Digital Barbarians at the Gate
The Tech Threat to Commercial & Investment Banking
In the last decade, most of us have experienced first-hand how digital technology has disrupted retail banking. In Europe alone 58.5% of customer bank online and increasingly fewer people see the branch as their main source of banking services. For most of us our bank is inside our smartphone.
There are numerous drivers behind this shift but the main ones are demand, technology, money and regulation. Customers’ service expectations have changed and are shaped by big tech firms. They now compare their bank to Amazon and not to another bank. Technology is cramming immense digital capabilities into ever smarter, smaller and cheaper devices delivering customer experience unthinkable a few years (months?) ago. Investors are sniffing an opportunity, pouring substantial investment into financial services innovation and driving competition. Last but not least, regulators see innovation as a way to give way to a better and fairer class of financial products for consumers. It would seem that the end of retail banking as we know it is nigh.
We hear much less about changes that are happening in Commercial and Investment Banking (CIB), yet the seismic shift that has engulfed banking is affecting these businesses too. Less visible but relentless, innovation is putting the entire sector in a corner, where the only way forward is to fundamentally change the current business models. In an industry that always thrived on keeping information close to their chest and where collaboration was rare, the only way to survive may well be to embrace transparency and cooperation. Yet, some part of this sector do not feel the urgency to change. Here’s where this false sense of security may come from:
Demand: Whilst retail bank customers have formed their expectations outside finance and demanded digital innovation for some time, large corporates engaged in CIB have started to require better digital services later. With no obvious competition from Big Tech firm, a customised offering and strong corporate relationships, some CIBs have felt that they could take their time to waive in innovation.
Technology: Tech providers have often been more innovative in serving the CIB sector than retail banking and the level of customisation and internal built has been high. This has resulted in higher barriers to entry for challengers, making it very hard for a startup - even if well funded - to challenge the domination of the incumbent providers.
Regulation: CIB is a heavily regulated sector but interventions tend to be a lot less concerned with driving competition and facilitating new entrants than with ensuring good behaviour. This has somehow shielded CIBs from the ferociousness of the unbundling suffered by retail banking.
Money: Risk capital is abundant in CIB, the challenge is that the risk/reward upside associated with backing digital disruption versus leaving things unchanged is not always visible in the short term. That may be why so much CIB corporate venture money flows into consortia. Here the incumbent - the firms that would be most disrupted by new technology - are supposed to back innovation aimed at making them less relevant. From the outside this could look like an effort to innovate without really changing much.
This attitude toward digital change, that some may find complacent, carries great risks. While in retail banking the FinTech wave is resulting in an improved offering and more competition, in CIB digital change could potentially make the entire industry redundant. Here are a few trends that should worry the CIB behemoths:
Blockchain & Distributed Ledgers
Traditionally success in the CIB industry in the past has been driven by one key asset: the ownership of proprietary information and relationships. Distributed ledgers will potential undermine this asset.
The blockchain will make it unnecessary to have paid intermediaries to manage the transfer of money, financial assets and contracts. In its most extreme form, the blockchain could replace:
Payments and FX: Create a global instant payment alternatives to the current clunky infrastructure for sending money, clearance and settlement. A good example of this is Corda by R3, which is openly challenging the monopoly of SWIFT.
Security trading: A blockchain based alternative model, with brokers and banks as expensive intermediaries, with a much cheaper and secure protocol. A company to watch here is ThinkCoin, which has launched TradeConnect, a global digital trading platform that uses both blockchain and AI to completely reinvent multi-asset security trading.
Decentralised Clearance Protocols: This approach simplifies the securities trading process profoundly reducing the demand for lawyers, auditors, KYC agencies to protect investors in the security markets by embedding regulatory and creditworthiness requirement directly in the transactions. Polymath is a leader in this sector, using the blockchain to replicate another function traditionally provided by banks and other intermediaries.
