Study of The Impact of Digitalization on The Banking Sector

LITERATURE REVIEW

A Study on Digitalization and Its Role in the Indian Banking Sector

In all industries, "digital" is the new buzzword. Banking, like other businesses, is
undergoing a global shift toward digitization. To preserve a competitive advantage and give
the best effective service to their customers, banks of all types and countries are keen to
invest in digital innovations. Because of digitalization, India's banking sector has seen
significant growth in recent years, driving a higher rate of capital formation (Jagtap, 2018).
Because of the financial help that delivers to other industries and promotes capital formation,
the banking sector is known as the sector for developing all other sectors. Despite being one
of the world's fastest developing nations, India is falling behind in adopting digitalization in
the banking sector.

The term "digitalization" refers to and includes the complete spectrum of advancements
in the banking sector (Shetty et al., 2019). Digitization is when information is converted into
a digital format through technology. There are a variety of web- and mobile-based payment
applications that are mainly concentrated on the user experience and frequently strive to
incorporate monetary transactions within the commercial value chain effectively. However,
these service providers do not seek banking licences and typically do not provide banking
facilities beyond payments (Seshadri Puram, 2020). To implement internet banking, the
Indian government drafted the IT Act, 2000, which took effect on October 17, 2000. The
conventional banking system in India appears to be overtaken by technological
developments. The following are some of the digitization initiatives taken by Indian banks
( Sonia Dara, 2019)

 Banks are active on social media sites such as Facebook and Twitter.
 Implementation of an online tax accounting system
 The Reserve Bank of India has introduced a cardless withdrawal facility.
 The Business Transformation Programme was introduced by the Bank of Baroda.

The technique of digitalization (Jagtap, 2018):

 Real-Time Gross Settlement

 Prepaid Instruments
 Electronic Clearing Services
 Mobile Banking
 National Electronic Fund Transfer Fund
 Credit Debit Cards

Need for digitalization in the Indian banking sector:

In the late 1980s, the Indian banking sector recognized the need for computerization to
improve customer service, bookkeeping, and record-keeping. The Reserve Bank of India then
constituted a committee to explore computerization in banks in 1988, which Dr C.
Rangarajan chaired. With the Indian economy reforming from 1991 to 92, the
 Study of The Impact of Digitalization on The Banking Sector
computerization process accelerated. The increasing entry of private and international banks
into the banking sector was one of the key drivers of this development. Several commercial
banks began to shift toward
digital service delivery to stay competitive and relevant in the race. The advent of Cheque
processing based on MICR, the electronic transfer of funds, the interconnection of bank
branches, and the adoption of ATMs have resulted in the convenience of banking time for
commercial banks in India. Due to a lack of cash during the demonetization period, people
were driven to use mobile banking or digital payment, which looked to be a better alternative
for them. The Indian government is now encouraging digital payments extensively. United
Payments Interface and Bharat Interface for Money were launched by the National Payments
Corporation of India, which are crucial steps in the payment mechanism. UPI is a mobile
platform that allows customers to send money across accounts at different banks using a
virtual address instead of their bank account numbers.

Review of literature:

Sharma & Bhalla, (2018) This article is collected from secondary sources gathered from
newspapers, periodicals, and the Internet to learn more about Indian people's comfort levels
with online transactions. The result indicated that the Indian citizen coordinated with
government decisions toward digitalization. However Indian government give their best to
enhance cashless transactions in the Indian economy.

Shetty et al. (2019) Study the Digitalization of banks development in India, concentrating on
the difficulties and prospects. The study revealed that digitalization helped improve customer
services, cost and time of banks and customers, helpful in enhancing competitive advantages
and earning extra income from promotional activities. Still, there is a threat from cyber-
attacks, selection of ATM locations, selection of right technology.

Shettar, (2019)According to the study, digital banking has significantly lowered bank
operating costs. Banks have been able to charge reduced service fees and offer increased
interest rates on deposits as a result of this. Bank earnings have increased as operational costs
have decreased. Digital banking, according to the report, has huge potential to reshape the
picture of financial inclusion. Digital banking's ease of use can hasten the unbanked
economy's absorption into the mainstream.

