The July 2020 report from EY revealed that COVID-19 impacted the financial sector, as the need for different strategies around innovation and digital banking became apparent. As technology develops, it also results in a rise in customer expectations of banking.
What fintechs have done is cash in on the sentiment, by collaborating with tech giants and offering instant and personalised services. And the broader impact has been felt across the legacy banking sector, as the latter has understood the need to go digital to remain relevant.
The report has indicated that the initial months of lockdown saw a 72% increase in the use of fintech apps in Europe. This shift has defined the new direction of 21st-century banking. With steady internet and smartphone penetration around the world, people now prefer to conduct their banking activities on phones rather than visiting physical branches.
As a result, we are seeing the emergence of “digital-only banks.” Legacy banks are now under pressure to convince investors and stakeholders of their strategies for effectively integrating digital options for customers. At the same time, they must reduce costs without compromising operational resilience.
Banks are now embedding the “digital” scheme of things in their expansion strategies, as the pandemic has successfully changed this generation of customers’ behaviour. The trend holds for big economies like the United States and United Kingdom.
“The journey that banking digitisation has taken in both the US and UK has been less of a sprint and more of a marathon, with some twists, turns and potholes to navigate along the way. As the years have rolled on, technological innovations have gradually influenced how people interact with money. We’ve seen how embedding convenience, security and flexibility into consumers’ payment journeys has reshaped the entire payment landscape,” Alex Reddish, Head of Market Expansion & GTM Strategy at Tribe Payments, summed up things through these words.
US and UK: Two contrasting tales
Both British and American markets have lots of common characteristics: mature, well-regulated financial and payment systems, populations that have a high engagement level with financial services, and excellent telecom and internet penetration levels. However, the way each market has embraced widespread digital banking shifts tells two very contrasting stories.
Strict regulation, along with time and cost restraints, has forced the financial services industry to take a measured approach to embracing technological advancements. However, with the emergence of generative AI, particularly large language models (LLMs), organisations now have an opportunity to maximise the value of their data to streamline internal operations and enhance operational efficiencies.
However, while adopting AI, financial organisations are also facing the need to prioritise responsible data management, strict privacy regulations and careful curation of the information they use to train their models. Whilst consumer chatbots have brought generative AI to the mainstream, the true potential of this transformative technology lies in its ability to be tailored to the unique needs of any organisation, in any industry, including the financial sector.
While the above-mentioned scenario sums up the opportunities and challenges faced by the global financial sector, in terms of going digital, it is not that every region is following the same rulebook.
“When it comes to modernising outdated banking systems and navigating complex regulatory frameworks, the US and UK have drifted in different directions, at the expense of interoperability and cross-border banking efficiencies,” Reddish added.
Fintech vs embedded finance
In Europe, embedded finance (EF) has emerged as a popular concept, with a July 2024 report from McKinsey and Company suggesting revenues from this domain will surpass the 100-billion-euro mark by the end of the current decade.
The distribution of financial products and services like loans and insurance in third-party channels is gaining importance as technology and data are facilitating instant and seamless customer journeys, and customers increasingly expect to find financial services when and where they need them, such as during a large purchase.
The EF market generated an estimated 20-30 billion euro in Europe in 2023, about 3% of total banking revenues. Over the last ten years in the continent, embedded finance volumes grew three times as fast as directly distributed loans.
In 2023 and 2024, McKinsey interviewed a range of business leaders in the EF value chain, who expected consumer credit volumes to continue migrating toward embedded lending. For SMEs, these leaders expected factoring and other straightforward types of financing to become embedded as enterprise resource planning vendors and SME-supplier marketplaces provide them at the point of need.
Customers are increasingly demanding convenience and seamlessness in their customer journeys. A 2023 McKinsey survey of auto finance found that 40% of consumers already prefer online channels for financing a car purchase. They want instant access to affordable financial services such as loans and insurance, when and where needed, with the fewest possible clicks.
For merchants, embedded finance has increased sales through higher conversions, increased basket sizes, and enhanced customer lifetime value. According to an RBC Capital Markets research report, buy now, pay later solutions are now contributing to a 20-30% increase in checkout conversion and even greater improvements in basket size.
In fact, on the supply side, the cost of offering embedded finance has been significantly reduced in recent years due to technological advances such as in applications programming interfaces, making it easier for systems to interoperate, and better and more widely adopted electronic identification schemes.
For financial services providers, embedded finance will become an increasingly important means of customer acquisition in some areas. In one major European market, McKinsey found that the acquisition cost of a qualified SME lending lead is 15 to 20 times higher than an EF lead.
The United States, on the other hand, is witnessing a battleground called “Real-Time Payment,” where big tech companies and traditional banks are vying for dominance. Payment service providers (PSP) are ruling the roost now, by facilitating electronic payments between merchants and their customers by bringing all financial parties together to deliver a simple, fast, and reliable user experience.
“Because payment services don’t involve working capital and focus on a simple, fast, reliable, scalable, and ubiquitous user experience, it plays to the strengths of large Internet tech companies,” F5 Financial Services stated.
Then there are various fintech companies (typically start-ups) that aim to use innovative technologies to compete with traditional financial methods in delivering different financial services. These financial services span all the major categories in banking services: trading, insurance, and risk management.
