Introduction

The banking industry has undergone a sustained period of change over recent years, and this pace of change is set to continue. In this paper, the “Bank” refers to Bank of Ireland (BoI) Group, and specifically BoI Markets and Treasury, which is the Bank’s customer treasury services provider and market risk manager.  Using the PESTEL tool to analyse the broad macro-environment for banking, the two factors most pertinent to BoI at present are Technology and Legal. 

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Technology factors

Retail banks are experiencing unprecedented change and disruption from technology, with payments services at the forefront of customer switching habits. In recent years, customer expectations have shifted from the traditional face-to-face retail branch banking model of banking to always on, 24/7 contact through digital channels. The vast majority of Irish banking customers execute their day-to-day banking through online channels, mobile and tablet apps.  “In the past decade, digital banking activity has almost quadrupled: it has grown from 23.3 million payments in 2007 to 87.1 million last year.” (BPFI Payments Monitor, H2 2017.)

“Customers have more choices, variegated customer needs can find expression, and supply alternatives are more transparent.” (Teece, 2010, p. 172).

Customers’ behaviours are being moulded by their digital experiences in other industries such as music and home entertainment. Fintechs operating in the Irish marketplace, e.g. Revolut or Transferwise, are offering superior customer experience, reduced fees and charges, and increased transparency for customers, thereby giving customers choice, where until recently there was none. Such disruption has caused changes in customer behaviour and expectations and consequently customer adoption virtually overnight.

According to a PwC Global FinTech report in 2017, and as is the experience with BoI currency payment customers, “more consumers will adopt non-traditional Financial Services providers. Early adopters will most often conduct payment and money transfer activities with non-traditional providers, and personal finance will emerge as the next most populous activity at risk.”

As is the case with BoI, legacy IT systems underpinning traditional banks are high cost, complex and difficult to innovate. In order to keep apace with this fast-changing market, BoI has had to replace its core banking platform, overhauling end-to-end customer journeys and revising its customer propositions.

Such strategy can be prohibitively complex or expensive, and per PwC 82% (of respondents) expect to increase FinTech partnerships in the next three to five years. In replacing its core banking platform, BoI could either stand up its own platform, or partner with a recognised banking software specialist, and as is becoming the norm, BoI has opted to contract the services of an established banking software specialist Temenos.

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With the possible commoditisation of certain customer propositions, such as currency payments in BoI, technology factors will force traditional banks to re-assess their core business offerings, both business model and role in society. As such, where fintechs can offer a superior customer experience at a lower cost for certain services, e.g. payments, it will become prudent for traditional banks to focus their strategy on the core tenet of banking, value creation, and value-add service offerings such as advisory, with the potential to partner with  or outsource certain services to fintechs.

New technologies such as artificial intelligence, data analytics, APIs, and Blockchain may also present traditional banks with significant opportunities in value creation and risk management. Per McKinsey, “Yet technology is not just a threat to banks. It could also provide the productivity boost they need. Many institutions are already digitizing their back-office and consumer-facing operations for efficiency. But they can also hone their use of big data, analytics, and artificial intelligence in risk modeling and underwriting—potentially avoiding the kind of bets that turned sour during the 2008 crisis and raising profitability. 

Such emerging technologies may facilitate the automation of compliance and customer identification processes, such as Know Your Customer, which heretofore have been resource heavy, requiring significant manual intervention.

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Legal factors

Arising from the global financial crisis and the subsequent sovereign debt crisis in the Eurozone, the European banking industry has experienced a prolonged period of regulatory reform, with banks facing a wave of new regulations in recent years including European Banking Union, PSD II, MiFID II, EMIR, Basel III, Benchmark Reform and the proposed EU Directive on Cross Border Payments. Moreover Brexit, in whichever manifestation, poses its own set of challenges to the European banking and payments industry.

As per Strumeyer and Swammy (2017), such regulatory reform “has started to significantly impact business models. It has affected the industry’s revenue earning capacity, it has led to a significant increase in costs of operations, and we are starting to see an impact on competition and concentration levels in the industry.” 

