Could the advent of digital-only banks mean the end of the high street banking? Professor Brian Scott-Quinn from Henley Business School writes for The Conversation.

Banks always seem to be doing something to upset us. Lately, for instance, they have been getting pilloried for shutting branchesand taking away cashpoints. But in reality, banking is just going the way of CDs, high street travel agents, or standing by the roadside in the rain trying to hail a cab. The world has changed. The upcoming generations don’t see the same need to visit a physical branch, let alone use paper money.

To satisfy this demand, a rash of digital-only banks has sprung up in the UK in the past five years, such as Monzo and Revolut. They have no branches; operate via apps with 24-7 live support; and offer services such as real-time spending notifications, free payments abroad and virtual debit cards that can be used immediately through Apple Pay or Google Pay.

It is often incredibly easy to become a customer, signing up for an account online without even talking to anyone. In a short space of time, this has begun to threaten the incumbents. Market leader Monzo, for instance, has signed up more than 3m UK customers since launching in 2015 – albeit such operators are still making losses which seem to be ever growing.

At any rate, now comes the fight back: RBS has just become the first major UK bank to launch a competitor into this space in the form of Bó, complete with a money-managing app and snazzy yellow debit cards. Other incumbents such as HSBC and Santander have digital designs of their own. So how well placed are these banks to defend their patch?

The starting gun

Banking took longer than most industries to take advantage of the fourth industrial revolution, mainly because of regulation. Until a decade ago, regulators would not authorise new banks unless they were completely sure they would be “safe”. They would not permit bank software to use cloud services or to be bought in rather than made in-house, both of which massively reduce the cost of opening a new bank.

This changed when the Financial Conduct Authority (FCA) took over as regulator in 2013. The government was keen to shake up banking in the wake of the financial crisis of 2008-09, and explicitly required the FCA to not only protect consumers but to encourage competition, too.

This put the UK at the forefront of the new digital banking industry. A similar trend is taking place elsewhere, such as the US, Germany and Hong Kong, where even traditional players like Bank of China have acquired a “virtual” licence, and will learn from operating a digital-only bank whether to import the idea to the mainland.

The challenge for so-called legacy banks everywhere is that altering the course of a tanker is difficult. The very name “legacy” comes from the fact that their IT, though it works well in many regards, is outdated. Their systems are underpinned by IBM-type “big iron” mainframes that run on COBOL, an old programming language that is difficult to integrate with the innovations that customers now want and expect from digital banking. It costs a high proportion of bank IT budgets just to keep the old computer code working – yet it is too difficult to replace old systems while keeping a bank functioning.

This problem of traditional banks stuck in the past goes further than tech. They also often have issues with organisational structure. The old way of running a bank was – and still is – to have silos for IT, operations, marketing, business/products and of course HR. When a new product or feature is required, the business side will usually “throw the specifications over the wall into the cage” of the IT side and let them get on with it. Six months later or whenever, the IT side will come back with the product.

The new banks operate quite differently. They focus on so-called “agile” principles, which develop products/updates using “squads” or “scrums” of people from relevant departments who are jointly responsible for the project. It’s a less hierarchical approach that may involve producing a quick prototype in “sprints” of as little as two weeks. It will then be beta-tested by customers to garner feedback, and then refined – similar to when Microsoft, for example, issues new software to select customers.

Any company can adopt this cultural approach, though of course legacy IT makes it much harder for traditional banks. Having said that, the best example is arguably from that side of the fence: DBS Bank of Singapore, which is active across Asia, was crowned Euromoney Bank of the Year 2019 for “embedding digital innovation into everything it does”.

Bó arrives

In contrast to DBS Bank, RBS and other traditional UK banks appear to be backing two horses – the old and the new. RBS/NatWest is both modernising the traditional operation with things like banking apps and virtual cards, while also setting up Bó for retail customers – as well as another brand called Mettle for businesses. Both will compete with the existing retail bank, though RBS/NatWest may incentivise its customers to transfer across.

Bó is certainly more likely to appeal to millennials and Gen Zthan to older generations, and thus may be a good gateway to ensuring that the RBS Group keeps attracting young customers. Unlike rivals like Starling and Monzo, however, it does not yethave all the features of a full-service bank. So, for instance, while the app gives you instant-spending notifications and lets you create spending budgets, there is no offer of interest on savings and no overdraft facility. There is also no Google/Apple Pay feature.

Some people in the industry have accused RBS of doing too little too late for this venture to be successful, predicting it will lose interest after a year or two. This ignores RBS’s major incentive here: if Bó and Mettle succeed, it will make it easier for RBS to close branches in future, and to move away from the ancient IT architecture that makes it so difficult for legacy banks to progress.

RBS/NatWest could then have the pre-conditions for future financial success – top-class IT, greatly reduced costs and a large enough customer base to make Bó profitable – a great combination that the independent start-ups yet lack. For some challengers, their best hope must still be that an incumbent bank launches a bid for them at some point in the future.

This post first appeared on The Conversation , 3 December 2019. Professor Brian Scott-Quinn is the founder and chairman of the ICMA Centre for financial markets at Henley Business School, University of Reading. He formerly worked in the City of London in the international bank credit and capital markets.