DIGITAL TRANSFORMATION OF THE BANKING INDUSTRY, Part 3

  (Source: East Japan Railway Company)

Leverage Digital Technology

In the banking sector, players should strive to become trailblazing purveyors of financial services that leverage digital technology.

There are areas in the banking services value chain where firms should work independently to generate unique, in-house, high-value-added services and products; there are also areas where banks stand to benefit by collaborating with other firms to drive down costs. Also, firms should consider collaborating with other firms to leverage economies of scale and economies of scope, parlaying cost centers into new profit centers, and securing a role in the industry infrastructure.

In actual operation, after deliberating and implementing such initiatives, big-data analytics and the automation of all processes will prove the most important. Here as well, a shift to a modular supply structure will be required, and a critical factor in determining the success of financial institution management will be alliances — namely, how adroitly firms partner with other entities.

In Conclusion

Celent offers the three points below as food for thought and policy prescriptions for modernization in the banking industry.

1. Technology as a driver of growth:

  • Look for ways to pioneer new segments through the use of technology without fixating on the segments that have been your bread and butter up to this point.
  • For example, robo-advisors can be used not only for mutual fund but also for insurance products sales to retail customers. Bancassurance and alternative distribution channels should also be driven by robo-advisors.

2. Vertical disintegration:

  • Prioritize finding the sweet spot for cost and risk and revisit and rethink your processes (such as vertical integration and/or internalization, and the use of horizontal division of labor and/or outsourcing) across the board.
  • For example, enhancing the agility of new payment product research and development might be achieved by vertical disintegration of banking business into payment services discovery, development, and marketing organizations.

3. Industry-wide priorities:

  • Place top priority on initiatives to raise financial and IT literacy among customers.
  • Actively seek to leverage monetary policy and system reform as business opportunities; avoid a passive approach to system reform.
  • Rebuild the industry value chain through methods of modularization, specialization, and integration.

Legacy modernization in the banking industry is much more than simply the application of novel technology. Rather, it portends nothing less than a structural overhaul of the banking industry, an opportunity to envisage anew and redefine the industry’s future. There can be no doubt that this transcends the mere establishment of a digital channel; rather it will certainly impact products, services, IT units, and sourcing models, and, in so doing, provide the banking service providers of the future a chance to seriously consider exactly what kind of companies they would like to be and the corporate cultures they would like to foster.

Celent perceives legacy modernization in the banking industry as instigating change at a fundamental level, in both business execution and organizational structure. Moreover, this transformation promises to have legs and vast implications that will play out over the long haul. Legacy modernization is much more than just new technology and it will have sweeping implications.

 

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Related releases:

Legacy Modernization in the Japanese Banking Industry, Part 1

Legacy Modernization in the Japanese Banking Industry, Part 2

 

DIGITAL TRANSFORMATION OF THE BANKING INDUSTRY, Part 2

  (Source: Charles Schwab)

The Banking Industry of the Future

The securities industry can be regarded as the first sector in the financial industry to have embarked down the path of modularization. Mutual funds was the first major area involved in this first step toward modularization. Mutual funds are now mainstream products of banking and wealth management. The banking industry should not overlook the following episodes.

The mutual fund business model can be broken down into two process areas: 1) selecting investments or investment destination (portfolio building), and 2) sales of the created mutual funds. In the former, the products (portfolio) are designed and created (produced), while the latter involves the sales of investment firm securities (mutual fund beneficiary certificates), with sellers undertaking the office processing such as customer transaction reports.

In the closed model era of brokers and mutual fund firms, the norm until the 1960s, mutual fund firms would outsource sales to securities companies (full service brokers). This resulted in mutually beneficial consignment-based relationships between the investment trust companies and securities firms that endured for a long time with a fixed fee structure (investment sales commissions paid from the customer to the securities company) and securities trading fees (paid by the mutual fund company to securities company). These sales formats have since diversified.

No-load funds entered the market starting in the 1970s, spurred on by the liberalization of commissions for the brokering of securities, sluggish demand in the stock market, and the emergence of discount brokers that did not offer investment advice. This era was characterized solely by diversification of sales methods, and was entirely absent changes to the closed model that covered planning, manufacturing, and sales.

