banking business model evolution

The future of banking: Time to rethink business models

4-MINUTE READ

• Banking is changing as a new wave of digital-only players fragment the market, componentize products and challenge age-old business models.
• New research examines the business models of traditional and digital-only players to identify how value chain fragmentation is reshaping the industry.
• Our analysis shows that the digital-only players using adaptive models enjoyed higher revenue growth compared to players with traditional models.
• Incumbent banks can catalyze growth by operating a range of new models in parallel with the current core of the business.

An age-old model gets turned on its head

The digital revolution has finally come for one of banking’s long-standing foundations.

For years, business models in the industry were as fixed as panes of stained-glass cathedral windows. A bank typically owned each layer of the value chain and would create, package, and distribute its products, whether the bank was a century-old global titan or a neobank offering a digital alternative to traditional offerings. Its models were monolithic, linear and vertically integrated.

But new waves of digital-only players have unshackled themselves from vertical integration and are fragmenting the banking value chain by choosing which layers they want to play in. They are also unbundling traditional products into micro-products or services and re-bundling their own offerings together with components from other providers to offer better customer propositions.

Many digital-only players are using this non-linear and adaptive business model to attack incumbent banks where they are most exposed. The strategy of each challenger varies, but they are unified in their ability to configure innovative products and propositions quickly and at scale, with lower customer acquisition costs.

The result in most markets? A steady outflow of banking and payments revenues from incumbents to new entrants.

There’s value in going non-linear, our report shows

Our Future of Banking report analyzes the business models of leading incumbent banks and digital-only players to identify how value chain fragmentation and product componentization are reshaping the banking market of the future.

We found that digital-only players with non-linear business models are outperforming those that simply emulate vertically integrated models in the digital world. They can also adapt more easily to product componentization and further value chain fragmentation to respond quickly to future disruption in the market.

The average compound annual revenue growth of banks and competing players in our study that utilize different business models (between 2018 and 2020):

digital-only players with non-linear models.

digital-only players emulating traditional vertically integrated models.

traditional banks with vertically integrated models.

The performance of these digital-only, non-linear challengers offers inspiration for incumbent banks looking for breakout growth and higher market valuations. The billion dollar question is: where to begin?

The life centricity playbook

Crafting a kaleidoscope of business models.

Large banks are understandably reluctant to discard the vertically integrated business models that still drive their profitability. The good news is that taking on non-linear business models is not an all-or-nothing proposition.

The key to success in this flexible, fluid environment is not just to shift from yesterday’s business model to a new one. Rather, it is to evolve from reliance on a single, vertically integrated business model to multiple non-linear models and roles in the value chain.

Owning the value chain end-to-end and selling only your own products are no longer requirements for success. Architecting and creating value for the end-customer or for the next player in the value chain offer new paths to differentiation and growth. This requires having the vision and flexibility to reimagine and “package” compelling propositions that truly focus on customers’ needs and intentions.

To become a value architect, banks should consider playing a range of roles in the value chain. Depending on the size, market and strength of the bank, an incumbent can embrace any mix of these approaches to increase business model flexibility and differentiate itself from the competition.

Sell the bank’s own products

Control all layers of the value chain, from manufacturing to distribution, in a traditional model of vertical integration

Build a distribution-driven ecosystem

Distribute financial products of all kinds from other companies, or even non-banking products.

Sell banking capability as a service

Reach scale by manufacturing technology or business processes that are invisible to end-clients.

Create new propositions through bundling

Build or package fragmented micro-products or products for distribution through other companies and digital experiences.

In the leading banks of tomorrow, the traditional model of vertical integration will co-exist with an endlessly configurable kaleidoscope of non-linear models. This will allow these banks to both defend their existing business and seize new opportunities. By unshackling themselves from the traditional value chain, they can grow and scale in new markets while lowering the cost of growth.

You can find more detail on the  future of banking business models in our report .

By rethinking their business models and embracing the innovative strategies of digital-only banking and financial services new entrants, banks could boost revenues by nearly 4% annually.

Senior Managing Director – Global Banking Lead

Managing Director – Strategy & Consulting, Credit Lead, EMEA

Dilnisin advises financial services firms on how to stay ahead of major changes in credit, helping them to transform their business for the future.

MORE ON THIS TOPIC

Purpose: Driving powerful transformation for banks

The banking experience reimagined

Global banking industry outlook

Related capabilities, intelligent operations.

At the New York Fed, our mission is to make the U.S. economy stronger and the financial system more stable for all segments of society. We do this by executing monetary policy, providing financial services, supervising banks and conducting research and providing expertise on issues that impact the nation and communities we serve.

Introducing the New York Innovation Center: Delivering a central bank innovation execution

Do you have a Freedom of Information request? Learn how to submit it.

Learn about the history of the New York Fed and central banking in the United States through articles, speeches, photos and video.

Markets & Policy Implementation

• Effective Federal Funds Rate
• Overnight Bank Funding Rate
• Secured Overnight Financing Rate
• SOFR Averages & Index
• Broad General Collateral Rate
• Tri-Party General Collateral Rate
• Treasury Securities
• Agency Mortgage-Backed Securities
• Repos & Reverse Repos
• Securities Lending
• Central Bank Liquidity Swaps
• System Open Market Account Holdings
• Primary Dealer Statistics
• Historical Transaction Data
• Agency Commercial Mortgage-Backed Securities
• Agency Debt Securities
• Discount Window
• Treasury Debt Auctions & Buybacks as Fiscal Agent
• Foreign Exchange
• Foreign Reserves Management
• Central Bank Swap Arrangements
• ACROSS MARKETS
• Actions Related to COVID-19
• Statements & Operating Policies
• Survey of Primary Dealers
• Survey of Market Participants
• Annual Reports
• Primary Dealers
• Reverse Repo Counterparties
• Foreign Exchange Counterparties
• Foreign Reserves Management Counterparties
• Operational Readiness
• Central Bank & International Account Services
• Programs Archive

As part of our core mission, we supervise and regulate financial institutions in the Second District. Our primary objective is to maintain a safe and competitive U.S. and global banking system.

The Governance & Culture Reform hub is designed to foster discussion about corporate governance and the reform of culture and behavior in the financial services industry.

Need to file a report with the New York Fed? Here are all of the forms, instructions and other information related to regulatory and statistical reporting in one spot.

The New York Fed works to protect consumers as well as provides information and resources on how to avoid and report specific scams.

The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions.

The New York Fed provides a wide range of payment services for financial institutions and the U.S. government.

The New York Fed offers several specialized courses designed for central bankers and financial supervisors.

The New York Fed has been working with tri-party repo market participants to make changes to improve the resiliency of the market to financial stress.

• High School Fed Challenge
• College Fed Challenge
• Teacher Professional Development
• Classroom Visits
• Museum & Learning Center Visits
• Educational Comic Books
• Lesson Plans and Resources
• Economic Education Calendar

We are connecting emerging solutions with funding in three areas—health, household financial stability, and climate—to improve life for underserved communities. Learn more by reading our strategy.

The Economic Inequality & Equitable Growth hub is a collection of research, analysis and convenings to help better understand economic inequality.

This Economist Spotlight Series is created for middle school and high school students to spark curiosity and interest in economics as an area of study and a future career.

« Unequal Burdens: Racial Differences in ICU Stress during the Third Wave of COVID‑19 | Main | The Housing Boom and the Decline in Mortgage Rates »

Going with the Flow: Changes in Banks’ Business Model and Performance Implications

Nicola Cetorelli, Michael G. Jacobides, and Samuel Stern

Does the performance of banks improve or worsen when banks enter into new business activities? And does it matter which activities a bank expands into, or retreats from, and when that decision is made? These important questions have remained unaddressed due to a lack of data. In a recent publication , we used a unique data set detailing the organizational structure of the entire population of U.S. bank holding companies (BHCs). In this post, we draw on that research to show that while scope expansion on average hurts performance, entering into activities that are highly synergistic with core banking at a given point in time yields net performance benefits.

Transformation in U.S. Banks’ Organizational Structure

In the past two to three decades, U.S. banking institutions have gone through the largest and deepest process of scope transformation in history. Throughout the 1990s and early 2000s, more than half of the population of BHCs (accounting for about 97 percent of total industry assets) either created or took control of tens of thousands of subsidiaries, spanning virtually every activity within the financial industry and even beyond. For example, between 1990 and 2006, more than 230 distinct U.S. BHCs incorporated securities-dealer or broker subsidiaries, about 500 took control of insurance agencies, and over 1,000 added one or more special purpose vehicle legal entities to their organizations.

Costs and Benefits of Adding Subsidiaries

The so-called “agency view” predicts that adding new operational units, especially those engaged in activities that the organization has not previously focused on, will impose a variety of costs (misallocation of resources, for example) associated with agency frictions within the organizational hierarchy. And yet, scope expansion is widely observed through time and across industries, suggesting that adding subsidiaries may promise underlying economic gains . An influential strand of research in the strategy literature, known as the “ resource-based view ,” has emphasized that a firm may benefit from expanding scope into business activities where its current resources can be efficiently redeployed. This, in turn, rests on the premise that certain activity types are more likely than others to share similar processes, knowledge bases, human capital, and so on. Such relatedness across activities should translate into relatively larger efficiency gains and/or the attainment of return synergies associated with their joint operation.

A challenge in trying to capture relatedness across activities is that sectors are not static. As Teece et al. have observed, industries evolve, and so should the opportunities for synergies across activities. This suggests that relatedness has a life cycle, so that certain additions may confer different performance benefits at different points in time . The observation rings particularly true for U.S. banking, where the mode of financial intermediation changed so dramatically during the 1990s and 2000s.

The banking sector shifted from a model where commercial banks brokered supply and demand of intermediated funds, to a decentralized system where matching increasingly took place through much longer credit intermediation chains, with nonbank entities emerging as providers of specialized inputs along the way. This evolution created new opportunities for potential synergies across a variety of businesses—but the value of those synergies also varied depending on regulatory, technological, and market conditions. For example, the newfound benefits from combining commercial banking with securities dealing and underwriting, following the institution of Section 20 subsidiaries in the late 1980s/early 1990s, appear to have increased firm-level value, and probably especially so in the run-up to the 90s technology boom. Likewise, the surge in asset securitization throughout the 1990s likely created the conditions for banking institutions to add specialty lenders, special purpose vehicles, and servicers, among others.

Empirical Study of Relatedness

The empirical analysis of an evolving relatedness has represented a major challenge in applied studies because of the demanding data needs. However, we are able to address these needs in our study. Following the strategy literature, we capture relatedness by looking at how many BHCs choose to hold a given activity at a given time, under the plausible assumption that the more popular activities are those closer to the current core of intermediation. Such a metric could only be computed by having full information on scope of the entire population of BHCs, which is what our database provides.

We can offer a simple visualization of this concept of evolving relatedness. The chart below shows, for a sample of alternative business activities, the proportion of BHCs in any quarter/year reporting at least one entity that both is part of their organization and was engaged in that activity. So, for instance, special purpose vehicles (included in “Other financial vehicles”) were hardly found in BHCs’ organizational structures in the early 1990s, but they indeed became a staple for BHCs in later years, as the asset securitization boom prompted banks to move into that business area, and new synergies emerged as a result.

Waxing and Waning of Banks’ Business Scope

Sources: Board of Governors of the Federal Reserve System, Report of Changes in Organizational Structure (Y-10); authors’ calculations.

Conversely, entities managing residential dwellings (included in “Lessors of residential buildings and dwellings”) were relatively very popular in the cross section of BHCs in the early 1990s. These were indeed times when balance-sheet assets such as mortgages and their collateral defined the predominant scope of a commercial bank—but later they declined into obscurity, probably mirroring the subsequent evolution toward the originate-and-distribute model of intermediation. At the same time, securities brokerage entities and insurance brokerage firms start at similar levels of popularity but diverge later on.

How Should Relatedness Contribute to Performance?

Using the chart above as an illustration, we conjecture that a BHC entering the insurance business for the first time when this activity is at the nadir of its popularity should yield a smaller performance boost than if entry is done at a time when the insurance business is more integrated with banking, as reflected by insurance subsidiaries being found more frequently across BHCs. We find that this is indeed the case. According to our estimates, BHCs that expanded into this activity in the early 1990s were more likely to experience a net negative impact on their return on equity . Conversely, for BHCs that expanded instead when the activity was at its maximum popularity (around the mid-2000s), the return on equity increased.  

We brought this intuition to the data and sought more systematic evidence, and our overall findings confirm this example: BHCs pursuing scope transformation strategies on averagedo not do as well as their peers. However, it matters a lot whichactivities a BHC expand into, but even more importantly whensuch entry occurs: entry into activities when those activities are highly related to core bankingtranslates into significant net performance gains.

We find that expansion into activities when they are highly related to core banking seems to be beneficial for BHCs. However, we should also clarify that benefits for BHCs that transform their scope do not necessarily imply concomitant benefits for society as a whole, nor do they rule out the possibility of associated negative systemic externalities (see, for example, Rajan 2011 and Jacobides et al 2014 ). This in an important issue, and one deserving of a separate undertaking.

Nicola Cetorelli is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

Michael G. Jacobides is the Sir Donald Gordon Professor of entrepreneurship and innovation and Professor of strategy and entrepreneurship at London Business School.

Samuel Stern is a Ph.D. student at the University of Michigan and a former senior research analyst in the Federal Reserve Bank of New York’s Research and Statistics Group.

How to cite this post: Nicola Cetorelli, Michael G. Jacobides, and Samuel Stern, “Going with the Flow: Changes in Banks’ Business Model and Performance Implications,” Federal Reserve Bank of New York Liberty Street Economics , September 1, 2021, https://libertystreeteconomics.newyorkfed.org/2021/09/going-with-the-flow-changes-in-banks-business-model-and-performance-implications.

Related Reading Same Name, New Businesses: Evolution in the Bank Holding Company The Evolution of Banks and Financial Intermediation Were Banks Ever ‘Boring’? Were Banks ‘Boring’ before the Repeal of Glass-Steagall?

Disclaimer The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Share this:

This is a very useful and interesting piece of work. Was it not possible to bring the data forward to analyze the period through and post financial crisis? The addition of more fee based businesses like asset management would seem important to understand.

The comments to this entry are closed.

Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.

The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.

Liberty Street Economics does not publish new posts during the blackout periods surrounding Federal Open Market Committee meetings.

The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.

Economic Inequality

Most Read this Year

• Credit Card Delinquencies Continue to Rise—Who Is Missing Payments?
• Deposit Betas: Up, Up, and Away?
• The Great Pandemic Mortgage Refinance Boom
• The Post-Pandemic r*
• Spending Down Pandemic Savings Is an “Only-in-the-U.S.” Phenomenon
• Economic Indicators Calendar
• FRED (Federal Reserve Economic Data)
• Economic Roundtable
• OECD Insights
• World Bank/All about Finance

We encourage your comments and queries on our posts and will publish them (below the post) subject to the following guidelines:

Please be brief : Comments are limited to 1,500 characters.

Please be aware: Comments submitted shortly before or during the FOMC blackout may not be published until after the blackout.

Please be relevant: Comments are moderated and will not appear until they have been reviewed to ensure that they are substantive and clearly related to the topic of the post.

Please be respectful: We reserve the right not to post any comment, and will not post comments that are abusive, harassing, obscene, or commercial in nature. No notice will be given regarding whether a submission will or will not be posted.‎

Comments with links: Please do not include any links in your comment, even if you feel the links will contribute to the discussion. Comments with links will not be posted.

Send Us Feedback

The LSE editors ask authors submitting a post to the blog to confirm that they have no conflicts of interest as defined by the American Economic Association in its Disclosure Policy. If an author has sources of financial support or other interests that could be perceived as influencing the research presented in the post, we disclose that fact in a statement prepared by the author and appended to the author information at the end of the post. If the author has no such interests to disclose, no statement is provided. Note, however, that we do indicate in all cases if a data vendor or other party has a right to review a post.

