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Digital disruption in banking

Banks may be relatively unaffected so far by digital developments in finance, but that could quickly change owing to the trust factor, argues Robert Wardrop, Executive Director of the Cambridge Centre for Alternative Finance at Cambridge Judge Business School.

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Many bankers would argue that their basic business model has remained largely intact as the digital revolution has transformed industries ranging from music to apparel retailing – and they mostly would be correct.

So far, new digital entrants in finance have targeted consumer and small business lending, while their market shares are still relatively limited. And some of their growth has come in collaboration with incumbent lenders, so the big banks have grown along with the newcomers through such transactions.

But banks shouldn’t only look at the financial sector in forecasting how their futures may unfold. It’s the digitisation of diverse sectors in the broader economy, outside of financial services, that will prove to be the real catalyst in disrupting the current business model for banking.

Whether buying a used car, or choosing a brand-name product, trust is what often drives consumer behaviour. With the headlines full of scary stories about data leaks and online fraud, parties perceived as more “trusted” will increase in value along with the importance of privacy and security – particularly as more attention is focused on how data are generated, shared and analysed.

So while digital innovation in financial services is referred to as “fintech”, the “tech” is viewed by many people as more trustworthy than the “fin” – so traditional “fin” industries will be at a comparative disadvantage as digitisation takes hold. A recent global trust survey placed banks and financial services at the bottom (along with media), while the most-trusted sectors include technology, consumer electronics and agriculture.

There are some other trends that may increasingly favour new digital entrants to the financial sector: online lending such as peer-to-peer networks enjoy lower loan origination costs compared to traditional bank networks, and (at least for now) less regulation in the online financial sector translates into lower compliance costs.

The growing importance of the Internet of Things – which will soon connect more than 20 billion “things” – also has huge implications for the banking sector as sensors create data that can be analysed in real time. Large tech companies are already embedded in the systems of large enterprises, and as they work with these firms they will potentially have access to information flows across supply chains.

Another issue for the traditional banking sector: most of the top tech brands have financial services initiatives underway. So while payment systems by Apple and Google are well known today, don’t underestimate the range of other financial services these giants may muscle into down the road.

To be sure, recent events show that fintech firms are not immune to questions about trust. Reports by the Cambridge Centre for Alternative Finance show very mixed views on the state of regulation in the alternative finance industry around the world. Some critics have drawn parallels between peer-to-peer lending and the subprime lending crisis that led to the financial meltdown of 2007-2008; and a lending scandal at the big San Francisco-based fintech firm Lending Club led to the ouster of its chief executive earlier this year.

Of course, the recent scandal at big retail bank Wells Fargo – where staff opened unauthorised accounts for customers in order to meet sales targets – reminded everyone of the trust deficit for traditional banks.

In summary, the threat to financial services incumbents is that tech firms are becoming increasingly embedded in the digitalisation of the broader economy – and therefore in the flow of data with investment and credit relevance. This threat is compounded by the fact that tech is more trusted than finance today, and this presents a big challenge in a future economy in which concerns about cyber security and privacy take on heightened importance.