However, change descended on the market in the form of the mutual fund supermarket revolution. With the launch of Mutual Fund OneSource in 1992, Charles Schwab offered multiple funds that customers could purchase without paying a commission, but for which Schwab’s mutual fund management arm collected an annual management fee based on asset balance. Metaphorically speaking, this approach was akin to companies putting mutual funds on the shelves of a supermarket and charging commissions only for the products sold. The interface between mutual fund companies and securities companies opened up, and the creation and sales components were decoupled and functionally modularized.

More change is on the horizon. An era is coming in which the banking industry should orchestrate a shift to a structure that hinges on modular demand to respond to new needs fostered by digital technology and the new demand of the emerging digital generation.

Industry players should be ditching vertically integrated direct sales, or so-called keiretsu, which are tantamount to direct sales routes; instead, they should establish delivery models that are more dynamic and open. Omnichannel initiatives are not only opportunities for firms to launch or shut down these channels, but also to revisit and reconsider their optimal delivery model. Moreover, collaborating with non-financial sector players, including start-ups, opens the door to the possibility of accessing vast and new untapped market frontiers.

Robo-advisor initiatives can be expected to accelerate the speed of advances in modular demand structure. Presumably, coming delivery channels will seek to optimize information and investment expertise, driven by approaches that respond to the needs of investors by providing automated advice and harnessing bankers as human support mechanisms.

To be continued – Click here

 

Related releases:

Legacy Modernization in the Japanese Banking Industry, Part 1

Legacy Modernization in the Japanese Banking Industry, Part 2

 

Digital Transformation of the Securities Industry in Japan and Asia

Modularization of Industry

Industries across the board are undergoing structural change. This change extends beyond individual firms and spills across industrial sectors. Other industries that have been exposed to the tide of technology-driven structural changes have through the process harnessed technology to be reinvented as new industries befitting this evolution in industrial structure. The financial industry traditionally has been far from the vanguard of this change.

The proliferation of the Internet and digital technologies is only accelerating the evolutionary modular shift across all industries. This stands in stark contrast to the traditional non-modular, vertically integrated structure (that is to say, the antithesis of a modular structure, where all the products and services are provided through and within one exclusive value chain) that the industry has historically embraced.

However, disruptive new market players have visibly forced conservative, existing entities to begin to seek new approaches; at the same time, regulatory authorities have also started to embark on establishing a new, more robust system for regulating the financial industry.

The Securities Industry of the Future

The securities industry can be regarded as the first sector in the financial industry to have embarked down the path of modularization. A major area that has been involved in this first step toward modularization has been mutual funds.

In the closed model era of brokers and mutual fund firms, which was the norm until the 1960s, mutual fund firms would outsource sales to securities companies (full service brokers). Then, the market witnessed the emergence of no-load funds starting in the 1970s. This era was characterized solely by diversification of sales methods, and was entirely absent changes to the closed model that covered planning, manufacturing, and sales. Finally, change descended on the market in the form of the mutual fund supermarket revolution. Metaphorically speaking, this approach was akin to companies putting mutual funds on the shelves of a supermarket and charging commissions only for the products sold. The interface between mutual fund companies and securities companies opened up, with this the creation and sales components were decoupled and functionally modularized.

The Role of New Technology: Robo-advisor

Robo-advisor initiatives can be expected to accelerate the speed of advances in modular demand structure. Presumably, coming delivery channels will seek to optimize information and investment expertise provided, driven by approaches that respond to the needs of investors by sometimes providing "automated advice" and sometimes harnessing brokers as "a human support mechanism.”

In Japan, megabanks, startups, and dedicated online brokers are all jockeying to leverage their strengths in a way that accords them the most advantageous position possible. Their robo-advisor initiatives so far largely appear tailored to support the sales of mutual funds. As easy-to-use, non-face-to-face channels, they are garnering interest from investors with a level of comfort with IT and a degree of financial literacy. Moving forward, further advancements that draw on both the asset management facet and technology are expected in the 4 areas; diversity of products, diversity of services, automation, accommodating B2B.