• February 2024
• January 2024
• December 2023
• November 2023
• October 2023
• September 2023
• August 2023
• February 2023
• January 2023
• December 2022
• November 2022
• October 2022
• September 2022
• August 2022
• February 2022
• January 2022
• December 2021
• November 2021
• October 2021
• September 2021
• August 2021
• February 2021
• January 2021
• December 2020
• November 2020
• October 2020
• September 2020
• August 2020
• February 2020
• January 2020
• December 2019
• November 2019
• October 2019
• September 2019
• August 2019
• February 2019
• January 2019
• December 2018
• November 2018
• October 2018
• September 2018
• August 2018
• February 2018
• January 2018
• December 2017
• November 2017
• October 2017
• September 2017
• August 2017
• February 2017
• January 2017
• December 2016
• November 2016
• October 2016
• September 2016
• August 2016
• February 2016
• January 2016
• December 2015
• November 2015
• October 2015
• September 2015
• August 2015
• February 2015
• January 2015
• December 2014
• November 2014
• October 2014
• September 2014
• August 2014
• February 2014
• January 2014
• December 2013
• November 2013
• October 2013
• September 2013
• August 2013
• February 2013
• January 2013
• December 2012
• November 2012
• October 2012
• September 2012
• August 2012
• February 2012
• January 2012
• December 2011
• November 2011
• October 2011
• September 2011
• August 2011
• Request a Speaker
• International, Seminars & Training
• Governance & Culture Reform
• Data Visualization
• Economic Research Tracker
• Markets Data APIs
• Terms of Use

• Search Search Please fill out this field.
• Understanding Banking History

Banking in the Roman Empire

European monarchs discover easy money, adam smith gives rise to free-market banking, merchant banks come into power, j.p. morgan rescues the banking industry, the end of an era, the birth of the fed, world war ii and the rise of modern banking, banking goes digital.

• History of Banking FAQs

The Bottom Line

• Personal Finance

The Evolution of Banking Over Time

From the ancient world to the digital age

Banking has been in existence since the first currencies were minted and wealthy people realized they needed a safe place to store their money. Ancient empires also needed a functioning financial system to facilitate trade, distribute wealth, and collect taxes. Banks were to play a major role in that, just as they do today.

Key Takeaways

• Religious temples became the earliest banks because they were seen as safe places to store money.
• Before long, temples got into the business of lending money at interest, much as modern banks do.
• By the 18th century, many governments gave banks a free hand to operate, based on the theories of economist Adam Smith.
• Numerous financial crises and bank panics over the decades eventually led to increased regulation.

Banking Is Born

The barter system of exchanging goods for goods worked reasonably well for the earliest communities. It prove problematic as soon as people started traveling from town to town in search of new markets for their goods and new products to take home.

Over time, coins of various sizes and metals began to be minted to provide a store of value for trade.

Coins, however, need to be kept in a safe place, and ancient homes did not have steel safes. Wealthy people in Rome stored their coins and jewels in the basements of temples. They were seen to be secure, given the presence of priests and temple workers, not to mention armed guards.

Historical records from Greece, Rome, Egypt, and Babylon suggest that temples loaned money in addition to keeping it safe. The fact that temples often functioned as the financial centers of their cities is one reason why they were inevitably ransacked during wars.

Coins could be exchanged and hoarded more easily than other commodities, such as 300-pound pigs, so a class of wealthy merchants took to lending coins, with interest , to people in need of them. Temples typically handled large loans, including those to various sovereigns, while wealthy merchant money lenders handled the rest.

The Romans, who were expert builders and administrators, extricated banking from the temples and formalized it within distinct buildings. During this time, moneylenders still profited, as loan sharks do today, but most legitimate commerce—and almost all government spending—involved the use of an institutional bank.

According to the World History Encyclopedia, Julius Caesar initiated the practice of allowing bankers to confiscate land in lieu of loan payments. This was a monumental shift of power in the relationship of creditor and debtor , as landed noblemen had previously been untouchable, passing debts on to their descendants until either the creditor’s or debtor’s lineage died out.

The Roman Empire eventually crumbled, but some of its banking institutions lived on in the Middle Ages through the services of papal bankers and the Knights Templar. Small-time moneylenders who competed with the church were often denounced for usury .

Eventually, the monarchs who reigned over Europe noted the value of banking institutions. As banks existed by the grace—and occasionally, the explicit charters and contracts—of the ruling sovereignty, the royal powers began to take loans, often on the king’s terms, to make up for hard times at the royal treasury.

This easy access to financing led kings into gross extravagances, costly wars, and arms races with neighboring kingdoms, not to mention crushing debt.

In 1557, Philip II of Spain managed to burden his kingdom with so much debt due to several pointless wars that he caused the world’s first national bankruptcy —as well as the world’s second, third, and fourth, in rapid succession. These events occurred because 40% of the country’s gross national product (GNP) went toward servicing the nation's debt.

The practice of turning a blind eye to the creditworthiness of powerful customers continues to haunt banks today.

Banking was already well-established in the British Empire when economist Adam Smith introduced his invisible hand theory in 1776. Empowered by his views of a self-regulating economy, moneylenders and bankers managed to limit the state’s involvement in the banking sector and the economy as a whole. This free-market capitalism and competitive banking found fertile ground in the New World, where the United States of America was about to emerge.

In its earliest days, the United States did not have a single currency. Banks could create a currency and distribute it to anyone who would accept it. If a bank failed, the banknotes that it had issued became worthless. A single bank robbery could crush a bank and its customers. Compounding these risks was a cyclical cash crunch that could disrupt the system at any time.

Alexander Hamilton , the first secretary of the U.S. Treasury, established a national bank that would accept member banknotes at par , thus keeping banks afloat through difficult times. After a few stops, starts, cancellations, and resurrections, this national bank created a uniform national currency and set up a system by which national banks backed their notes by purchasing Treasury securities , thus creating a liquid market . The national banks then pushed out the competition through the imposition of taxes on the relatively lawless state banks .

The damage had been done, however, as average Americans had grown to distrust banks and bankers in general. This feeling would lead the state of Texas to outlaw corporate banks with a law that stood until 1904.

Most of the economic duties that would have been handled by the national banking system, in addition to regular banking business like loans and corporate finance , soon fell into the hands of large merchant banks . During this period, which lasted into the 1920s, the merchant banks parlayed their international connections into enormous political and financial power.

These banks included Goldman Sachs ; Kuhn, Loeb & Co.; and J.P. Morgan & Co. Originally, they relied heavily on commissions from foreign bond sales from Europe, with a small backflow of American bonds trading in Europe. This allowed them to build capital.

As large industries emerged and created the need for major corporate financing, the amounts of capital required could not be provided by any single bank. Initial public offerings (IPOs) and bond offerings to the public became the only way to raise the amount of money needed.

Successful offerings boosted a bank’s reputation and put it in a position to ask for more to underwrite an offer. By the late 1800s, many banks demanded a position on the boards of the companies seeking capital, and if the management proved lacking, they ran the companies themselves.

J.P. Morgan & Co. emerged at the head of the merchant banks during the late 1800s. It was connected directly to London, then the world’s financial center, and had considerable political clout in the United States.

Morgan & Co. created U.S. Steel, AT&T, and International Harvester, as well as duopolies and near- monopolies in the railroad and shipping industries, through the revolutionary use of trusts and a disdain for the Sherman Antitrust Act .

It remained difficult, however, for average Americans to obtain loans or other banking services. Merchant banks didn’t advertise and rarely extended credit to the “common” people. Racism was widespread. Merchant banks left consumer lending to the lesser banks, which were still failing at an alarming rate.

The collapse in shares of a copper trust set off the Bank Panic of 1907 , with a run on banks and stock sell-offs. Without a Federal Reserve Bank to take action to stop the panic, the task fell to J.P. Morgan personally. Morgan used his considerable clout to gather all the major players on Wall Street and persuade them to deploy the credit and capital that they controlled, just as the Fed would do today.

Ironically, Morgan’s move ensured that no private banker would ever again wield that much power. In 1913, the U.S. government formed the Federal Reserve Bank (the Fed). Although the merchant banks influenced the structure of the Fed, they were also pushed into the background by its creation.

Even with the establishment of the Fed, enormous financial and political power remained concentrated on Wall Street. When World War I broke out, the United States became a global lender, and by the end of the war, it had replaced London as the center of the financial world.

At that point, the government decided to put some handcuffs on the banking sector. It insisted that all debtor nations pay back their war loans—which traditionally were forgiven, especially in the case of allies—before any American institution would extend them further credit.

This slowed world trade and caused many countries to become hostile toward American goods. When the stock market crashed on Black Tuesday in 1929, the already-sluggish world economy was knocked out. The Fed couldn’t contain the damage, which led to some 9,000 bank failures from 1929 to 1933.

New laws emerged to salvage the banking sector and restore consumer confidence. With the passage of the Glass-Steagall Act in 1933, for example, commercial banks were no longer allowed to speculate with consumers’ deposits, and the Federal Deposit Insurance Corp. (FDIC) was created to insure accounts up to certain limits. The insured limit as of 2023 is $250,000 per account.

World War II may have saved the banking industry from complete destruction. For the banks and the Fed, the war required financial maneuvers involving billions of dollars. This massive financing operation created companies with huge credit needs that, in turn, spurred banks into mergers to meet the demand. These huge banks spanned global markets.

More importantly, domestic banking in the United States finally settled to the point where, with the advent of deposit insurance and widespread mortgage lending , the average citizen could have confidence in the banking system and reasonable access to credit. The modern era had arrived.

The most significant development in the world of banking in the late 20th and early 21st centuries has been the advent of online banking , which in its earliest forms dates back to the 1980s but really began to take off with the rise of the internet in the mid-1990s.

The growing adoption of smartphones and mobile banking apps further accelerated the trend. While many customers continue to conduct at least some of their business at brick-and-mortar banks, a 2021 J.D. Power survey found that 41% of them have gone digital-only.

What Does a Central Bank Do?

A central bank is a financial institution that is authorized by a government to oversee and regulate the nation’s monetary system and its commercial banks. It produces and manages the nation's currency. Most of the world’s countries have central banks for that purpose. In the United States, the central bank is the Federal Reserve System.

Who Regulates Banks in the U.S. Today?

Depending on how they are chartered, commercial banks in the United States are regulated by a number of government agencies, including the Federal Reserve, the Office of the Comptroller of the Currency (OCC) , and the Federal Deposit Insurance Corp. (FDIC).

State-chartered banks are also regulated by the state in which they do business.

Investment banks are largely regulated by the U.S. Securities and Exchange Commission (SEC) .

What Is the Difference Between a Commercial Bank and an Investment Bank?

Commercial banks provide services to the general public and to businesses. They take deposits, issue loans, and operate ATMS.

Investment banks provide services only to large companies, institutional investors , and some high-net-worth individuals . Those services include helping companies raise money by issuing stocks or bonds or obtaining loans. They may also be deal-makers, facilitating corporate mergers and acquisitions.

Investopedia / Yurle Villegas

Banks have come a long way from the temples of the ancient world, but their basic business practices have not changed much. Although history has altered the finer points of the business model, a bank’s purposes are still to make loans and to protect depositors’ money.

Even today, where digital banking and financing are replacing traditional brick-and-mortar locations, banks still perform these fundamental functions.

World History Encyclopedia. “ Banking in the Roman World .”

World History Encyclopedia. “ Caesar as Dictator: His Impact on the City of Rome .”

World History Encyclopedia. " Knights Templar ."

New World Encyclopedia. “ Philip II of Spain .”

Adam Smith Institute. “ The Theory of Moral Sentiments .”

JSTOR. " Banks' Own Private Currencies in 19th-Century America ."

Office of the Historian, United States House of Representatives. " The First Bank of the United States ."

Federal Reserve History. " National Banking Acts of 1863 and 1864 ."

Texas Department of Banking. " History of the Banking Industry in Texas and the Department ."

National Bureau of Economic Research. " Banks, Insider Connections, and Industrialization in New England: Evidence from the Panic of 1873 ."

JPMorgan Chase & Co. " History of Our Firm ."

National Bureau of Economic Research. " Did J. P. Morgan's Men Add Value? An Economist's Perspective on Financial Capitalism ," Table 6.2.

Federal Reserve History. “ The Panic of 1907 .”

Federal Reserve History. " Overview: The History of the Federal Reserve ."

East Tennessee State University. " Neither a Borrower Nor a Lender Be: America Attempts to Collect its War Debts 1922-1934 ," Pages 5-6.

Federal Deposit Insurance Corp. “ The First 50 Years: A History of the FDIC .”

Federal Reserve History. " Banking Act of 1933 (Glass-Steagall) .

Federal Deposit Insurance Corporation. " Deposit Insurance at a Glance ."

J.D. Power. “ U.S. Retail Banks Nail Transition to Digital During Pandemic, J.D. Power Finds .”

Board of Governors of the Federal Reserve System. " About the Fed ."

Federal Reserve Bank of San Francisco. “ Are All Commercial Banks Regulated and Supervised by the Federal Reserve System, or Just Major Commercial Banks? ”

U.S. Securities and Exchange Commission. " The Role of the SEC ."

• A Primer on Important U.S. Banking Laws 1 of 29
• Dodd-Frank Act: What It Does, Major Components, and Criticisms 2 of 29
• Major Regulations Following the 2008 Financial Crisis 3 of 29
• Too Big to Fail: Definition, History, and Reforms 4 of 29
• Volcker Rule: Definition, Purpose, How It Works, and Criticism 5 of 29
• Understanding the Basel III International Regulations 6 of 29
• What Is Basel I? Definition, History, Benefits, and Criticism 7 of 29
• Basel II: Definition, Purpose, Regulatory Reforms 8 of 29
• Basel III: What It Is, Capital Requirements, and Implementation 9 of 29
• What Basel IV Means for U.S. Banks 10 of 29
• A Brief History of U.S. Banking Regulation 11 of 29
• The Evolution of Banking Over Time 12 of 29
• How the Banking Sector Impacts Our Economy 13 of 29
• What Agencies Oversee U.S. Financial Institutions? 14 of 29
• Dual Banking System: Meaning, History, Pros and Cons 15 of 29
• Glass-Steagall Act of 1933: Definition, Effects, and Repeal 16 of 29
• Bancassurance: Definition, How It Works, Pros & Cons 17 of 29
• Electronic Fund Transfer Act (EFTA): Definition and Requirements 18 of 29
• Bank Secrecy Act (BSA): Definition, Purpose, and Effects 19 of 29
• How Banking Works, Types of Banks, and How To Choose the Best Bank for You 20 of 29
• Chartered Bank: Explanation, History and FAQs 21 of 29
• Nonbank Financial Institutions: What They Are and How They Work 22 of 29
• Shadow Banking System: Definition, Examples, and How It Works 23 of 29
• Islamic Banking and Finance Definition: History and Example 24 of 29
• What Is Regulation E in Electronic Fund Transfers (EFTs)? 25 of 29
• What Is Regulation CC? Definition, Purpose and How It Works 26 of 29
• Regulation DD: What it is, How it Works, FAQ 27 of 29
• Regulation W: Definition in Banking and When It Applies 28 of 29
• Deregulation: Definition, History, Effects, and Purpose 29 of 29

• Terms of Service
• Editorial Policy
• Privacy Policy
• Your Privacy Choices

KPMG Personalization

• Rethinking new business models for banking

Adapting platforms, ecosystems, payments and data for the future, the banking business model has proven to be resilient to disruption.

• Share Share close
• Download Rethinking new business models for banking pdf Opens in a new window
• 1000 Save this article to my library
• View Print friendly version of this article Opens in a new window
• Go to bottom of page
• Home ›
• Insights ›

Tech trends |  Adapting the business model |  Essential building blocks  |  A roadmap for adoption | Call to action

Innovations that change the way value is offered to consumers threaten the integrity and resilience of the traditional banking model.

New trends in financial service offerings such as embedded finance and decentralized finance threatens the integrity of the traditional banking business model. Examples include Uber’s embedded payments and Afterpay’s cannibalization of unsecured consumer credit. These trends also eroded the value of the ‘trust premium’ banks have held for so long. For example, Nano Home Loans, a non-bank fintech lender established in 2019, offers to approve home loans at highly competitive rates within ten minutes of an online application; this value proposition has resulted in faster-than-system growth rates.

While fintech and innovators dismember the banking value chain, incumbents also face the very real threat of highly capitalized tech giants. Many with deep customer connections and loyalty, are stepping directly into financial services, potentially redefining the category. For example, although Google has abandoned plans to launch Google Plex (a transaction account for Google Pay), the proposition found strong consumer endorsement of innovative features that embedded financial services into everyday lifestyle choices.

Finally, regulators are deliberately adjusting their posture to help increase competition (e.g., open banking) and reduce entry barriers (e.g., the Restricted ADI offers a limited risk fast track for small challenger banks to start operating as a bank in Australia). Consequently, banks are (and should be) exploring alternative business models to deepen their value pools, entrench customer relationships and expand their value propositions.