Y. Gupta & Khan walker, (2019) Based on information and statistics published by numerous
secondary sources, this study focused on the steps and policy measures done by the Indian
government to improve the current state and prospects of financial inclusion in digital India.
The research paper indicated that providing adequate financial services in rural regions is
essential for economic growth since it will assist rural people in funding the expansion of
individual livelihoods.

Gupta et al. (2020) Study the impact of information technology on Indian banks. The selected
banks for the study were PNB, SBI, and UBI. The information used in this study was
gathered from secondary sources. The researcher concluded that ICT has a significant
contribution to Indian banks. The researcher witnessed the proper strength and function of
digitalization through cashless transactions, which are only feasible today due to digitization
in banking.
 Study of The Impact of Digitalization on The Banking Sector

Singh & Srivastava, (2020)This study's findings are discussed in digital online banking, add
to new research on the use of digital banking services, and give information to financial
institutions and banks on mobile banking use in India. Additionally, the adoption criteria
substantially affected customers' using mobile payment systems. Perceived security, ease of
use, mobile self-efficacy, customer assistance and social influence were among the
adoption factors.

Shifa Fathima (2020) studied digitalization development in Indian banks and described why
banks adopt digitalization. Researchers concluded that the transition to digitalization and its
consistency should help the company save money by reducing labour and automating the
system. In the digital age, the main task is to ensure that all clients are secured from
cybercrime and that the best technical mechanism is used.

Kanungo & Gupta, (2021) The impact of digitalization-driven financial inclusion on public
banks and the socially disadvantaged segment of Indian society was researched to see that
overall socio-economic well-being had been achieved. Results indicated that banks have
sought to go in the correct direction with good financial coverage. Additionally, digitalization
has hardly promoted financial inclusion.

Kaur et. al., (2021) Study of the impact of digitalization on customers’ satisfaction. The
researcher used the SERVQUAL model to conduct the study. The result revealed that
Northern Indian customers of digital banking were delighted with the services given by the
digitalization of banks. Additionally, tangibility and responsiveness have less impact in
comparison to responsiveness.

The Digital Transformation of the Banking Sector

The changing habits of consumers and the new competitive environment are forcing banks
to address their digitalisation process as a matter of urgency if they are not to be left behind in
a market which finds itself in the full throes of transformation. We have identified three
successive stages in a bank’s digitalisation process: the first, where new channels and
products are developed; the second, featuring adaptation of the technological infrastructure;
and the last, involving far-reaching changes in the organisation, so as to achieve strategic
positioning in the digital environment.

1. The financial digitalisation era: changes in demand and demand

Demand: changes in consumer habits

The penetration of the internet and mobile phones (see Figures 1 and 2) has produced a
profound transformation of the habits and preferences of consumers, who are becoming
increasingly used to interacting via digital media to share information about themselves,
conduct their dealings with the authorities, shop online or access new services. A leading role
in this aspect has been played by the penetration of next-generation mobile devices, above all
 Study of The Impact of Digitalization on The Banking Sector
within the developed economies, where mobile broadband networks (3G and 4G) are
available at competitive prices.

The internet has also represented a huge showcase for consumers, where they can
compare all kinds of goods and services and share their experiences as customers of various
firms. Online comparison sites have proliferated, especially in sectors such as insurance,
telecommunications and financial services (featuring comparisons and rankings for products
and services such as deposits, mortgages or brokers). This phenomenon has endowed
customers with greater empowerment and hastened the smoother functioning of market
forces to the benefit of customers.

As more consumers have by and by adapted to digital interaction in several areas of

their lives, they have also been calling for financial services that are available anywhere 24/7
and which are as user-friendly as the social networks or email solutions that they use every
day. In fact the role of the social networks has had a substantial multiplier effect in hailing the
advent of digitalisation within several industries, thanks to the “natural” or seamless way in
which digital solutions have become an extension of our traditional social interaction
(Skinner, 2014). Facebook alone, that most popular of social networks, was able to point to
almost 1.5 billion users in the first quarter of 2015.