Excluding Japan, Hong Kong, and Singapore, Asia is a fragmented market for retail investors, and therefore it’s still inaccessible. In addition, such markets as Taiwan and Korea are showing an increase in home bias. Thus, how the robo-advisor business thrives in the Asian market will depend on its distribution dynamics, along with its asset growth potential and product development.

Legacy modernization in the securities industry is much more than the application of novel technology. Rather, it portends nothing less than a wholesale structural overhaul of the securities industry that is an opportunity to envisage anew and redefine the industry’s future. There can be no doubt that this transcends the mere establishment of a digital channel; rather it will certainly impact products, services, IT units, and sourcing models, and, in so doing, provide the securities service providers of the future a chance to seriously consider exactly what kind of companies they would like to be and the corporate cultures they would like to foster.

 

Related releases:

Legacy Modernization in the Japanese Securities Industry, Part 1

Legacy Modernization in the Japanese Securities Industry, Part 2

Fintech and Robo Advisors: Booming in Japan

Legacy Modernization in Japan’s Financial Industry, Part 2: What the Auto Industry Can Teach the Financial Sector

 

Fidelity’s exit and the Indian mutual fund industry

Fidelity Mutual Fund, which started its India operations in 2004, recently announced its decision to quit the Indian Mutual fund industry. L&T Finance, a subsidiary of L&T Finance Holdings Ltd., is likely to acquire Fidelity’s India business. The new entity is likely to have a 2% market share and 13th position in the industry in terms of asset base. This will be L&T’s second acquisition in this market after the acquisition of DBS Chola Mutual Fund in 2010. India’s mutual fund industry has witnessed many such exits by market participants at different points in time, but this is perhaps the most high profile case of an internationally established major player deciding to shut down its India operations. In India the mutual fund industry has been heavily dominated by the corporate segment, unlike other countries where retail investors account for most of the industry assets. Fidelity had a very high proportion of its business coming from the retail and the HNI segments. As a result equity investments accounted for bulk of Fidelity’s assets as the focus was on meeting clients’ long term financial goals. Therefore the Fidelity L&T deal has been priced much higher (5-6% of asset) as compared to other such deals in the Indian industry which are usually valued at 1-3% of assets under management. Fidelity’s decision to quit the industry comes in the backdrop of its accumulated losses, driven mainly by a high cost structure. In 2010-11, the company’s staff cost grew around 50% over previous year and was around 90% of its revenue, while staff cost accounts for only 13% for some of its competitors in the industry. This decision has once again brought to the fore issues relating to the regulation of India’s mutual fund industry and its impact on firms’ profitablity. Many argue removal of entry load and limiting payment of upfront commision to distributors (to prevent misselling of products) is hurting fund houses’ ability to sell more and grow the top line at a time when costs are rising rapidly. At the same time it needs to be said that a recent study found that ‘among 15 of 46 AMCs operating in the fund industry, which collectively manage 85-90 per cent of the entire industry’s assets und­er management,10 large AMCs registered net profit in FY11 and 12 AMCs had positive accumulation of net profits over the years till FY11’. This then raises the question if the Indian Mutual Funds industry is more favourable to the larger players and what is the critical asset base a fund house must garner to break even or become profitable, especially in the changing economic scenario. This also raises the question if the new regulations are affecting the smaller players more than the larger players. In this evolving scenario when growth has been hit, regulations are changing fast and firms are increasingly finding hard to stay competitive, some Indian fund houses are looking to partner with global players to attract global funds, investors as well as expertise. In such arrangements, the local expertise of domestic firms complement the supeerior knowledge and capabilities of global partner to create a win win strategy for all.

