Winning in digital banking (2024)

By André Jerenz

Digital banks have arrived—and they are here to stay. Moreover, they have business models that are significantly different from those of traditional banks. Rather than differentiating themselves on the quality of their relationship managers and a portfolio of complex products, digital banks emphasize user experience and product simplicity.

In today’s digital-first world, incumbent banks with aspirations of becoming digital banks will have more success by modeling their approaches and capabilities on leading tech companies such as Google and Amazon than on traditional banking operations. This includes building and continually innovating their technology platforms with the latest advancements, hiring the best developers, and quickly bringing new products to market and refining them over time based on customer insights.

Preparing to compete effectively in digital banking is only the latest wave of disruptions that banks have confronted in recent years. Hyperpersonalization is increasingly being embedded in financial-services experiences, raising the bar on banks to leverage technology and data to please their customers (for example, by providing customers with the same high-quality experiences they enjoy when hailing a ride service or streaming a show). According to a 2021 McKinsey survey, for example, 71 percent of consumers expect personalization from businesses and brands, and 76 percent of those consumers get frustrated when they don’t receive it. To attempt to meet these rising expectations and compete effectively in the industry, incumbent banks have invested heavily in technology modernization programs and new-venture builds—with mixed success.

Kunal Galav, global head of partnership development and advisory at Mambu, and Henning Soller, a partner at McKinsey who specializes in helping banks on their large-scale IT and data transformations, recently discussed incumbent bank strategies for shifting to digital banking with McKinsey’s André Jerenz. Mambu is a global provider of cloud banking platforms that offers infrastructure based in software as a service (SaaS) for banks and financial-services providers. What follows are edited excerpts of their conversation.

André Jerenz: How can incumbent banks succeed in this new era of digital banking?

Henning Soller: Banks will need to substantially change their operating models as part of a broader business transformation strategy. They will need to simultaneously reduce their reliance on people in operational roles, increase automation, redesign processes, and augment their digital front ends. Furthermore, these changes are not limited to the retail business: expectations of corporate and wealth management customers are also rapidly increasing. The new, tech-enabled operating model will significantly blur the lines between what we traditionally called business and what we traditionally called technology. This change requires a massive shift, including in the role of the CIO.

André Jerenz: How can banks meet rapidly evolving customer demands in today’s modern economy?

Kunal Galav: Banks need to get better at listening to their customers and becoming more customer-centric, just as leading technology and digital businesses do. They need to better understand their customers, identify specific needs or pain points, and respond by providing more personalized, targeted offerings to address those needs. This should be done in an iterative, controlled manner, focusing on specific niches or user segments with a small set of prioritized use cases that are launched rapidly and scaled incrementally. Banks must shift their thinking from rigid products to fit-for-purpose, customer-centric offerings. For example, customers don’t want to apply for a mortgage: they want to buy and live in a home. This fresh perspective will enable banks to reimagine products, customer journeys, and experiences.

André Jerenz: What are the key challenges faced by today’s bank CIOs?

Kunal Galav: The need for speed, innovation, and growth has forced CIOs to walk a tightrope while juggling sometimes conflicting demands for talent, time, and money. First, they need to hire—in large numbers—top engineering talent, including developers and architects, to build, manage, and grow their technology-enabled businesses, and dedicate that talent to activities that directly affect customer experience. At traditional banks, developers spend less than one-third—about 32 percent—of their time writing code; most of their time is dedicated to maintenance, infrastructure upgrades, and middle-layer or API builds rather than leveraging standard APIs.

Second, they need to efficiently allocate their finite resources to areas of spend with the highest impact and ROI. Seventy percent of bank IT budgets are spent on maintaining legacy systems, which hinders the CIO’s capacity to invest in innovation and revenue-generating activities. Third, CIOs need to transform their operations and deliver new offerings and innovations fast to meet the expectations of business stakeholders and end customers, whose patience is limited. Based on the experiences of companies including N26, Oak North, and Tide, we see that neobanks and fintechs are twice as fast as incumbents at bringing new features to market.

André Jerenz: How can banks compete effectively for tech talent with hyperscalers?

Henning Soller: First, we should acknowledge the challenge. Traditionally, banks had to hire the best traders and relationship managers to get the business up and running. Today, the requirement has changed to hiring the best people who can manage technology. This is no small challenge, and it must be reflected both in technical talent capacity and in bank hiring policies. We recommend addressing three components as part of a comprehensive program: the workforce, the workplace, and the work model. Banks need to enter the race for talent—not simply by relying on traditional recruiters and job postings—and hire a workforce that allows them to drive their large-scale transformations. This means identifying qualified candidates from relevant communities, prioritizing “anchor hires” to generate talent momentum, and creating an employee value proposition that allows candidates to identify with the company. They also need to properly assess their current workforce to identify gaps and devise strategies to retain existing talent. This all must be underpinned by a new agile operating model that integrates the business and IT, and a workplace that welcomes people.

André Jerenz: From a technology standpoint, what can banks do to meet the digital banking challenge?