Another major factor which has helped bring about the digital transformation process in a
big way has been the penetration by mobile devices. According to figures from Skinner
(2014), the average penetration rate of mobile phones worldwide is approaching 70%, and
this phenomenon has become the platform for running new mobile app developments to be
 Study of The Impact of Digitalization on The Banking Sector
used far beyond social communication. This is illustrated by the fact that, according to a
survey by Bain & Company (2014) of digital consumers from 22 countries, utilisation of
mobile banking apps grew by 19 percentage points over 2013 and 2014, whereas usage of
computer-based banking services remained virtually unchanged.

By population segment, there is notably intensive use of new technologies, particularly

as regards digital banking, by the millennium generation (the cohort which started adult life
in around the year 2000). According to Nava et al. (2014), more than 70% of the youngest
segment in the United States have used mobile banking services in the last 12 months,
compared to only 40% for the rest of the adult population, added to which around 94% of
those in the millennium generation are active users of online banking.

Supply: a new competitive field

the divide that exists between the new demands of customers and the sometimes out moded
services which the traditional banks offer, where these are overly burdened by the limitations
of industry regulation, as well as their structure and corporate culture. These new
competitors, known as FinTech companies, unbundle the value chain of banks by specialising
in their different components, such as payments, foreign exchange, lending, access to capital
markets, financial advisory services etc.

Conceived around new technologies, the FinTech companies are typically highly flexible,
adept at the swift incorporation of change and tend to have a low cost structure. In most cases
they also exhibit sharply redefined business models which are highly disruptive of traditional
paradigms. For example, this is true of financial crowdfunding platforms and virtual
currencies, which have the potential to cut bank intermediation out of the equation
completely.

The high hopes for FinTech companies have attracted snowballing investment in recent
years, which amounted to nearly USD3bn in 2013 (see Figure 3)
 Study of The Impact of Digitalization on The Banking Sector

The major internet companies - such as Apple, Google, Amazon or Alibaba - have also made
inroads into the financial sector by offering services of this kind, mainly in the areas of
payments and lending, as a bolton to their core business. Since they operate globally and have
large numbers of customers, such companies can draw on substantial economies of scale.

Companies from other sectors, such as mobile phone carriers, are also on the lookout for new
lines of revenue centred on financial services. Given that mobile phones are the digital
channel with the most potential, they are starting to offer payment services using these
devices. Notable too are the electronic money products they offer, which are particularlly
significant in developing countries, where they mainly target unbanked segments of the
population.

In general, the new entrants are beginning to offer financial services which are similar to
those within traditional banking but are not subject to the same degree of regulatory pressure
as that faced by the financial institutions in terms of licences, capital and/or rules which apply
to identifying customers and monitoring and reporting transactions. In many cases, they
operate from geographical zones where regulation is more lax or simply non-existent, even
though the orbit of their activities extends beyond borders. The differences are even more
patent in terms of supervision, where the rules are less uniform internationally.

This state of affairs has a particularly detrimental effect on the end consumers, who, while
unaware of the regulatory differences among providers yet lured by a better user experience,
access services comparable to those offered by traditional banking, oblivious to the risk to
which they might be exposing themselves.

Finally, the openness of regional markets, which is prompted by initiatives such as the
“European passport”, means that the traditional banks can broaden the range of digital
products which they offer in geographical areas where they have no physical presence,
thereby bringing greater competitive pressure to bear on the financial arena

