Banking on Innovation: The Digital Revolution in U.S. Financial Services

Financial Services Trends

The financial services industry, especially the banking industry, is increasingly becoming a tech-like business. More than ever, the competitiveness of various financial-centric products is differentiated by the technology solutions that enable them.

Tech Companies Continue to Expand Competitive Presence

Real-time payment is a battle ground between Big Tech companies and traditional banks. A payment service provider (PSP) facilitates 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.  

Fintech Fuels Innovation

There are also various FinTech companies (typically startups) 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.

These FinTech solutions could be data-driven algorithms to help small businesses secure personalized 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. Other solutions use machine-learning algorithms to help customers analyze spending trends, hit savings goals, and find areas where money is inefficiently spent. Yet another example is the use of SaaS solutions to provide credit access to people in underserved parts of the world via alternative data to underwrite users who don’t have a traditional credit history. The list goes on and on.

Investors are reacting positively to possibilities of new financial products. In recent years there have been over 1,500 entrants into the FinTech marketplace. In 2019 alone, FinTech funding reached new investment highs, pulling in $34.5 billion across 1,913 deals. Twenty-four of the sixty-seven VC-backed unicorn FinTech firms were started in 2019. Together they represent a combined worth of $244.6 billion.^[1]

But because FinTech companies (startups) typically don’t 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 don’t 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.

These ecosystems are flourishing thanks to open banking initiatives, which 47% of banks indicated they were embracing.^[2] 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/point programs that include a broad variety of partners^.[3]

It’s also important to acknowledge the infusion of technology into financial services isn’t only coming from tech companies.

How Banks are Using Tech to Improve the Customer Experience

The use of technology in financial services is evidenced by their annual IT budgets. In 2019, many of the big banks significantly increased their IT spend. JPMorgan Chase & Co. allocated $11.4 billion to IT spend. Likewise, Bank of America intends to spend $10 billion on IT, while Wells Fargo will invest $9 billion, and Citigroup approximately $8 billion on technology^[4]. Banks and other financial service providers use technology to improve the customer experience for different financial products, to increase agility when introducing new services, and to lower the cost of offering services. Because financial products are mostly digital, the role that technology plays in the banking business is becoming baked into various financial products—meaning, the technology is starting to define the products.

Apart from real-time payments, the high barrier on working capital and inefficient use of capital for financial services companies (low ROA) when compared to tech companies protects the financial services industry against encroachment from big tech. But it doesn’t protect financial services companies from each other. The differentiation in the way technology is used for the same or similar financial product (for example, loans) really determines the success or failure of one bank’s loan program versus that of another bank.

Technology + Financial Product = Competitive Advantage

Banks with significant capital—more than $100 billion—are more likely to focus on innovation. Just about a quarter (26%) of small banks prioritize innovation while more than one in three (35%) of large banks are focused on innovation. Larger banks are also more likely to focus on security, another significant differentiator with today’s more security-savvy customer.^[5]

The ability to fuse technology and financial product is now a competitive advantage and can be a major disruption in the market. From the head of technology  of a major financial institution’s perspective, in addition to the operational tasks of “keeping the lights on,” top-of-mind topics typically include:

•  Using technologies (software, analytics, mobile, IoT) to remove friction from the customer journey, improve integrated multi-service delivery.
• Using big data, AI, and cognitive computing to develop finer-grained, even personalized, services.
• Developing multi-channel technology to expand digital payment offerings.
• Automating manual processes via applications and AI.
• Using APIs and open banking to build partnerships between banks & FinTech firms.
• Researching and monitoring challenger FinTech firms and alternative banks, as well as disruptive technologies and initiatives (quantum computing, AI, AR/VR, Blockchain, and so).
• Transforming your CIO organization from technology buyers to technology solution developers.
• Establishing an agile culture and workflow, as well as automating and improving risk management.
• Addressing audit requirements often manifested as matters regarding immediate attention (MRIA).
• Responding and adhering to new and emerging banking regulations.

Many of these technologies are emergent. There’s a limited number of people working in these fields and, in the case of technologies like quantum computing and AI-related domains, an even smaller pool of experts. Attracting and retaining that kind of talent requires financial institutions take a closer look at tech companies.

Modeling Financial Institutions After Big Tech

From the perspective of the head of technology of a major financial institution, there’s a lot to learn from the tech industry, especially the big Internet companies mentioned earlier in this article. As previously described, the core of the financial services as a $6–8 trillion industry (to that matter, even the banking sector) isn’t under attack. 

Lessons from tech firms provide a roadmap on where to intersect or where it makes sense to compete with other banks/financial services firms. This roadmap offers broad insights—whether it’s  how to engage with a new payment processor or examples of services that financial institutions need to adopt to remain competitive. Clearly the ratio of bankers to coders within these institutions is changing. To remain competitive banks must innovate, and that requires new and novel application services.

Can Financial Institutions Compete with Big Tech for Big Talent?

Hiring modern application developers puts financial institutions into direct competition with the likes of Google, Amazon, and Facebook to recruit and retain top software development talent. As we’ve mentioned, these institutions must innovate. And competition for the people with these hard-to-find skills is fierce.

Strong recruiting programs and lucrative packages are a must. Modern developers are keen to adopt an agile infrastructure and are used to self-service solutions offered by today’s progressive cloud providers. Most financial institutions are just dipping their toes in the water with public clouds and have instead focused efforts on internal, company-owned solutions. This requires that institutions shift their focus to automation and orchestration with an eye to both reducing personnel costs and to increasing agility. An increase in agility will offer modern developers the self-service solutions they’re looking for.

