Reimagining Banking through Technology
Technological innovation is dramatically disrupting society at every level, and financial services are no different. It is impossible to predict how technology will evolve, but the most successful banks will be the ones that adapt to become technology companies themselves, says Michael F. Spitz, CEO of Main Incubator, the research and development unit of Commerzbank.
As technology continues to transform societies, banks are being forced to reimagine their businesses. The most forward thinking and ambitious are reinventing themselves as digital technology companies. It is not enough to operate a product development unit that responds to clients' stated needs: modern banks require a research and development division to anticipate changes in technology, as well as society more broadly, and their impact on financial services.
At Commerzbank we already see evidence of this change. Where we used to speak predominantly with treasury departments and CFOs, today we increasingly speak with product and technology departments. This allows us to engage with our clients in a more holistic way, meaning we understand them better and can provide better insights than ever before.
The banks that embrace technological change are best placed to steer innovation in ways that ensure their continued relevance. Those that watch from the sidelines, or fear the impact new technology will have on their legacy businesses, are at greatest risk of disintermediation.
Few technologies better exemplify these changes than distributed ledger technology (DLT). In developed markets the most interesting applications for DLT harness its trustlessness to replace intermediaries. This is especially useful where a large number of partners rely on shared information, or where parties do not have an established relationship that has generated trust between them.
These characteristics exist in trade finance, and particularly in post-trade processes in the middle and back offices, and to a lesser extent also pre-trade.
Post-trade processes are complicated by the huge variety of settlement instructions different traders have. Modern technology provides powerful tools that allow for the automation of these complex settlement instructions. Immutable technology like DLT provides an audit trail, increasing transparency and efficiency.
In the future, 90% or even 95% of all issues will likely be resolved without human intervention. As a result humans themselves will have the opportunity to focus more on interhuman interaction and collaboration. Commerzbank is embracing this future, having recently replicated an FX Forward trade with Thyssenkrupp using DLT, eliminating the need for a manual or semi-automated reconciliation with the client, thereby reducing operational risk.
That is just one example among many: since 2016, Commerz has worked on mor than 80 proofs of concept involving DLT. In many cases these experiments have shown SQL databases work just as well, usually where the parties had established a relationship of trust. But four of those PoCs were developed into pilot trades, where DLT really adds value to the bank-client relationship.
For now, these DLT systems run alongside legacy systems, and it is not yet clear which variations of DLT are best suited to different use cases. There is always a trade-off between security encryption and scalability, and different incarnations of DLT, such as Ethereum, Fabric and Corda, strike a different balance. Each platform may be better suited to different tasks, and it is unlikely there will be a winner-takes-all outcome in the competition of these platforms. Rather, financial services may benefit most from a strong ecosystem working together to increase transparency and efficiency, making services cheaper, better and more secure.
For now it remains unclear exactly how transformational the concept of cash on a ledger will be for financial services. At one extreme, central bank money on a ledger could unlock possibilities potentially more exciting than anything possible using cryptocurrencies not backed by fiat. The reduction in volatility, for example, could make such DLT much more useful for payments.
Banks are also looking at storing their own cash on ledgers. Ultimately it is possible to envisage a world without primary capital markets, where financing is raised exclusively in the secondary market, via continuous offerings, with existing securities increased automatically.
It will take time for these ideas to be developed, and their implications fully evaluated. Laws will also need to be updated to ensure maximum client protection. Regulators are playing an important role here. In Germany, the European Central Bank, BaFin and Bundesbank have set up dedicated teams that understand DLT, and other regulators are doing the same thing.
Regulatory engagement will ease the transition to digital finance, but regulators are responsible for safeguarding and applying existing rules, not formulating new ones. Politicians will have to write the rules, but they cannot steer digital innovation. Banks therefore have a huge responsibility to innovate carefully. Just as VHS was not the end of the story once it prevailed against Betamax, so DLT will not be the end of financial innovation. The important thing is to identify what a particular business needs, then it is relatively simple to determine whether that is best achieved by Ethereum, Fabric or Corda, or a new technology that is yet to be developed.
However it evolves, DLT will not likely replace the advisory role financial institutions play for clients, in terms of securities issuance, M&A or buyside work, even if other services are disintermediated. The amount of data now available can be overwhelming, but this increases the value of the bank's advisory services, helping clients differentiate between what is useful and what is noise.
But where once banks advised exclusively on questions such as the relative merits of the 5 versus 10 year, floating versus fixed, or dollar versus euros markets, today they might also advise on how to build a more efficient bookbuilding system. Clients increasingly want to talk about how technology will change their relationship with the bank. To serve their clients, banks must be sure they have thought carefully about how they plan to embrace the digital transformation themselves.