2. The process of transformation towards digital banking

Given the profound changes in the demand for financial services, the banks are
responding to the digital challenge by using different approaches and at varying speeds, as
not all companies understand what it means to transform into a digital bank in the same way.
But what is digital banking? The literature does not offer a concise definition of this new
concept. Whatever the case may be, this concerns issues such as generating the supply,
distribution and sales of financial products and services via digital channels, exploiting
cutting-edge technology to know customers better and anticipate their needs swiftly and
suitably, and an omni-channel solution, or the possibility of customers communicating with
their bank via all channels, both analogue and digital, as well as the automation of services. It
is generally expected that digital banking will give priority to the needs of end customers
ahead of product creation, since they are the focal point for which the range of products and
services on offer is defined and there is something of a consensus that the concept of digital
banking above all applies to retail banking.
 Study of The Impact of Digitalization on The Banking Sector

In this regard, the traditional banks which commit to digital banking are undergoing a
transformation which allows them to position themselves within the new ecosystem. This
digital transformation depends on the set of circumstances with which each institution starts
out, although it is evident that there are several phases depending on the level of maturity. In
this paper we have boiled the process down to three main phases.

2.1. Reaction to the new competition

At an initial phase, banks react to changes in the supply and demand for financial
services by developing new digital channels and products with which to position
themselves in the new competitive environment.

New channels: focus on mobile devices

Since the end of the 90s, most financial institutions have offered internet banking services
whereby a part of their product portfolio can be accessed. In recent years, besides
modernising these platforms, efforts have focussed on opening up new access and
distribution channels via mobile devices. New apps have thus appeared for smartphones or
tablets with attractive interfaces and simple text, having been inspired by the user experience
 Study of The Impact of Digitalization on The Banking Sector
offered by the social networks, where any function is just one click away and where
immediacy has special significance

Digital products: focus on retail payments

The banks are likewise developing new digital products, mainly within the field of retail
payments, such as digital wallets, near-field (NFC) technology payment solutions, or
applications to transfer money between individuals (P2P) that are similar to those offered by
the competition of the new FinTech companies.

In this initial phase of digitalisation, institutions normally treat digital developments as stand-
alone projects and handle the various distribution channels either partially or totally on a
separate basis (see Figure 5). Creating new digital channels and products in any case involves
bolting complex new systems onto the pre existing technological infrastructure, that have to
be integrated with previous architectures.

2.2. Technological adaptation

The second phase in the banking digitalisation process consists of carrying out a
makeover of the echnology platform, to convert it into a more modular and flexible
infrastructure which enables new technologies to be integrated, as well as speedier new
product development.

New technology integration and architecture redesign

A hallmark of banking technology infrastructure is that this has tended to involve
running large, centralised transaction platforms furnished with high-security systems that date
from the 70s and which have had to cohabit with distributed systems that appeared in the 90s
with the advent of the internet. Complex systems have thus come into being, in which the
 Study of The Impact of Digitalization on The Banking Sector
various products and services operate in isolation and where there is inefficient overlapping,
and they have to be adapted to comply with regulatory requirements imposed by local,
nationwide and supra-national authorities.

On the other hand, the new digital projects call for swift generation and processing of large
volumes of information from various channels, which is vital to having the capability to offer
multi-channel, ultraconvenient and user-friendly experiences that also satisfy demands for
immediacy and full 24/7/365 availability for digital customers. Yet the infrastructure
currently in place is not sufficiently modular for rapid integration of the new technologies or
to move with the fast-changing requirements of business, whereupon a point of no return is
reached where the whole technology platform needs to be completely remodelled, even to the
point of effectively starting again from scratch.
In this phase, several institutions also consider adopting cloud computing technology which
allows optimal utilisation of in-house resources. The intention is to maximise the efficiency
of the technology pool and achieve greater flexibility over the entire production process.
Outsourcing services in the cloud provides even greater benefits, although the decentralising
of the data housed in myriad servers does make its use impracticable for financial institutions,
owing to compliance problems.

Automation of processes
It is also during this phase along the path to digitalisation that institutions think about
automating processes to cut out manual and repetitive tasks, thereby improving efficiency
and speeding up the whole system. Although the financial institutions have been aware of
automation as a concept for some years now, in this phase of digitalisation it takes on a new
significance: now the focus is not only on back-office jobs, but also on implementing
automated front-office processes to bring in, and build up loyalty among, customers. Thus,
for example, they are beginning to use analytical techniques and sophisticated algorithms
based on artificial intelligence to improve scoring, make automated and customised product
proposals or provide personalised advisory services.

