Digital Banking: A look toward the next evolution

I thought for today’s article I would try to both deliver some new analysis on the evolving digital banking landscape as well as share with my audience my thoughts around, what I perceive will be the next wave of transformation to sweep through the digital banking landscape.

Overview

To use a phrase from Brett King’s Banking 4.0 book published 3 years ago, my exploration of the digital banking landscape has always been about trying to find new participants who are trying to put first principles to work within their value proposition, rather than continue a journey in derivative design and delivery.

What do I mean by this? In a nutshell, my interest is in entrepreneurs who have built their proposition on a blank canvas, in which no element of the banking design is sacrosanct, and new possibilities to get closer to delivering what a target customer really “wants and needs” from their financial partner becomes possible. Elon Musk undertook this approach when founding SpaceX, and the result is a rocket design that can carry the same payload of a Saturn Rocket but at a 90% reduced cost.

As we are no longer in the “start-up” phase of digital banking, solution designs that merely can demonstrate near real-time account opening, e-signature authorization, omni-channel access, and a range of intelligently integrated accounts that streamline the movement of money are no longer, as they once were, qualifiers for first principle thinking.??This also applies to most financial products which, while now digitally accessible, are still primarily structured in the same way, and still operating within assessment models that are 20+ years old.

First Principle Thinking

When I start to think about applying first principles to digital banking design, I ask myself the following:

1)????How does the presence of Open Banking infrastructure, and the availability of a banking ecosystem in which one can interact digitally with multiple competing counterparties for their financial services facilitate a new type of digital banking proposition?

[Of course, Open Banking principles allow for account aggregation and in turn a level of personal financial management that was never possible before, alongside a payment model that has at last brought us all much closer to a real-time payment world, but there is significant value beyond this that has yet to be realized (more on this later)

2)????Have individuals become so comfortable with the cost/benefit of recommendation engines elsewhere in their daily routines and digital interactions that they are more ready and willing to follow the lead of a financial counterparty applying the same playbook but with a different rewards structure?

[We are already seeing consumers putting some of their financial affairs, particularly in relation to savings and investment on autopilot. Further we are seeing consumers adopting recommendations to reduce costs and unnecessary discretionary spending in their daily lives when the right type of rewards are offered to them, not all of which are financial incentives]

3)????Do a broad range of macro themes that are focused on preservation, reusability, sustainability all speak toward a broader human desire to embrace machine assistance to discover ways of continuously achieving optimal outcomes across a wide range of topics at a personalized level?

[Segmentation banking has truly arrived in the last few years and is still evolving. Freelancers, Creative Types, Minorities, people with different religious beliefs are now all being targeted by digital banking propositions that align values, functional needs, and smart integration all into their platform design. Many of these solutions are deploying pre-packaged business logic, and some basic machine learning identity principles into their DNA that give users advice, guidance, and access to an appropriate and suitable set of products for free]

4)????Has the evolution of e-money accounts (not defi) vs. traditional money accounts become so functionally blurred in the minds of consumers that non-banks of all shapes and sizes can now exploit the broader program design possibilities of the former without ever fully requiring the trust/security, or regulatory position of the later?

[Digital Banking service providers are often E-Money firms that are exploiting the high charge, high friction and silo design that is still present in most banking organizations, whether they have a digital capability and omni-channel access or not. E-Money firms can not only exploit the utility infrastructure that is built and maintained by banks but can create ecosystems between different types of financial institutions based on entirely different types of business models. These are derived from customer engagement and activity and not from capital, and the balance sheet]

Who’s caught my attention so far?

The list of interesting players I have identified has by design excluded organizations that are operating in emerging markets, or in the new world powerhouse economies.?My list has also excluded those who’s major differentiator is their bridge to the world of decentralized finance, and access to the various blockchain initiatives, and altcoins. While I absolutely recognize the value to savers, borrowers, investors, and payment users that can be accessed, I have chosen to ignore these.

Based on the above constraints, I initially identified 16 fintech firms that seemed to be thinking about their proposition with some consideration to first models. ?The common themes that these firms have can be summarized as follows:

1)????They are building highly integrated product stacks driven by the availability of open banking and the way that open finance facilitates visibility, transparency, and low-cost money movement.

2)????They are launching marketplaces as part of their proposition to be able to provide their client with the best deal to meet their needs. Most of the focus of the ecosystem design is to deliver the money supermarket approach within, and to have a business model that aims to match their customer not only to the best terms, but also to the most suitable proposition for them; in other words, cost optimization and personalization in one transaction flow.