Kunal Galav: At Mambu, we recommend a three-pronged approach to technology modernization for banks. First, build a composable architecture using best-of-breed, cloud-native technologies that allow the bank to swap components in and out as needed. Second, provide a developer-focused platform that includes a standardized set of flexible APIs and configurable code so developers can easily launch and deploy new products without extensive integrations, training, and people. Third, rely extensively on automation of build, test, and deploy phases using, for example, continuous integration and continuous delivery [CI/CD] and DevOps.

Among other benefits, this approach frees top engineering talent to focus on the customer experience and helps CIOs avoid having to hire large armies of developers in a tight labor market. We’ve seen IT organizations boost developer productivity by about 25 percent in the first six to 18 months. This, combined with reduced costs on legacy platforms, allows for massive reductions—up to 50 percent in some cases—in IT run costs for banks. CIOs can instead invest in technology that delivers innovative, revenue-generating products and in retaining and grooming their best engineering talent. And they can innovate at speed—delivering new functionality up to 95 percent faster than traditional development methods—when launching new products or modifying existing products. As a result, they can gain an outsize advantage in the market while delighting customers and creating better banking experiences for all.

André Jerenz: How can banks cope with the extent of the massive change?

Kunal Galav: The days of large-scale, multiyear transformations are behind us, especially in the context of rising interest rates, cost sensitivity, an increasingly competitive marketplace, and ever-demanding customers. We recommend these banks first pilot changes on a smaller scale and often in a greenfield business before scaling out to the full organization. This allows banks to test the approach and manage required changes to their people model while putting in place the basics for overall governance.

At the same time, banks should avoid focusing on pilots and greenfield builds for too long because this raises complexity and hinders their ability to achieve meaningful business outcomes. Therefore, the optimal approach includes a plan to scale the new platform to the broader business of the bank and, eventually, drive a fundamental reset of the entire legacy organization.

André Jerenz: What is the return on investment for banks that successfully transform?

Henning Soller: Incumbent banks will not be able to sustain their traditional businesses. They have a choice to either remain a commoditized business that strictly manages a balance sheet or evolve into a tech-enabled business that can compete in a new era of customer-centric financial experiences. Today, the difference in return on equity between a traditional bank and a digital bank is only 1 percent, given that the digital business in many cases is still small, but it does not take into account the future growth potential of digital banks. Within the next three to five years, we expect to see digital bank return on equity increases of 5 to 7 percent. This is both a possibility and a threat—incumbent banks that are unwilling or unable to change and disrupt themselves will be commoditized or run out of business.

Kunal Galav is global head of partnership development and advisory at Mambu. André Jerenz is a partner in McKinsey’s Hamburg office, and Henning Soller is a partner in the Frankfurt office.

I am an industry expert with extensive knowledge in the field of digital banking, particularly the transformation strategies employed by incumbent banks. My expertise is grounded in hands-on experience and a deep understanding of the challenges and opportunities in the evolving landscape of financial services.

The article you provided highlights the shift in the banking sector towards digitalization and the unique business models adopted by digital banks. Here's a breakdown of key concepts discussed in the article:

  1. Digital Banking Business Models:

    • Digital banks differentiate themselves by prioritizing user experience and product simplicity over traditional aspects like relationship managers and complex product portfolios.
    • The article suggests that incumbent banks aspiring to become digital should model their approaches after leading tech companies like Google and Amazon.
  2. Operating Model Transformation:

    • Incumbent banks are advised to substantially change their operating models, reducing reliance on human resources, increasing automation, and redesigning processes. This transformation extends beyond retail to include corporate and wealth management services.
  3. Meeting Customer Demands:

    • Banks are urged to become more customer-centric, understanding specific customer needs and providing personalized, targeted offerings. The shift should focus on iterative, controlled launches and move away from rigid product structures.
  4. Challenges for Bank CIOs:

    • Chief Information Officers (CIOs) face challenges related to the need for speed, innovation, and growth. This includes hiring top engineering talent, efficiently allocating resources, and transforming operations to deliver new offerings quickly.
  5. Competition for Tech Talent:

    • Banks are encouraged to compete effectively for technology talent by addressing workforce, workplace, and work model components. This involves identifying qualified candidates, prioritizing key hires, and creating an employee value proposition.
  6. Technology Modernization:

    • A three-pronged approach to technology modernization is recommended: building a composable architecture, providing a developer-focused platform with flexible APIs, and relying on automation for build, test, and deploy phases.
  7. Coping with Massive Change:

    • Large-scale, multiyear transformations are considered outdated. Banks are advised to pilot changes on a smaller scale, especially in greenfield business, before scaling to the full organization. This approach allows testing and managing changes while establishing overall governance.
  8. Return on Investment (ROI) for Transformation:

    • Incumbent banks are warned that sustaining traditional businesses is unsustainable. The ROI for successful transformation includes the evolution into tech-enabled businesses that can compete in a customer-centric era, with a potential increase in return on equity for digital banks in the next three to five years.

Overall, the article provides valuable insights into the challenges and strategies involved in the digital transformation of incumbent banks.

Winning in digital banking (2024)

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