Traditional Banks’ Risks. Fintech Or Die?
It is said that profit is a reward for risk-bearing. It is very true when we bear in mind the case of the banking industry. Banks are literally exposed to many different types of risks. A successful banker is one that can mitigate bank risks and create significant returns for the shareholders on a consistent basis.
Banking risks management begins by first correctly identifying the risks, why they arise and what damage can they cause. In this article, we have identified the major risks and challenges that Eurozone banks face according to European Central Bank research.
Modern banking risks. It’s time to drop the dead weight
The recent Eurozone bank assessment made by the European Central Bank (ECB) revealed several bank risks and challenges to overcome. The ECB representative stated the following key risk indicators for banks in Eurozone:
- The business model assessment demonstrated that most significant institutions’ cost of capital exceeds their earnings.
- Lots of supervisors are concerned with low profitability, that’s why they shift the focus of their attention on banks’ resilience in the future and their business models sustainability.
- A significant number of instances show that management bodies do not succeed in performing their main functions, and internal controls are weak.
- The main eurozone banks are reporting that non-performing loans rate continued to fall to €543Bn in September last year, down from over €1Tn during the eurozone financial crisis in 2008.
Thereby, we may conclude that a lot of banks have either ineffective business models, or bad debts that lead to low profitability, or unbalanced cost structure. Let us step by step think over ECB findings and try to find reasons and ways to improve risk management in the banking sector of the Eurozone.
Operational management. Are banks overstuffed with staff?
The major problem of traditional banks is that their infrastructure is way too conservative to adjust and implement modern achievements and IT-innovations.
To carefully analyze what costs can be revised and reduced, let’s take a look at Figure 1.
Fig. 1. Typical cost structure in banks
In the typical cost structure of retail bank expenditures on staff salaries can reach up to 35% of total bank income. The costs on physical branches combined with costs on communication cut off another 10% from a bank’s “income pie”.
In the era of digital transformation and business process automation, some traditional banks still neglect modern IT trends that can drastically improve operational effectiveness thus reducing the staff quantity and increasing productivity.
Existing business process automation software, risk management solutions, scoring systems, loan origination programs, and mobile applications can significantly improve overall bank performance and essentially reduce operational costs.
Modern innovative software can easily automate routine procedures, make them faster and more accurate than people. Chatbots and virtual assistants are able to replace entire call-centers. Artificial Intelligence (AI) and Machine Learning (ML) can analyze data flow to make forecasts and frame business strategies.
Branchless banking, or sweet fruit of branchless trees
It has been mentioned above that traditional banking is tied to physical branches. And it certainly costs quite a bit. The expenditures on leasehold and freehold premises as well as on communication between branches can reach up to 10% of total income. But let’s ask ourselves, how often a visit to the bank is really needed? Is it really necessary to stand in tiresome queues when the internet and mobile phones let customers avoid it?
Branchless banking is something that helps banks get rid of the cannonballs of costly infrastructure.
The advantages of branchless banking are manifold.
To be fair, it should be looked at from both sides – the customer side and the banking side. From the customer perspective, it is a convenience all the way. Be it urban-based tech-savvy customers or clients who are located in a rural area, there are a number of opportunities open today to access banking services right from the comfort of their home or hometown.
Everything one needs is a device, and an internet connection and banking transactions can be done within minutes.
From the perspective of banks, it is less costly. There are substantial savings in cost when a bank moves to branchless channels instead of opening traditional bank branches. The saved cost can be utilized for various functions like launching new products or reaching out to newer geographies.
Moreover, branchless banking helps to gain customers’ goodwill due to the following advantages:
- 24/7 access
- transfer funds
- check balance
- pay bills
- schedule transfers and payments
- receive alerts
Branchless banking is basically the future of Digital banking where all day to day banking transactions can be fully done through internet banking, phone banking, mobile banking, ATM and cheque deposit machines. Clients’ expectations are vividly shown in Figure 2.
Fig. 2. Clients’ expectations from digital banking
Transfers, checking balances, applying for new accounts, investment options, depositing cash or cheques, and withdrawing money or even logging complaints and feedback can all be done easily with some few button clicks.
Traditions vs innovations: a look from inside
Alexander Tsorlinis, the Head of Market Risk Management at Raiffeisen Bank International AG, agreed to give his comments and share his point of view on the subject. He is sure that running the traditional bank costs are extremely high. This is not only about branches and the staff needed on-site, but also connected with the internal IT-organisation. There are endless systems for each kind of subprocess bought from external vendors. That leads to extreme complexity of IT-organisation. And this costs a lot. Some banks have discovered that deficiency and try to work a way out.
These banks go other ways. They buy Fintechs or cooperate with them because Fintechs provide end-to-end systems with a lot of flexible modules. The systems simplify the work regarding one particular product line end-to-end. But the integration and replacement of the old legacy world is extremely costly and painful.
Additionally, Alexander Tsorlinis admits that if in some aspects Fintechs are really good, banks can take up them. An automatic scoring system as an example which immediately calculates potential borrower’s credit score on the basis of data collected from the web in addition to internal data. And it is completely done by a machine. No humans are involved.
He supposes that new technologies based on machine learning (ML) are very valuable for banks. They can process a lot of data about customers without having relationship with them. And the data, in its turn, can be used for different purposes including credit scoring.
Alexander Tsorlinis agrees that traditional banks are rather slow in adopting technologies end-to-end. But in the Austrian market end-to-end internet banks have currently only a very simplified product scope compared to traditional universal banks. In addition they cannot offer some services which traditional banks can like safe depository, for instance.
The digital transformation of the modern world is full of tough calls the banking industry has to deal with. In spite of its conservative nature, it has to adjust and evolve. Our team of experts is always ready to provide you with all experience and knowledge we have.
In the next article we are going to discuss how finely-tuned up-to-date Business Rules Management System (BRMS) helps avoid the emergency situation and minimize negative effects.