Upgrading technology infrastructure means new investments which are additional to overall
IT spending, which is already a major item on bank balance sheets. It should be noted that a
very high percentage of IT spending is a recurring cost that is required for the upkeep of
major data centres and telecommunications infrastructures (see Figure 6)
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2.3. Strategic positioning

The most advanced financial institutions in the digital transformation process try to
make large technology investments profitable by pursuing digital strategies that imply
profound organisational changes.

Digital products and channels are not only a new means of access, distribution and
conducting transaction business that improves solutions for the customer, but they also
represent an opportunity to bring in customers and build loyalty. In conjunction with
advanced analytical techniques, these new channels help to intensify and personalise
commercial relations. They also make it possible to be proactive in terms of the customer’s
needs, thereby enhancing the sales force. In this sense the institutions which are further ahead
in the digital transformation process set more ambitious goals for improving the productivity
of distribution channels than do other, more traditional institutions.

In this phase, proper metrics have to be set up which quantify the effect of digital investments
in terms of winning customers, building loyalty and marketing products. In this way,
institutions can set spending and investment priorities successfully and shelve projects which
do not add sufficient value.

Yet a technological revolution is not a sufficient condition for the institutions to attain
efficiency and productivity improvements. In this, the last phase of the digital transformation,
they face far-reaching organisational changes that are aimed at simplifying their structures
and operational models, to make gains in accelerating the decision-making process, and
 Study of The Impact of Digitalization on The Banking Sector
which are intended to make strategy genuinely customeroriented and omni-channel. These
changes affect the entire organisation, from the office network to central services and on
many occasions they become the object of in-house resistance, as they imply a radical change
in the organisational culture.

One way to accelerate this cultural shift is to establish contact with technology start-ups via
enterprise and mutual partnership programmes that can be backed up by investments or even
acquisitions by the financial industry. Besides becoming familiar with the most innovative
ideas at first hand, these small enterprises are a source of new skills and the talent required
for digital transformation.

Another notable change is applying rapid software development approaches, in contrast to the
lengthy cycles in previous phases, where the time that passed between the needs analysis and
the software coming on-stream was so long that the result often no longer matched the needs
of the business at that particular moment.

The institutions that reach this phase in the digital transformation process will be better-
prepared to compete within the new technological milieu in which society is immersed, and
they will be able to make the move from a situation of reacting to new entrants to taking up a
leading role in providing financial services suited to their customer-base.

3. What effects are, or should be, noticeable as regards digital banks?

The first changes in the digital transformation are already starting to become apparent,
both in the availability of a greater number of services via new channels and in the
branch network.

In the new ecosystem in which the banks operate, certain changes are already noticeable — in
the way that the institutions and their customers behave. In the medium and long term, further
changes of greater significance are also likely to become observable. It could be that the first
few steps are being taken towards a new industrial revolution, not only in the way the
financial sector operates, but the other sectors as well.

The institutions are already displaying certain attitudes and changes in their structures,
depending on what stage of internalisation of the “digital” concept they have reached.
Generally speaking, those institutions which have a more highly-developed digital strategy
might be expected to be well-advanced as regards the following changes:

 New forms of interaction with the customer and changes in the consumer
experience. In the first phases of digitalisation of an institution, the digital channels come
more to the forefront and banking starts to be provided on a “self-service” basis. The
opportunities for contact between the customer and the institution via web apps and mobiles
thus start to proliferate, as they do for new ATM functions and phone-based dealings. In the
short term, changes in the consumer experience are likely to remain as the element that sets
banking institutions apart from each other but, in the medium to long term, it will be the
product that
marks the difference, as is maintained in the February 2015 report by Forrester Research,
titled Banking of the future: how banks will use digital capabilities to remain competitive.
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 New branch formats: from areas used for providing services to sales offices. One of the
consequences of the automation of transaction business will be that branches will become
centres for marketing products and adding value for the customer.

