Development Strategies for Digital Banks

Approaches used by banks on the path of digitalization

When reading popular websites about digital trends in banking, one can notice that two out of three articles talk about Big Data, Artificial Intelligence, and even quantum computing. At the same time, the majority of the banking market players are still determining an optimal business strategy for digital transformation in financial services, looking closely at the successes and failures of those who have already taken the plunge into digital business transformation and the use of the latest technologies.

In this article, we would like to highlight examples of digital strategies for retail bank development, which we consider worthwhile, as well as discuss their pros and cons.

Creation of a digital bank keeping with the spirit of the age

The main idea of this strategy is a gradual transformation of the business into digital, which means the possibility of using most of the services online. This model doesn’t presuppose a revolutionary change in the principles of the bank's operation.

Here, the main goals are the following:

• cost reduction, 

• creation of a flexible product line, 

• improvement of the customer experience. 

To some extent, this strategy can be called a survival strategy since it is the basis for more complex and ambitious models.

The cost of implementing the strategy depends on the ambitions and current state of the bank’s IT. On average, digital transformation in banking requires investments amounting to 10% of annual expenses for a period of no fewer than three years. It should be understood that the basic expenses usually go towards the replacement of core systems, while the replacement of fronts is 20-30% of the total cost.

Creation of a digital ecosystem around the bank

There are many examples of the ecosystem approach. This strategy was applied by banks from South-East Asia (DBS), Russia (Tinkoff and Sberbank), and Europe (BBVA).

However, the approaches to building ecosystems differ from each other:

1. The bank purchases various businesses, incidentally not only financial ones but also, for instance, food delivery, real estate search, etc., and builds its ecosystem out of them. An example of this approach can be Sberbank in Russia, which has already acquired more than a dozen companies and now is intertwining their services into its web and mobile bank.

2. The bank builds an architecture that allows various businesses to offer their services to the bank's clients in its app on a partnership basis, integrating through an API. The integration happens seamlessly for the client, in one window. This is how Tinkoff and Ant Financial work, for example.

Today, more and more banks are paying attention to niche ecosystems. Technically, the principles of building such ecosystems are no different from those described above, but the focus is on particular customer needs, for example, the desire to purchase a car or real estate.

A good example of such an ecosystem is the project of the Russian division of Societe General - Rosbank Dom (Russian for “Rosbank House”). The project has brought together partner businesses that cover all aspects of this demand by helping with purchasing real estate, appraising the property, mortgages, insurance, etc.

The cost of implementing a strategy depends on many factors. For example, Sberbank spent around 3% of the net profit earned over the same period on building the non-banking part of its ecosystem. Even if you don’t choose to buy companies to include them in your ecosystem, building a technology platform and corresponding infrastructure of the scale of Sberbank will cost hundreds of millions of dollars.

Alternative strategies

There are other digital development strategies, of course. However, upon closer examination, it turns out that they somehow overlap with one of those indicated above.

Creation of a service according to the Banking as a Service model

This model has two main approaches:

1. The bank gives its license to other financial companies to create unique products for their customers, for example, savings accounts, loans, debit cards.

2. The bank provides financial companies with its technology platform through the API layer.

By connecting to the bank's platform, companies can access functionality for transferring funds, creating accounts, identifying customers, preventing fraud, monitoring transactions, etc.

Traditional banks often choose to provide their own back-offices, while BaaS as a set of universal APIs is usually for banks that are more like tech companies with a banking license, such as Solarisbank in Germany or Starling in the UK.

In the future, traditional banks will probably try to catch up with BaaS companies by direct integration with FinTechs without intermediaries.

Judging by the results of the IPO of those banks, the main business of which is BaaS, the cost of implementing the model is tens of millions of dollars.

Acquisition of FinTechs

Within the framework of this strategy, the benefits are as follows:

1. Possibility for banks to offer their customers new products with a completely new user experience.

2. Possibility for banks that have accumulated a huge amount of legacy systems to become technologically fresher and start the transformation process of the core business, thus creating a startup atmosphere. Quite often, a bank buys not a product but its team which then becomes a driver of further growth.

3. Way to withstand competition from aggressive and ambitious FinTechs in the local market.

The range of costs for implementing the strategy is incredibly wide: from a million to several billion dollars. For example, the French bank Société Générale recently acquired Fintech Shine for €100 million in order to offer a full online service to its business customers. And Tandem Bank acquired the LendTech Allium Money for $76 million, which offers clients financing to improve the energy efficiency of houses.

Choosing a development model depends on a number of factors: the availability of the right specialists, the current state of the bank's IT systems, the ability to invest, and the regulatory barriers in a particular location. It is important to determine the most appropriate strategy before starting any transformational processes and to weigh the level of ambition against the above-mentioned factors.