The banking industry has changed dramatically in terms of risk tolerance, and now faces increased regulation and demand for transparency. Simultaneously, banks face competition from a new breed of financial institutions. New players have changed the rules of the game with online lending and payment services, and giant retailers are offering credit cards and banking.

Forward-thinking financial institutions are looking beyond survival and eyeing opportunities to transform their businesses to meet new challengers head on. To succeed, banks must be open to new levels of innovation that will enable them to surpass customer expectations, achieve differentiation, grow strategically and manage risks, while reducing costs and complying with dynamic regulations.

Innovation need not be drastic; it can be a small change in the way banks carry out a particular activity. However, to innovate, banks must align business processes with enabling technology. Consider the following approaches.

Emerging countries are a lucrative option for business expansion. A PricewaterhouseCoopers report titled "Banking in 2050: How Big Will the Emerging Markets Get?" predicts that "the banking sector is going to grow significantly faster than GDP in these emerging economies as they develop." Countries like China, India, Brazil, Indonesia, Mexico, Russia and Turkey "have the potential to develop banking sectors of comparable scale to major European countries," the report says.

A bank must recognize that its international ambitions are dependent on its technology infrastructure. Software should enable — not hinder — growth. For example, Eurobank in Greece expanded regionally by acquiring assets and opening new entities. To support this growth, it standardized back-office operations, enabling it to deliver a uniform customer experience and rationalize the cost of operations without hindering growth or financial success.

Banks also can grow through emerging markets at home. For example, Generation Y represents a large opportunity. To capitalize on it banks need to be aware that Gen Y customers are different in the way they conduct daily business, interact with people and make purchases. They demand exclusivity and they know how to access information for selecting and buying the best products or services available in the market via one click. As important, they rely on opinions from users rather than corporate marketing information.

To tap into this segment, banks must adapt or adopt new business models, provide multiple channels and increase personalized service. They also must invest in their Internet programs, not only on company Web sites, but also in social networking forums.

Japan's Jibun Bank, for example, offers the entire life cycle of banking services on a mobile phone and provides multichannel access through the Internet, ATMs and e-commerce. The bank acquired more than 500,000 customers within its first year and continues to grow rapidly.

Regardless of target market segments, banks must offer innovative products to achieve differentiation and enhance customer satisfaction and loyalty. They can offer products like Bancassurance, which generally involves a partnership to offer insurance products via banking channels, to increase fee-based income, diversify their product base and enhance customer satisfaction by offering a one-stop financial services mall.

They also can look at niche offerings like private wealth management in Islamic banking, like the Bank of London and the Middle East recently did to tap into a new market. In addition, banks can focus on financial inclusion projects like microfinance, especially in developing countries where large populations do not have banking relationships. But they must have agility to quickly roll out new features.

Identifying new markets or segments and creating innovative products is not enough. Financial institutions also need reliable, flexible, enterprisewide business systems that support innovation. Many have realized the need to upgrade or replace their inflexible legacy systems and modernize their IT infrastructure, which allows them to innovate and makes their operations cost-effective and more responsive to business drivers.

With flexible technology and business systems as a stable base, banks can evolve to embrace today's Web 2.0 world. The Web offers new opportunities but also new competition, not only from other banks, but also from new players like Prosper and Zopa, which offer unique lending programs. Mere having an operation in the virtual world will not suffice. Banks must differentiate themselves.

Customers today demand the comfort of transacting any time, via any channel. The virtual world provides great opportunity for banks to increase customer touch points, offer innovative products and establish themselves with minimal cost. For example, National Australia Bank established a direct bank and is moving away from branch banking. Absa Bank created a Facebook page to address customer grievances, driving a surge in customer satisfaction.

Banks, however, cannot move to the Web and other innovative channels without first ensuring they are prepared for threats such as identity theft, money laundering and fraud. This means they need to have risk management and fraud detection policies and systems in place.

As the industry evolves, banks will have to revisit business models, broaden their global profile and optimize operations for survival and growth. Those that look past the short term and see the opportunity to create a competitive advantage for the future will come out on top.