Banking in the time of non-linear change
What will a bank look like 10 years from now? Will banks even exist 10 years from now? These are some of the existential questions that are being asked at a time when every aspect of banking is seemingly under threat from well-funded fintech start-ups.
It would be foolhardy to write obituaries for banks, but all agree a bank will look radically different 10 years from now. In this situation, banks face one of the most disconcerting forms of change that we call non-linear change. In our taxonomy, there are three kinds of change. The first is incremental change, focused on process improvement—for example, approving a loan in five days instead of in seven.
Then there is disruptive change, which is very painful, but where the end-state is well known. Several multinational information technology (IT) services companies faced this, when they recognized that they had to embrace the global delivery model perfected by Indian software services companies. In the last few years, many of these MNCs turned around their business models and reached a point where most of their employees are delivering services out of India. The change was painful, but they had a sense of where they were, and where they needed to be.
The third change—non-linear change—is where the end state is difficult to predict. In the telecom industry, who would have predicted that WhatsApp would carry 30 billion messages a day? As against this, all the telecom companies in the world put together do 20 billion SMS(es) per day. In the transport industry, who would have predicted that Uber, a company founded in March 2009, would be valued at $62.5 billion in June 2015?
For many years, it seemed like the banking sector was relatively immune to change. However, Indian banking is set to enter an era of non-linear change due to the confluence of changes in the regulatory landscape, changes in the business landscape that have enabled the growth of well-funded fintech start-ups, and seismic shifts in technology.
On the regulatory front, after years of tight controls over the issuance of licences for new banks, the Reserve Bank of India (RBI) is now moving to a regime where licences will be provided on tap. This move will open up competition from within the banking sector. As if that was not enough, banks also face competition from a new sector that barely existed 10 years ago—fintech start-ups. Typically, these start-ups attack one small slice of the banking pie, and offer narrowly focused solutions in areas like lending, payments, money transfers, etc. By offering customer-focused solutions, fintech start-ups could put pressure on some of the most profitable aspects of banking.
On the technology front, the combination of a billion Aadhaar identities, smartphones which are expected to reach a penetration of 700 million by 2020, and bank accounts will transform India from a data-poor country to a data-rich one. The Jan Dhan Yojana led to the opening of over 306 million new bank accounts. Over the last seven years, India has also been creating a powerful technology architecture for financial inclusion, which is referred to as the ‘India Stack’, by the India Software Product Industry Round Table (iSPIRT)—a technology think tank. The India Stack will enable cashless, presence-less and paperless transactions, with a consent network on top.
Given this backdrop, banking is set to change far more in the next five years than it has in the last 50 years. Navigating this non-linear change requires a new playbook that consists of building an adaptive organization and running multiple learning pilots.
To build an adaptive organization, banks have to move to the third generation of IT systems that enable rapid reconfiguration and adaptation. If the first generation of banking IT was inwardly focused, the second generation brought in enterprise systems like core banking, and led up to net banking. The third generation of banking IT will be one where the bank evolves into a platform built around open Application Programming Interfaces (APIs) that enable IT systems to talk to each other. This enables banks to rapidly partner with other organizations, foster open innovation and bring in new ideas from outside.
Once the bank has built a platform, and opened up its APIs to third parties, its ability to run multiple learning pilots increases dramatically, and the cost of experimentation declines steeply. In a world that is unpredictable, banks can open their platforms to third parties and let the market decide the winners and losers. These experiments can be crafted such that if the learning pilot does not work, there is very little downside to the bank, and if the pilots do succeed, the bank gets to share the upside gains.
Opening up their platform to third parties enables banks to try out innovative ideas they may never have been able to imagine, and provide customers with a constellation of services they may never be able to do just by themselves. Such openness means that in addition to the “build” or “buy” models that banks have been used to, they will have to adopt a new ‘partnering’ model. In this model, a bank partners with start-ups and online platforms to acquire new technologies, or extend their reach via new online distribution channels, or explore new business opportunities.
In recent times, such partnerships have helped banks acquire new technology capabilities like payment services; expand distribution of products like credit cards; and reach out to new customer segments like taxi drivers and small- and medium-sized enterprises that were underserved earlier. Some of the more progressive banks that have adopted this model report that they have been able to launch new products much faster than if they were to do it themselves, and that their distribution reach has been greatly extended through such partnerships.
To sum, banking is entering an era of non-linear change where no one can predict what the end-state will look like. To navigate non-linear change, banks need to become adaptive organizations and make a range of bets, closely monitor what’s working and double down on that, and retire the bets that are not working. This requires partnering with online platforms and start-ups, which can be enabled through open APIs. In this new era of non-linear change, the ability to survive and grow is predicated on the ability to adapt.
Venkatesh Hariharan is a fellow and director (fintech) at iSPIRT.