Posted: 5th February 2019

First published on Thomson Reuters' Complinet in January 2019.

The world of finance has certainly embraced the information revolution, utilising the speed and flexibility offered by digital technologies to reshape how we pay and save.

But uptake has not been universal. Cash and branch-based banking continue to be central to the lives of millions of people in the UK, especially those in more rural areas. Long queues in high street banks across the country show that many people still like to speak to someone behind the desk.

Challenger banks, prepaid cards, mobile payments and block-chain enabled technologies aren’t for everyone, it seems. In fact, they’re not even for the majority yet. The FCA noted, in its June 2018 Strategic Review of Retail Banking Business Models Progress Report, that major banks with largely traditional business models still hold 80% of the personal current account (PCA) market share.

However, digital challengers will surely grow rapidly and take a large chunk of that market share for one very simple, differentiating reason: firms that embrace digital capabilities understand the value of customer data to their business model, and know how to turn this to their customers’ advantage.

In the Final Report of this Strategic Review (December 2018), the FCA noted that firms could deliver better value and enhanced customer service if they utilised data more efficiently and allowed their customers better access to this data.

But what would it take for digital uptake to increase? And in what way will this level of take-up affect the banking landscape?

The crossroads

We are now at a crossroads. The future of retail banking could change dramatically and rapidly, or it could continue to grow more gradually as it is now. This will depend on countless unpredictable factors, ranging from macroeconomic change to the personal preferences of individual customers. The FCA sees a range of potential scenarios for the future landscape of retail banking.

For example, if the population embraces technology but consumers remain with their existing providers, banks will likely become something of a ‘utility’; with disintermediation leaving banks to focus on “product manufacturing” while losing direct customer relationships as other players seek to cover the distribution. A similar result could come if large platform providers move into the sector, either through disintermediated services or full-scale retail banking offerings.

Of course, if neither tech take-up nor switching increases rapidly, there would be a more gradual evolution towards tech-able banks and relatively stable markets with competitive advantage remaining in the hands of incumbents for some time to come.

The FCA sees what it calls a ‘waterbed’ effect coming into play if only a small percentage of the tech-savvy population used their knowledge to switch. This uneven landscape could result in some customers reaping the benefits of switching to new providers, while incumbent banks introduce new charges to their remaining customers in order to recover lost revenue.

One other possibility is the ‘big switch’ scenario, where tech-uptake and switching both increase rapidly with data-driven services helping consumers compare deals and switch with ease. In this scenario, alternative providers begin to take market share from incumbent banks, overcoming the scale advantages that currently keep them in place, and driving a faster pace of change in the banking landscape.

If we assume that increased competition will result in better deals for consumers, then it would seem that challengers will be hoping for a ‘big switch’ in the near future, while incumbent banks will already be evolving into a more utility- or platform-like model.

But what would it take for the ‘big switch’ to occur in, say, 2019 (or at any time in the foreseeable future)?

Flicking the switch

We’ve already seen the introduction of two of the key ingredients in the ‘big switch’: Open Banking and the Revised Payment Service Directive (PSD2).

As the regulator says, “in combination, Open Banking and PSD2 are causing traditional banks to take a new role in the way they own and manage consumer data. The principle of both regulations is that individuals own their own personal data and should be able to choose how they are used and with whom they are shared.”

And yet, even with these two massive changes within the landscape, we still have not seen the 'big switch' come to fruition.

Inertia remains a powerful factor within markets such as utilities, insurance, telecoms and banking. People simply tend to stay with their current providers, even if they could get a better deal elsewhere. There are many reasons for this, such as the fact that people find it easier and safer to stick to previous decisions, as well as the lack of time and access that so many working people face.

We must also consider that tech-literacy is not universal. Many thousands of banking and payments customers cannot access the technological innovations that have made switching so easy for others. Varying levels of education, disability, financial situation or lack of access to the Internet can all mean a person is left behind while others race ahead.

If we overlook this reality, we risk walking straight into the ‘waterbed’, in which one cohort of customers obtains better deals at the expense of many others.

Data-managers and tech-developers need to ensure that all sections of society are equally able to make the switch. It’s a monumental task, for sure, but if we are to avoid a ‘waterbed’ scenario, it’s almost a case of one and all or none at all.

Trust will, of course, play a huge part in the switch as well. Customers will need to be confident their data is being used appropriately and worth sharing. Big banks and challengers will have to ensure they effectively communicate the benefits of new technologies, as well as ensuring that the data they manage is protected from cyber criminals.

The ‘big switch’ and compliance

Even if the ‘big switch’ does not happen as dramatically as some may hope, it is likely that we will continue to see an “unbundling” of PCA products as firms seek to balance service offerings with enhanced functionality and data usage, while looking to capture profitable revenue streams.

The FCA continues to monitor the landscape, developing and improving regulations that protect customers from unfair charges and encourage competition. While reporting and compliance will remain an ongoing cost for firms, the quick and easy access to data that technology allows should serve to lower the costs of doing so. This alone should encourage large and small banks to move towards data-centric business models.

The need to ensure security of data will surely result in greater scrutiny from the regulator. In fact, as indicated in the Strategic Report, the FCA will continue to work with industry, government and other regulators in this field. The regulator will also conduct a “programme of analysis” to understand the value chains of new payments business models to ensure that the majority are benefitting from shifts in the landscape.

In the end, it is hard to say whether the ‘big switch’ will occur in the near future. Until banking and payments technology is readily available to all and there are enough tech-enabled challengers in the market, we should probably continue to expect a more gradual evolution.

We should not downplay the fact that technology evolves incredibly rapidly, however. There will come a point when the landscape changes irreversibly and regulation will catch up relatively quickly. Firms should prepare for that future now, so they are ready whenever it comes.

Matt drage

Matthew Drage

Director of Advisory Services