Navigating through tumultuous WM landscape in India

The Indian wealth management market is dominated by domestic wealth management providers in the mass affluent segment, while international firms and private banks are strong players in the high and ultra-high net worth segment. Insurance providers are dominant players in the mass market. Brokerages and retail banks have started separate wealth management businesses and they are gaining strong ground in high affluent segments. Another characteristic of the Indian wealth management market is the large share of the business captured by unorganized players. The size of this business is estimated to be about twice the size of the business of organized players. The unorganized segment mainly comprises of private financial advisors and chartered accountants who provide personalized financial advisory such as tax and investment advisory. Increased penetration of the organized players is slowly drawing the clients away from the unorganized players. However, the picture is not all hunky dory for wealth management providers, as the industry is beset with several challenges. Rising competition and resulting downward pressure on advisory fees, along with a large chunk of ‘invisible’ wealth are some of the reasons why private banks and wealth management providers are not able to monetize the opportunity easily. By ‘invisible’ wealth, we refer to wealth that is hidden away in tax havens and black money which has become a topic for heated public debate in the country today. Also, not to forget the negative investor sentiment caused by a series of scams and the slide in equity markets, which has made the challenge greater. Lack of product variety is also a matter of concern. Alternative investment vehicles such as hedge funds and private equity provide limited options for investment, and regulatory constraints on overseas investments have resulted in poor product variety comprising mostly of vanilla products. The Indian market is still nascent for exotic investments such as art and luxury goods. Also, the affinity of wealthy individuals towards investments in gold and real estate which do not require the specialized services of a wealth manager further contributes to target segment shrinkage. There is a gradual shift to advisory based feel model from transaction based fee models, with regulators stepping in protect investor interests. While it seeks to remedy conflict-of-interest between wealth managers and their clients, it also exerts downward pressure on fees. We might eventually see smaller players being forced out of the business. Large players would have to stay invested for sufficient length of time before returns start trickling in. Therefore, large banks and brokerages which have high reach and who can monetize the potential for cross-selling banking/mutual fund products would be placed at an advantage in capturing this market.

Trends in Indian Mutual Funds since Abolition of Entry Load

The Securities and Exchange Board of India (SEBI) has undertaken a number of initiatives and brought in new regulations for the mutual fund industry in the last two years, the most important change being the abolition of entry load for selling mutual fund products since August 2009. The effect of this rule change has been widely debated. Some argue the impact of this change has not been significant as fund flows have registered year on year growth in 2009, while others argue that in absence of upfront commission distributors are now less motivated to sell mutual funds. We take a look at quarterly sales data of equity mutual funds to analyze the effect. Sales of euity funds, which constitute a third of industry AuM, is a good proxy to understand retail investor buying behavior, because the retail (including HNI) segment accounts for around 85% of total equity fund assets. According to data from AMFI, quarterly sales have been steady since the second quarter of 2009, and higher than they were in 2008. However, one needs to decouple the effects of the crisis that hit the markets in 2008. From the figure, one can conclude that though equity fund sales grew after the rule change, they are still far below the trends observed during 2006–2007. The decline in 2008 was due to market conditions, but subsequent recovery has not been commensurate with overall market improvement. Equity fund sales moved in tandem with SENSEX in the pre-2008 period, but post-2008 the gap has widened. Two points are worth considering here. The crisis of 2008 may have made investors more risk averse. While they were buying heavily during the bull run of 2006-07, post-crisis they have become apprehensive of investing in mutual funds. Another reason for lack of investor participation can be the lower returns generated by the fund managers. A recent study by Standard & Poor’s and CRISIL showed that a majority of actively managed mutual fund schemes in India have underperformed their respective benchmarks over the five-year period ended December 31, 2010. This may have made retail investors shy further away from investing in mutual funds. In summary, it can be said that the recovery of the Indian mutual fund industry since the crisis of 2008 has not been commensurate with the overall market recovery. The abolition of entry load has had an impact on sales from the retail segment, but it is not the only reason. Failure to outperform benchmark indices is another equally important issue afflicting the industry.

Quarterly Equity Mutual Fund Sales

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The Securities and Exchange Board of India (SEBI) has undertaken a number of initiatives and brought in new regulations for the mutual fund industry in the last two years, the most important change being the abolition of entry load for selling mutual fund products since August 2009. The effect of this rule change has been widely debated. Some argue the impact of this change has not been significant as fund flows have registered year on year growth in 2009, while others argue that in absence of upfront commission distributors are now less motivated to sell mutual funds. We take a look at quarterly sales data of equity mutual funds to analyze the effect. Sales of euity funds, which constitute a third of industry AuM, is a good proxy to understand retail investor buying behavior, because the retail (including HNI) segment accounts for around 85% of total equity fund assets.

