Banks vs Financial Services - Tech and regs are creating a demarcation line

Three years ago, at a presentation for industry analysts, software giant SAP put up a slide showing the industry sectors it was focusing on: aerospace, automotive, industrials, media, pharmaceuticals, etc, etc.

Half-a-dozen financial services analysts, including me, raised their eyebrows – where was banking and financial services? The answer was that FS wasn’t an industry in itself, so it wasn’t there for the same reason that IT wasn’t – it is an underpinning service for all the other sectors.

Given that most of the large banks spend in the region of $10 billion on IT annually, a fair amount of it with SAP, that’s quite a statement.

But there is a grain of truth in it, as was underlined a few months later when senior tech and business leaders from the banking and financial services world gathered in Sydney for Sibos, an annual conference and exhibition held by Swift, the bank-owned consortium that develops messaging standards and operates the secure international network over which most of the world’s financial transactions flow.

It’s an event where banks competed to have the biggest exhibition stands, flying their own baristas around the world and entertaining at Michelin-starred restaurants – less lavishly after the 2008 financial crisis, and not physically last year and this. It was a puzzle why most of the invitations in my schedule were from tech companies like Red Hat, Microsoft and IBM rather than the more FS-focused specialists like ACI, Finastra, FIS Infosys and Temenos.

The answer was that the industry had finally stopped worrying and learned to love the cloud. For years they had been saying that they had embraced cloud architecture in their data centres but public cloud platforms were less secure and regulatory restrictions on confidential data made it unsuitable for their needs.

Fast forward to now, and we find that most banks aim to have as many apps as they can get on to cloud platforms, leaving only some systems running on-prem – typically those that have been optimised as much as possible and would be very expensive to operate on public cloud. A recent report from Finextra and Red Hat suggested that 82% of large banks said they were adopting hybrid cloud models. Some – including Goldman Sachs, JP Morgan, Deutsche and others – have gone further and contributed proprietary applications to the open-source community.

What changed? Several things. First there was the move by national payment systems to implement real-time payment systems, starting with the UK’s Faster Payments. Established batch-based bank ledger systems simply can’t handle real-time payments (many banks use what are called stand-ins, taking data from ATM and Point of Sale networks to create a reasonably accurate balance).

But that’s just consumer banking, which is not where the big money is. Corporate and Investment banking is where you need to look for that. Investment banking remains the province of the Wall Street giants – even the small amounts invested by retail investors will flow up through their systems.

The second driver of change is in the use of consumer technology to deliver account information to customers. Most large corporations have a treasury unit, handling foreign exchange transactions, moving money to overseas subsidiaries, hedging currencies, and generally making sure that the right money is in the right place at the right time.

Until very recently, these corporate treasurers were very poorly served by their banks – balance reconciliation was manual and based on information that was often weeks out of date. Their frustration grew as they increasingly found that the sort of services they were paying through the nose for at work was being delivered free of charge in their personal life their smartphones and tablets. One study, three years ago, found that nearly 90% of treasurers at mid-sized European businesses would move their primary banking business to an alternative just to get real-time balance information.

At the same time, regulatory change created the opportunity for newcomers to provide those services. In particular, the European Union created a new entity called a payment services provider (PSP) there are different flavours of PSP, but banks are no longer the only kind of PSP. On top of this, regulated PSPs have to share customer data with others (only the ones that the customers permits, of course) creating an Open Banking ecosystem.

Meanwhile, the ISO 20022 financial messaging standard has been mandated by most regulators, allowing for much more information to be carried in a payment message. While this will create new opportunities to deliver improved services – not least of which will be including an invoice number with a payment to automate the reconciliation process for business customers – it will also create new data management challenges.

Banks have reacted differently: roughly speaking, some have seen this as a huge competitive opportunity, while others view it as a problem for the compliance department. There will be losers and winners in both camps, of course, but it is not simply a battle between the incumbent banks and the fintech challengers like Starling, Revolut and the other fintech poster children. These changes also allow banks of all sizes to move into sectors that would have previously been denied to them because of the cost of entry. Smaller banks can scale up their small-business services to address mid-sized or larger customers (and the big corporate banks can penetrate the much larger small business sector through automated versions of their full-blown corporate services that use AI rather than an army of relationship managers.

In a nutshell, Bill Gates was nearly right when he said “banking is necessary, banks are not” back in 1994. Financial services are necessary, but they don’t have to be provided by banks. Banks, as regulated holders of funds in a protected environment, are still needed. Apologies to digital ledger technologists, but if that environment is based on DLT, it’s still a bank. Especially if it’s a Central Bank Digital Currency (CBDC).

As this year’s Sibos hoves into view – online from 11 October – the implications of these changes will be front and centre. Swift has been positioning itself as a platform capable of handling whatever comes along. In the past two years it has effectively upgraded the cross-border payments network to real-time, as far as the limitations of time zones allow, linked those to domestic payment systems internationally, and connected low-value international business payments.

That’s a lot of replumbing. It’s going to be interesting to see what service providers – of all kinds – build on it.