3)????They are trying to integrate into their solution design personal cash flow management capabilities that are aimed at reducing financial stress. While none of the solution designs initiate micro lending solutions for their users, they do incorporate concepts like Salary advance, instant invoice financing (for sole traders/creative artists) and short-term lending.

4)????Many are attempting to develop financial guidance for their audiences with a voice, delivery approach, and user experience that they think will resonate with their clients.?While the most usual audience for this are younger less financially mature individuals in the GenZ and Millennial age groups, WeMoney for example is building a broader community.

5)????A number are trying to make sustainability, fairness, and accessibility part of their central mission and operational tenant. There are different ways that this is being executed but almost all involve some type of automated allocation model, in some cases with funds being directed toward direct sustainability projects, while in other charitable causes, and environmental initiatives, via cashback are being offered.

6)????Almost all continue to focus on operational models where:

a.?????Many transactional costs, esp involving cross border, and peer to peer payments that are commonly charged by the established banks are waived. This is a particular phenomenon for initiatives that originate in Spain and Scandinavia.

b.?????Account structures can be set up utilizing a wallet approach as opposed to separately managed facilities that need to operate under different KYC, and regulatory frameworks. When firms use e-money permissions or piggyback off of a number of different service providers within a BAAS approach they are able to not only offer distinct “pots” within the same wallet but also provide pots that can be shared among trusted parties, i.e. friends and family.

The table below highlights my understanding of each of the 16:

Are these initiatives displaying first principle thinking?

When I look at these entities, some of which are much more recently funded, they strike me as more evolutionary and revolutionary in nature. ?They highlight that

Evolving the Cashback Principle

1)????The notion of cashback can now days be applied and redirected to almost any type of beneficiary. ?We are still in the age of this redirection being to constructed programs that need to be set up in advanced, but when you are occupying a world of open finance, and instant payment and connectivity, the direction of travel is self-evident, and user defined cash back programs, for example, will soon be upon us. There is also the opportunity of awareness here (more on this)

Evolving Accounts to Wallets

2)????Organizations that are building new banking capabilities from scratch, not only don’t need to operate in a siloed products world, but obviously for data reasons certainly don’t want to. Integrated wallets based on a single header account led hierarchy are increasingly the norm rather than exception and are rapidly killing off the notion of a specific type of account for a specific type of purpose and process. Instead, we are entering the world where the user can segregate the distribution of their funds as they see fit, and can rely on a combination of smart rules, and an available ecosystem of personalized solutions, to optimize the results. ?This increasingly speaks toward a world where regulatory concepts like suitability and appropriateness become decided through behavioral considerations that are being measured in real-time, rather than based on past decisions in terms of products, payments, and counterparties.

Evolving toward Personalized Guidance

3)????We are moving closer to the transition from digital content curation, and rules/best practice guidance into something more akin to actual scalable personalized advice. ?None of the initiatives I have seen are there yet, but we are inching toward digital systems that are able through a combination of data aggregation, derived data processing, and machine learned classification to create and maintain a much more intelligent profile of an individual, regardless of the complexity of their financial lives. When organizations can deliver what I define as “real-time” fact find in a holistic way, they are building the foundations for a banking service model that can matched and evolve to the changes in your financial life, and deliver an advice process, through a variety of different delivery models as and when needed; in other words, offer a “just in time” service. At the moment, most new players are more comfortable to just stick with combining using different conditional rules to build automated processes so that their clients are always, by default, seeming to do the right thing (i.e. save more, invest more, waste less, reduce debt etc), but decision making based on these principles alone is still too generic and rigid.

All these types of initiatives are making it a lot easier for users of banking services to define what they need, how they want to attain it, and execute it with little fuss, hassle, or cost. ?These types of approaches don’t so much seek to wrestle the customer away from the incumbent bank, but rather to make themselves a far better service, cheaper, and more flexible banking partner, and one who is addressing user defined needs through financial solutions, rather than the other way around. These providers also see themselves as well as gateways to like minded collaborators, valuing their role as the central protagonist in a hub and spokes universe.?They are offering a number of advances on the initial neobanks and challengers but they are not yet offering financial counterparties built on first principle thinking. Instead they continue the death by a thousands cuts journey that has continued to weaken incumbents, and increasingly repurpose them as little more than trusted utilities.

