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Traditional financial institutions, primarily banks, are struggling. Interest rates keep falling, margins are shrinking, and new competitors are waiting in the wings. At the same time, they have to comply with a more stringent regulatory framework. If not, they face huge fines. Does digital transformation offer a way out? BDO specialists Laurent Claassen and Dirk de Hen outline the perspectives.
European banks are not in the best position at present. At the end of 2019, the European Bank Authority sounded the alarm in the report ‘Risk Assessment of the European Banking System’ which concluded that continual low interest rates are undermining income. Dutch banks have to rely on the wafer-thin profits they make on their mortgage portfolios for a meagre margin. But the concerns go deeper. The very business model of traditional banking is under severe pressure, the EBA said. This is partly due to the emergence of fintech and partly due to alternative sources of finance, such as peer to peer lending, crowdfunding and private equity. In addition, banks, insurance companies, pension funds and other financials are confronted with increasing regulatory pressure. They have to automate their compliance more efficiently, be transparent toward the regulators, and take on roles which used to be the domain of national government, such as monitoring and reporting unusual financial transactions. If they don’t, they face stiff sanctions. Insurance companies and pension providers have also been charged with better screening their clients.
The turmoil, and on occasion, panic, is made complete by the emergence of new digital technologies. These are making traditional services unnecessary, undermining existing earnings models, and streamlining processes which used to be done by entire departments. Take the digitalisation of credit applications and the onboarding of new clients, for example. Last but not least, the coronavirus crisis has proved to be an additional problem.
Screening clients is not easy
All this raises many questions. Do big players still have a future? What will the digital transformation mean for financials? Little can be done about the macro-economic uncertainty and the arrival of new players. But financials can, or rather, should, be pressing ahead with issues such as screening clients, says Laurent Claassen, a BDO specialist in risk, compliance and anti-money laundering. ‘Banks,’ he says, ‘need to thoroughly screen their clients in the wake of several high-profile money laundering scandals. It is tricky to do, all the more so because different units within the same bank work with different IT systems which are not, or only sparingly, linked. The quality of data which emerges is often insufficient. As a bank, you might have great procedures in place, but if your data is wrong or can’t be found, then you still have a problem. Insurers also need to screen their clients properly, but run up against the same problem. But they cannot be seen to facilitate criminals or fraudsters.’
Dirk de Hen, a financial forensic specialist and active in fraud investigations via data analytics, points out that many banks and insurance companies cannot link crucial sources of information in their system. ‘Financial service providers are often the result of a string of mergers and acquisitions, which have created a spaghetti network of old and new IT systems which do not communicate with each other,’ he says. ‘And that makes streamlining investigations a real puzzle.’ Currently, he says, it takes a lot of manpower to screen data properly, at a time when financial companies face limits in time, budget and people. The consequence of this, he says, is that you end up treating the symptoms but not the root cause. ‘You have to be on your guard against this,’ he says. ‘You need to really get to grips with the underlying systems and technology.’
Dirk de Hen is a partner at BDO Nederland’s Forensics & Technology arm. He specialises in the fields of financial economic crime, fraud, integrity issues and international compliance.
Laurent Claassen is a partner at BDO’s Risk Advisory Services and part of the Financial Services team. He has worked in the accountancy and consultancy sector since 1985 and is a specialist in risk, compliance, and AML & sanctions.
Work from a central unit
Financial institutions have been wrestling with complex IT systems for years, and usually try to solve it on a project basis. ‘So they take the approach of trying to clear it all up in one go,’ says Claassen. ‘Everything might seem then to be in order, but that is often not the case. The shortcomings which have been found are not translated into improvements in working methods and in systems. And so every clean-up leads to new shortcomings.’ Claassen says he would advise tackling such a project from a central base within the company, one which has oversight of the entire operation, and which can adapt and link systems centrally. ‘Big banks are increasingly taking this approach,’ he says. ‘It takes a considerable amount of investment, but it does show you really mean business. Such a team would include data scientists and data analysts but also legal experts, for example.’ Centralisation also allows for easier identity management De Hen adds. ‘So a customer would be known purely by a client number, and would not appear under different versions of their name in different systems. You can also get a better picture of family relationships. This is where things often go wrong at the moment.’