As banks evolve their market role, they will likely also need to adapt their business models. Many of the innovations that have been a threat may also be a source of strategic strength as they incorporate them to complement their core.

Adapting the business model — platforms and ecosystems

Although platforms and ecosystems are not mutually exclusive, they are distinct. Platforms can help reduce market friction by connecting suppliers with the consumer, while ecosystems orchestrate complementary value propositions focused on a pattern of customer needs (Fig. 1).

By adopting these innovative business model options, banks can complement their basic banking model (deposits, loans, transactions) and market strengths (e.g., scale of customer franchise, valuable banking licenses, strength of balance sheet) with new value propositions to help differentiate and deepen customer relationships.

For example, Goldman Sachs pivoted to become more like a platform, expanding its portfolio into consumer banking by deploying the Marcus offering, including a credit card partnership with Apple. A goal for Marcus has been to establish banking as-a-service — a platform business.

Meanwhile, DBS Singapore has built DBS Marketplace to orchestrate ecosystems of partnerships offering value propositions shaped to address specific lifecycle needs experienced by their customers, such as car ownership. This ecosystem model deepens the bank’s relationship with their customers and keeps value circulating within the ecosystem.

Essential building blocks

Three foundational capability building blocks are essential to establish either platform or ecosystem, business models:

• Value orchestration: This includes establishing, coordinating and governing participation (partner management) while also measuring the value of involvement (ecosystems or platforms) to help generate more value than the sum of the parts.
• Data-driven insights: This is the ability to convert raw data into valuable insights on customers and operations. Harnessing the power of data can lead to continuous improvement, validation through experimentation and innovation (including accidental discovery through sophisticated pattern analysis); increasingly, this is machine-driven as AI and other advanced analytics tools become mainstream and accessible.
• Digital interoperability: This refers kpmg.com.au to the ability to safely exchange information and drive functionality between participants, including orchestrating end-to-end processes across multiple participants.

Bringing these to life in a banking context involves building blocks that need to be augmented by the basic banking capabilities of financial management, payments, and risk management.

Payments are a significant capability for banks battling for consumer relevancy. Payments provide a cohesive capability for both platforms or ecosystems and maintains a connection with the basic banking value proposition (cash, credit, and transaction). It also works to generate valuable contextual and behavioral data.

A roadmap for adoption

In KPMG professionals’ experience, banks that choose to adapt and future proof their business model should start the transformation by exploring three steps (see Fig. 2).

Assess capability maturity:  Does the bank have the foundational capabilities needed to deploy the future business model effectively? If not, start work immediately as this is an investment with no regrets, while, in parallel, work on the other two steps.

Evaluate the bank’s role in the market:  How will the bank differentiate along the spectrum of a ‘utility bank’ to an ‘intimate bank’? This can be unlocked by looking at what strengths the bank already has (e.g., if its cost discipline, it may be more suited to a ‘utility’ play).

Identify adaptions to the current business model:  Does the bank need to adapt its historical business model by incorporating a platform or ecosystem play?

Fig. 2. Roadmap to adapt the banking business model

Call to action

The banking industry faces a volatile future, but one that is rich with opportunity. KPMG professionals believe banks that prepare to adapt their business models now by establishing the basic capabilities of the future and agreeing between the board and executive on the bank’s role will likely be best positioned to take advantage of those rich opportunities.

This article is featured in Frontiers in Finance – Resilient and relevant

Explore other articles › Subscribe to receive the latest financial services insights directly to your inbox ›

Frontiers in Finance

Download the report (pdf 2.5 mb), connect with us.

• Find office locations kpmg.findOfficeLocations
• Email us kpmg.emailUs
• Social media @ KPMG kpmg.socialMedia
• Request for proposal

Stay up to date with what matters to you

Gain access to personalized content based on your interests by signing up today

Browse articles,  set up your interests , or  View your library .

You've been a member since

Explore more chapters

Latest market insights and forward-looking perspectives for financial services leaders and professionals.

Latest market insights and forward-looking perspectives for financial services leaders.

The leaders are uncovering new ways to accelerate and scale their innovation

Everyone from central banks to businesses are eyeing cryptoassets.

Platform models are changing the game for financial services firms.

The New Equation

Executive leadership hub - What’s important to the C-suite?

Tech Effect

Shared success benefits

Loading Results

No Match Found

The commercial banking business model is changing

A more strategic approach begins with addressing how to effectively meet client needs.

While banks of all sizes are evaluating technology-led transformation, their conversations are often limited to functional improvements such as onboarding or credit decisioning. This kind of around-the-edges experimentation might enhance customer experience and improve efficiency, but it lacks the depth necessary to differentiate and define the bank over the next three to five years.

We believe a more strategic approach begins with addressing how to effectively meet client needs—needs that keep shifting due to the growing use of technology and the entry of nontraditional competitors. In fact, a number of basic banking products already have shifted beyond the control of the bank itself. Non-banks are displacing an increasingly large part of the commercial lending market, and a growing number of companies are building payments and treasury management operations in-house.

Download The commercial banking business model is changing

Three principles to shape the next move, 1. m&a is an option, but will not solve the problem alone.

Scale-driven advantage is often mentioned as a requirement for serving the largest segments of the market in the most efficient and technology-enabled manner. However, the ability to reach the “needed” scale of a top five bank through consolidation is highly unlikely. Many smaller banks will need to find other ways to outflank their larger competitors and maintain or increase their relevancy.

2. Embrace data, but only if committed to data guiding business decisions

Can banks continuously adapt to improve how they use data? In our experience, most institutions are very good at understanding their customers but this is now a baseline expectation for how the industry uses data. Rather, banks should begin to ask whether they are linking their data to business decisions and adjusting their business processes accordingly. Few organizations have made this transition smoothly.

3. Counter the tech spend of universal banks with an ecosystem approach

New digital technologies are raising the pressure to use IT to the company’s advantage rather than using it to support the business. Most detractors will point to the disparity in tech spend where scale has an overwhelming advantage—top universal banks spend 12 times that of the top regional banks on technology.

But this unreachable technology investment can be replicated as long as the costs associated with the commodity aspects are reduced or shared. One option is with an open architecture, financial institutions can leverage larger ecosystems of innovation without incurring heavy capital and maintenance costs.

The traditional service model grounded in local relationships and substantial technology spend may no longer be viable. As the largest US banks grow significantly faster than their regional competitors and the structural shifts continue in core areas such as corporate, the long-standing dynamics will be reshaped. 

Given this evolution in commercial banking, a strategy of how to replicate the unreachable - through novel uses of data, partnerships, and technology flexibility - will be crucial. Outspending the Big Three, or out-innovating tech-based competitors, has become a nearly insurmountable task.

{{filterContent.facetedTitle}}

{{item.publishDate}}

{{item.title}}

{{item.text}}

Principal, Strategy&, PwC US

Tel: +1 (617) 515 6497

Roland Kastoun

Asset and Wealth Management Consulting Solutions Leader, PwC US

Rahul Wadhawan

© 2017 - 2024 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details.

• Data Privacy Framework
• Cookie info
• Terms and conditions
• Site provider
• Your Privacy Choices

• Open access
• Published: 18 June 2021

Financial technology and the future of banking

• Daniel Broby   ORCID: orcid.org/0000-0001-5482-0766 1  

Financial Innovation volume  7 , Article number:  47 ( 2021 ) Cite this article

40k Accesses

52 Citations

4 Altmetric

Metrics details

This paper presents an analytical framework that describes the business model of banks. It draws on the classical theory of banking and the literature on digital transformation. It provides an explanation for existing trends and, by extending the theory of the banking firm, it illustrates how financial intermediation will be impacted by innovative financial technology applications. It further reviews the options that established banks will have to consider in order to mitigate the threat to their profitability. Deposit taking and lending are considered in the context of the challenge made from shadow banking and the all-digital banks. The paper contributes to an understanding of the future of banking, providing a framework for scholarly empirical investigation. In the discussion, four possible strategies are proposed for market participants, (1) customer retention, (2) customer acquisition, (3) banking as a service and (4) social media payment platforms. It is concluded that, in an increasingly digital world, trust will remain at the core of banking. That said, liquidity transformation will still have an important role to play. The nature of banking and financial services, however, will change dramatically.

Introduction

The bank of the future will have several different manifestations. This paper extends theory to explain the impact of financial technology and the Internet on the nature of banking. It provides an analytical framework for academic investigation, highlighting the trends that are shaping scholarly research into these dynamics. To do this, it re-examines the nature of financial intermediation and transactions. It explains how digital banking will be structurally, as well as physically, different from the banks described in the literature to date. It does this by extending the contribution of Klein ( 1971 ), on the theory of the banking firm. It presents suggested strategies for incumbent, and challenger banks, and how banking as a service and social media payment will reshape the competitive landscape.

The banking industry has been evolving since Banca Monte dei Paschi di Siena opened its doors in 1472. Its leveraged business model has proved very scalable over time, but it is now facing new challenges. Firstly, its book to capital ratios, as documented by Berger et al ( 1995 ), have been consistently falling since 1840. This trend continues as competition has increased. In the past decade, the industry has experienced declines in profitability as measured by return on tangible equity. This is partly the result of falling leverage and fee income and partly due to the net interest margin (connected to traditional lending activity). These trends accelerated following the 2008 financial crisis. At the same time, technology has made banks more competitive. Advances in digital technology are changing the very nature of banking. Banks are now distributing services via mobile technology. A prolonged period of very low interest rates is also having an impact. To sustain their profitability, Brei et al. ( 2020 ) note that many banks have increased their emphasis on fee-generating services.

As Fama ( 1980 ) explains, a bank is an intermediary. The Internet is, however, changing the way financial service providers conduct their role. It is fundamentally changing the nature of the banking. This in turn is changing the nature of banking services, and the way those services are delivered. As a consequence, in order to compete in the changing digital landscape, banks have to adapt. The banks of the future, both incumbents and challengers, need to address liquidity transformation, data, trust, competition, and the digitalization of financial services. Against this backdrop, incumbent banks are focused on reinventing themselves. The challenger banks are, however, starting with a blank canvas. The research questions that these dynamics pose need to be investigated within the context of the theory of banking, hence the need to revise the existing analytical framework.

Banks perform payment and transfer functions for an economy. The Internet can now facilitate and even perform these functions. It is changing the way that transactions are recorded on ledgers and is facilitating both public and private digital currencies. In the past, banks operated in a world of information asymmetry between themselves and their borrowers (clients), but this is changing. This differential gave one bank an advantage over another due to its knowledge about its clients. The digital transformation that financial technology brings reduces this advantage, as this information can be digitally analyzed.

Even the nature of deposits is being transformed. Banks in the future will have to accept deposits and process transactions made in digital form, either Central Bank Digital Currencies (CBDC) or cryptocurrencies. This presents a number of issues: (1) it changes the way financial services will be delivered, (2) it requires a discussion on resilience, security and competition in payments, (3) it provides a building block for better cross border money transfers and (4) it raises the question of private and public issuance of money. Braggion et al ( 2018 ) consider whether these represent a threat to financial stability.

The academic study of banking began with Edgeworth ( 1888 ). He postulated that it is based on probability. In this respect, the nature of the business model depends on the probability that a bank will not be called upon to meet all its liabilities at the same time. This allows banks to lend more than they have in deposits. Because of the resultant mismatch between long term assets and short-term liabilities, a bank’s capital structure is very sensitive to liquidity trade-offs. This is explained by Diamond and Rajan ( 2000 ). They explain that this makes a bank a’relationship lender’. In effect, they suggest a bank is an intermediary that has borrowed from other investors.

Diamond and Rajan ( 2000 ) argue a lender can negotiate repayment obligations and that a bank benefits from its knowledge of the customer. As shall be shown, the new generation of digital challenger banks do not have the same tradeoffs or knowledge of the customer. They operate more like a broker providing a platform for banking services. This suggests that there will be more than one type of bank in the future and several different payment protocols. It also suggests that banks will have to data mine customer information to improve their understanding of a client’s financial needs.

The key focus of Diamond and Rajan ( 2000 ), however, was to position a traditional bank is an intermediary. Gurley and Shaw ( 1956 ) describe how the customer relationship means a bank can borrow funds by way of deposits (liabilities) and subsequently use them to lend or invest (assets). In facilitating this mediation, they provide a service whereby they store money and provide a mechanism to transmit money. With improvements in financial technology, however, money can be stored digitally, lenders and investors can source funds directly over the internet, and money transfer can be done digitally.

A review of financial technology and banking literature is provided by Thakor ( 2020 ). He highlights that financial service companies are now being provided by non-deposit taking contenders. This paper addresses one of the four research questions raised by his review, namely how theories of financial intermediation can be modified to accommodate banks, shadow banks, and non-intermediated solutions.

To be a bank, an entity must be authorized to accept retail deposits. A challenger bank is, therefore, still a bank in the traditional sense. It does not, however, have the costs of a branch network. A peer-to-peer lender, meanwhile, does not have a deposit base and therefore acts more like a broker. This leads to the issue that this paper addresses, namely how the banks of the future will conduct their intermediation.

In order to understand what the bank of the future will look like, it is necessary to understand the nature of the aforementioned intermediation, and the way it is changing. In this respect, there are two key types of intermediation. These are (1) quantitative asset transformation and, (2) brokerage. The latter is a common model adopted by challenger banks. Figure  1 depicts how these two types of financial intermediation match savers with borrowers. To avoid nuanced distinction between these two types of intermediation, it is common to classify banks by the services they perform. These can be grouped as either private, investment, or commercial banking. The service sub-groupings include payments, settlements, fund management, trading, treasury management, brokerage, and other agency services.

How banks act as intermediaries between lenders and borrowers. This function call also be conducted by intermediaries as brokers, for example by shadow banks. Disintermediation occurs over the internet where peer-to-peer lenders match savers to lenders

Financial technology has the ability to disintermediate the banking sector. The competitive pressures this results in will shape the banks of the future. The channels that will facilitate this are shown in Fig.  2 , namely the Internet and/or mobile devices. Challengers can participate in this by, (1) directly matching borrows with savers over the Internet and, (2) distributing white labels products. The later enables banking as a service and avoids the aforementioned liquidity mismatch.

The strategic options banks have to match lenders with borrowers. The traditional and challenger banks are in the same space, competing for business. The distributed banks use the traditional and challenger banks to white label banking services. These banks compete with payment platforms on social media. The Internet heralds an era of banking as a service

There are also physical changes that are being made in the delivery of services. Bricks and mortar branches are in decline. Mobile banking, or m-banking as Liu et al ( 2020 ) describe it, is an increasingly important distribution channel. Robotics are increasingly being used to automate customer interaction. As explained by Vishnu et al ( 2017 ), these improve efficiency and the quality of execution. They allow for increased oversight and can be built on legacy systems as well as from a blank canvas. Application programming interfaces (APIs) are bringing the same type of functionality to m-banking. They can be used to authorize third party use of banking data. How banks evolve over time is important because, according to the OECD, the activity in the financial sector represents between 20 and 30 percent of developed countries Gross Domestic Product.

In summary, financial technology has evolved to a level where online banks and banking as a service are challenging incumbents and the nature of banking mediation. Banking is rapidly transforming because of changes in such technology. At the same time, the solving of the double spending problem, whereby digital money can be cryptographically protected, has led to the possibility that paper money will become redundant at some point in the future. A theoretical framework is required to understand this evolving landscape. This is discussed next.

The theory of the banking firm: a revision

In financial theory, as eloquently explained by Fama ( 1980 ), banking provides an accounting system for transactions and a portfolio system for the storage of assets. That will not change for the banks of the future. Fama ( 1980 ) explains that their activities, in an unregulated state, fulfil the Modigliani–Miller ( 1959 ) theorem of the irrelevance of the financing decision. In practice, traditional banks compete for deposits through the interest rate they offer. This makes the transactional element dependent on the resulting debits and credits that they process, essentially making banks into bookkeeping entities fulfilling the intermediation function. Since this is done in response to competitive forces, the general equilibrium is a passive one. As such, the banking business model is vulnerable to disruption, particularly by innovation in financial technology.