This level of regulatory complexity poses significant resource and cost challenges to banks such as BoI, with investment in risk and compliance functions growing, and the burden of compliance here to stay. From a BoI Markets and Treasury perspective, there are several regulations and changes to the regulatory landscape that pose the significant threats to income and resource capacity, including the Payment Services Directive (PSD) 2, and the EU Directive on Cross Border Payments.

PSD2 came into force in January 2018, requiring banks to give third-party payment service providers (PSPs) access to their customer’s data through open API (Application Program Interface) technology, with the aim of increasing competition in payments services, as well as lowering the cost for customers.

PSD2 represents a significant step toward commoditization in the EU banking sector”. PSD2 is viewed as a game changer for the banking industry, posing significant challenges to incumbent banks like BoI, where minimum compliance has been the initial focus. Challenges include customer attrition to the above-mentioned Fintechst; and the inability to innovate at a sufficient pace due to legacy IT infrastructure and competing investment priorities; both of which will cause loss in revenues.

However, PSD2 also presents opportunities, not least inclining banks to “perform a rigorous self-assessment as they transition to the world of opening banking, including their market positioning and competitive strengths”. PSD2 encourages slow-to-innovate banks such as BoI to consider partnerships with fintechs, and the use of open APIs as a means to address gaps in their propositions, which may enable them to reach new customers and markets.  “Banks can define their desired open-banking footprint. They should maintain or develop internal capabilities for products and services they deem “core” to their value proposition, but they might turn to third-parties for ancillary offerings”.  (PwC 11th hour)

The proposed EU Directive on Cross Border Payments which was published by the European Commission in March 2018 will amend current cross border payment rules for all EU member states, with the express aims of lowering the cost of intra-EU cross-border currency payments in non-Euro countries, and increasing transparency regarding currency conversion practices. This proposed regulation will have a profound impact on the BoI Markets and Treasury currency payments business, where currently income is derived from cross border fees, as well as embedded margin on currency conversion.

Conclusion 

Both technology and legal factors have caused major changes in the banking and payments industry in recent years, with the pace of transformation set to continue. Both factors require retail banks to determine their fundamental core propositions and innovate their business models accordingly. “Technological innovation often needs to be matched with business model innovation if the innovator is to capture value.” Teece, p186.

Bibliography

Teece: Business Models, Business Strategy and Innovation

Redrawing the lines: FinTech’s growing influence on Financial Services (PwC Global FinTech report)

BPFI Payments monitor H2 2017

https://www.mckinsey.com/industries/financial-services/our-insights/a-decade-after-the-global-financial-crisis-what-has-and-hasnt-changed

Strumeyer and Swammy (2017) – The Capital Markets

PwC: The Future of Banking  – Innovation & Disruption in light of the revised European Payment Services Directive (PSD2)

PwC: Waiting until the 11 Hour

PSD2: Taking advantage of open-banking disruption (McKinsey January 2018)

Proposal for a Regulaton of the European Parleimant and of the Council amending Regulation (EC) No 924/2009 as regards certain charges on cross-border payments in the Union and currency conversion charges

Transient advantage

Johnson – the book!

Works cited

Teece: Business Models, Business Strategy and Innovation

Redrawing the lines: FinTech’s growing influence on Financial Services (PwC Global FinTech report)

BPFI Payments monitor H2 2017

https://www.mckinsey.com/industries/financial-services/our-insights/a-decade-after-the-global-financial-crisis-what-has-and-hasnt-changed

Strumeyer and Swammy (2017) – The Capital Markets

PwC: The Future of Banking  – Innovation & Disruption in light of the revised European Payment Services Directive (PSD2)

PwC: Waiting until the 11 Hour

PSD2: Taking advantage of open-banking disruption (McKinsey January 2018)

Proposal for a Regulaton of the European Parleimant and of the Council amending Regulation (EC) No 924/2009 as regards certain charges on cross-border payments in the Union and currency conversion charges

Transient advantage