A broad range of problems and resulting capital inefficiency in the financial services industry is mostly based on how information, records, documents, and data are designed, managed, accessed, stored, shared, and used — both within, and between organizations.
The traditional solutions have been the intermediary and physical audit laden system that exists, with even statutory requirements and functions that, in many cases, were designed even prior to the discovery of electricity.
What Is The Cost Of The Status Quo In Capital Markets And Financial Services?
The short answer is more than $1,000,000,000,000 annually.
A recent report from OECD and the International Federation of Accountants estimated the annual cost to markets to reconcile assets across global jurisdictions costs more than $780,000,000,000 (that’s BILLION). Nearly a trillion dollars per year drain on capital markets just to ensure rules are being followed between jurisdictions! That’s a lot of money that would otherwise go to profit and yield. It is estimated that 5-10% of a financial institution’s annual turnover is consumed by costs related to regulatory divergence.
Institutional costs for dealing with regulatory divergence includes:
- Increased head count to manage local, international, and cross-jurisdictional regulatory matters.
- Training costs for personnel to deal with regulation and legislation across different regions, in addition to cross- jurisdictional issues.
- Systems costs, including the need for multiple different systems and systems implementation specifically designed to address regulatory divergence.
- Restructuring compliance department to better adjust to regulatory divergence.
- Costs of external consultants to help deal with regulatory divergence.
And this is just one example of the inefficiencies that are perpetuated by business processes and practices created before computers even existed. Bank fund transfer and payment systems are literally engineered around a messaging model from the telegraph era.
Trusting information is still literally another human being vouching for the authenticity of documents and data, which get replicated, hacked, lost, outdated, and even forged or intentionally destroyed to cover up fraudulent activity.
Imagine $1,000,000,000,000 in wasted, anachronistic efforts being eliminated and sent straight to the bottom line with a single click.
That’s ultimately the vision of XDEX, the Global Financial Record Network.
The Financial Industry Continues To Face Ever-increasing Compliance Costs
Since 2008, banks have spent more than $321 billion on settlements, enforcement actions and fines. The financial services industry spends more than $270 billion annually in compliance and regulatory obligations. The most impacted are smaller institutions, who spend a larger average percentage. Smaller institutions are required to adhere to the same or similar compliance requirements with fewer resources.
Traditional Banking Models Are Facing Total Displacement
Europe is ahead of the U.S. with digital-first, “banking-as-a-service” software platforms operating as a licensed institution. Agile new entrants are grabbing the customer experience and digital innovation spotlight.
Digital Financial Institutions Perform Better Than Traditional Ones
The financial sector is amid a historic transformation as nimble, digitally-native, non-traditional players test the old guard. With approximately 39 million users globally, digital banks provide low-cost, highly-personalized, customer-friendly offerings as a result of this branch-less, plug-and-play open platforms, APIs, and agility from digital stacks that drive efficient operations, and lower back and front-end costs.
Asset Tokenization Market Projected To Rapidly Grow
The global asset tokenization market projected to reach $24 trillion by 2027 across multiple asset classes. Legacy institutions & supporting enterprise information systems will adapt or succumb to those who do.
- Tokenization allows the creation of a new financial system – one that is more democratic, more efficient, and more vast than anything we have seen.
- Tokenization is already a reality. New players are rapidly building their own infrastructure, while the traditional market infrastructures are also showing signs of paving the way for mainstream adoption.
- Obstacles stand in the way of widespread adoption, principally in the form of regulation. But obstacles can be overcome wit the support of actors from all levels.
- Only institutions that engage with the technology, plan, and adapt to the realities will thrive.
Banking Regulators Becoming More Friendly Towards Digital Assets and Blockchain
After several years of resistance, debate, and refusal to embrace the emergence of the transformation in financial technology, government officials and regulators are visibly warming to the adoption of blockchain technology. Proposed policies to create U.S. Treasury blockchain wallets and a digital dollar have even appeared in drafts of legislation, including the Covid-19 stimulus CARES Act.
There are two major recent shifts that have signaled banking regulator readiness to permit both state and federally-chartered banking institutions to engage in activities around digital assets:
- State of Wyoming Special Purpose Depository Institution (SPDI) – Wyoming has led the nation in creating state-level special purpose depository institution (SPDI) non-lending banking license for digital asset connectivity to traditional banking system. The SPDI is a new form of banking charter under Wyoming legislation that permits a non-lending form of financial services-focused institution.