A bank is an idiosyncratic corporate entity due to its ability to generate credit by leveraging its balance sheet. That balance sheet has assets on one side and liabilities on the other, like any corporate entity. The assets consist of cash, lending, financial and fixed assets. On the other side of the balance sheet are its liabilities, deposits, and debt. In this respect, a bank’s equity and its liabilities are its source of funds, and its assets are its use of funds. This is explained by Klein ( 1971 ), who notes that a bank’s equity W , borrowed funds and its deposits B is equal to its total funds F . This is the same for incumbents and challengers. This can be depicted algebraically if we let incumbents be represented by Φ and challengers represented by Γ:

Klein ( 1971 ) further explains that a bank’s equity is therefore made up of its share capital and unimpaired reserves. The latter are held by a bank to protect the bank’s deposit clients. This part is also mandated by regulation, so as to protect customers and indeed the entire banking system from systemic failure. These protective measures include other prudential requirements to hold cash reserves or other liquid assets. As shall be shown, banking services can be performed over the Internet without these protections. Banking as a service, as this phenomenon known, is expected to increase in the future. This will change the nature of the protection available to clients. It will change the way banks transform assets, explained next.

A bank’s deposits are said to be a function of the proportion of total funds obtained through the issuance of the ith deposit type and its total funds F , represented by α i . Where deposits, represented by Bs , are made in the form of Bs (i  =  1 *s n) , they generate a rate of interest. It follows that Si Bs  =  B . As such,

Therefor it can be said that,

The importance of Eq. 3 is that the balance sheet can be leveraged by the issuance of loans. It should be noted, however, that not all loans are returned to the bank in whole or part. Non-performing loans reduce the asset side of a bank’s balance sheet and act as a constraint on capital, and therefore new lending. Clearly, this is not the case with banking as a service. In that model, loans are brokered. That said, with the traditional model, an advantage of financial technology is that it facilitates the data mining of clients’ accounts. Lending can therefore be more targeted to borrowers that are more likely to repay, thereby reducing non-performing loans. Pari passu, the incumbent bank of the future will therefore have a higher risk-adjusted return on capital. In practice, however, banking as a service will bring greater competition from challengers and possible further erosion of margins. Alternatively, some banks will proactively engage in partnerships and acquisitions to maintain their customer base and address the competition.

A bank must have reserves to meet the demand of customers demanding their deposits back. The amount of these reserves is a key function of banking regulation. The Basel Committee on Banking Supervision mandates a requirement to hold various tiers of capital, so that banks have sufficient reserves to protect depositors. The Committee also imposes a framework for mitigating excessive liquidity risk and maturity transformation, through a set Liquidity Coverage Ratio and Net Stable Funding Ratio.

Recent revisions of theory, because of financial technology advances, have altered our understanding of banking intermediation. This will impact the competitive landscape and therefor shape the nature of the bank of the future. In this respect, the threat to incumbent banks comes from peer-to-peer Internet lending platforms. These perform the brokerage function of financial intermediation without the use of the aforementioned banking balance sheet. Unlike regulated deposit takers, such lending platforms do not create assets and do not perform risk and asset transformation. That said, they are reliant on investors who do not always behave in a counter cyclical way.

Financial technology in banking is not new. It has been used to facilitate electronic markets since the 1980’s. Thakor ( 2020 ) refers to three waves of application of financial innovation in banking. The advent of institutional futures markets and the changing nature of financial contracts fundamentally changed the role of banks. In response to this, academics extended the concept of a bank into an entity that either fulfills the aforementioned functions of a broker or a qualitative asset transformer. In this respect, they connect the providers and users of capital without changing the nature of the transformation of the various claims to that capital. This transformation can be in the form risk transfer or the application of leverage. The nature of trading of financial assets, however, is changing. Price discovery can now be done over the Internet and that is moving liquidity from central marketplaces (like the stock exchange) to decentralized ones.

Alongside these trends, in considering what the bank of the future will look like, it is necessary to understand the unregulated lending market that competes with traditional banks. In this part of the lending market, there has been a rise in shadow banks. The literature on these entities is covered by Adrian and Ashcraft ( 2016 ). Shadow banks have taken substantial market share from the traditional banks. They fulfil the brokerage function of banks, but regulators have only partial oversight of their risk transformation or leverage. The rise of shadow banks has been facilitated by financial technology and the originate to distribute model documented by Bord and Santos ( 2012 ). They use alternative trading systems that function as electronic communication networks. These facilitate dark pools of liquidity whereby buyers and sellers of bonds and securities trade off-exchange. Since the credit crisis of 2008, total broker dealer assets have diverged from banking assets. This illustrates the changed lending environment.

In the disintermediated market, banking as a service providers must rely on their equity and what access to funding they can attract from their online network. Without this they are unable to drive lending growth. To explain this, let I represent the online network. Extending Klein ( 1971 ), further let Ψ represent banking as a service and their total funds by F . This state is depicted as,

Theoretically, it can be shown that,

Shadow banks, and those disintermediators who bypass the banking system, have an advantage in a world where technology is ubiquitous. This becomes more apparent when costs are considered. Buchak et al. ( 2018 ) point out that shadow banks finance their originations almost entirely through securitization and what they term the originate to distribute business model. Diversifying risk in this way is good for individual banks, as banking risks can be transferred away from traditional banking balance sheets to institutional balance sheets. That said, the rise of securitization has introduced systemic risk into the banking sector.

Thus, we can see that the nature of banking capital is changing and at the same time technology is replacing labor. Let A denote the number of transactions per account at a period in time, and C denote the total cost per account per time period of providing the services of the payment mechanism. Klein ( 1971 ) points out that, if capital and labor are assumed to be part of the traditional banking model, it can be observed that,

It can therefore be observed that the total service charge per account at a period in time, represented by S, has a linear and proportional relationship to bank account activity. This is another variable that financial technology can impact. According to Klein ( 1971 ) this can be summed up in the following way,

where d is the basic bank decision variable, the service charge per transaction. Once again, in an automated and digital environment, financial technology greatly reduces d for the challenger banks. Swankie and Broby ( 2019 ) examine the impact of Artificial Intelligence on the evaluation of banking risk and conclude that it improves such variables.

Meanwhile, the traditional banking model can be expressed as a product of the number of accounts, M , and the average size of an account, N . This suggests a banks implicit yield is it rate of interest on deposits adjusted by its operating loss in each time period. This yield is generated by payment and loan services. Let R 1 depict this. These can be expressed as a fraction of total demand deposits. This is depicted by Klein ( 1971 ), if one assumes activity per account is constant, as,

As a result, whether a bank is structured with traditional labor overheads or built digitally, is extremely relevant to its profitability. The capital and labor of tradition banks, depicted as Φ i , is greater than online networks, depicted as I i . As such, the later have an advantage. This can be shown as,

What Klein (1972) failed to highlight is that the banking inherently involves leverage. Diamond and Dybving (1983) show that leverage makes bank susceptible to run on their liquidity. The literature divides these between adverse shock events, as explained by Bernanke et al ( 1996 ) or moral hazard events as explained by Demirgu¨¸c-Kunt and Detragiache ( 2002 ). This leverage builds on the balance sheet mismatch of short-term assets with long term liabilities. As such, capital and liquidity are intrinsically linked to viability and solvency.

The way capital and liquidity are managed is through credit and default management. This is done at a bank level and a supervisory level. The Basel Committee on Banking Supervision applies capital and leverage ratios, and central banks manage interest rates and other counter-cyclical measures. The various iterations of the prudential regulation of banks have moved the microeconomic theory of banking from the modeling of risk to the modeling of imperfect information. As mentioned, shadow and disintermediated services do not fall under this form or prudential regulation.

The relationship between leverage and insolvency risk crucially depends on the degree of banks total funds F and their liability structure L . In this respect, the liability structure of traditional banks is also greater than online networks which do not have the same level of available funds, depicted as,

Diamond and Dybvig ( 1983 ) observe that this liability structure is intimately tied to a traditional bank’s assets. In this respect, a bank’s ability to finance its lending at low cost and its ability to achieve repayment are key to its avoidance of insolvency. Online networks and/or brokers do not have to finance their lending, simply source it. Similarly, as brokers they do not face capital loss in the event of a default. This disintermediates the bank through the use of a peer-to-peer environment. These lenders and borrowers are introduced in digital way over the internet. Regulators have taken notice and the digital broker advantage might not last forever. As a result, the future may well see greater cooperation between these competing parties. This also because banks have valuable operational experience compared to new entrants.

It should also be observed that bank lending is either secured or unsecured. Interest on an unsecured loan is typically higher than the interest on a secured loan. In this respect, incumbent banks have an advantage as their closeness to the customer allows them to better understand the security of the assets. Berger et al ( 2005 ) further differentiate lending into transaction lending, relationship lending and credit scoring.

The evolution of the business model in a digital world

As has been demonstrated, the bank of the future in its various manifestations will be a consequence of the evolution of the current banking business model. There has been considerable scholarly investigation into the uniqueness of this business model, but less so on its changing nature. Song and Thakor ( 2010 ) are helpful in this respect and suggest that there are three aspects to this evolution, namely competition, complementary and co-evolution. Although liquidity transformation is evolving, it remains central to a bank’s role.

All the dynamics mentioned are relevant to the economy. There is considerable evidence, as outlined by Levine ( 2001 ), that market liberalization has a causal impact on economic growth. The impact of technology on productivity should prove positive and enhance the functioning of the domestic financial system. Indeed, market liberalization has already reshaped banking by increasing competition. New fee based ancillary financial services have become widespread, as has the proprietorial use of balance sheets. Risk has been securitized and even packaged into trade-able products.

Challenger banks are developing in a complementary way with the incumbents. The latter have an advantage over new entrants because they have information on their customers. The liquidity insurance model, proposed by Diamond and Dybvig ( 1983 ), explains how such banks have informational advantages over exchange markets. That said, financial technology changes these dynamics. It if facilitating the processing of financial data by third parties, explained in greater detail in the section on Open Banking.

At the same time, financial technology is facilitating banking as a service. This is where financial services are delivered by a broker over the Internet without resort to the balance sheet. This includes roboadvisory asset management, peer to peer lending, and crowd funding. Its growth will be facilitated by Open Banking as it becomes more geographically adopted. Figure  3 illustrates how these business models are disintermediating the traditional banking role and matching burrowers and savers.

The traditional view of banks ecosystem between savers and borrowers, atop the Internet which is matching savers and borrowers directly in a peer-to-peer way. The Klein ( 1971 ) theory of the banking firm does not incorporate the mirrored dynamics, and as such needs to be extended to reflect the digital innovation that impacts both borrowers and severs in a peer-to-peer environment

Meanwhile, the banking sector is co-evolving alongside a shadow banking phenomenon. Lenders and borrowers are interacting, but outside of the banking sector. This is a concern for central banks and banking regulators, as the lending is taking place in an unregulated environment. Shadow banking has grown because of financial technology, market liberalization and excess liquidity in the asset management ecosystem. Pozsar and Singh ( 2011 ) detail the non-bank/bank intersection of shadow banking. They point out that shadow banking results in reverse maturity transformation. Incumbent banks have blurred the distinction between their use of traditional (M2) liabilities and market-based shadow banking (non-M2) liabilities. This impacts the inter-generational transfers that enable a bank to achieve interest rate smoothing.

Securitization has transformed the risk in the banking sector, transferring it to asset management institutions. These include structured investment vehicles, securities lenders, asset backed commercial paper investors, credit focused hedge and money market funds. This in turn has led to greater systemic risk, the result of the nature of the non-traded liabilities of securitized pooling arrangements. This increased risk manifested itself in the 2008 credit crisis.

Commercial pressures are also shaping the banking industry. The drive for cost efficiency has made incumbent banks address their personally costs. Bank branches have been closed as technology has evolved. Branches make it easier to withdraw or transfer deposits and challenger banks are not as easily able to attract new deposits. The banking sector is therefore looking for new point of customer contact, such as supermarkets, post offices and social media platforms. These structural issues are occurring at the same time as the retail high street is also evolving. Banks have had an aggressive roll out of automated telling machines and a reduction in branches and headcount. Online digital transactions have now become the norm in most developed countries.

The financing of banks is also evolving. Traditional banks have tended to fund illiquid assets with short term and unstable liquid liabilities. This is one of the key contributors to the rise to the credit crisis of 2008. The provision of liquidity as a last resort is central to the asset transformation process. In this respect, the banking sector experienced a shock in 2008 in what is termed the credit crisis. The aforementioned liquidity mismatch resulted in the system not being able to absorb all the risks associated with subprime lending. Central banks had to resort to quantitative easing as a result of the failure of overnight funding mechanisms. The image of the entire banking sector was tarnished, and the banks of the future will have to address this.

The future must learn from the mistakes of the past. The structural weakness of the banking business model cannot be solved. That said, the latest Basel rules introduce further risk mitigation, improved leverage ratios and increased levels of capital reserve. Another lesson of the credit crisis was that there should be greater emphasis on risk culture, governance, and oversight. The independence and performance of the board, the experience and the skill set of senior management are now a greater focus of regulators. Internal controls and data analysis are increasingly more robust and efficient, with a greater focus on a banks stable funding ratio.

Meanwhile, the very nature of money is changing. A digital wallet for crypto-currencies fulfills much the same storage and transmission functions of a bank; and crypto-currencies are increasing being used for payment. Meanwhile, in Sweden, stores have the right to refuse cash and the majority of transactions are card based. This move to credit and debit cards, and the solving of the double spending problem, whereby digital money can be crypto-graphically protected, has led to the possibility that paper money could be replaced at some point in the future. Whether this might be by replacement by a CBDC, or decentralized digital offering, is of secondary importance to the requirement of banks to adapt. Whether accommodating crytpo-currencies or CBDC’s, Kou et al. ( 2021 ) recommend that banks keep focused on alternative payment and money transferring technologies.

Central banks also have to adapt. To limit disintermediation, they have to ensure that the economic design of their sponsored digital currencies focus on access for banks, interest payment relative to bank policy rate, banking holding limits and convertibility with bank deposits. All these developments have implications for banks, particularly in respect of funding, the secure storage of deposits and how digital currency interacts with traditional fiat money.

Open banking

Against the backdrop of all these trends and changes, a new dynamic is shaping the future of the banking sector. This is termed Open Banking, already briefly mentioned. This new way of handling banking data protocols introduces a secure way to give financial service companies consensual access to a bank’s customer financial information. Figure  4 illustrates how this works. Although a fairly simple concept, the implications are important for the banking industry. Essentially, a bank customer gives a regulated API permission to securely access his/her banking website. That is then used by a banking as a service entity to make direct payments and/or download financial data in order to provide a solution. It heralds an era of customer centric banking.

How Open Banking operates. The customer generates data by using his bank account. A third party provider is authorized to access that data through an API request. The bank confirms digitally that the customer has authorized the exchange of data and then fulfills the request

Open Banking was a response to the documented inertia around individual’s willingness to change bank accounts. Following the Retail Banking Review in the UK, this was addressed by lawmakers through the European Union’s Payment Services Directive II. The legislation was designed to make it easier to change banks by allowing customers to delegate authority to transfer their financial data to other parties. As a result of this, a whole host of data centric applications were conceived. Open banking adds further momentum to reshaping the future of banking.

Open Banking has a number of quite revolutionary implications. It was started so customers could change banks easily, but it resulted in some secondary considerations which are going to change the future of banking itself. It gives a clear view of bank financing. It allows aggregation of finances in one place. It also allows can give access to attractive offerings by allowing price comparisons. Open Banking API’s build a secure online financial marketplace based on data. They also allow access to a larger market in a faster way but the third-party providers for the new entrants. Open Banking allows developers to build single solutions on an API addressing very specific problems, like for example, a cash flow based credit rating.

Romānova et al. ( 2018 ) undertook a questionnaire on the Payment Services Directive II. The results suggest that Open Banking will promote competitiveness, innovation, and new product development. The initiative is associated with low costs and customer satisfaction, but that some concerns about security, privacy and risk are present. These can be mitigated, to some extent, by secure protocols and layered permission access.

Discussion: strategic options

Faced with these disruptive trends, there are four strategic options for market participants to con- sider. There are (1) a defensive customer retention strategy for incumbents, (2) an aggressive customer acquisition strategy for challenger banks (3) a banking as a service strategy for new entrants, and (4) a payments strategy for social media platforms.

Each of these strategies has to be conducted in a competitive marketplace for money demand by potential customers. Figure  5 illustrates where the first three strategies lie on the tradeoff between money demand and interest rates. The payment strategy can’t be modeled based on the supply of money. In the figure, the market settles at a rate L 2 . The incumbent banks have the capacity to meet the largest supply of these loans. The challenger banks have a constrained function but due to a lower cost base can gain excess rent through higher rates of interest. The peer-to-peer bank as a service brokers must settle for the market rate and a constrained supply offering.