 The employees of banking institutions will change from dividing their time between
administrative and sales tasks to focussing on the relationship with the customer and
designing and marketing high-value products. This should finally lead to an increase in new
customer business, a stronger bond with the banking institution and a reduced incidence of
account migration.

 The new operational formats will prevail over the more traditional methods. The new
competitors have shown that things can be done differently, in a way where the bank has
efficient processes, is faster to abandon poor decisions and faces reduced costs. Thus
traditional banking will speed up its operational rocesses, decision-making, acting on those
choices it has taken and correcting bad decisions.

 The new competitors have imposed the view of the value chain of the various products
and services as an element that can be split out into segments where each of these can be
improved. All efforts should therefore focus on incorporating the best alternatives throughout
the value chain.

 New metrics have been generated that are aligned with these new operational formats and
new processes. The ability to gather and analyse project data very rapidly will become
increasingly important, as will gauging the average profitability of customers, given their
product profiles and the time they have been associated with the institution, with a high
degree of accuracy.

 One of the desirable changes which might be brought about in the medium or long term
will be the chance to compete on equal terms for all of the players in the industry. With this
in mind, the existing regulatory requirements for traditional providers of financial services
should be brought into line with those with which new entrants into the industry or areas
along the value chain (payments, lending, etc.) are required to comply.

All of these changes are occurring or will occur at banking institutions with a clear
direction: improving or maintaining profitability levels. They will also need to defend
themselves against new entrants. It is generally expected that the first effects will be on costs,
and that at some stage in the digital transformation process the more advanced banking
institutions will be able to offer differentiated products and services that are bigger income
generators. Achieving lower costs in the short term and greater income in the medium and
long term will hinge on making the right choices about digital investments, on the investment
effort, and on the in-house attitude to change.

4. The impact of fintech on the banking industry

 Study of The Impact of Digitalization on The Banking Sector
A key manifestation is that fintech may lead to the disaggregation of the value chain.
Interfaces may come about that help bundle the product offerings of different providers,
thereby becoming the direct point of contact for customers. The distribution related
economies that we eluded to may actually lead to such disaggregation of the value chain.

Online platforms and disaggregation

Online platforms could disrupt existing financial institutions. Disaggregation of the value
chain could follow from online platforms becoming the preferred customer interface. Online
platforms could offer a supermarket type model facilitating access to various products and
services of disparate providers along with record keeping. Technology firms such as Google,
Facebook, Amazon or Apple may use a payments solution such as Apple Pay as a platform
and gain direct customer interface for related products and services. Legacy financial
institutions then might be relegated to serving as the back office to the platform.
The disruptive forces affecting banking – information technology and fintech in particular –
may also offer new opportunities for other businesses that have tried to enter banking. For
example, Tesco, a large UK supermarket chain provides banking services to its customers
under its own brand. There is also no reason why a platform should be limited to offering
only financial services. A life-style oriented focus could integrate financial and non-financial
offerings. The financial services platform might act as a market place where people interact
directly and financial institutions serve the limited role of an advisor or broker. P-2-P lending
has parties transacting directly without the benefit of a financial intermediary (except
possibly for back office services).

New specialized lenders have arisen that seek to replace relationship lenders and traditional
credit scoring with sophisticated algorithms based on Big Data mining. While still in its
infancy, such analysis predicts creditworthiness by analysing buying habits, memberships,
reading proclivities, lifestyle choices and all manner of opportunistic demographic correlates.
Similarly, the growing

availability of inexpensive information allows for public certification of creditworthiness

similar to the trustworthiness scores on eBay, or the client satisfaction scores on TripAdvisor.
One could envision similar developments enabling P-2-P lending as well. Whether society
will accept the widespread use of these data is a different matter. In any event, more and
more potentially sensitive personal information can already be obtained with a few mouse
clicks.
Big Data may also facilitate crowdfunding, another form of direct lending involving multiple
lenders and a singular borrower.