Agile Processes Aren’t Just for Tech Anymore

A desire for agility isn’t confined to technology. It is also being embraced by finance. Traditionally a new financial product like a new home loan, credit card, or reward program was defined and rolled out using a very linear process, like that of product development in traditional technology companies.

Now, banks have learned agile methodologies from technology companies and are applying them to financial products. This extends to forming multi-function SCRUM teams to define and develop financial products. These teams, made up of financial product managers and software developers, use collaboration tools such as Jira to capture product requirements and define them in EPIC stories. Product definition, development, and launch are accomplished in an agile, iterative manner. As a result, banks have started seeing their new product introduction process significantly shortened.

A need for business agility is seen in the majority (76%) of financial services that indicated velocity of new product introduction as the primary reason for embarking on digital transformation initiatives.^[6]

Balancing agility against stability is a constant challenge and one that big banks will need to learn how to address.

Business Resiliency Is a Requirement

Risk management as an established business function with methodologies, processes, and systems is critical to any financial organization to balance the risk introduced by financial products. FinTech organizations must develop this discipline as they expand their financial products beyond transactional services.   

Banks also understand the relationship between business resiliency and core systems. FinTech has been adopting leading practices that rely on commodity hardware and chaotic testing methods to ensure operational resiliency but are less focused on testing business resiliency. As FinTech organizations continue to explore new financial models these organizations will need to learn from the banking industry how to build, test, and maintain systems that ensure business resiliency.

Digital transformation is one of the factors behind changes we have seen in the use of application services across the financial services industry.

Macro-Level Trends in Application Services 

Large Fin Serv accounts are moving toward a more software-centric approach to application delivery and security and are moving away from appliance-based solutions.

Nearly one in five (19.03%) of financial respondents prefer application services in a container form factor. Another 16.15% prefer virtual machines^[7]This is a move toward using software where it makes sense, not an attempt to replace other systems altogether. Along this same lines is a focus on using automation to reduce man hours and increase agility.

Moving to the Cloud, Selectively

The majority of large banks are moving some workloads to public clouds, but it’s a small percentage of their overall application volume. A majority (62.5%) of financial institutions indicate they will have less than half their application workloads in the public cloud by the end of 2020^.[8]

A multinational bank that closed the majority of its data centers and moved the lion’s share of its applications to AWS is now seeing large bills from Amazon, as well as fielding concern from federal regulators about the risk of using a single cloud provider.

Of the financial institutions that have moved significant workloads to the public cloud, more than half (55%) indicate they are repatriating workloads back to the data center,^[9]citing security and cost concerns. Most other banks are building infrastructure and offering self-service deployment to their internal DevOps teams. These new data centers are being built to optimize network traffic and minimize risk.

One-Size-Fits-All IT Doesn’t Fit Anymore

There’s an ongoing shift from one-size-fits all IT infrastructure to an approach focused on applications and the best way to make them more agile and extensible. Large Fin Serv accounts are moving toward microservices-based architectures and away from legacy monolithic models. Today, this is often implemented in production with container-based platforms like Red Hat OpenShift.

One of the greatest advantages of modern container-based architectures is that the application code operates well in many different environments including the private cloud, hybrid solutions, and the public cloud.  Of course, large Fin Serv accounts are risk averse and operate under the crushing weight of regulation and audit. As a result, private cloud is today’s most common platform for mission-critical applications. In that same vein, application services follow a similar path from monolithic to application-specific deployment architectures.

We’re also seeing the impact of a shortage of security talent across industries in which the demand for security services has increased. A majority (58%) of financial institutions cited hiring or acquiring skilled cybersecurity talent as the third most challenging aspect of managing security risk.^[10] This is one of the factors behind the majority of financial services leaders ranking real-time threat analytics as their number two strategic trend, compared to number six across all other industries.^[11]

As consumers get more comfortable with the “new normal” of staying home and avoiding public contact, many will find that managing their money digitally is easier and safer. 

Micro-Level Trends in Application Services

We’re seeing an increase in adoption of enterprise-wide, hybrid licensing models in Financial Services accounts. In the first 6 months of this fiscal year, we’ve more than doubled 2019 volume of these constructs.  Advance web application firewalls (WAFs) are now commonly used; in fact, few applications are deployed without a WAF.

Customer interest in, and concern with, encrypted threats is growing. As a result, we’re seeing more pilots and quotes for F5® SSL Orchestrator®.  

Some of our accounts have been through federal audits and are focused on MRIA solutions. F5 supplied a solution to a major financial institution for mitigation of a repeat of last year’s compromise and is providing professional services to another to address an MRIA.

Conclusion

Given the trends we’ve outlined, we expect U.S. financial institutions to be leaders in terms of stability while other geographies take the lead in innovation. This is primarily because of  regional regulations and cultural differences in terms of tolerance for financial risk. We anticipate this will encourage expansion of FinTech beyond digital payments, while banks are likely to embrace partnerships and acquisition to help them develop their financial product portfolios.

^{[1] CBInsights, State of FinTech
[2] F5 State of Application Services 2020 Financial Services Edition
[3] Statistica, Reasons for Using Credit Cards as a Payment Means 
[4] Forbes, How much do banks spend on Technology?
[5] CIO Dive 2019
[6] F5 State of Application Services 2020
[7] F5 State of Application Services 2020
[8] F5 State of Application Services 2020
[9] DC, Cloud Pulse Survey Q2 2019
[10] Deloitte Insights, Global Risk Management Survey, 10th Edition
[11] F5 State of Application Services 2020, Financial Services Edition}

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