- U.S. Treasury OCC Now Allowing Federal Banks to Custody Digital Assets – The recent decision by the Office of the Comptroller of the Currency to allow Federally chartered banks to custody digital assets is a huge boost to the marketplace. This removes a significant barrier to the emergence of the tech. More people can now access cryptocurrency and digital asset products than ever before.
Financial Institutions Are Unprepared For Central Bank Digital Currencies (CBDCs) Presently Under Development
CBDCs will force a major overhaul of financial institution’s information systems. Central processing and payment system solution providers will be forced to overhaul legacy products and platforms. Every segment of the financial market must update internal systems to support the emergent technology.
Multiple national central banks are now actively in development and pilot including Canada, France, and China. Former CFTC Chair Christopher Giancarlo has formed the Digital Dollar Project in the U.S. to define policy and technology approaches to the development of a U.S. digital dollar. The U.S. Treasury OCC is now led Brian Brooks, who worked in a senior role at Coinbase, the nation’s largest cryptocurrency-related firm.
It’s not a matter of if a CBDC is coming, it’s when.
China’s Digital Yuan System Is A Threat To Global Banking & Finance
China has deployed their digital yuan currency network in over 100 cities with active pilots with even U.S. multinationals like McDonald’s & Starbucks for payment systems. Based on China’s stated goals to use digital currency to dominate the global financial system, the attractiveness of a very cheap, deflationary payment system will become a competitive choice for global consumers.
Banks will be excluded from the payment transfer framework, which could spread to other forms of banking services and asset management once adoption is scaled up. China has prepared infrastructure for the creation of a bond market to follow up the payment framework with revenue-generating municipal debt products.
Traditional Banks Aren’t Very Good at Data
Despite lower average compliance costs relative to assets, traditional banks are badly lagging in leveraging data as an asset.
Legacy Core Banking Systems Are Simply Incapable of Adapting
Near-term wins versus long-term growth is an age-old dilemma for banks. Generally, speaking, firms tend to choose short-term benefits And as a result, they layer new and sometimes less-compatible business models over existing legacy systems, which leads to ever-increasing complexity and high maintenance costs.
Complex legacy layers limit straight-through processing from the front-to-back office. And that affects customer experience and operational excellence. Moreover, banks’ proprietary systems complicate the adoption and integration of emerging technologies – such as blockchain, artificial intelligence, process automation, and API-based microservices. An unfortunate but now well-known conclusion – a layered legacy system reduces the overall capability to innovate and improve value for customers and shareholders.
Why Do Financial Institutions Struggle With Innovation?
There are many obstacles to in-house innovation, the biggest of all are linked to an organization’s leadership’s resistance to change and willingness to allocate an appropriate budget to meet the tidal wave of market transition. In addition to lack of data usage, a risk-averse mindset can undermine innovation and impede incumbent growth. Financial institutions that cannot utilize good-data-hungry emerging technologies are at a disadvantage when it comes to developing products that today’s increasingly tech savvy clients demand.
Many Roadblocks to Transforming a Traditional Financial Services Firm Into an Automated Digital Platform
To create a scalable platform, firms must carefully build a foundation around four pillars – people, finance, business, and technology – that work in concert to create harmony and ensure efficiency. When polled by Cap Gemini, bank executives said vision, systems, culture and security stood out as the most imposing concern surrounding platformification.
- Vision – More than half of the financial services executives have said their firm did not focus on a strategic roadmap with adequate budgeting. This revelation indicates the underlying market myopia – short-sighted inward thinking wherein a firm focuses on itself versus market dynamics and customer expectations.
- Systems – When it comes to IT systems, bankers around the world are adherents to the “if it isn’t broke, don’t fix it” principle. Incumbents avoid legacy system transformations, and instead create complicated, non-linear systems, and propped up extensions and patchworks. Workarounds make emerging technology adoption difficult, limit straight-through processing, and lack real-time processing capability. Performance issues and rigidity of aging systems constrict platform development.
- Culture – Incumbents often struggle with cultural friction during the platformification journey. Banks that choose a build approach may face cultural discord as the work to re-skill a legacy workforce. Banks that buy a platform must integrate two, often very different cultures. And when power struggles ensure, guess who wins The “culture eats strategy for breakfast” philosophy attributed to legendary management consultant Peter Drucker colorfully describes how corporate personality clashes can significantly impede platformification.