‘You have to report more often, the reporting process changes and the reports themselves are
more in depth’
Dirk de Hen
Regulators are making increasing demands on financial institutions when it comes to reporting. Not only are reporting requirements getting tougher, but banks and insurance companies have to report to more agencies. Reporting is now done digitally, De Hen says. ‘It used to be a question of form-based reporting in which you would combine all the results of your reports into standardised forms and hand these over to the regulators. But they now want to see the underlying data as well. They want to better understand how a bank or insurance company came to a given conclusion. In short, you have to report more often, the reporting process changes and the reports themselves are more in depth.’ All this means that if you have not organised your systems and data bases properly, something is bound to go wrong at some point. ‘Then you won’t be able to make good, complete reports,’ says Claassen. ‘That is why the big banks in particular have set up special teams to manage regulatory reporting procedures very tightly. If you don’t do this, you risk a major fine. And a regulator like the Dutch central bank is very critical of how some financials report.’
Think carefully about your data strategy
Banks and insurance companies feel the need to transform digitally, but what about other financial institutions? ‘They do, but to a lesser extent,’ says Claassen. ‘Pension providers have the same problem. They cannot always get the information requested by regulators out of their systems. In addition, they not only have to screen participants, but the asset managers who carry out the investments on their behalf. This is an enormous task and one which the pension sector is behind in. If you compare them with banks, pension providers have some way to go in terms of using technology and fintech-type solutions.’ Current regulatory reporting requirements are forcing the entire financial sector to think long and hard about what data they want to record, which datebases they want to keep it in and how accessible that data should be. ‘But approach this in a evolutionary way rather than as a revolution,’ says De Hen. ‘Some companies are too eager to make use of the newest digital tools and they could end up taking the wrong decisions.’
‘Tackle such a project from a central base within the company, one which has
oversight of the entire operation’
Bigtechs have more impact than fintechs Another problem facing financial companies is the rise in competition from fintech and giants such as Apple, Google and Amazon. The arrival of PSD2, the new European directive which allows consumers and companies to decide whether to share their bank details with third parties is an added dimension. ‘We have been hearing for years that fintechs are threatening the position of the big banks,’ says Claassen. ‘But I don’t really see this happening in the Netherlands. In practice, most fintechs lack clout, particularly when it comes to access to capital. And in uncertain times like these, clients tend to stick to a traditional bank with an established name.’ De Hen sees more potential for companies like Apple, Adyen and Google: ‘They have their own payment systems and deep pockets, and they are potentially a far greater threat to traditional banks,’ he says. ‘Apple Pay is doing well, particularly among young consumers. I think the traditional banks will lose a lot of the payment traffic which they have always facilitated. However, I would note that the bigtechs are not as tight about privacy issues as they should be – and they will have to work on that in the coming years.’
So is it better for traditional financial institutions which have been looking to transform digitally to buy promising fintechs themselves or to organise the process better internally? De Hen believes in the latter approach. ‘In that way, you keep your expertise in house. Successful banking innovation almost always happens on the fringes of a company. So make new initiatives and innovative projects part of the company, but don’t place them at the heart of the operation – because then you run the risk they will suffocate in a blanket of corporate bureaucracy. ABN Amro has a separate floor for digital projects. The coronavirus crisis, however, has added a new dimension to the mix. What is the impact likely to be on the digital transformation process? ‘Most businesses have continued to operate, with staff based at home,’ says Claassen. ‘At the beginning people were understandably concerned about, for example, data security. But that proved to be unfounded. On balance, the coronavirus crisis will speed up the digitalisation of the financial sector considerably.’
DIGITAL TRANSFORMATION TIPS
Set priorities when collecting and analysing information to make sure you don’t drown in a sea of data.
Involve staff early on in the digital transformation process. Encourage them to share ideas, to win their support, and train them well and in time.
Companies which are digitally future-proof in terms of the finance department, make more attractive employers.
Go digital, but make sure clients still have the option of personal contact with a member of staff to maintain a strong relationship.