They are bringing data-driven algorithms into play to help small businesses secure personalised loans or applications to leverage cryptocurrency for loans by using blockchain’s evidence-based, chain-of-custody smart contracts to ensure the crypto is verified and safely transferred.
Machine-learning algorithms are helping customers analyse spending trends, hit savings goals, and find areas where money is inefficiently spent. SaaS (Software as a Solution) solutions provide credit access to people in underserved parts of the country via alternative data to underwrite users who do not have a traditional credit history. In recent years there have been over 1,500 entrants into the fintech marketplace. In 2019 alone, funding in the sector reached new investment highs, pulling in $34.5 billion across 1,913 deals. Some 24 of the 67 VC-backed unicorn fintech firms were started in 2019 and now together, they represent a combined worth of $244.6 billion.
“But because FinTech companies (startups) typically do not have the large user base and brand name trustworthiness that Big Tech companies do, and trust is one of the most important assets in the financial services industry, major financial institutions typically do not see them as much of a disruption. More often, they view fintech as an extension of their own in-house technology development. As a result, major financial institutions tend to build an ecosystem of FinTech partners to complement their own services. And sometimes, these FinTech companies are acquisition targets of major financial institutions,” F5 Financial Services noted.
“These ecosystems are flourishing thanks to open banking initiatives, which 47% of banks indicated they were embracing. Such ecosystems are important for attracting and retaining customers. For example, 40% of consumers indicate their primary driver for using bank-issued credit cards is reward or point programmes that include a broad variety of partners,” it added.
Even legacy banks are now spending big on IT front, with the aim of improving the overall customer experiences, apart from increasing agility when introducing new services, and lowering the cost of offerings. Because financial products are mostly digital, the role that technology plays in the banking business is becoming baked into various financial products. Technology is now defining the products.
The ability to fuse technology and financial product is now providing a competitive advantage to these banks, in terms of introducing major market disruptions. Terms like software, analytics, mobile, IoT, big data, AI, cognitive computing, multi-channel technology, automation, APIs and blockchain are being mentioned in the board meetings, in order to make financial products and offerings personalised, digital and agile as per the changing market dynamics.
Banks are keeping a close eye on the fintechs, their disruptive technologies and initiatives, ways of automating and improving critical functions like risk management, addressing audit requirements and adhering to new and emerging banking regulations. Partnerships between legacy banks and fintechs are becoming the new normal in the American financial industry.
Similar drawbacks affect both
As per Alex Reddish, Head of Market Expansion and GTM Strategy at Tribe Payments, the United Kingdom and mainland Europe have ensured that “digital banking is now second nature for many.” With extensive and long-established digital channels in place for over 20 years now, consumers expect to manage their finances online with ease, thereby reflecting how convenience and access have become the cornerstones of 21st-century tech-powered banking.
Regulatory frameworks are emerging to provide guardrails to new services like AI and consumers are expecting faster, more immersive payment experiences. Banks are facing the need to ensure that they can continue to adapt and meet shifting consumer demand with dynamic, future-proof services that will keep customers coming back for more. Things have gone contactless, due to the availability of the chip and PIN infrastructures.
The United States, on the other hand, has embraced digital wallets. Tech providers have leapt into action much sooner than their British and European counterparts, forming partnerships with banks and merchants to create wallet-based services that could provide a host of appealing services. Terms like neobanks and fintechs have become the new normal there.
For many American consumers, smartphones have become an all-in-one portal for activities like financial management, bill splitting with friends, rich reward schemes and e-commerce, with the added security of tokenisation and biometric authentication.
So, the rulebooks may be different, but we can concur here on the point that both the US and Europe have made smooth yet giant strides towards having robust 21st-century digital banking infrastructures, yet challenges remain for them.
One common disadvantage has been the legacy banking tech. Updating outdated banking systems has arguably emerged as the biggest roadblock in the way of greater banking efficiencies for both regions.
“While traditional banks seek to overhaul their legacy systems and embrace the latest technologies to emulate the success of neobanks, these digital challengers are shifting their strategies too. A growing number of neobanks are going full circle and are now expanding into traditional banking products like mortgages and personal loans, offering customers a fuller range of services and building deeper, more meaningful relationships,” Reddish continued.
Neobanks, despite unlocking the full spectrum of advantages of digital banking, are still operating under regulatory frameworks designed for conventional banks, which in turn is restricting their pace of innovation. They also face high customer acquisition costs and relatively low revenue per customer.
“Meanwhile in the US, long-standing loyalty to credit products, driven by rewards and incentives, still plays a significant role in deepening customer trust. You only have to look at how brands with big pockets like American Express and Chase dominate consumer spending to see that in action. In a market where trust is largely the preserve of traditional banking giants, it is clear to see that digital banking providers will have to work harder to tempt them away,” Reddish said.
“This is where the UK has a slight advantage, with banks and consumers having already embraced digital banking more widely, but the journey is not over yet. Banks in both regions cannot afford to be complacent when it comes to building consumer trust, developing personalised experiences, and offering tailored solutions that grab the interest of customers,” he concluded.