The Restructuring of Financial Services in the Wake of Digitalisation
Finance Monthly hears from the Financial Services team of Roland Berger in the Middle East, represented by Andreas Buelow, Bhavin Shah and Feroz Sanaulla. Between them, they cover the Middle East region across all financial services sectors – most notably banking, insurance and asset management. Their individual focus areas are based on their strong points: Andreas leverages his past experience at a global blue-chip insurer to cover our insurance clients, Bhavin focuses on banking and regulators based on his previous experience in consulting and Feroz builds the bridge between the financial services world and the tech world with his rich background as a corporate VC executive. Below, we speak with them about their passion to tackle the challenges arising from the digitalisation of financial institutions in the Middle East.
What is the current state of digitalisation in the Middle East?
We need to consider that digitalisation is an important driver of transformation in the financial services space globally. Additional dynamics such as low-to-zero interest rates, a challenging global economic environment (US-China trade war, coronavirus, etc.) and changing regulatory environments add to this challenge. Moreover, in the Middle East, markets are highly competitive due to the number of financial services players present. In combination, these dynamics put the traditional business models of banks and insurance companies into question.
Many established financial services players have started experimenting with digitalisation, often with the aim to improve customer experience through new forms of interaction such as chatbots, facilities to conduct business online (e.g. insurance renewal) and financial planning tools such as mortgage calculators. In addition, some financial institutions have started replacing their legacy core systems, ranging from full replacement of the core system to light-core system and middleware connected by a host of API-linked systems.
Digitalisation is a topic that continues to occupy substantial mind-share with financial services executives on transformation projects and as a strategic challenge to their market positioning.
What is happening beyond the existing financial services players?
Digitalisation also allows players from outside the financial services space to make inroads into banking and insurance, often leveraging highly developed customer insights. One example in this regard is telecom providers moving into financial services in a bid to broaden their traditional offerings. They leverage extensive information about customers for businesses such as micro-lending, crowdfunding, credit scoring and others. Other players in highly customer-centric industries are considering similar models – retailers are a good example.
The current low-interest-rate environment not only threatens traditional business models in financial services but also serves to push the emergence of FinTech companies as direct challengers to financial institutions.
The current low-interest-rate environment not only threatens traditional business models in financial services but also serves to push the emergence of FinTech companies as direct challengers to financial institutions. They are fueled by cheap money seeking return and the substantial efforts of governments to attract new industries in their bid for economic diversification and development. FinTechs are interesting not only because they seek to innovate, but also because they have a different risk profile: where established players need to get their digital strategy right in order to not jeopardise existing business and employment, FinTechs can take a stab at one specific problem time and again. In the worst case, they go out of business when they run out of capital. The founders then have the choice to pivot and take another stab at the problem with a new company – so long as they manage to continue raising funding. Fail fast approach to innovation is now becoming a norm and many corporates are in the early stages of figuring out how to embed this in their own organisations.
As the popularity of FinTech in the region increases, banks are no longer bound to innovate internally. Instead, they may carry out the process through partnerships with the startups. Currently, the choice between organic innovation and partnership stands as a crucial decision that could have a significant impact on the outcome of substantial effort and investment. Therefore, firms must be cautious about the advantages and disadvantages of each option before making a decision.
How has digitalisation affected the banking and finance industry in the Middle East?
Digitalisation has a substantial impact on the financial services industry in the Middle East. Just think of three key developments: drive towards simplicity, development of best-of-breed partnerships and the innovation strides of regulators.
Moving from complexity towards simplicity is prevalent in many industries. In the automotive industry, the combination of internal combustion engines and fuel is being replaced by a combination of electric motors and battery packs. The key to optimising electric motors and batteries is in the software that manages the systems, hence, Tesla's ability to improve performance over-night through software updates. Similarly, the financial services industry is increasingly making use of flexible, lighter cores that are complemented by a variety of other systems – held together by software that connects and makes sense of the data. There are a number of providers of such light tech-stack solutions that enable new forms of partnerships that allow for digital onboarding, personal finance management and digital loyalty programs to be provided from various sources, held together by a flexible middleware.
We are also noticing the rise in multiple FinTech arms of big established players from non-Financial Services sector like telcos, retailers, logistics, etc. across the region.
So we are talking more about a patchwork of partnerships and integrations that are emerging as a solution?
Yes, developing best-in-breed partnerships has become a key advantage: the usage of SDKs and APIs allows real-time connectivity between systems from a variety of specialised providers. This enables a fast and flexible roll-out of services compared to cycles of pure in-house development. One important effect from this is an increase in the overall level of product quality if the technical aspects are properly resolved. Another important effect is to reduce the advantage of pure size for financial institutions and thus to further increase competitive pressure in the market. As a specific example, consider telco providers partnering with financial institutions to provide micro-lending via a smartphone app like Tamam.life in Saudi Arabia. Originating from such simple beginnings like microlending and wallet solutions, telcos can build strong offerings to become serious digital banking contenders.