The money demand M by lenders on the y axis. Interest rates on the y axis are labeled as r I and r II . The challenger banks are represented by the line labeled Γ. They have a price and technology advantage and so can lend at higher interest rates. The brokers are represented by the line labeled Ω. They are price takers, accepting the interest rate determined by the market. The same is true for the incumbents, represented by the line labeled Φ but they have a greater market share due to their customer relationships. Note that payments strategy for social media platforms is not shown on this figure as it is not affected by interest rates

Figure  5 illustrates that having a niche strategy is not counterproductive. Liu et al ( 2020 ) found that banks performing niche activities exhibit higher profitability and have lower risk. The syndication market now means that a bank making a loan does not have to be the entity that services it. This means banks in the future can better shape their risk profile and manage their lending books accordingly.

An interesting question for central banks is what the future Deposit Supply function will look like. If all three forms: open banking, traditional banking and challenger banks develop together, will the bank of the future have the same Deposit Supply function? The Klein ( 1971 ) general formulation assumes that deposits are increasing functions of implicit and explicit yields. As such, the very nature of central bank directed monetary policy may have to be revisited, as alluded to in the earlier discussion on digital money.

The client retention strategy (incumbents)

The competitive pressures suggest that incumbent banks need to focus on customer retention. Reichheld and Kenny ( 1990 ) found that the best way to do this was to focus on the retention of branch deposit customers. Obviously, another way is to provide a unique digital experience that matches the challengers.

Incumbent banks have a competitive advantage based on the information they have about their customers. Allen ( 1990 ) argues that where risk aversion is observable, information markets are viable. In other words, both bank and customer benefit from this. The strategic issue for them, therefore, becomes the retention of these customers when faced with greater competition.

Open Banking changes the dynamics of the banking information advantage. Borgogno and Colangelo ( 2020 ) suggest that the access to account (XS2A) rule that it introduced will increase competition and reduce information asymmetry. XS2A requires banks to grant access to bank account data to authorized third payment service providers.

The incumbent banks have a high-cost base and legacy IT systems. This makes it harder for them to migrate to a digital world. There are, however, also benefits from financial technology for the incumbents. These include reduced cost and greater efficiency. Financial technology can also now support platforms that allow incumbent banks to sell NPL’s. These platforms do not require the ownership of assets, they act as consolidators. The use of technology to monitor the transactions make the processing cost efficient. The unique selling point of such platforms is their centralized point of contact which results in a reduction in information asymmetry.

Incumbent banks must adapt a number of areas they got to adapt in terms of their liquidity transformation. They have to adapt the way they handle data. They must get customers to trust them in a digital world and the way that they trust them in a bricks and mortar world. It is no coincidence. When you go into a bank branch that is a great big solid building great big facade and so forth that is done deliberately so that you trust that bank with your deposit.

The risk of having rising non-performing loans needs to be managed, so customer retention should be selective. One of the puzzles in banking is why customers are regularly denied credit, rather than simply being charged a higher price for it. This credit rationing is often alleviated by collateral, but finance theory suggests value is based on the discounted sum of future cash flows. As such, it is conceivable that the bank of the future will use financial technology to provide innovative credit allocation solutions. That said, the dual risks of moral hazard and information asymmetries from the adoption of such solutions must be addressed.

Customer retention is especially important as bank competition is intensifying, as is the digitalization of financial services. Customer retention requires innovation, and that innovation has been moving at a very fast rate. Until now, banks have traditionally been hesitant about technology. More recently, mergers and acquisitions have increased quite substantially, initiated by a need to address actual or perceived weaknesses in financial technology.

The client acquisition strategy (challengers)

As intermediaries, the challenger banks are the same as incumbent banks, but designed from the outset to be digital. This gives them a cost and efficiency advantage. Anagnostopoulos ( 2018 ) suggests that the difference between challenger and traditional banks is that the former address its customers problems more directly. The challenge for such banks is customer acquisition.

Open Banking is a major advantage to challenger banks as it facilitates the changing of accounts. There is widespread dissatisfaction with many incumbent banks. Open Banking makes it easier to change accounts and also easier to get a transaction history on the client.

Customer acquisition can be improved by building trust in a brand. Historically, a bank was physically built in a very robust manner, hence the heavy architecture and grand banking halls. This was done deliberately to engender a sense of confidence in the deposit taking institution. Pure internet banks are not able to do this. As such, they must employ different strategies to convey stability. To do this, some communicate their sustainability credentials, whilst others use generational values-based advertising. Customer acquisition in a banking context is traditionally done by offering more attractive rates of interest. This is illustrated in Fig.  5 by the intersect of traditional banks with the market rate of interest, depicted where the line Γ crosses L 2 . As a result of the relationship with banking yield, teaser rates and introductory rates are common. A customer acquisition strategy has risks, as consumers with good credit can game different challenger banks by frequently changing accounts.

Most customer acquisition, however, is done based on superior service offering. The functionality of challenger banking accounts is often superior to incumbents, largely because the latter are built on legacy databases that have inter-operability issues. Having an open platform of services is a popular customer acquisition technique. The unrestricted provision of third-party products is viewed more favorably than a restricted range of products.

The banking as a service strategy (new entrants)

Banking from a customer’s perspective is the provision of a service. Customers don’t care about the maturity transformation of banking balance sheets. Banking as a service can be performed without recourse to these balance sheets. Banking products are brokered, mostly by new entrants, to individuals as services that can be subscribed to or paid on a fee basis.

There are a number banking as a service solutions including pre-paid and credit cards, lending and leasing. The banking as a service brokers are effectively those that are aggregating services from others using open banking to enable banking as a service.

The rise of banking as a service needs to be understood as these compete directly with traditional banks. As explained, some of these do this through peer-to-peer lending over the internet, others by matching borrows and sellers, conducting mediation as a loan broker. Such entities do not transform assets and do not have banking licenses. They do not have a branch network and often don not have access to deposits. This means that they have no insurance protection and can be subject to interest rate controls.

The new genre of financial technology, banking as a service provider, conduct financial services transformation without access to central bank liquidity. In a distributed digital asset world, the assets are stored on a distributed ledger rather than a traditional banking ledger. Financial technology has automated credit evaluation, savings, investments, insurance, trading, banking payments and risk management. These banking as a service offering are only as secure as the technology on which they are built.

The social media payment strategy (disintermediators and disruptors)

An intermediation bank is a conceptual idea, one created solely on a social networking site. Social media has developed a market for online goods and services. Williams ( 2018 ) estimates that there are 2.46 billion social media users. These all make and receive payments of some kind. They demand security and functionality. Importantly, they have often more clients than most banks. As such, a strategy to monetize the payments infrastructure makes sense.

All social media platforms are rich repositories of data. Such platforms are used to buy and sell things and that requires payments. Some platforms are considering evolving their own digital payment, cutting out the banks as middlemen. These include Facebook’s Diem (formerly Libra), a digital currency, and similar developments at some of the biggest technology companies. The risk with social media payment platform is that there is systemic counter-party protection. Regulators need to address this. One way to do this would be to extend payment service insurance to such platforms.

Social media as a platform moves the payment relationship from a transaction to a customer experience. The ability to use consumer desires in combination with financial data has the potential to deliver a number of new revenue opportunities. These will compete directly with the banks of the future. This will have implications for (1) the money supply, (2) the market share of traditional banks and, (3) the services that payment providers offer.

Further research

Several recommendations for research derive from both the impact of disintermediation and the four proposed strategies that will shape banking in the future. The recommendations and suggestions are based on the mentioned papers and the conclusions drawn from them.

As discussed, the nature of intermediation is changing, and this has implications for the pricing of risk. The role of interest rates in banking will have to be further reviewed. In a decentralized world based on crypto currencies the central banks do not have the same control over the money supply, This suggest the quantity theory of money and the liquidity preference theory need to be revisited. As explained, the Internet reduces much of the friction costs of intermediation. Researchers should ask how this will impact maturity transformation. It is also fair to ask whether at some point in the future there will just be one big bank. This question has already been addressed in the literature but the Internet facilities the possibility. Diamond ( 1984 ) and Ramakrishnan and Thakor ( 1984 ) suggested the answer was due to diversification and its impact on reducing monitoring costs.

Attention should be given by academics to the changing nature of banking risk. How should regulators, for example, address the moral hazard posed by challenger banks with weak balance sheets? What about deposit insurance? Should it be priced to include unregulated entities? Also, what criteria do borrowers use to choose non-banking intermediaries? The changing risk environment also poses two interesting practical questions. What will an online bank run look like, and how can it be averted? How can you establish trust in digital services?

There are also research questions related to the nature of competition. What, for example, will be the nature of cross border competition in a decentralized world? Is the credit rationing that generates competition a static or dynamic phenomena online? What is the value of combining consumer utility with banking services?

Financial intermediaries, like banks, thrive in a world of deficits and surpluses supported by information asymmetries and disconnectedness. The connectivity of the internet changes this dynamic. In this respect, the view of Schumpeter ( 1911 ) on the role of financial intermediaries needs revisiting. Lenders and borrows can be connected peer to peer via the internet.

All the dynamics mentioned change the nature of moral hazard. This needs further investigation. There has been much scholarly research on the intrinsic riskiness of the mismatch between banking assets and liabilities. This mismatch not only results in potential insolvency for a single bank but potentially for the whole system. There has, for example, been much debate on the whether a bank can be too big to fail. As a result of the riskiness of the banking model, the banks of the future will be just a liable to fail as the banks of the past.

This paper presented a revision of the theory of banking in a digital world. In this respect, it built on the work of Klein ( 1971 ). It provided an overview of the changing nature of banking intermediation, a result of the Internet and new digital business models. It presented the traditional academic view of banking and how it is evolving. It showed how this is adapted to explain digital driven disintermediation.

It was shown that the banking industry is facing several documented challenges. Risk is being taken of balance sheet, securitized, and brokered. Financial technology is digitalizing service delivery. At the same time, the very nature of intermediation is being changed due to digital currency. It is argued that the bank of the future not only has to face these competitive issues, but that technology will enhance the delivery of banking services and reduce the cost of their delivery.

The paper further presented the importance of the Open Banking revolution and how that facilitates banking as a service. Open Banking is increasing client churn and driving banking as a service. That in turn is changing the way products are delivered.

Four strategies were proposed to navigate the evolving competitive landscape. These are for incumbents to address customer retention; for challengers to peruse a low-cost digital experience; for niche players to provide banking as a service; and for social media platforms to develop payment platforms. In all these scenarios, the banks of the future will have to have digital strategies for both payments and service delivery.

It was shown that both incumbents and challengers are dependent on capital availability and borrowers credit concerns. Nothing has changed in that respect. The risks remain credit and default risk. What is clear, however, is the bank has become intrinsically linked with technology. The Internet is changing the nature of mediation. It is allowing peer to peer matching of borrowers and savers. It is facilitating new payment protocols and digital currencies. Banks need to evolve and adapt to accommodate these. Most of these questions are empirical in nature. The aim of this paper, however, was to demonstrate that an understanding of the banking model is a prerequisite to understanding how to address these and how to develop hypotheses connected with them.

In conclusion, financial technology is changing the future of banking and the way banks intermediate. It is facilitating digital money and the online transmission of financial assets. It is making banks more customer enteric and more competitive. Scholarly investigation into banking has to adapt. That said, whatever the future, trust will remain at the core of banking. Similarly, deposits and lending will continue to attract regulatory oversight.

Availability of data and materials

Diagrams are my own and the code to reproduce them is available in the supplied Latex files.

Adrian T, Ashcraft AB (2016) Shadow banking: a review of the literature. In: Banking crises. Palgrave Macmillan, London, pp 282–315

Allen F (1990) The market for information and the origin of financial intermediation. J Financ Intermed 1(1):3–30

Article   Google Scholar  

Anagnostopoulos I (2018) Fintech and regtech: impact on regulators and banks. J Econ Bus 100:7–25

Berger AN, Herring RJ, Szegö GP (1995) The role of capital in financial institutions. J Bank Finance 19(3–4):393–430

Berger AN, Miller NH, Petersen MA, Rajan RG, Stein JC (2005) Does function follow organizational form? Evidence from the lending practices of large and small banks. J Financ Econ 76(2):237–269

Bernanke B, Gertler M, Gilchrist S (1996) The financial accelerator and the flight to quality. The review of economics and statistics, pp1–15

Bord V, Santos JC (2012) The rise of the originate-to-distribute model and the role of banks in financial intermediation. Federal Reserve Bank N Y Econ Policy Rev 18(2):21–34

Google Scholar  

Borgogno O, Colangelo G (2020) Data, innovation and competition in finance: the case of the access to account rule. Eur Bus Law Rev 31(4)

Braggion F, Manconi A, Zhu H (2018) Is Fintech a threat to financial stability? Evidence from peer-to-Peer lending in China, November 10

Brei M, Borio C, Gambacorta L (2020) Bank intermediation activity in a low-interest-rate environment. Econ Notes 49(2):12164

Buchak G, Matvos G, Piskorski T, Seru A (2018) Fintech, regulatory arbitrage, and the rise of shadow banks. J Financ Econ 130(3):453–483

Demirgüç-Kunt A, Detragiache E (2002) Does deposit insurance increase banking system stability? An empirical investigation. J Monet Econ 49(7):1373–1406

Diamond DW (1984) Financial intermediation and delegated monitoring. Rev Econ Stud 51(3):393–414

Diamond DW, Dybvig PH (1983) Bank runs, deposit insurance, and liquidity. J Polit Econ 91(3):401–419

Diamond DW, Rajan RG (2000) A theory of bank capital. J Finance 55(6):2431–2465

Edgeworth FY (1888) The mathematical theory of banking. J Roy Stat Soc 51(1):113–127

Fama EF (1980) Banking in the theory of finance. J Monet Econ 6(1):39–57

Gurley JG, Shaw ES (1956) Financial intermediaries and the saving-investment process. J Finance 11(2):257–276

Klein MA (1971) A theory of the banking firm. J Money Credit Bank 3(2):205–218

Kou G, Akdeniz ÖO, Dinçer H, Yüksel S (2021) Fintech investments in European banks: a hybrid IT2 fuzzy multidimensional decision-making approach. Financ Innov 7(1):1–28

Levine R (2001) International financial liberalization and economic growth. Rev Interna Tional Econ 9(4):688–702

Liu FH, Norden L, Spargoli F (2020) Does uniqueness in banking matter? J Bank Finance 120:105941

Pozsar Z, Singh M (2011) The nonbank-bank nexus and the shadow banking system. IMF working papers, pp 1–18

Ramakrishnan RT, Thakor AV (1984) Information reliability and a theory of financial intermediation. Rev Econ Stud 51(3):415–432

Reichheld FF, Kenny DW (1990) The hidden advantages of customer retention. J Retail Bank 12(4):19–24

Romānova I, Grima S, Spiteri J, Kudinska M (2018) The payment services directive 2 and competitiveness: the perspective of European Fintech companies. Eur Res Stud J 21(2):5–24

Modigliani F, Miller MH (1959) The cost of capital, corporation finance, and the theory of investment: reply. Am Econ Rev 49(4):655–669

Schumpeter J (1911) The theory of economic development. Harvard Econ Stud XLVI

Song F, Thakor AV (2010) Financial system architecture and the co-evolution of banks and capital markets. Econ J 120(547):1021–1055

Swankie GDB, Broby D (2019) Examining the impact of artificial intelligence on the evaluation of banking risk. Centre for Financial Regulation and Innovation, white paper

Thakor AV (2020) Fintech and banking: What do we know? J Financ Intermed 41:100833

Vishnu S, Agochiya V, Palkar R (2017) Data-centered dependencies and opportunities for robotics process automation in banking. J Financ Transf 45(1):68–76

Williams MD (2018) Social commerce and the mobile platform: payment and security perceptions of potential users. Comput Hum Behav 115:105557

Download references

Acknowledgements

There are no acknowldgements.

There was no funding associated with this paper.

Author information

Authors and affiliations.

Centre for Financial Regulation and Innovation, Strathclyde Business School, Glasgow, UK

Daniel Broby

You can also search for this author in PubMed   Google Scholar

Contributions

The author confirms the contribution is original and his own. All authors read and approved the final manuscript.

Corresponding author

Correspondence to Daniel Broby .

Ethics declarations

Competing interests.

I declare I have no competing interests.