- Security – The financial services industry is among the most exposed to cyberattacks. Moreover, game-changing regulations, such as Europe’s PSD2 and GDPR, are testing banks’ cybersecurity capabilities. PSD2 regulation has spurred several new types of transactions that open the door to additional cybersecurity challenges. As platformification empowers more and more banks to become active participants in the open financial services ecosystem, multiplying digital devices will prompt network traffic vulnerabilities.
An agile, risk-friendly work environment, with a data-centric business model, and scalable systems is necessary for banks to achieve platformification goals. Adequate preparation to overcome concerns will also help to mitigate potential issues or business interruption.
While vision and cultural harmony are critical, modernized core banking technology is more essential to surmount system and security challenges and to deliver successful platform-based banking experiences.
COVID-19 Accelerated Financial Services Digital Transformation Urgency
The uncertainty of the current pandemic is motivating consumes to embrace digital interactions and transactions across all market segments. Even customers who love in-person interactions are choosing to interact via digital with their banks. This will become more and more commonplace, especially as the population shifts to younger, more digitally acclimated users.
While traditional financial institutions struggle with operational challenges and closed branches, institutions with API-enabled platform-based models are better-positioned to deliver virtual services implemented by remote workforce.
Banking Risk Mitigation Has Pulled Back Capital to Cover Potential Portfolio Losses
Only the largest institutions were spending significant R&D money on innovation and technology. Smaller banks rely upon vendors to deliver line of business solution advancements. But the largest banks have now set aside $28 billion on top of a previous $19 billion in capital reserves for portfolio losses, thus impacting spend on innovation and research projects.
It is literally the end of the road for traditional financial services.
In 2018, Gartner reported that by 2030, 80% of traditional financial services firms will close, become commoditized, or exist formally but will not compete effectively.
These firms will struggle for relevance as global digital platforms, fintech companies and other nontraditional players gain greater market share, using technology to change the economics and business models of the industry. Established financial services providers will have to move faster on digital business by building digital platforms or finding niche products and services to sell on others’ platforms.
Digital transformation is largely a myth as institutional mindsets, processes and structures stand firm. Established financial services providers will have to move faster on digital business by building digital platforms or finding niche products and services to sell on others’ platforms
In addition, emerging technologies (such as blockchain) offer transformational opportunities by creating trust between parties that do not know each other, without intermediary relationships that incumbent financial firms cultivate. Equally, peer-to-peer consensus algorithms can directly match borrowers to those with money, without requiring a bank to mediate.
Of the 20 percent of traditional firms that will remain as winners, three types will flourish:
- Power Law Firms – Companies that own a digital platform will use its scale, low-cost infrastructure and the customer information it generates to create new services and enter new markets. Very few (5 percent) of these winning heritage institutions have the ability to become power-law firms.
- Long-tail firms – The dramatically lower costs enabled by digital platforms will allow some traditional providers to act as service brokers. This is likely for large populations of poor and working-class people around the world that were not profitable customers previously. Simultaneously, they can act as concierge providers of bundled offerings to high-net-worth individuals. Around 80 percent of winning traditional financial services providers can become long-tail firms.
- Fintechs – Individual companies or pure-play/neo-bank subsidiaries will dis-aggregate traditional financial services in discrete product areas. They will participate in digital platforms, but will not own them. Less than 15 percent of the winning group of traditional firms can convert themselves into or successfully spin off fintechs.
Capital markets and financial services work better together with automated, trusted information networks.
In 1977, Fifth 3rd Bank launched the first ATM funds transfer network, Jeanie. The Jeanie network was revolutionary as the first standardized electronic ATM network for moving money at the retail consumer level without requiring a physical branch location visit during operating hours for a human-powered process.
That gave birth to the entire Electronic Funds Transfer (EFT) industry and how banking entered the digital age at scale.
XDEX is the next generation in financial information automation.
Just as the Jeanie network automated electronic funds transfer, XDEX automates assets and capital markets.
Capital markets stakeholders like financial asset issuers, sellers, buyers, allocators, investors, analysts, attorneys, accountants, auditors, bankers, lenders, trustees, exchanges, brokers, dealers, wealth managers, transfer agents, fund managers, limited partners, insurers, real estate managers, family office administrators, government agencies, examiners and regulators all work better together with XDEX.
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