This is welcomed by many regulators in the Middle East, it seems?
Innovation strides by the regulators are an important driver of innovation overall. The Middle East has seen a massive increase in activities of the regulators to attract, encourage and adopt innovation. Open banking regulations are one example of the introduction of innovation through regulation. Regulatory sandboxes are another, very relevant example as they allow new players to test new business models and partnerships without the full burden of comprehensive regulations. In free zones, there have been deliberate strides in creating a robust innovation culture paired with light regulation so that startups have a home for experimentation. Some free zones then aim to bridge and communicate with the regulators to slowly migrate these innovations into the mainstream economy. None of these dynamics would be possible without support from the regulators.
Does it seem like there is more to come?
Online and mobile banking indeed changed the industry. However, they represent how customers access banking services instead of a change in the core workings of a bank. We think that this presents a real opportunity and threat at the same time. As FinTech and BigTech become more important threats to traditional players in the industry, banks must consider the way they innovate. In this respect, we believe that banks should pursue "real across the value-chain innovation" rather than "superficial front end services".
These three developments are just the start of how digitalisation is changing the financial services space in the Middle East. A look beyond towards the US, China and Europe provides some perspective of what is yet to come, including fully digitalised banks and insurers, algorithmic support in core processes such as claims management or credit scoring and much more. Take China for example - just to name one example, Ant Financial operates Alipay, the world's largest mobile and online payments platform as well as Yu'e Bao, the world's largest money-market fund. Ant Financial also operates credit payment company Huabei, as well as an online bank called MYbank. In 2015 Ant Financial launched Ant Fortune, a wealth management platform. Another example is Ping An, the insurance company that has developed from a brick-and-mortar insurer into a veritable tech platform over the past decade or so. These super apps and large-scale platforms are only in their infancy in the Middle East. They are mostly a matter of creating scale and cooperation between players, and will sooner or later also land in the Middle East.
A low-interest future poses major challenges for central banks around the world.
What are the key challenges that financial services in the Middle East face?
The first key challenge for financial services players in the Middle East is customer-centricity. Banks and insurance companies have traditionally been cumbersome to deal with – and many still are if you just think about the average claims experience or mortgage application. Simple processes like KYC and document collection are often still manual and e-signatures are not considered legal means of transaction yet with applications such as eSignOnline waiting yet to be adopted. Products are developed mainly from the perspective of financial institutions' and the legal environments' needs when customers may require entirely different solutions for their needs. The second key challenge is scale, or rather the lack thereof. With the exception of Egypt, Saudi Arabia and to some degree the UAE, markets in the Middle East are mostly small in size (both in terms of GDP and population). This limits the ability of companies to grow and to, therefore, invest in new technologies. This is a particularly significant issue in the insurance space but by no means less important in banking. The third key challenge is the transformation of organisations and along with this, the skills, mindset and capabilities of employees. This includes, for example, the acceptance of new working styles, agile management methods and the embracing of innovation by an industry and workforce which has traditionally been very conservative.
If we look at customer centricity, what specifically needs to be done?
Being able to adjust interactions to the specific demands and needs of customers is key for customer-centricity – ideally down to the level of the individual customer. This is what financial institutions are not very good at, which opens opportunities for more customer-centric organisations such as telcos, retailers, native online players, and others to create viable value propositions. For example, not many financial institutions in the Middle East analyse their NPS or their customer complaints registries in a structured and continuous manner for improvement potential. Social media posts (Twitter, Facebook, LinkedIn) are mostly ignored as a means for gathering customer feedback – and these are low hanging fruits. Augmenting this through platform use and technologies can help in making substantial progress towards understanding their customers better and deeper.
This is where the scale problem comes into the mix. Domestic markets in the Middle East are often comparably small in terms of the addressable market. In addition, some are (over-)saturated with financial services players and therefore faced with strong competition. This combination of small scale and often fierce competition limits individual companies’ ability to justify the required substantial investments into new technologies and innovation. The obvious solution of consolidation has been on the cards for over a decade now – but it yet has to happen at scale. As an alternative option, some players are already considering pooling and partnering as viable options to enable themselves to utilise technology, e.g., across the value chain in insurance to enhance the customer experience.
Can you give a specific example?
Open Banking is an interesting example because regulation is forcing banks to share data with not just other banks but any unaffiliated businesses looking for that data. This data portability has created several innovative business models like DAPI (a UAE born company), the first financial API in MENA that lets FinTech apps leverage open banking by initiating payments and accessing real-time banking data. But that is just the beginning, Open Banking will fundamentally change the landscape of banking and insurance.