According to data from AMFI, quarterly sales have been steady since the second quarter of 2009, and higher than they were in 2008. However, one needs to decouple the effects of the crisis that hit the markets in 2008. From the figure, one can conclude that though equity fund sales grew after the rule change, they are still far below the trends observed during 2006–2007. The decline in 2008 was due to market conditions, but subsequent recovery has not been commensurate with overall market improvement. Equity fund sales moved in tandem with SENSEX in the pre-2008 period, but post-2008 the gap has widened.

Two points are worth considering here. The crisis of 2008 may have made investors more risk averse. While they were buying heavily during the bull run of 2006-07, post-crisis they have become apprehensive of investing in mutual funds. Another reason for lack of investor participation can be the lower returns generated by the fund managers. A recent study by Standard & Poor’s and CRISIL showed that a majority of actively managed mutual fund schemes in India have underperformed their respective benchmarks over the five-year period ended December 31, 2010. This may have made retail investors shy further away from investing in mutual funds.

In summary, it can be said that the recovery of the Indian mutual fund industry since the crisis of 2008 has not been commensurate with the overall market recovery. The abolition of entry load has had an impact on sales from the retail segment, but it is not the only reason. Failure to outperform benchmark indices is another equally important issue afflicting the industry.

Exchange Trading of Mutual Funds in India

In the last year and a half, the Securities and Exchange Board of India (SEBI) has taken a number of steps to develop the mutual funds industry in India. One significant move in this direction has been allowing trading of mutual funds at the country’s stock exchanges. After studying the feasibility of doing this in 2009, SEBI approved mutual fund transactions through stock exchanges in November last year. This was done to extend the convenience of the secondary market infrastructure to mutual fund investors who could earlier invest in funds only through the existing distributor/agent channel. India’s exchanges with a large number of trading terminals connected through numerous Lease Lines and VSAT terminals can reach investors in over 400 cities. Besides reach, exchange trading offers number of other benefits too: opportunity to invest in multiple asset class through a single (demat) account, aggregation of entire portfolio in a single place enabling easy monitoring and more efficient investment decision making, reduction of paper work and errors etc. Also the exchanges’ existing delivery vs payment process offers de-risking of settlement process and increases transparency. Following SEBI’s approval, the two Indian Exchanges, the National Stock Exchange of India (NSE) and the Bombay Stock Exchange (BSE) started trading in mutual funds in November-December, 2009 (NSE: Mutual Fund Service System, BSE: StAR MF). Under the current arrangements investors would be able to deal in Mutual funds that have signed up with the exchanges and in the schemes which the fund houses have permitted to be traded at the exchanges. Out of 40 Asset Management Companies, around 20-22 have signed up with the two exchanges so far. SEBI is planning to make listing of all schemes mandatory. A look at the figures (see graph below) reveals this new channel for investing in mutual funds has not been very popular among investors yet. It can be noted in this context, average daily transaction value (sales+redemptions) for the overall industry during May-July, 2010, had been around 690 bn Rs, which makes exchange trading around 0.3% of total trading during the same period. The occasional jump (July) in trading value is more because of market fluctuations than investors’ preference for exchange trading: Industry Assets Under Management went down by 10% in July as compared to May, as a result subscription went up. Though it has to be acknowledged that of late, there has been a push from the fund houses to encourage investors to take the exchange route. However, these are still early days for this new system. Moreover, since removal of entry load (distribution fee charged by agents to investors) in August, 2009, the industry has been in a state of flux with agents now focusing more on selling insurance products which have high distribution fees. To overcome this problem the fund houses have been trying a number of new distribution models in last one year for attracting new investors; but a clear pattern is yet to emerge. It can be argued with more investor education and awareness about the new technology channels and SEBI’s continuous push, exchange trading of mutual funds is likely to pick up in the future. Banks are a big player in mutual funds and the regulators’ urging banks to transact through exchanges may be one step towards achieving this. Another recent phenomenon is that many brokerages are placing orders through exchanges in the recent months. These all hold good promise for this new channel, however, its long term impacts are yet to be seen.