Technology will drive biggest change in next five years, banks say

New technologies are expected to have the biggest impact on banks in the next five years, more so than customer demands and changing regulation, according to a report sponsored by software company Temenos.

As payment firms and e-commerce disruptors continue to offer greater embedded finance solutions alongside growing consumer expectations of more personalised products and services, banks must assess how to adapt, says the Economist Impact report, titled “Byte-sized banking: Can banks create a true ecosystem with embedded finance?”.

Providing a ‘super digital ecosystem’

This year, technologies such as artificial intelligence (AI), blockchain, quantum and cloud computing are rated as having the biggest potential impact on banks in the next five years, which is “unsurprising”, according to Kanika Hope, chief strategy officer at Temenos. “This is a finding that’s been consistent since 2019,” she says. 

“In the early years of the report, regulation — and how regulation would shape the industry — was top of mind for banks. Then there was an inflection point where customer demand was above regulation. From 2019 onwards, it’s been technology.” 

A fifth (20%) of the 300 global banks surveyed in the report expect their business model to evolve in the coming years to offer banking-as-a-service (BaaS) to brands and fintechs, and enable embedded finance within their own products and services. Nearly twice as many (38%) want to retain the consumer-facing experience and act as a true digital ecosystem themselves.

“Disruptive technologies are seen as having a profound impact on the way the industry is evolving and the way the banking value chain is disintermediating,” Ms Hope says.

Banks want to establish a “true digital ecosystem themselves” without over-reliance on BaaS, she says, adding: “In the mind of the end consumer, banks cannot afford to be a commodity.

“When you look at the industry, you do see that a lot of embedded finance initiatives are not owned by the bank. But banks’ aspiration is to provide the super digital ecosystem themselves.”

Driving a shift in operating models towards developing a true digital ecosystem with banking and non-banking products and services, 79% of executives said they expect banking to become embedded in consumers’ and businesses’ value chains. 

According to the report, banks are less concerned about challengers, given the increasing consideration of the impact of e-commerce disruptors such as Apple Pay, particularly within investments, international remittances and payment solutions.

As bank-fintech collaboration deepens, banks stand in “fierce competition” with non-traditional entrants regarding the ownership of customer relationships, the report says. Payment providers like PayPal and Alipay are seen to be banks’ biggest competitors in the next five years, although, the proportion of respondents citing this fell from 50% in 2020 to 41% in 2023.

Emerging trends and ESG

Unlocking value from AI will be key to banks’ success, Ms Hope says. In particular, the use of cloud software is gaining maturity. Half (51%) of respondents agreed that banks will no longer own any data centres due to the move to public cloud in the next five years. 

Environmental concerns are also accelerating banks’ shift to the cloud, the report says, although those who cited environmental, social and governance (ESG) plans offered contrasting results. When compared with other priorities — such as improving personalised and embedded customer experience and engagement, improving productivity and improving product agility — embedding ESG across the business came out as the lowest strategic priority for banks in the next five years.

Yet, when asked whether banks will offer embedded ESG or sustainable banking propositions to their customers, the majority of respondents (73%) agreed. A similar proportion also reported that banks will play a key role in the climate agenda by providing capital to environmentally friendly projects or investments.

“That’s because it’s not mutually exclusive,” Ms Hope says. “Banks have competing priorities and while embedding ESG may not be a top priority, it can still be a priority alongside others. Banks agree that ESG and sustainable banking propositions will definitely happen.”

Jonathan Birdwell, global head of policy and insights at Economist Impact, says clear “winners and losers” will emerge in terms of which banks are able to adapt on climate action.

“For example, banks which can adapt business models quickly, who can properly scale green finance, and who can embed ESG and other sustainable banking propositions into their main products and services, both for retail and corporate customers [will succeed]. The pressures are coming on both sides there. Those demands will become even more prevalent,” he says.

Customer centricity will also drive banks to offer more sustainable banking propositions to their customers in the future, Mr Birdwell says, and ESG requirements will pile up.

Regional strategic priorities

North American banks emphasised product agility and enabling embedded finance as key strategic priorities. “Banks recognise that they must be on top of this new technology or risk being left behind,” Mr Birdwell says. 

He adds that the establishment of “true” digital ecosystems may be more difficult in North America given regulatory challenges and the dominance of certain traditional players.

Competition will have a significant impact over the next half-decade for Europe’s banks, banks reported, as payment providers and tech firms increasingly come to the fore. 

As a result, creating the digital ecosystem “seems to be a higher strategic priority for European banks”, Mr Birdwell says. He points to EU regulation, such as the revised Payment Services Directive, as supporting a “vibrant ecosystem” of both collaboration and competition.

For banks in Latin America, Africa and the Middle East, changing customer behaviour and demand will drive change, with the shift from physical to digital banking emerging as a top priority, the report says.

While these regions have substantial unbanked or underbanked groups, appetite is growing among consumers for more digital experiences, products and services, Mr Birdwell says. This ties into the region’s strategic banking priorities focused on migrating client usage from physical to digital channels.

Across all regions, as regulatory, consumer, and ESG demands on the financial sector grow, banks’ ability to harness disruptive technologies will determine their role in the financial sector.

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