Additional information

Publisher's note.

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Rights and permissions

Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. The images or other third party material in this article are included in the article's Creative Commons licence, unless indicated otherwise in a credit line to the material. If material is not included in the article's Creative Commons licence and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder. To view a copy of this licence, visit http://creativecommons.org/licenses/by/4.0/ .

Reprints and permissions

About this article

Cite this article.

Broby, D. Financial technology and the future of banking. Financ Innov 7 , 47 (2021). https://doi.org/10.1186/s40854-021-00264-y

Download citation

Received : 21 January 2021

Accepted : 09 June 2021

Published : 18 June 2021

DOI : https://doi.org/10.1186/s40854-021-00264-y

Share this article

Anyone you share the following link with will be able to read this content:

Sorry, a shareable link is not currently available for this article.

Provided by the Springer Nature SharedIt content-sharing initiative

• Cryptocurrencies
• P2P Lending
• Intermediation
• Digital Payments

JEL Classifications

You are using an outdated browser. Upgrade your browser today or install Google Chrome Frame to better experience this site.

• IMF at a Glance
• Surveillance
• Capacity Development
• IMF Factsheets List
• IMF Members
• IMF Timeline
• Senior Officials
• Job Opportunities
• Archives of the IMF
• Climate Change
• Fiscal Policies
• Income Inequality

Flagship Publications

Other publications.

• World Economic Outlook
• Global Financial Stability Report
• Fiscal Monitor
• External Sector Report
• Staff Discussion Notes
• Working Papers
• IMF Research Perspectives
• Economic Review
• Global Housing Watch
• Commodity Prices
• Commodities Data Portal
• IMF Researchers
• Annual Research Conference
• Other IMF Events

IMF reports and publications by country

Regional offices.

• IMF Resident Representative Offices
• IMF Regional Reports
• IMF and Europe
• IMF Members' Quotas and Voting Power, and Board of Governors
• IMF Regional Office for Asia and the Pacific
• IMF Capacity Development Office in Thailand (CDOT)
• IMF Regional Office in Central America, Panama, and the Dominican Republic
• Eastern Caribbean Currency Union (ECCU)
• IMF Europe Office in Paris and Brussels
• IMF Office in the Pacific Islands
• How We Work
• IMF Training
• Digital Training Catalog
• Online Learning
• Our Partners
• Country Stories
• Technical Assistance Reports
• High-Level Summary Technical Assistance Reports
• Strategy and Policies

For Journalists

• Country Focus
• Chart of the Week
• Communiqués
• Mission Concluding Statements
• Press Releases
• Statements at Donor Meetings
• Transcripts
• Views & Commentaries
• Article IV Consultations
• Financial Sector Assessment Program (FSAP)
• Seminars, Conferences, & Other Events
• E-mail Notification

Press Center

The IMF Press Center is a password-protected site for working journalists.

• Login or Register
• Information of interest
• About the IMF
• Conferences
• Press briefings
• Special Features
• Middle East and Central Asia
• Economic Outlook
• Annual and spring meetings
• Most Recent
• Most Popular
• IMF Finances
• Additional Data Sources
• World Economic Outlook Databases
• Climate Change Indicators Dashboard
• IMF eLibrary-Data
• International Financial Statistics
• G20 Data Gaps Initiative
• Public Sector Debt Statistics Online Centralized Database
• Currency Composition of Official Foreign Exchange Reserves
• Financial Access Survey
• Government Finance Statistics
• Publications Advanced Search
• IMF eLibrary
• IMF Bookstore
• Publications Newsletter
• Essential Reading Guides
• Regional Economic Reports
• Country Reports
• Departmental Papers
• Policy Papers
• Selected Issues Papers
• All Staff Notes Series
• Analytical Notes
• Fintech Notes
• How-To Notes
• Staff Climate Notes

IMF Working Papers

Post-crisis changes in global bank business models: a new taxonomy.

Author/Editor:

John C Caparusso ; Yingyuan Chen ; Peter Dattels ; Rohit Goel ; Paul Hiebert

Publication Date:

December 27, 2019

Electronic Access:

Free Download . Use the free Adobe Acrobat Reader to view this PDF file

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

The Global Financial Crisis unleashed changes in the operating and regulatory environments for large international banks. This paper proposes a novel taxonomy to identify and track business model evolution for the 30 Global Systemically Important Banks (G-SIBs). Drawing from banks’ reporting, it identifies strategies along four dimensions –consolidated lines of business and geographic orientation, and the funding models and legal entity structures of international operations. G-SIBs have adjusted their business models, especially by reducing market intensity. While G-SIBs have maintained international orientation, pressures on funding models and entity structures could affect the efficiency of capital flows through the bank channel.

Working Paper No. 2019/295

Banking Financial institutions Financial services Financial statements Foreign banks Global systemically important banks Investment banking Public financial management (PFM)

9781513522883/1018-5941

WPIEA2019295

Please address any questions about this title to [email protected]

• © 2019

Banking Business Models

Definition, Analytical Framework and Financial Stability Assessment

• Rym Ayadi 0

CASS Business School, City University of London, London, UK

You can also search for this author in PubMed   Google Scholar

• Delivers a complete novel analysis on business models in banking
• Provides market participants, depositors, creditors, regulators and supervisors with a useful tool to better understand the nature of risk attached to each bank business model
• Offers a unique framework to assess systemic risk in banking using the business model analysis

Part of the book series: Palgrave Macmillan Studies in Banking and Financial Institutions (SBFI)

14k Accesses

11 Citations

1 Altmetric

• Table of contents

About this book

Authors and affiliations, about the author, bibliographic information.

• Publish with us

Buying options

• Available as EPUB and PDF
• Read on any device
• Instant download
• Own it forever
• Durable hardcover edition
• Dispatched in 3 to 5 business days
• Free shipping worldwide - see info

Tax calculation will be finalised at checkout

Other ways to access

This is a preview of subscription content, log in via an institution to check for access.

Table of contents (13 chapters)

Front matter, introduction, changing role of banks in the financial system, defining a business model in banks, identification of business models, bank business models and financial stability assessment, business models, ownership, organisational structures and size, migration of business models, performance of business models, risk of business models, regulation and business models, resolution and business models, conclusions, correction to: banking business models, back matter.

This book is a result of several years of research to provide readers with a novel and comprehensive analysis on business models in banking, essential to understanding bank businesses pre- and post- financial crisis and how they evolve in the financial system. This book will provide depositors, creditors, credit rating agencies, investors, regulators, supervisors, and other market participants with a comprehensive analytical framework and analysis to better understand the nature of risk attached to the bank business models and its contribution to systemic risk throughout the economic cycle. The book will also guide post-graduate students and researchers delving into this topic.

• Banking regulation
• Banking economics
• Micro-prudential regulation
• systemic risk
• bank business model analysis

Rym Ayadi is Honorary Professor at CASS Business School, Member of the Centre for Banking Research (CBR) at the City University in London, UK, and President of the Euro-Mediterranean Economists Association in Barcelona.

She is a member of several high-level expert groups in the European Commission including the Financial Services Users Group (FSUG), an academic member of the European Banking Authority (EBA) Stakeholders Group (BSG), an external advisor to the European Parliament on both the Economic and Financial Committee and Committee on Foreign Affairs, an advisor to the Parliamentary Assembly of the Mediterranean (PAM) and the Union for the Mediterranean (UfM), and an invited expert in international organisations including OECD and IMF, among others.

Rym’s fields of expertise include international financial systems, financial markets and institutions, global financial regulation and governance, and socio-economic development and foresight in economies in transition.  Previously, Rym served as Professor of International Business and Finance at the Department of International Business, Director and Board Member of the Alphonse and Dorimène Desjardins Institute for Cooperatives, and Founding Director of the International Research Centre on Cooperative Finance (IRCCF) at HEC Montreal, Canada, and a Senior Research Fellow and Head of Research of the Financial Institutions Unit at the Centre for European Policy Studies (CEPS), a policy think tank in Brussels.

Book Title : Banking Business Models

Book Subtitle : Definition, Analytical Framework and Financial Stability Assessment

Authors : Rym Ayadi

Series Title : Palgrave Macmillan Studies in Banking and Financial Institutions

DOI : https://doi.org/10.1007/978-3-030-02248-8

Publisher : Palgrave Macmillan Cham

eBook Packages : Economics and Finance , Economics and Finance (R0)

Copyright Information : The Editor(s) (if applicable) and The Author(s) 2019

Hardcover ISBN : 978-3-030-02247-1 Published: 06 May 2019

eBook ISBN : 978-3-030-02248-8 Published: 23 April 2019

Series ISSN : 2523-336X

Series E-ISSN : 2523-3378

Edition Number : 1

Number of Pages : XVIII, 183

Number of Illustrations : 18 b/w illustrations

Topics : Banking

Policies and ethics

• Find a journal
• Track your research

The evolution of banking in the 21st century

Download the conference draft

Subscribe to the Economic Studies Bulletin

Evidence and regulatory implications, samuel g. hanson , samuel g. hanson marvin bower associate professor - harvard business school victoria ivashina , victoria ivashina professor of business administration - harvard business school laura nicolae , laura nicolae ph.d. candidate - harvard university @lauramnicolae jeremy c. stein , jeremy c. stein moise y. safra professor of economics - harvard university adi sunderam , and adi sunderam professor - harvard university daniel k. tarullo daniel k. tarullo nonresident senior fellow - economic studies , the hutchins center on fiscal and monetary policy.

March 27, 2024

The paper summarized here is part of the spring 2024 edition of the Brookings Papers on Economic Activity , the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellows  Janice Eberly  and  Jón Steinsson .

See the spring 2024 BPEA event page to watch paper presentations and read summaries of all the papers from this edition.  Submit a proposal to present at a future BPEA conference  here .

Uninsured deposits should be subjected to tougher regulatory requirements to guard against the type of rapid runs that toppled three large regional banks last spring, suggests a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on March 29.

In the wake of the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank (three of the four largest bank failures in U.S. history), the authors look at two trends over the past quarter century—the substantial growth of uninsured deposits and the migration of business lending to non-banks. The trends challenged the failed banks and banks like them, and in some cases left them vulnerable to runs. And, using a simple model they constructed, the authors assess regulatory options for reducing the risk of destabilizing runs.

“One of the most striking developments that we document … is a dramatic growth in the economy-wide ratio of bank deposits to GDP [gross domestic product], with much of this growth coming from large uninsured deposits,” write Samuel G. Hanson, Victoria Ivashina, Laura Nicolae, Jeremy C. Stein, Adi Sunderam, and Daniel K. Tarullo, all from Harvard University.

According to their paper—”The Evolution of Banking in the 21 st Century: Evidence and Regulatory Implications ” —total deposits in the fourth quarter of 1995 were 49% of GDP, with 20% of those deposits uninsured. By the third quarter of 2023, total deposits were 75% of GDP, 39% of them uninsured. Adding to that vulnerability, technology and social media have made it increasingly easier for large depositors to quickly withdraw their money.

Meanwhile, banks with the most rapid growth in deposits have seen the biggest declines in business lending, which has migrated toward non-bank entities such as securitization vehicles, mutual funds, insurance companies, and, in recent years, private-credit funds and business development companies. (Smaller community banks tend to specialize in lending to smaller firms and have been less affected by the growth of non-bank institutions.)

Instead of lending to large- and medium-size businesses, regional banks have shifted toward investing in longer-term Treasury securities and government-guaranteed mortgage backed securities. Those securities have little or no credit risk (the risk of default) but they are subject to interest-rate risk. When interest rates rise sharply, as they did in 2022 when the Federal Reserve raised rates to fight inflation, existing long-term securities lose value because investors can earn more from newly issued securities.

To reduce the risk of runs, the authors looked at expanding federal deposit insurance to cover all or most deposits. But that expansion of the government’s footprint would increase taxpayer exposure and could weaken banks’ incentives to guard against risk. Also, in the case of banks that have shifted away from lending, it would in effect subsidize bond holding rather than lending.

Instead, the authors favor strengthening liquidity regulations, which aim to ensure banks have funds available to meet deposit withdrawals. The authors would require banks with more than $100 billion in assets to back their uninsured deposits by pre-positioning collateral, largely in the form of short-term government securities, at the Federal Reserve. That requirement would enable them to withstand a run by borrowing from the Fed’s discount window and would encourage them to shift their asset-mix away from longer-term securities and toward short-term securities, which are much less subject to interest-rate risk.

The authors also recommend that regulators re-think rules that, except for the eight largest U.S. banks, shield regulatory capital from reflecting most market losses on the securities banks hold.

And, the authors recommend that regulators “look more positively on proposed mergers of mid-size regionals and on acquisitions of smaller banks by mid-sized regionals.” That could either help regionals to better compete with the largest banks or could aid in wringing out excess capacity to the extent that the business model of the regionals continues to be under pressure.

Hanson, Samuel, Victoria Ivashina, Laura Nicolae, Jeremy Stein, Adi Sunderam, and Daniel Tarullo. 2024. “The evolution of banking in the 21st century: Evidence and regulatory implications.” BPEA Conference Draft, Spring.

David Skidmore authored the summary language for this paper. Chris Miller assisted with data visualization.

Stein and Tarullo are former members of the Federal Reserve Board of Governors. Sunderam was a visiting scholar at the Federal Reserve Bank of Boston from January-June 2023, and Ivashina has been a visiting scholar there since 2015. The authors did not receive financial support from any firm or person for this article or, other than the aforementioned, from any firm or person with a financial or political interest in this article. The authors are not currently an officer, director, or board member of any organization with a financial or political interest in this article.

Economic Studies

Brookings Papers on Economic Activity Election ’24: Issues at Stake

Aaron Klein

March 18, 2024

Online only

12:30 pm - 2:00 pm EDT

David Wessel

March 12, 2024

• Topical Index

Federal Reserve System

Community Banking Connections

A supervision and regulation publication.

System Outreach

Policy and guidance.

• District Connections

The Evolution of Community Bank Business Model Series: Rural Banks Endure in the Face of Challenges

The Evolution of the Community Bank Business Model series 1 concludes with this article that focuses on how urban and rural banks have been influenced by changes in the banking environment. 2 Some changes have uniformly affected both rural and urban banks. From 2015 to 2019, for instance, rural community banks decreased in number by 14 percent, while urban community banks decreased in number by 17 percent — a relatively modest difference in rates of contraction. 3 A similar story emerges from comparisons of profitability, as returns on assets from 2015 to 2019 were higher at rural banks than at urban banks in some years and lower in others. 4

However, other changes in the banking environment have affected urban and rural banks differently. This article focuses on the following six differences: lending specialization, branching, competition, small business lending, managerial succession, and technology. These are not inclusive or thoroughly analyzed in a way that accounts for variation in size across banks in urban and rural markets. Nevertheless, they are important, both individually and collectively, in demonstrating how rural community banks remain competitive in today’s banking environment.

Lending Specialization

Lending specialization is important in understanding community banks, as risks and returns vary by loan type, time period, and degree of diversification. 5 They also vary by urban and rural location.

Urban banks are more concentrated in commercial real estate lending. This lending specialty was relatively unprofitable prior to the Great Recession and relatively profitable afterward. 6 Rural banks are more concentrated in agricultural lending (Figures 1 and 2), which has been a relatively profitable specialization for decades. 7 Other concentrations are more similarly distributed for urban banks and rural banks.

Figure 1: Percentage of Urban Banks with Assets Under $10 Billion, Specialized by Loan Type

Source: Call Report data. The numbers represent the percentages of community banks specializing in various lending categories.

Figure 2: Percentage of Rural Banks with Assets Under $10 Billion, Specialized by Loan Type

Looking at changes over time, the percentages of banks specializing in the various forms of lending have generally increased by amounts that are modest in raw percentages but, in some cases, represent large proportions relative to initial levels. These changes, however, do not appear to be markedly and systematically different across rural and urban locations. This contrasts with earlier findings that urban banks were more likely to change specializations than rural banks. 8

Branching activity is important both as a method of delivery for financial services and as a scale by which endurance can be weighed. The balance appears to favor rural banks (Table 1). In 2019, for instance, 1,540 branches closed in urban areas compared with 98 in rural areas. Ratios of closed to total branches follow a similar pattern, at levels of 0.14 percent in rural areas and 2.21 percent in metropolitan areas. Although rural branch closures are less common than urban branch closures, they may be more impactful because rural customers have fewer alternative services than customers in urban areas.

