Traditional banking is at an inflection point. A changing regulatory environment and altered consumer expectations are driving a shift away from the usual business models, while advances in technology are transforming the industry.
Banks have historically benefited from the fact that new competitors face significant barriers to entry. These include access to and knowledge of customers' risk profiles; control over the payment system; a balance sheet to warehouse risk; a secure financial infrastructure; the ability to physically distribute cash and other financial materials; and institutional and consumer trust. Perhaps the most important barrier to entry is the banking industry's closed regulatory architecture, which presents high hurdles for getting a banking license.
Today, virtually all of these barriers are being disrupted primarily by technology. Internet-connected devices, coupled with comfort with mobile communication, is obviating the need for physical locations. Big Data is enabling novel statistical and econometric algorithms that allow companies to use thousands of facts to provide more granular information about customers' creditworthiness. The four-party payment model, in which banks and transaction processors control access to consumers and merchants in a closed-loop network, is also being chipped away by tech.
The notion that risk must be kept on balance sheet to intermediate between savers and borrowers is increasingly being challenged. Various peer-to-peer lending platforms match savers with borrowers directly, without taking on capital risk.
The integrity of banks' infrastructure is being attacked, and in some cases, breached. And the financial crisis, along with a series of recent missteps, have led to a breakdown in trust between consumers and large banks in the U.S. and western Europe.
Banks, in the meantime, are largely failing to respond to these developments. Instead they remain entrenched in maximizing net interest margin. Many major banking innovations have arguably come about in an effort to enhance the bottom line while treating customers as the means to an end. This mindset is setting the banks up for disruption.
Disruption in banking is not a new phenomenon. Credit cards disrupted cash as a medium of exchange in the 1960s. ATMs disrupted physical tellers in the 1970s. Bond markets disrupted traditional loan markets in the 1970s and 1980s. And electronic execution disrupted traditional equity brokerage in the 1990s.
What is new is that the disruptors today are tech companies, and what they are attacking is the core banking businesses of payments and lending.
How can banks compete in this new ecosystem? Every bank should be focused on three core questions. They need to identify the businesses that are in a mature and slow-growth phase but are still providing cash flow. They also need to consider where and how they can adopt novel technological tools to re-energize and enhance existing business models. Lastly, they need to ask themselves about where they should be rethinking their business models entirely in light of technology threats and opportunities.
While these may be inconvenient questions to ask, four perspectives can help guide this thinking.
First, do not get stuck on front-end veneers that's not where the revolution is happening. Think about embracing technology front-to-back to become a true digital financial partner to customers.
Second, identify which segments you can be truly distinctive in, and what technology partnerships you need to transform service delivery to customers. Only by harnessing the full potential of customer data can banks be relevant in a decade.
Third, stop thinking of your bank as a spread lender and start thinking about it as a service and information company. You can originate without keeping risk on your balance sheet. In fact, there are non-bank entities that would be prepared to assume the risks you don't want to hold.
Fourth, invest in data and tech-savvy human capital. No amount of technology will help you if you don't address the people side of digitization. This requires seeking out entirely new categories of talent. Today's esoteric job description of "data scientist" will evolve to become one of the most pervasive roles in banks 10 years from now.
In the classic American film "It's a Wonderful Life,"the character George Bailey epitomized what bankers stood for: relationship- and community-oriented customer service. The George Baileys of the world have since become an endangered species.
If history is any indication, a number of traditional banks will be able to adapt to the challenges of the new digital world and succeed as leaders. But many others will be disintermediated by technology. Those banks that do make the transition intelligently will have a very auspicious opportunity. Through technology, they can empower their employees to re-emerge as George Baileys for the modern age.
Hamid Biglari is a managing partner of TGG Group. He previously held several senior executive positions within Citigroup, including head of emerging markets and vice chairman of Citicorp.