Historically, the financial sector has been dominated by retail banks. In fact, such is the strength of their oligopoly that around 75 per cent of UK bank accounts are held with the ‘big five’ (HSBC, Lloyds, Barclays, Santander, RBS).
By owning the payment processing systems, BACS and others, since the 1980s, retail banks have never really been challenged by competitors, meaning there was no reason to significantly change or improve over the last 30 years. But now the legacy systems’ limited ability and high maintenance costs are holding the banks back. For consumers this means longer processing times for payments, higher fees and lower interest paid on savings.
However recent scandals, such as the infamous PPI mis-selling and Libor rate rigging, along with innovative technology have opened up the market to several initiatives, such as peer-to-peer (P2P) lending, to challenge the leading lenders.
The financial technology revolution
Research group Liberum estimates the banks’ ageing technology costs the British economy an estimated £30billion pounds every year. These mindboggling figures can mostly be attributed to the average cost of a transaction. Using the old technology systems means that processing a payment now costs the same in relative terms as it did in 1900. There has been zero advance in efficiency in 114 years.
In contrast, P2P is 60 per cent more efficient than the equivalent banking process - a major reason Liberum estimates this new industry will be worth £45billion within a decade. This is phenomenal growth considering the industry was worth almost nothing before the recent market crash. In addition to the smart use of technology its success can be attributed to disintermediation. By removing the middle man (the bank, with its high overheads) from the transaction, costs are dramatically reduced and these savings can be passed onto the customer.
Competition has initiated the beginning of the end for the traditional banking model and not for the first time. Before 1986 British banks were under threat from international competitors. Then came the financial ‘Big Bang’ and banking boomed as the industry was driven into the modern age.
Now the banks must evolve again or face marginalisation, maybe even extinction.
They must leave behind the legacy systems that have served them so well over the years and adopt similar models to those used by modern sectors such as P2P. Up until now, the banks have stuck to the tried and tested legacy systems which have grown organically over the years. Although new front ends such as online banking tools have been used to improve the appearance of systems and oil has been applied to stop hinges squeaking, the core technology is still the same as it was in the 1980s.
Time for a change
The Financial Conduct Authority (FCA) sees technology risk as a priority, specifically targeting the issue of cybercrime. Cyber-criminals are using the latest technology and equipment which legacy systems are inadequately protected against.
The FCA getting involved means it is now a question of when rather than if things change. The period of transition will soon come to a conclusion and the result will go one of a few ways.
Obviously the banks could invest in overhauling their systems. This would need a significant investment but in the long term it would save money. The main issue would be downtime – customers could be left without access to accounts during maintenance and this will take time, a reality that some customers might not accept. It would also mean relinquishing control over BACS, instead turning to technology from a third party and levelling the playing field.
Another route that has already been adopted by one major bank is to partner with a P2P lender. Earlier this year the government announced plans to make banks refer small businesses which have been declined for credit to alternative lenders. The bank/P2P platform partnership will benefit small businesses because the newer technology used by P2P platforms provides an accept/deny answer and quote much faster than the bank.
Alternatively the banks could adopt technology to create their own marketplace lending but this would mean competing directly with established P2P platforms. The banks have brand power behind them but as mentioned before, this might not be a good thing.
Competition drives change and any of these outcomes is possible. The one certainty is the financial landscape is changing. If available technology is grasped now, the financial sector could see a metamorphosis and even a boom like in the 1980s. Not only would the new technology give institutions a practical migration path from their legacy systems but it would provide them with an immediate revenue stream.
Banks must now embrace innovative IT systems or they will be found guilty of ignorance in the trial by technology.