At the customer level, we may see a (re)emergence of more community-oriented

arrangements. As P-2-P lending and crowdfunding suggest, customers may take matters in
their own hands; empowerment thus. Local arrangements may emerge where communities
organize their financial affairs directly among themselves. Information technology therefore
may not only invite an increase in scale, but might also facilitate more tailor-made local
arrangements. The
latter would fit the empowerment that customers may increasingly desire. This point is more
general. Many of the recent fintech related
developments may put customers in the driving seat. For example, the platforms would give
them easier access to a variety of providers.43 The consultancy McKinsey talks about
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platforms creating ‘a customer-centric, unified value proposition that goes beyond what users
could previously obtain…’ and is ‘often more central in the customer journeys’ (McKinsey,
2017). This points at empowerment by customers, and simultaneously casts doubts on
whether banks are able to continue to control the customer interface.

The Impact of Fintech on Banking

The influence of fintech is beginning to be felt in the banking sector and capital markets. This
article surveys its development and its impact on efficiency, banking market structure,
strategies of incumbents and entrants, and financial stability.

Fintech has a welfare-enhancing disruptive capability but regulation needs to adapt so that
the new technology delivers the promised benefits without endangering financial stability.
Fintech may be understood as the use of innovative information and automation technology
in financial services.52 New digital technologies automate a wide range of financial activities
and may provide new and more cost-effective products in parts of the financial sector,
ranging from lending to asset management, and from portfolio advice to the payment system.
In those segments, the impact of fintech competitors is beginning to be felt in the banking
sector and capital markets.53 However, the fintech sector is small in comparison to the size
of financially intermediated assets and capital markets, and lags behind in Europe, both in
level and growth rate, compared to the US or China. In the European Union (EU), only the
UK has a significant
development. Even the largest fintech market, in China, is of marginal size compared to the
overall country financial intermediation. In the EU, much of fintech is concentrated in the
United Kingdom. Furthermore, fintech in Europe tends to be based domestically and with
very limited cross-border flows. This is in contrast to the US and China where new entrants
can develop the economies of scale of serving a large market.

With the generation of new business models based on the use of big data, fintech has the
potential to disrupt established financial intermediaries and banks in particular. Big data can
be treated with algorithms from artificial intelligence (AI), profiting from advanced
computing power (including cloud computing, mobile storage through the cloud, and mobile
hardware, which allows continuous accessibility). Machine learning is a variant of AI that
allows computers to learn without an explicit program; “deep learning” refers to the attempt
to derive meaning from big data using layers of learning algorithms. The result of the
application of the new techniques could be lower costs of financial intermediation and
improved products for consumers. For example, fintech facilities may help to better assess
the creditworthiness of loan applicants when an institution screens them, and improve the
interface between financial clients and their service providers. Take as an example the
mortgage market in the US where the market share of shadow banks (that is, non-bank
lenders) has almost tripled in the period 2007-2015. At the end of the period, fintech firms
accounted for close to a third of shadow bank loan originations. Buchak et al. (2017) estimate
that the increased regulatory burden on traditional banks (in terms also of raised capital
requirements and legal scrutiny) explains about 55% of shadow bank growth in the period but
that 35% of this dynamic is explained by the use of financial technology. Indeed, it is found
that the online origination technology allows fintech outlets to provide more convenience for
their borrowers and that they command an interest rate premium among the borrowers that
value more this convenience. Fintech firms better screen potential borrowers using improved
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statistical models based on big data and are more capable to price mortgage risk and price
discriminate. They can do so by combining existing data or by using other dimensions of data
that traditional banks cannot access. The authors find that interest rates charged explain more
of the variation in prepayment outcomes across borrowers for loans of fintech firms than for
those of non-fintech intermediaries.

