The post-pandemic financial sector: crisis or Annus Mirabilis?
What we call History is just the record of the quantum events that have disproportionate impact on the development of humanity. Among these events we find wars, great discoveries, inventions, revolutions, schisms and, of course, pandemics.
Not only have each of the pandemics that have occurred to date had a strong influence over the behaviors of individuals and on a given moment, but also on the development of humanity as a whole, marking each as a great milestone in the history of the world.
The current pandemic we are living through is unlikely to be the exception.
If you combine an analytical vision of history with a predictive mathematical model, as we did, you will arrive at an understanding of the possible impact this pandemic has had – and will continue to have – on the three central social agents: people, companies and the State. Without needing any calculations, we can already project a base-line change in behaviors of these agents, given that we have already seen significant changes in social, cultural, family, aesthetic and recreational matters. These changes are not only expected to remain in effect because of actual isolation policies, but because of the unintended social experiment’s conclusions , many of which the three central social agents can benefit from.
What does the pandemic hold for the financial sector?
The financial sector is a sub-set of the greater economic structure that the world rests upon and will be subject to all consequences of the changes in interrelations from the three central social agents. In addition, the sector will need to translate those changes into a smaller scope: the one found between government, people and financial institutions.
In the same way that we can predict a more predominant role of the State in the economic framework and redefinitions in work dynamics, trade flows, public services and public policy priorities, it is also possible to forecast a series of transformations in the financial sector. We’ll mention the most relevant:
Public banking and financial technology: a gateway for inclusion of unbanked/underbanked population
States will be taking a center role in protecting its individuals in order to ensure public wellbeing, which in most countries means helping and supporting individuals and institutions face and overcome the severity of the economic crisis taking place worldwide. Most states will do this through public banking; increasing the State’s presence and reach in remote areas where a significant part of the population is unbanked. This means that most of the population will be flooding into the banking system and that having a bank account will be perceived as a right – rather than an asset – for all individuals. Given that most developing countries’ states have little or no infrastructure to do so, they’ll probably be leaning on the private sector to achieve this goal.
According to the most recent Global Findex prepared by the World Bank, by 2017 the number of adults who had access to a bank account in Latin America and the Caribbean was 54.4%i. Although this figure has probably changed in the last three years, it still implies that nearly half the adult population in this region does not have the means to pay or receive money without physical contact. In the current context, this represents a major logistical problem as transactions between employers and their employees digitally impossible. Thus, the incentives for the creation of financial products extended to the entire population increase considerably.
A core of these products could be, for example, the establishment of an ID-Account opened automatically for each citizen at birth. Logically, public banking would be the natural mechanism in which these products could be promoted, as it would have the support and resources to reach the most disadvantaged sectors. However, since public banking does not have the level of digitization or advanced financial technologies (Fintech) of private banking, it is highly likely that there will be a collaborative environment between these three entities, redefining the way in which they have been working until now.
States will also need to innovate in public banking through mobile access, not only for remote areas, but also for areas that’ll need to respect social distancing regulations driven by the pandemic. Mobile technology could also help considerably to increase inclusion to formal financial services. According to GSMA data, 5.20 billion people own mobile devices todayii, which means that almost 70% of the world’s population have access to mobile technology. It constitutes an excellent opportunity for digital tools provided by Fintech and incumbent financial institutions to be used to create inclusive solutions and to provide financial services to a wider demographic.?
From Open Banking through Client’s data endorsement
Open banking, a concept widely used in Europe today, presumes that financial data belongs to the client and not to the financial institution that owns it. This assumes that, regardless of which institution or country it originally comes from, the information of a person within the financial system can be shared between public and private banks and even Fintechs. One of the changes already observed as a result of the pandemic is that many professional services have become more global, with Open Banking representing a highly relevant platform for the management of financial data and accounts between countries.
Initially, this could be perceived as a threat to traditional banking, as organizations previously unable to offer services due to imperfect information have embraced Fintech and now have all the data and an even greater ability to process and manage it.
This doesn’t mean it can’t also be a major opportunity for traditional banks: Few institutions offer and guarantee as much trust as banks, thus, they could take advantage of Open Banking to establish themselves as the new guardians of clients’ data. Their high level of reliability, their presence in several countries, and the fact that they are highly regulated entities, make them the ideal organization to attest this kind of information. This may even extend beyond the financial world: If we currently trust banks to take care of our money, why shouldn’t we be able to trust them with our personal data? Banks could potentially endorse individuals’ academic, employment, or criminal records.
Flight-to-quality with new players
Flight-to-quality is a herd-like behavior that occurs almost inexorably in all crises and refers to the process by which clients shift their deposits from smaller or less reputable organizations to those of greater size and higher perceived resilience. This behavior can be observed in two different ways and could bring key players in the financial sector to a new balance. The most traditional way, already being observed in the United States, is when clients transfer the assets they own in Fintech or in small banks to more consolidated banks. The second way is when deposits migrate from traditional banks towards financial savings solutions offered by companies such as Google, Apple, Microsoft, or Facebook, because they are huge asset-rich organizations with even less likelihood to disappear.