Table 1: Branch Closings, 2015 to 2019 Number of closed branches 2015 2016 2017 2018 2019 Rural 94 103 102 102 98 Urban 1992 1395 1191 1447 1540 Ratio of closed branches to total branches Rural 0.13% 0.14% 0.14% 0.14% 0.14% Urban 1.58% 1.94% 1.66% 2.06% 2.22% --> Note: The sample consists of full-service brick-and-mortar bank branches operating outside main offices. Closings for a given year occur during the one-year period ending on June 30 of that year. The ratio of closed branches to total branches is calculated as the number of branches that closed within that year divided by the number of branches in existence at the beginning of the year. Rural banks are those located outside metropolitan or micropolitan statistical areas. Urban branches are in metropolitan statistical areas. Source: FDIC Summary of Deposits data

Market Concentration

More competition helps consumers by encouraging greater product differentiation, a lowering of the cost of financial intermediation, and more access to financial services. 9 It can hurt banks to the extent that it leads to lower net interest margins (lower interest rates on loans and higher interest rates on deposits). It also may foster excessive risk taking and thereby lead to a less stable banking environment. 10 Regulators balance these factors in monitoring banking market structure.

Rural banks operate in more concentrated markets than urban banks. 11 In 2019, for instance, less than 28 percent of the banks in urban markets (Figure 3) operated in markets considered to be highly concentrated, compared with about 89 percent of the banks in rural markets (Figure 4). Moreover, this difference has become more pronounced over time. From 2000 to 2019, the number of rural banks in concentrated markets has increased (from 88 percent to 89 percent), while the number of urban banks has decreased (30 percent to 28 percent).

The foregoing analysis of market concentration shows that community banks in urban areas are subject to tougher competition, which, theoretically, lessens their influence over the pricing and provisioning of bank services in their markets. Rural banks, alternatively, experience less in-market competition for banking products and services.

Figure 3: Percent of Urban Markets with HHIs Greater Than 1,800

Source: FDIC Summary of Deposits data

Figure 4: Percent of Rural Markets with HHIs Greater Than 1,800

Small Business Lending

Small business lending often is described as the hallmark of community banking. But this traditional role has been challenged by non–community banks as well as by other lenders. For example, from 2015 to 2019, loans to small businesses as percentages of assets at community banks declined by 8 percent while increasing by 4 percent at non–community banks. 12

Rural banks, however, were less impacted than urban banks (see Table 2). Loans to small businesses, expressed both in dollar volumes and as percentages of assets, were relatively stable from 2015 to 2019 for rural banks, while declining for urban banks. This may indicate an evolution in banking that varies by geographic location, with rural banks maintaining a more traditional banking model.

Table 2: Small Loans to Businesses at Community Banks Rural Urban Loans (% of assets) $38.2 (12.1%) $40.6 (11.7%) $228.9 (11.2%) $209.5 (10.2%) Number of Banks 1556 1342 3657 3030 --> Source: Call Report data. Dollar amounts are expressed in billions.

Rural banks are often said to be challenged by difficulties in attracting qualified managers. Some analysts have contended that if talent is correlated with performance and is less accessible in rural communities, then difficulty in replacement of managers at rural banks, compared with equivalent replacement at urban banks, could, over time, erode their competitiveness. Evidence in support of this contention, however, is anecdotal rather than empirical. A 2018 study that directly examined differences in performance between urban and rural banks when new chief executive officers came on board 13 found that the competitiveness of rural banks is not, in fact, eroded by succession problems.

Technological Innovation

The introduction of new technologies historically has been slower in rural banking markets than in urban banking markets. This may be related, in part, to disinterest among rural populations, or lesser access to internet services, which, in 2015, were used by 75 percent of urban populations but by only 69 percent of rural populations. 14 “We have approximately 4,000 separate customers using 16,000 loan and deposit accounts,” noted one banker in response to the Conference of State Bank Supervisors 2020 National Survey of Community Banks. 15 “Yet, we have less than 500 users of our mobile banking app.”

Another problem may reflect difficulties in supply, rather than demand, in technological services — that is, the limited operational capabilities of small, rural banks may be important, as well as the preferences of rural bank customers. In this regard, consider the tiny, but growing, use of internet deposits (Table 3), almost all of which were raised by non–community banks operating in urban areas. Rural banks, perhaps, could seek to access such out-of-market deposit gathering strategies as a possible response to locally contracting markets. They previously have been successful in introducing other technologies, including mobile banking and interactive teller machines. 16

Table 3: Internet Deposits Dollar Amount in Billions Number of "Cyber" Branches June 2019 June 2020 June 2019 June 2020 All Banks $407 $662 191 190 --> Source: Call Report

Succession difficulties, limited loan demand, branch closures, and other factors that erode the competitiveness of rural banks are important, in part, because the loss of banking services is particularly impactful for customers in remote areas. However, the challenges facing rural community banks, compared with those in urban areas, may not be as stark as is sometimes suggested. They are doing better in small business lending, are not necessarily disadvantaged by succession, and are closing branches at lower rates. Their profitability approximates that of other banks, supported, perhaps, by advantages of operating in more concentrated markets. In some cases, community banks are overcoming technological limitations by adding new products and services. They have grown more similar to urban banks in how they change lending specializations.

Despite a more challenging economic environment, as stated in a 2018 speech by then Vice Chair for Supervision Randal K. Quarles, “rural community banks appear to be holding their own relative to urban community banks.” 17

• 1 This article is the second in a two-part series based on research conducted in 2019 by Federal Reserve staff: Bettyann Griffith, Federal Reserve Bank of New York; Deeona Deoki, Federal Reserve Bank of New York; Chris Henderson, Federal Reserve Bank of Philadelphia; Chantel Gerardo, Federal Reserve Bank of Philadelphia; James Fuchs, Federal Reserve Bank of St. Louis; Mark Medeiros, Federal Reserve Bank of Atlanta; Justin Reuter, Federal Reserve Bank of Kansas City; Jonathan Rono, Board of Governors; and James Wilkinson, retired from the Federal Reserve Bank of Kansas City. The first article, “The Evolution of the Community Bank Business Model Series: Impact of Technology,” appeared in the Third Issue 2021 of Community Banking Connections and is available at www.cbcfrs.org/articles/2021/i3/the-evolution-of-the-community-bank-business-model-series-impact-of-technology .
• 2 For purposes of this analysis, “rural” community banks are located outside, and “urban” community banks are located inside metropolitan statistical areas.
• 3 Data were obtained from the Consolidated Reports of Condition and Income (Call Reports).
• 4 Data are from the Call Reports.
• 5 Specialization is measured using the methodology from the Federal Deposit Insurance Corporation (FDIC) Community Bank Study (2012) to categorize banks as specialists in mortgages, consumer loans, commercial real estate loans, agricultural loans, or business loans or as multi-specialists that focus on more than one category. The study is available at www.fdic.gov/regulations/resources/cbi/report/cbsi-execsumm.pdf .
• 6 FDIC Community Bank Studies (2012 and 2020).
• 7 FDIC Community Bank Studies (2012 and 2020).
• 8 FDIC Community Bank Study (2012).
• 9 A. Demirguc-Kunt, “Bank Concentration, Competition, and Financial Stability: What Are the Trade-Offs?” World Bank Blogs, May 11, 2010, available at https://blogs.worldbank.org/allaboutfinance/bank-concentration-competition-and-financial-stability-what-are-trade-offs .
• 10 See Demirguc-Kunt, “Bank Concentration, Competition, and Financial Stability: What Are the Trade-Offs?,” 2010.
• 11 A banking market with a Herfindahl–Hirschman Index (HHI) greater than 1,800 is considered by the U.S. Department of Justice and the Federal Reserve System to be “highly concentrated.” For the definition of HHI, an explanation of how HHI is calculated, and the use of the index to assess market concentration, see “The ABCs of HHI: Competition and Community Banks,” On the Economy blog, St. Louis Fed, June 11, 2018, available at www.stlouisfed.org/on-the-economy/2018/june/hhi-competition-community-banks .
• 12 Data were obtained from the Consolidated Reports of Condition and Income (Call Reports).
• 13 D. Dahl, M. Milchanowski, and D. Coster, “CEO Succession and Performance at Rural Banks,” presented at the 2018 Community Banking in the 21st Century research and policy conference, available at www.communitybanking.org/~/media/files/communitybanking/2018 papers/session3_paper1_milchanowski.pdf .
• 14 D. Dahl, A. Meyer, and N. Wiggins. “How Fast Will Banks Adopt New Technology This Time?” Regional Economist, Fourth Quarter 2017, available at www.stlouisfed.org/publications/regional-economist/fourth-quarter-2017/banks-adoption-fintech .
• 15 Results of the survey were presented at the 2020 Community Banking in the 21st Century research and policy conference. See www.csbs.org/system/files/2020-09/cb21publication_2020.pdf .
• 16 Conference of State Bank Supervisors 2020 National Survey of Community Banks.
• 17 See the October 4, 2018, speech, “Trends in Urban and Rural Community Banks” at the Community Banking in the 21st Century research and policy conference. A video of the speech. is available at www.communitybanking.org/video/brightpop/fc63e5dfc02240bfb9537202032ec2b2 .

Also In This Issue

• A Message from Governor Bowman
• Community Banks Are Key Partners with Agricultural Producers Despite Reduced Agricultural Lending

The Federal Reserve System provides various resources for training, services, and more.

Connect to various Federal Reserve resources, including SR and CA Letters, regulations, request for comment on rulemaking proposals, the latest Federal Reserve System speeches, and more.

Community Banking Connections is a quarterly Federal Reserve System publication available electronically or in print .

We want to hear from you! Please share with us any comments, suggestions, or topics that you would like to see on our website or in our publications.

• Privacy Policy

UNDERSTANDING TRENDS FORGING STRATEGIES

Bank business models at a glance, the financial market structures and regulations in an ever-changing environment..

The Bank Business Models (BBM) analysis provides researchers and markets participants (i.e. depositors, creditors, rating agencies, regulators and supervisors) with a useful tool to:

• better understand the nature of risk attached to each bank business model
• its contribution to systemic risk throughout the economic cycle.

To identify the bank business model, we use the Activity/Funding definition based on an Asset/Liability Approach and clustering methodology and the Statistical Analysis System introduced and explained in Ayadi (2019) and (Ayadi et al, 2016) . Clustering analysis is a statistical technique that assigns a set of observations into a distinct cluster. To run the cluster analysis, a selection of instruments which are the defining activity – funding features of the BM are consdiered: Loans to banks (as % of assets); Debt liabilities (as % of assets); Customer loans (as % of assets); Trading assets (as % of assets); Derivative exposures (as % of assets).

About the founder, rym ayadi is honorary professor at cass business school, faculty of finance and member of the centre for banking research (cbr) at the city university in london, founding president of the euro-mediterranean economists association (emea) and founder and scientific director of the euro-mediterranean network for economic studies (emnes)..

area of interest

In a context of an evolution of market structures and regulations, the banks’ business models analysis can provide market participants, depositors, creditors, regulators and supervisors with a useful tool to better understand the nature of risk attached to each bank business model and its contribution to systemic risk throughout the economic cycle..

Promoted by EMEA

We're not around right now. But you can send us an email and we'll get back to you, asap.

Welcome to Finextra. We use cookies to help us to deliver our services. We'll assume you're ok with this, but you may change your preferences at our Cookie Centre . Please read our Privacy Policy .

Watch the latest FinextraTV stories covering fintech, banking and payments technology.

PREDICT 2024: Business Model Transformation driven by Economic & Geopolitical Shifts

Ole Matthiessen, Global Head of Cash Management & Head of Corporate Bank Asia Pacific, Middle East & Africa, Deutsche Bank, discusses the stand out emerging business models that are changing the financial and banking landscape today, the various use cases that indicate how this space is likely to evolve, and how the business model evolution within these industry changes are bringing together both the geopolitical and the digital angle.

More on /predictions

Related companies, lead channel, comments: (0).

Write a blog post about this story (membership required)

News in your inbox

For Finextra's free daily newsletter, breaking news and flashes and weekly job board.

The case for compliance as a competitive advantage for banks

Consider this short tale of two banks: Acme Bank’s top-notch compliance function kept the bank within its risk appetite, but the bank did not perform well. Its strategy team blamed compliance for slow growth, weak market share, and failed digital initiatives. At Apex Bank, the strategy team bypassed compliance to release new products quickly, expand into new customer segments, and ramp up acquisitions, all while keeping costs low. Soon, though, its main regulator brought a significant enforcement action. The stock price fell, key employees quit, the bank had to exit several important businesses, and compliance costs skyrocketed.

While these descriptions are caricatures, they’re not far from reality. Strategy and compliance often operate as antagonists or as ships passing in the night. This is a missed opportunity. Done well, communication and collaboration between the two parties can create competitive advantage. The stakes are particularly high now: technology offers promise, but new risks are rising on uncertain economic and geopolitical landscapes.

This article explains the benefits available when compliance and strategy leaders work together, the quick wins that are possible, and the structural solutions that can sustain and scale the change. In this article, we use the word “strategy” as a metonym for the broader set of decision makers (not just the strategy organization) who influence and shape banks’ strategic direction; these include business unit leaders, leaders in marketing and sales organizations, and product managers.

Finding competitive advantage

Banks’ compliance functions have typically focused on defense: preventing violations of policy, rules, regulation, and laws. The more complicated the regulatory, business, and technological environment, the more complex the defense.

But in complex environments, collaboration with the business  can deliver greater strategic value . In our experience, five objectives that define strategic posture  are ripe for collaboration: differentiating client experience, investing in fast-evolving areas, securing resilience against geopolitical disruptions, improving productivity, and acquiring programmatically. In each, when compliance and business stakeholders responsible for strategic decisions work side by side, institutions benefit by protecting against the downside, capturing more of the upside, or both (exhibit) .

In working with banks around the world, we have seen examples of compliance and strategy collaborating on these five objectives, with varying degrees of success. Here we describe how the successful collaborations were achieved for each objective.

Differentiated client experience

In the increasingly digital world, customer experience is king , and products and services are scrutinized in the court of public opinion—online ratings and social media. Already in 2018, of the 50 largest global banks, three out of four were publicly pledging to initiate some form of customer-experience transformation . We have seen banks’ customer-experience transformations boost the lifetime profitability of satisfied customers—those willing to recommend the bank to friends—to levels five to eight times those of customers with a negative perception.

Banks need processes that deliver a good customer experience in the moment, treat customers fairly, protect against fraud, and comply with laws and other regulations. Poorly designed compliance processes can compromise the experience, but insufficient checks can open the door to fraud or other abuses. Deep collaboration by compliance and business teams can capture opportunities as well as protect the downside.

Poorly designed compliance processes can compromise the experience, but insufficient checks can open the door to fraud or other abuses. Deep collaboration by compliance and business teams can capture opportunities as well as protect the downside.

For example, in retail banking and payments, some consumers have negative experiences with identity verification; it can be confusing and take a long time. Frustrated consumers may even walk away from their bank. Strategy teams with expertise in identifying customer needs, meeting those needs, and differentiating value propositions by bringing together viewpoints from across the organization can work with compliance teams to identify the most critical needs and embed compliance requirements seamlessly into customer journeys.

In institutional banking, some customers experience similar frustrations from the intense and sometimes overlapping queries for information aimed at meeting the complex know-your-customer (KYC) requirements straddling jurisdictions. Certain KYC queries may add operational cost and could even deter large multinational clients from starting new banking relationships. Closer collaboration between compliance and strategy teams helps banks simplify the process in a client-centric and risk-informed way. Our research has found  10 to 30 percent improvement in customer satisfaction scores and 20 to 40 percent reductions of administrative touchpoints.

Compliance and strategy teams can also work together on continual improvement. Customer complaints can indicate compliance issues—for example, problematic sales practices—but also opportunities to improve customer experience. Thus, input on customer experience can serve as an early warning about possible compliance issues.

How to start

Compliance and business operations can together initiate a review of priority client-facing processes. The effort may identify opportunities for improving user experience through simplification or rationalization of controls—for example, by removing redundant or overlapping controls.

Banks that aspire to offer a standout client experience typically form cross-functional teams focused on rapid, agile execution. Practically, this would involve including compliance experts in the core of the agile approach and team configuration from the start. For processes related to customer onboarding, teams can include experts in compliance, technology, operations, strategy, and other functions. This equips the team to incorporate guidance on compliance requirements in the most client-friendly way.

