Beyond COVID-19: Shifting Priorities To Accelerate Transformation In Lending
Global recession and ultralow interest rates have constrained financial institutions’ ability to increase revenue, thereby squeezing banks’ margins. According to a Mckinsey’s Global Banking Annual Review 2020 report, on an absolute basis, compared with pre-crisis growth projections, the COVID-19 crisis may cost the industry $3.7 trillion.
While profitability may remain depressed, needless to say, strong fiscal support for economies in terms of liquidity injections and policy rate cuts during the pandemic in 2020, have aided economic resilience.
Credit losses being on the rise due to the pandemic, the return on average equity of banks globally decreased to single digits due to growth in loan loss provisions and revenue losses.
While an economic rebound is underway in 2021, uncertainty looms large with many countries affected with subsequent waves of the pandemic and impending lockdowns.
Implications for Financial Institutions
For financial institutions to achieve operational efficiencies, optimization of credit processes and automation of low end credit processes to enable straight through processing, help drive down costs as well as reduce credit processing time. Cognitive artificial intelligence (AI) technologies extend OCR capability in understanding the documents being read and in synthesizing the data extracted to drive efficiencies, cycle time reduction, and cost benefits.
Vendor outsourced technology and business process services have helped financial institutions achieve cost efficiencies not just in labor arbitrage and process standardization, but in migrating to a “platform-model” of delivering business solutions as well. Cloud modernization helps with reducing capex and costs incurred with maintaining legacy applications, in addition to providing scalability for future business growth.
Digital transformation
For the financial services industry, the pandemic was a catalyst for digital transformation and innovation in product and service offerings. From having to stand up digital services overnight to disburse government loans and grants, to data-driven collection strategies to mitigate credit loss, banks have had to reimagine traditional approaches of financing and client servicing through ‘digitalization’ initiatives.
In most cases however, digital front ends were provided as quick fixes to tide through the period of contactless service and sales, resulting in the digitalization of customer journeys that was at best, heterogeneous. Digital transformation is already on firepower for most financial institutions and the momentum needs to be sustained.
Implications for Financial Institutions
With customer experience becoming the new battleground for not just lending, but deposit growth as well, frictionless consumer journeys and contactless experiences are setting the ‘gold standard’ for customer experience.
In addition to focusing on channel experience, a holistic digitalization strategy involving ‘front to back office systems’ or ‘channels to core’ will help in realizing the true value of digitalization.
Digital front ends without the supporting back end capabilities will fail to deliver a true customer experience. Banks should embark on cloud modernization with micro-services based architectures to realize the benefits of digitalization. API led integration connecting horizontal stacks, will help lending organizations deliver speed and agility required for business growth and to extend their systems to partner ecosystems.
Competitive landscape
The pandemic has also driven some shifts in the competitive landscape. Fintechs have already captured the lion’s share in certain lines of business such as personal loans and mortgages from conventional banks.
After the wave of Fintechs, TechFins and BigTechs are contesting banking boundaries, having established themselves as leaders in digital services, and competing for the distribution of loan products. While financial services’ based revenues is still not substantial for BigTechs, they do have the potential to rapidly change the industry given BigTechs’ captive user base, access to consumer data and their sheer size. According to Everest Group Research Lending revenue share of non-banks increased to 27% in 2019 from 6% in 2015
Open banking regulations requiring banks to open up their bank systems and data to third parties, are making it easier for newer entrants to foster value creation for customers through overlay services
Implications for Financial Institutions
With alternative providers of capital becoming an important part of the global financial system, and other fundamental factors such as low interest rates and evolving regulatory regimes adding to the woes of financial institutions, today’s banks need to be prepared for rapid, broad and constant change.
Financial institutions should strengthen digital sales and service channels, cut back on branch infrastructure and support functions that proved to be redundant during the pandemic and ensure that their digital strategy revolves around the customer. AI and emerging technologies, leveraging data, will help banks strengthen and sharpen their propositions and offer contextualized products and services to their customers. Migration to cloud-based modern architectures for reduced time-to-market will enable banks to react to market changes and launch new products quickly.
Regulatory environment
With newer entrants such as Bigtechs, regulators are tackling an interesting conundrum as they try to create an appropriate framework that strikes a balance between fostering innovation and protecting consumers.
Financial institutions have long been targets of cybercrime, and the pandemic has introduced new challenges in tackling fraud and financial crime. Maintaining effective controls with employees working remotely has challenged existing control mechanisms.
Employing technologies such as AI for loan underwriting is increasingly coming under regulatory scrutiny for “bias”.
Cyber security, business continuity and IT failures have been under focus for operational resilience. Additionally, financial institutions are exposed to potential risks and vulnerabilities beyond the regulatory perimeter due to their interconnectivity with the larger ecosystem such as cloud service providers, disparate data sources and third party software vendors.
Implications for Financial Institutions
Banks should focus on data standardization in terms of granularity, quality, consistency, and data lineage to build a robust regulatory reporting framework to support BAU and ad-hoc regulatory compliance requirements.
Ecosystem-induced risk management through real-time risk reporting using advanced analytics is gaining prominence in the era of open banking.
Financial institutions will have to gear up to better identifying emerging financial crime challenges, as well as increase the speed in responding to evolving threats. Financial crime management using AI/ML based fraud prevention solution and automation of critical KYC and AML processes will help improve enforcement actions in financial crime.