Trade finance: Disrupt Trade Finance, one of the most complex and antiquated business in CIB, still representing a large portion of their revenues. Moving goods across borders involves a number of financial instruments - such as Letters of Credit, factoring, export credit and insurance - and many third parties. It is expensive, slow and prone to fraud. The blockchain is offering a credible alternative, with many successful proofs of concepts - such as the partnership between IBM and Maersk to redesign global trade shipping though the blockchain and the use of smart contracts
Firms like R3, ThinkCoin and Polymath are after these revenue streams that CIBs have taken for granted. If there is a single technical innovation for CIBs to worry about that should be Distributed Ledgers.
Crowdfunding and ICOs
The ability of companies to bypass traditional means of fundraising is still nascent but is developing fast. Crowdfunding for both equity capital and lending is nowadays quite common for SMEs, which are often relying on peer-to-peer markets as an alternative source of funding, cutting out intermediaries such as banks and VCs. The following development could shake the fundraising industry:
Mass Crowdfunding: First-generation crowdfunders like Seedrs and Crowdcube are not currently seen as a real alternatives to traditional financing or IPOs, in part because of a perceived lack of transparency, shallowness of the capital pools, unclear regulatory framework and the perception by some that the market recognition of crowdfunding is “not right” for them. But as regulators step in and governance of distributed ledgers evolves linking directly investors and companies seeking funds, we could see this area grow rapidly.
ICOs & ITOs: Initial Coin Offerings and Initial Token Offering have become the preferred method of raising capital for blockchain companies. This gives a glimpse of the challenge ahead for CIB. According to CoinDesk, ICO funding has reached $6.3bil in the first quarter of 2018, which is more of the total amount raised in the whole of 2017 ($4bil). ICOs come with some headache, both in terms of lack of governance (the travails of the Telegram ICO are a good example) and in terms of risk - EY has calculated that about 10% of funds raised by ICOs have been stolen by hackers. However, as this sector matures and continue to offer a cheap source of funding, it can become an effective way of democratising and streamlining fundraising for corporates of all sizes and remove the need for CIB to act as intermediaries.
Artificial Intelligence and Cognitive Technologies
AI can automate processes that were too complex for machines in the past with a real impact on the quality and quantity of staff and third party support service. These processes include:
Data Extraction & Processing: Artificial Intelligence applied extraction and cleaning of data from multiple and dis-homogeneous information sources will usher a new set of opportunities for CIB. These could deliver better workflow routing and streamlining of tasks like client on-boarding and month-end reporting that will profoundly change the way banks operate today - increasing speed and decreasing costs (see UIPath).
Machine Learning: Analysing large data sets identifying patterns that will enable technology to support better decisions on areas ranging from CRM to fraud detection. Thetaray is doing just that.
Natural Language Processing: Converting information from multiple sources into searchable actionable data.This will have considerable impact on legal services providers both internal and external to the fim. The results achieved by JP Morgan COIN is a great example of the potential of this approach.
Cognitive Agents: Robots, chatbot and the like, supported by the above technology could be used across the firm and even externally. (see Kasisto’s KAI)
Implemented well, Artificial Intelligence can be a true gamechanger for the CIB sector by upgrading the capabilities, speed and efficiency of processes that today rely on human intellect. This will result in greater scope and productivity - but it is likely that it may well drive job losses in the industry as low complexity tasks traditionally performed by humans will move to robots.
All in all, technology innovation will have a considerable impact on the CIB sector. The development and adoption of technology is increasing at lightning speed, banks in CIB that are open to embrace new technologies can find themselves really quickly in a strong position against the laggard, like a car racing a horse. Late adopters in CIB risk may find themselves in a weak competitive spot and marginalised much more rapidly than their peers in retail banking.
The complete reshaping of the industry in the next few years is a real possibility. Embracing innovation, turning it to their advantage and being open to experiment with different business models may be the safest strategy going forward for CIB. Banks need to decide whether to open the door to new technologies or resist the “barbarians at the gate” in the hope that they will not replace the existing order.
By Sabrina Del Prete & Alessandro Hatami