for example, have been contracted out to more focused and specialised providers, driving efficiency and operational excellence.
Now, an increasing number of processes considered “core” or business critical are being handed off to third parties. Cloud computing, advanced analytics, natural language processing and a range of technology and business innovations are enabling service providers to externalise, consolidate and commoditise processes such as transaction monitoring, regulatory compliance and risk management, once uniformly handled in house.
This represents a fundamental change in the terms on which Financial Services companies compete. With the commoditisation of previously core competencies, financial institutions will shift focus away from process execution as a competitive marker, and onto more “human” differentiators, such as personal service and creative problem solving.
At the same time, this increasingly cloud-based business model will also enable small and medium-sized organisations to compete more successfully with large incumbents, by providing them access to top-tier processes that were once unreachable due to lack of scale.
The net result will be that, with lower barriers to entry and an increased focus across the board on high-value service differentiation, customers will be the ultimate winner.
Everything is connected
While the most imminent effects of digital disruption will be felt in the banking sector, the greatest impact is likely to be in the insurance sector, with the imminent transformation of the underwriting model thanks to the surge of connected devices and the Internet of Things.
Traditional underwriting models, based on customer-supplied information and 3rd party historical data, are already being supplanted by new, highly personalised models, based on real-time data gathered from a range of connected devices.
From telematics “black boxes” and connected cars, to wearable technology and connected homes, consumers will be able to take advantage of increasingly personalised insurance products, based on their actual behaviours rather than a notional type that may or may not be accurate.
Insurers will be able to track, analyse, understand and continuously refine individual risk profiles for more accurate underwriting of individual and organisational risk. For consumers, this will mean better products and lower premiums. For insurers, it will open up a whole new world of product and service opportunity.
Insurers will have to carefully navigate the regulatory and ethical complexities of personal data usage. Managed properly, however, they will be able to leverage these new capabilities to evolve into a risk manager for clients, with more frequent and meaningful customer interactions.
The on-going revolution
Digital transformation is a journey, not a one-off event, presenting a continuous pressure to innovate that will shape customer behaviours, business models and the long-term structure of the Financial Services industry for the foreseeable future. Decentralisation, externalisation and connectivity are just three of the many forces at work on the industry, presenting opportunities and threats in equal measure, for established incumbents and challengers alike.
All the while, technology manufacturers and service providers will continue to innovate, while regulations and consumer attitudes to privacy and data protection continue to evolve.
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