This means that the flight-to-quality will transcend sectors to those very much related to the services rendered and needed in the “new normal”.
Emergence of new services and approaches
We’ve already discussed how social distancing is forcing banks to re-evaluate their current strategies in reaching customers, but this fact not only affects how banks will reach customers, but with what they’ll reach them. Getting to the customer translates into the challenge of being able to offer remote and round-the-clock services and needing to guarantee multi-channel experiences. It is also an exceptional opportunity for banks to expand, adapt and re-define their offerings. Collaborating with Fintech and independent software partners, using digital technologies such as artificial intelligence, biometric identification and ‘big data’, would contribute to improving and providing much more personalized and unique experiences to clients.
Banks will not only change the channels by which they reach customers or the products they offer them, but also the relationship to their own employees. The fact that households are now being used as a workplace as well as the space for recreation, encourages the emergence of new approaches to traditional models, such as the bank producer operating with an ‘agent’ structure similar to that of the insurance sector. For example, an individual who has worked for several years for a bank would be granted a distribution license as an authorized agent. They would be able to serve, from their home, a wide portfolio of clients, many of whom probably live geographically close to the agent. In the longer term, this approach could lead to the equivalent of many bank branches operating from any location, including from a chaise-longue on the terrace of a house with a nice view. The agent would become a sort of mono-bank that could also tender with other banks. This means that, at any given time, someone in one place could distribute products from many different banks. This represents an important change in the financial sector, which would not only affect banking but also the world of pensions and insurance, given that they would have to compete with banks for the best representatives, which implies a much more fluid migration between these sectors.
Statistical model short-term slope
In the short term we are expecting a significant drop in the quality of statistical model forecasts and predictions because the data used to create these models is no longer relevant. Most models used for predictions, especially within the financial sector, are based on an assumption that the historic accumulation of behavioral data can be used to estimate the future. If we look at the measures implemented in recent months by governments and financial institutions around the globe aimed at postponing or even condoning the payment of customer debts, we can quickly conclude that if we were to draft an estimation now, it would be biased by the outliers in the most recent behavioral data. As a result, four categories of client that the statistical models would normally differentiate: those who want to pay, those who do not want to pay, those who can pay, and those who cannot pay, would now be unified into a single group. This unification restricts the automated decision-making process and represents a significant decrease in the role of statistical models, generating consequences that will take time to correct. Such models must therefore be calibrated and adjusted to this new reality. Additionally, they should consider the loss of valuable information in the short-term to avoid the possibility of obtaining misleading results for not providing a complete view of the client’s history.
The analog-system death
There is no doubt that the digitization of banking is an issue that has been discussed for many years and has taken longer than expected to materialize. The fundamental difference now is that the circumstances and incentives have changed in a way that digital transformation begins to be much more relevant for operational purposes.
Along with the need for multi-channel and more personalized customer experiences that imply the extended use of digital technologies, the most obvious reason for the acceleration of digitization is that manual processes are very difficult to maintain and justify in the current circumstances. However, if we analyze, from a technological point of view, the primary objectives of banks, we will find that operational continuity has always been the central focus. This is a fundamental difference amongst banks and Fintech companies: Fintechs focus on agility and innovation and less about guaranteeing continuity, whilst banks prioritize the robustness of their system and sacrificing flexibility, speed, efficiency and a customer-centered approach. For banks, the winning formula was to have unintelligible, expensive, and difficult-to-maintain but continuous and working legacy systems combined with human-based contingency models. The problem that now arises is that the circumstances created by the impact of the pandemic means their contingency models become unfeasible since they prevent individuals from operating these functions on-site. In the new scenario the death of the analog system occurs: Innovation and digitization become essential and provide an answer to the quest for guaranteeing operational continuity with minimal (or no) human intervention.
At the gates of another Annus mirabilis
Alluding to history again, it is entirely possible that we are at the gates of a new Annus mirabilis, which in Latin means the ‘year of miracles’ and refers to any year in which a disproportionate number of events of major importance are remembered.
We think this can equally apply to inventions or improvements. Looking back, three elements have generated disproportionate increases in innovation: the first, is the need, which sharpens ingenuity – being in a crisis involves more need and therefore more invention; the second, is the availability of information; and the third, is leisure.
Never in the history of humanity has there been a greater moment of conjunction of these three factors: crisis, leisure, and availability of information, because today they are co-existent with a high technological world, which opens the door to great innovations that will undoubtedly be seen in the coming years.
The invitation is to always think like the Spanish writer Miguel de Unamuno, “We should try to be the parents of our future rather than the offspring of our past.”