One North American institution created a task force of senior banking executives, including the chief compliance officer, to design a smooth customer onboarding process across its capital markets businesses. The team first established clarity around regulatory requirements and then reengineered customer journeys and built a consistent experience across regions. The resulting process minimized requests for client information and decreased the risk of inconsistencies and conflicts in client data.

Investment in fast-evolving areas

Growth into adjacent or secondary industries offers financial services institutions strong opportunity, yet some of the most alluring domains are fraught with uncertainty related to compliance. 1 Our recent research finds that in financial services, 35 percent of growth comes from secondary industries or expansion into new ones. Companies that grow into adjacent industries generated, on average, an extra 1.5 percentage points per year of shareholder returns above their industry peers. https://www.mckinsey.com/industries/financial-services/our-insights/managing-a-customer-experience-transformation-in-banking This is especially true of areas in which some combination of technology, products and services, business dynamics, and customer expectations are evolving quicky. Strategists weigh the opportunity from potential investments against costs of competition or regulation. Compliance can shape ideas for coping with the regulatory uncertainty and suggest implications for various investment options.

New business opportunities linked to data and analytics exemplify an area that shows promise but presents new and sometimes uncertain compliance expectations. Some institutions are considering investing in or partnering with data and analytics players that provide credit decisioning tools. When decisions about credit extension are informed by or fully based on AI algorithms, banks will need to demonstrate the fairness of such decisions and their compliance with customer protection rules. Compliance teams can inform assessments of these requirements, such as required investments in controls and the AI talent required to interpret algorithms’ output.

Environmental, social, and governance (ESG) offerings are another area of potential opportunity for collaboration. Institutions that aspire to bring attractive ESG offerings to market need well-designed processes for product creation and maintenance. Basic criteria include factors (and underlying data) used to construct ESG investment products that are transparent and reflective of the investment objectives described in the prospectuses. Strategy teams play a key role in defining ESG product initiatives based on market dynamics and client needs. Compliance teams working with strategy teams can provide insights on alignment of ESG factors with the declared investment objectives and regulatory guidance, as well as the processes for monitoring product performance and informing customers.

Compliance and strategy could collaborate to articulate the largest regulatory risks associated with products or segments that are new to the industry, growing in importance, or being considered as a new focus. Examples could include analytics or digital payments.

Compliance officers could regularly share with colleagues the latest regulatory developments in this space, including potential implications for a bank’s planned investment actions, if relevant. In addition, banks should consider explicitly designating compliance team members who will be on point to provide strategically informed compliance insights on fast-evolving areas that the institution has prioritized for potential investment. These people would have the dual mandate of being compliance officers while advising strategists in areas where the bank is exploring the potential for growth or an inorganic investment thesis. Banks can even consider forming a small compliance advisory team to provide such input as needed in areas of strategic significance. This team might sit either within the strategy or compliance functions, with a dotted-line relationship to the other group.

Resilience against geopolitical disruption

For global institutions, geopolitical forces up the ante, particularly when laws or regulations shift quickly in response to countries’ foreign-policy stances. Institutions with an international footprint have complicated links between countries. Rarely can such organizations disconnect rapidly from any given country, not least because of compliance requirements. The strategy function may lack routines for systematically analyzing and understanding geopolitical scenarios.

For example, companies doing business in Russia or with Russian entities when it invaded Ukraine in early 2022 had to quickly translate the implications of the sanctions that many other countries imposed on Russia. Predefined playbooks for handling similar geopolitical shocks would accelerate response and reduce the probability of any outsize operational losses or regulatory fines that might create opportunities in the defensive quadrant of the values matrix.

Given recent geopolitical shifts, strategy teams may be well advised to start building a planning capacity, with compliance teams included. Those engaged with strategy at the senior level, with participation from the senior level of the compliance function, can systematically develop and analyze a set of geopolitical scenarios. For example, scenarios might include imposition of sanctions or quickly exiting a country.

Improved productivity

Collaboration to improve process productivity delivers impact primarily on the value capture axis of the matrix. For example, the compliance team can suggest the productivity initiatives (e.g., streamlining compliance controls, suggesting process simplification ideas based on compliance risk assessments) that could lead to significant impact on margin or revenue growth, given that prioritization of productivity initiatives is key for value capture.

When strategy teams design operational productivity programs, they balance effectiveness and efficiency levers across thousands of individual processes. Compliance organizations are uniquely positioned to support these efforts based on their observation of issues and challenges across the organization. In addition, the compliance team can help structure companywide communication flows on process and control streamlining opportunities. For example, they may have data and insights from security breaches, fraud, suspicious activity, and anti-money-laundering (AML) flags, as well as insights from control testing. These insights can inform where to eliminate, establish, or maintain manual checks; eliminate overlaps in the scope of reviews; or reengineer processes more holistically.

At the start of any productivity improvement effort, banks have an opportunity to include compliance as part of the core team. Similarly, when deploying the agile approach to identify opportunities, compliance officers can be core to the team structure from the start. This collaboration enables the team to review prioritized processes for opportunities to streamline compliance risk assessments and identified overlapping controls.

As the productivity program establishes baselines—for example, collecting data to prioritize the highest-impact products, businesses, and processes to start with—compliance experts can help with specifying data types and inputs needed, especially in areas such as control performance, key risk indicators, or customer complaint themes. For prioritizing productivity initiatives, compliance experts can contribute insights related to control testing or compliance risk assessment.

Stronger programmatic M&A

The compliance team can also help the strategy and M&A teams generate differentiated insights on mergers and acquisitions. In particular, collaboration can help strengthen programmatic M&A strategies , which generate excess returns relative to peers because serial acquirers tend to grow faster and more profitably. 2 Among companies with revenue CAGR over 5 percent, our research has shown, those with programmatic M&A strategies generate shareholder returns 3.5 percentage points higher than for those growing organically.

Collaboration on acquisition-related themes enables both offensive and optimizing strategies. Organizations can generate differentiated insights for upside capture, such as compliance criteria integrated in M&A sourcing filters. They also can pursue the dual benefits of upside capture and downside protection, such as collaboration on postmerger decisioning and planning.

Successful execution requires strong M&A capabilities, and the compliance function has a key role to play in each capability, including M&A sourcing, due diligence, and integration planning and execution. To enable programmatic M&A, compliance can help design filtering criteria so target identification excludes companies with suspicious clients or that operate in jurisdictions with weak regulatory infrastructure. Strategy and compliance teams should also collaborate to ensure the filters stay calibrated to existing market conditions.

Collaboration on due diligence can include pressure-testing strategic and financial assumptions linked to compliance. Key questions to consider for accurate valuation and assessment of targets’ business models are whether the market sizing assumes no new restrictive regulation of the target’s core product and what it will cost to bring a target’s financial-crime controls in line with those of the acquiring bank.

During postmerger integration and planning, the compliance team can be a partner in deciding the nature and level of integration. In our experience, companies do make compliance part of premerger planning but frequently as a stand-alone workstream. However, the maturity of a target’s control infrastructure often has direct bearing on the right approach to business, process, and system integration. For example, limited control infrastructure and a history of regulatory relationship challenges may prompt the organization to pursue greater integration across functions in order to migrate the target’s businesses to the acquirer’s more controlled and mature environment.

Consider integrating the compliance team into the entire M&A deal workflow. Bringing compliance into the M&A deal workflow can be a simple change. For example, compliance officers can become permanent members of the deal team across the full deal life cycle, including deal identification (refining investment filters with compliance factors), due diligence (leading compliance-specific deep dives), and integration (using control performance to generate insights on the integration strategy).

Structural solutions to sustain and amplify collaboration impact

Walk a day in my shoes.

Strategists and compliance officers have not been natural bedfellows. Strategists may not fully grasp compliance-related risks, while compliance officers may not understand in detail competitor moves or friction that spurs clients to reduce their business. But in the world that lies ahead, mutual understanding will likely be foundational for gaining a competitive edge.

Life as a compliance officer

The compliance role has grown as regulatory frameworks and compliance requirements proliferate. Since 2010, more rules have been issued by the four regulatory agencies (Federal Reserve, OCC, FDIC and CFPB) than in the entire period since the creation of the Federal Reserve System in 1913 to 2010. Compliance officers must translate every new requirement into digestible obligations, alter policies and procedures accordingly (often individually for each product, business, and geography), and help the business side understand these obligations in the context of their processes. Failure to do so can result in large fines to the company, restrictions on business, and even liability of individuals including senior executives and board members.

Compliance officers view their core mission as protectors, so the business’s goals of serving clients better, growing, or improving productivity can easily be perceived as resistance to the compliance function’s mission.

Life as a strategist

Unaddressed market forces continually deplete profits , so strategists try to create and capture economic and social value sustainably in the face of uncertainty. As the pace of innovation and disruption accelerates, strategists’ role becomes ever more intense. They rely on insights into key driving factors to formulate powerful strategy, deep interpersonal engagement and debate from senior executives, and a mutual understanding that the business is prepared and willing to act on a strategy once adopted.

While strategists could benefit greatly from the insights supplied by the compliance function, they often struggle to see past the technical language of rules and regulations. They will likely be better able to appreciate the larger meaning behind compliance if they have information synthesized into terms they can apply to their process of strategy formulation.

Three main obstacles tend to hinder systematic collaboration between compliance and business. First, the compliance function is sometimes seen as lacking full understanding of the business, so the idea of collaboratively finding creative solutions never arises (see sidebar, “Walk a day in my shoes”). Second, the operating model, organizational structure, and talent often are not set up to support meaningful engagement that would allow working together. Third, processes and technology generally have not been designed to unlock and sustain such collaboration. Acting systematically in these three areas, banks can sustain and magnify the impact of the initial actions previously described.

Culture of collaboration

Culture is a key determinant of shifts in the collaboration model, but it is arguably the hardest structural dimension to change in a sustainable way. Banks can prepare the ground for larger change by introducing microhabits that start with understanding each other’s vantage point. As with many other aspects of cultural change, building such understanding is a top-down process. Two microhabits are essentials for cultivating mutual understanding:

• The right tone from the top . Senior executives, including heads of the business and functional leadership, should be fully aligned on the principle behind the operating model and reinforce its importance in their communications, decisions, and actions.
• Collaboration at the C-level . An alliance between the chief compliance officer and the chief strategy officer enable their teams to meet the goals of collaboration. Without the chemistry and meeting of minds at the top, simple process interventions won’t deliver meaningful results.

Talent and operating model

Meeting the need for compliance talent skilled in collaboration and strategy requires the right approach to recruiting and upskilling (such as learning pathways and job rotations). From the recruiting perspective, compliance functions may need to reassess their usual criteria for senior compliance hires, such as a legal background, in favor of more diversification and cross-pollination on the team. Recruitment of compliance leaders should leverage the full diversity of the risk and compliance professionals in the industry. Our recent research  indicates that 90 percent of the risk and compliance professionals in our data set did not start in risk roles.

In addition, given that value creation primarily happens within business units, compliance and strategy activities should reflect the needs of business units. Strategy and compliance teams can explicitly align on how to jointly serve relevant business units where needed. Such upfront alignment can then be translated into tactics for collaboration.

Underlying technology

More modular and integrated tech and data infrastructure can enable connectivity between the strategy and compliance systems. More specifically, investments in workflow capabilities would allow both compliance and strategy counterparts to collaborate in real time, assign tasks to each other, and leverage common data sources. Ideally, such systems are capable of ingesting compliance-related input such as data regarding future regulatory scenarios, the potential impact of geopolitical events, and the impact of control failures on M&A integration. The systems then can incorporate this knowledge into major scenario-planning or business valuation tools.

For example, a bank may design a platform for risk assessments where strategy and compliance have access to the same modules and analyses. Such a platform would source the data from business unit systems and allow the compliance officers to see the compliance assessments carried out in real time. This would have an additional benefit: minimizing the time spent on low-value tasks (reconciling data or replicating the analyses, for example). Instead, the teams could focus on jointly prioritizing key risks and on collaborating to select and implement mitigating actions.

Banks have a strong opportunity to realize impact through collaboration between their compliance and business strategists. Quick wins are possible, but banks wanting to unlock the full potential of such collaboration must consider how to build systems, processes, and foundational capabilities that will enable them to scale up their collaboration.

Irakli Gabruashvili is an associate partner in McKinsey’s New York office, where Ishaan Seth is a senior partner; Olivia White is a senior partner in the Bay Area office; and Alexis Yumeng Yang is a consultant in the Seattle office.

Explore a career with us

Related articles.

Lessons from banking to improve risk and compliance and speed up digital transformations

The future of operational-risk management in financial services

• International edition
• Australia edition
• Europe edition

Bank of England investigating claim Metro Bank put customers’ data at risk

Exclusive: Whistleblower raised concerns about security of in-branch coin-counter software

The Bank of England is examining claims that the high street lender Metro Bank put customers’ data at risk by allegedly misusing software at the centre of a long-running legal dispute.

Last month the central bank’s whistleblowing team was contacted by a person raising concerns about the integrity and security of software used to connect Metro Bank’s in-branch coin-counters – known as Magic Money Machines – to customer accounts.

The communications, seen by the Guardian, claimed that the original Magic Money Machine software “was not made to be used on an online banking system” but had been built out by the bank in a way that allowed cash to be deposited directly into customer accounts, potentially creating weaknesses in the system.

The whistleblower also claimed that the source code for the machines may have been shared by Metro with other parties in a way that left customer accounts “susceptible to compromise”, suggesting that cash could be accessed by potential hackers and bad actors.

Together, those issues potentially presented a “significant security risk to Metro Bank UK’s network”, the email said.

The whistleblowing team in the Bank of England is now reviewing the allegations and has shared the communications with the City watchdog, the Financial Conduct Authority.

The Bank and the FCA declined to comment. Metro Bank did not directly respond to the allegations.

Metro Bank, which has about 2.7 million customers and 76 branches, has not reported any incidents or complaints of security and data breaches to date.

The lender has been in a long-running legal dispute regarding its coin-counting machines, which are primarily designed to allow children to add up small change and which feature lively animations, including of its mascot, Metro Man.

A US company, Arkeyo, provided the software to Metro for six years and claims that the lender later leaked its source code to a rival firm. It has been pursuing Metro through US courts since 2017 and filed a fresh lawsuit in the UK in 2022 in an attempt to sue the bank for £24m.

Arkeyo claims that the lender infringed its copyright and misappropriated trade secrets relating to money counting machines.

High court documents outline how Metro and Arkeyo worked together between 2010 and 2016 and how the relationship broke down over the following year. Arkeyo claims Metro then instructed a Chicago-based company called Saggezza to reverse-engineer and copy Arkeyo’s software. Saggezza has denied wrongdoing.

Metro said it could not comment on ongoing legal proceedings, but it addressed the case in its latest annual report. “We believe Arkeyo LLC’s claims are without merit and are vigorously defending the claim,” it said.

after newsletter promotion

The Bank of England complaint, and ongoing legal dispute, comes during a challenging period for Metro Bank, which rushed to secure a £925m deal in October in order to avoid a potential breakup or takeover.

The bank was co-founded by the US billionaire Vernon Hill and became the UK’s first new high street lender in 150 years when it launched in 2010. Metro grew significantly in the UK, taking on established high street rivals by offering more convenient opening hours and dog-friendly policies.

In 2019 an admission that it had made an accounting mistake led to the biggest single-day collapse in a UK bank’s share price since 2008. The mishap shook confidence in the bank and was soon followed by the departures of Hill and its chief executive, Craig Donaldson.

Last year Metro Bank was thrown into further turmoil after failing to convince regulators to loosen capital rules. The regulator’s decision left Metro with a shortfall on its balance sheet, causing market panic, until it secured the emergency deal that left it 53%-owned by the Colombian billionaire Jaime Gilinski Bacal.

Earlier this month Metro said it was cutting 1,000 jobs and ending its seven-day branch model, after nearly tripling the size of its cost-cutting plan following the rescue deal.

• Bank of England

More on this story

Metro Bank increases job cuts to 1,000 and ends seven-day branch model

‘I’m still proud of what we created’: Metro Bank’s 14-year rollercoaster ride

Metro Bank to cut about 800 jobs and review opening hours

Metro Bank rescue deal can go ahead after shareholders back it

Who is the Colombian billionaire taking a high stakes punt on Metro Bank?

Metro Bank gets another shot at redemption – but too late for the small shareholders

Metro Bank to slash costs after £925m rescue deal

Metro Bank agrees rescue deal with investors

Metro Bank shares rebound amid reports of £600m capital offer

Most viewed.