Technology and digitalisation also allow regulators to become faster and more focused themselves.
Yet, this will raise an entirely new set of questions around ownership and usage of customer data, level playing fields, channels to the customer and many more. Will banking and insurance truly become open, or will the incumbents create artificial barriers to protect their data? Many a new business model is hidden in the answers to these questions.
In what ways have regulatory pressures and the low/zero-interest-rate environment in the Middle East affected the financial services sector?
A low-interest future poses major challenges for central banks around the world. Their initial measures to reverse negative interest rates were heavily criticised and more recent interventions, such as a graduated interest rate (introduced for example by the ECB), indicate that monetary remedies are reaching their limit.
The low-interest environment changes the dynamics of the game at two levels – the first one is the traditional business and revenue model in the financial services space as it is based on interest (or a profit markup in Islamic Finance that is at least loosely oriented on interest). On the second level, low-interest rates lead to a diversion of substantial funds into more risky asset classes such as early-stage funding and venture capital, which in turn fuels a growing number of challengers in the banking, insurance and asset management sectors. As a result, low-interest rates endanger the profitability of the incumbents and prop-up their competitors of tomorrow.
Regulation, on the other hand, is here to stay, albeit likely in a different shape. Mis-selling of financial products, the protection of consumer interests and rights (especially in a world where the product cycle is faster), the stability of the overall financial system and other dimensions warrant continued scrutiny by the regulators. Regulators will continue to focus on stability (capital adequacy, illiquidity, etc.), security (AML, Sanctions, Cyber, etc) and financial inclusion.
Technology and digitalisation also allow regulators to become faster and more focused themselves. This may lead to the current approach of creating relatively comprehensive licenses with extensive compliance and reporting requirements being replaced with a more nimble "a la carte"-approach for regulation. The regulatory sandboxes are the first step in that direction. To fully enable and support digital transformation, regulators will have to think about creating larger markets than the ones in existence today. This may require solutions such as passporting of financial services, a realisation amongst players that their individual positions are untenable and therefore they have to find (institutionalised) partners incl. through M&A and consolidation. What we have seen work in Europe can also work in the Middle East if the framework conditions are right.
The sector needs to accept that the changes brought about by digitalisation are real, fundamental and that they’re here to last.
What do you think are the best solutions for financial institutions to address these challenges and navigate digitalisation effectively?
First and foremost, the sector needs to accept that the changes brought about by digitalisation are real, fundamental and that they’re here to last. Once this realisation arrives in board rooms and executive management floors, the real work of transformation and change management starts. Addressing digitalisation is as much a question of creating the right mindset as it is of implementing new technologies.
To make a very simple and straight-forward example, certain Silicon Valley companies have KPIs on business model failures. They measure managers successes and failures. Too many successes and not enough failures mean that the managers are not pushing far enough. This is an interesting mentality at the very edge of management and meant to create an innovative culture by design. Could Middle Eastern financial institutions adopt a model of this nature?
However, the realisation of a changing world also allows rethinking business models in financial services, as the boundaries between financial services and other, adjacent industries, become less pronounced – think of the impact of self-driving cars on insurance. As banks and insurers are more closely integrated into the surrounding industries, customers can have a more seamless experience – think of microlending at the point of sale with just a swipe. This gives rise to platforms centred on customer needs, and financial services providers are natural candidates to organise such platforms due to the overarching nature of the services they offer, and the broad understanding they have of the economies and customers they serve (even if the latter is not apparent today).
The change of mindset in the board rooms and on executive floors of financial services players often starts with something as simple as an inspirational experience innovation in other places first-hand. This doesn’t have to be Silicon Valley as there is enough tangible, down-to-earth innovation and transformation going on elsewhere. Organisations then have to go through honest stock-taking of where they are - they have to understand what their assets are (tangible and intangible - incl., relationships, knowledge, etc. - idea of an asset repository) and where their liabilities are (financial and non-financial such as a legacy core system that doesn’t allow for change). On this basis, they can then determine the strategy going forward, which should integrate their existing business and any new businesses - it really is more of a bank strategy rather than a bank's digital strategy. The important element here is to make the strategy process tangible through an approach that aims to create minimum viable products that allow for quick testing with customers followed by the according adjustments in iterations, as well as the inclusion of partners in the process.
There are sweeping changes in banking which are changing the landscape and most of these innovations are coming from outside in. The ubiquity of the internet has produced warehouse/basement bankers who are disrupting without any legacy burdens. The regulators are sometimes sleeping through the change and in odd times struggling to catch up. For the sake of a brighter future, we hope everyone wakes up to this new reality.