Applying First Principles Thinking

Intelligent Banking at a New Level

My view on the financial institutions that are going to start to emerge as the new challengers in the next few years will at their heart be needs first organizations, that will be using technologies that allow intelligent agents to be aware of their clients in a whole new way. This awareness will not only be driven by a pro-active response to a client’s individual financial behaviour, but also by how activities within a person’s available ecosystem create positive and negative trade-offs. Financial institutions that can provide solutions to needs in this way will operate on the principle that

APIs can access everything about you

1)????Electronic interfaces are available to just about anything that one could want to know about an individual, a business, or some other type of entity.?While many of these would only be accessible on a for profit basis it would nevertheless be very possible to compile and maintain a complete financial picture much faster, much quicker, and within a data model that, via classification would be able to deliver actionable insights that were currently beyond the scope of any organization merely centering their efforts around the coverage afforded through open banking.?Clients of needs based FI will readily pay subscription fees to maintain these integrations, as well as curate actionable and educational content that is aligned to achieving these needs.

Decentralized Finance and a World operating within a global regulatory framework

2)????Financial services are accessible to their clients without borders. While this has already begun with the emergence of decentralized finance, I believe we are heading into a period based on a different regulatory construct where the rules defining affordability, accessibility, and suitability are going to be shaped by global rather than local protagonists. ?The most successful firms will be able to apply this framework into a global ecosystem that can match clients to the right solutions across each of these dimensions.

New Marketplaces to Unlock Capital and Value

3)????Digital marketplaces that are still in their infancy today, will be able to unlock capital liquidity in ways that have not been possible before. This will apply to both privately held assets as well as more and more types of physical assets that people both use and collect. The last few years have seen the emergence of new types of “private markets” accelerate, and using a DLT/Blockchain model, almost any type of asset can be fractionalized, tokenized, recorded, registered, and retrieved efficiently.?The new FI that operate within a holistic framework calculate financial wealth differently, build balance sheets that reclassify illiquid assets as useable collateral, and build creditworthiness scores based on an entirely different set of cash flow, and behavioral parameters.

Needs, Not products: The Dawning of the VPA

4)????A platform deployed to support a needs first approach should not only be hyper efficient when it comes to executing client led interactions, i.e. operating a highly scalable dynamic system that is built on instant decision and transaction capabilities, but is centered around the presence of AI models that are designed to operate as 24/7 personal assistance for each client. As such, these VPAs are constantly developing through behavioral analysis, a state of “awareness” when it comes to what clients will want and need in the future. This will allow the VPA to operate as both a responsive as well as pro-active partner who’s sole objective is to ensure every individual can attain their best “financial lives”.

Optimization 2.0

5)????There is a better way to apply optimization models than merely to address the “cost management” question. ?Data processes are already able to apply continent rules today to direct a client to a better deal that cost less and appear to offer better value for money. The new entrants I have already mentioned as well as those from the previous evolutionary cycle for digital banking can also help clients to avoid incurring late penalties, duplicating spending, and making poor decision in how they allocate capital and incur and manage debt. All these features form part of a cohort of services that I would define under the “protect thyself” mantra. These same principles increasingly help us to avoid money scams and over-indulge in financial activities that carry more risk than might be apparent at the outset.??For the next generation of financial counterparts, Optimization 2.0 will not only cover these aspects, but will also look toward introducing intervention that are designed to

Career Management converges with Personal Finance

a.?????Help a client maximize their own skill sets so that they can maximize their own income journey. This means bringing aspects of career and human resource management into the design and delivery of lending and credit product design and the decision engines that determine affordability and suitability.

Institution become their own Clubhouse

b.?????Give clients a new way of interacting and collaborating with others in their network. This will be driven by financial institutions that are able to transition individuals from seeing themselves as clients and instead defining their participation with the FI brand as much more aligned to club membership where they are able to interact more readily with others that share certain values, and aspirations, and can use new types of secure environments to exchange ideas, and opportunities. ?This will allow for the birth and execution of all types of new syndicate structures that have the purchasing power to do things as partners with their FIs in ways that are not possible today.

Pre-emptive Laser Accurate Planning

c.?????Make sure that individuals have the building blocks to plan and execute the objectives which they both “consciously” as well as “unconsciously” state through their own behavior and their interactions with others. Today most planning is based on “ballpark” assumptions that are applied into narrow, and rigid tradeoff frameworks. The 2.0 optimization engine will be able to access, not only highly accurate data, but also will be able to build probabilistic models that presents users outcomes and objectives that meet with their personal risk/reward appetite.

Conclusion

I would argue that the technologies are already there to support the creation of this type of financial institution. Furthermore, I would argue that this Is the exact type of platform that is increasingly needed by affluent individuals who have received far less benefit from the first decade of neo banking than those who are still at a much earlier stage of building wealth, acquiring knowledge and experience across a range of financial products, and learning about the responsible use of debt.

I am seeing glimpses of these ideas coming into play, but I haven’t seen them all emerge within a new platform design structure. It is something I am intent on changing. It is my vision for Project Porthos. Contact me to learn more about our next generation approach to affluent and premiere banking. More to come...