1. The fintech business and efficiency

The main developments in the application of digital technology have occurred so far in
lending, payment systems, financial advising, and insurance. In all those segments of
business fintech has the potential to lower the cost of intermediation and broaden the access
to finance increasing financial inclusion (that is, is fintech could be a door for subserviced
parts of the population and for less developed countries). One of the reasons for this
efficiency-enhancing role lies in the potential to help overcome information asymmetries,
which are at the root of the banking business. At the same time fintech firms have no legacy
technologies to deal with and a culture of efficient operational design. This leads them to
have a larger innovating capacity than traditional entities. Peer-to-peer (P2P) lending
platforms provide credits without bank intermediation where individuals and companies
invest in small business. Those platforms match borrowers and lenders directly: some allow
the lenders to choose the borrowers; in others they form packages of loans, and online
auctions are often used. These platforms frequently provide risk rankings of the business
obtained by algorithms to screen borrowers using big data. From a modest base, P2P lending
is growing fast in the United States (with Lending Club and Prosper as leaders), and in the
UK (with Zopa as an example). Other leading European countries for P2P consumer lending
are Germany, France, and Finland. P2P business lending is prominent in China, but its role is
limited in the EU. Crowd-funding platforms have increased significantly in EU countries,
with France, the Netherlands, Italy, and Germany taking the lead. Banks, as well as Visa and
MasterCard, still dominate the market for transaction payments, but payment innovations
often come from nonbanks such as PayPal, Apple, or Google. It is worth noting that mobile-
based payment schemes have a great impact in countries where the share of people owning a
current account at a bank is small. For instance, countries in Africa where only one in four
people has a bank account but, according to The Economist,54 many more have access to a
mobile phone, they are becoming testing grounds for new payment systems as well as for
loans for consumers with little credit history.

Traditional payment systems may also be disrupted by digital currencies such as Bitcoin. In
those currency systems, or cryptocurrencies, encryption techniques regulate the generation of
currency units using blockchain technology. This technology consists of a public digital
database in which transactions can be verified with a system of blocks of records in a
decentralized way. It allows value to be transferred peer-to peer without any intermediary to
verify the transaction, with a large number of computers authenticating each transaction
sequentially. Blockchain technology is potentially disruptive since it opens the gate to many
potential cost-saving innovations. It also permits a currency without the backing of
government or a trusted go-between, an intermediation function at which banks have
specialized. “Robo-advisors,” computer programs that generate investment advice according
to information they have about customers, and using machine- learning tools, are a cheap
alternative to human wealth advisors. Furthermore, if programmed properly, robo-advisors
may avoid some of the usual conflicts of interest that plague the sector. Robo-advising is still
 Study of The Impact of Digitalization on The Banking Sector
very incipient and small in relation to overall financial advising, particularly in Europe where
assets under management amount to less than 6% of those in the United States.

2. The impact of fintech on banking market structure

Fintech competitors are encroaching on the traditional business of banks, despite the fact that
banks are adapting to the digital world. New competitors are able to use hard (codifiable)
information to erode the traditional relationship between bank and customer, based on soſt
information (the knowledge gained from bank and customer relationships). However, most
new competitors stay clear of asking for a banking license in order to avoid compliance costs,
and try to skim profitable business from banks. A potential advantage of the new entrants lies
in exploiting the mistrust towards banks that millennials have developed at the same time that
they offer digital services with which the younger generation is at ease.

Banks have traditionally focused on products, while new entrants are more focused on
customers. Fintech competitors are putting pressure on the traditional business model of
banks. Two competitive advantages of retail banks which may be eroded by the new entrants
are that (1) banks can borrow cheaply with their access to cheap deposits and explicit or
implicit insurance by the government, and (2) they enjoy privileged access to a stable
customer base that can be sold a range of products. The presence of deposit insurance may
facilitate the entry of new competitors as banks, but in this case the entrants will have to pay
the cost of the banking license and compliance expenditures. In the mortgage market in the
US, Buchak et al. (2017) find that traditional banks have a somewhat lower shadow cost of
funding and that provide higher quality products than shadow banks (but still they lose
market share because of their increased regulatory burden). Fintech outlets profit from the
situation but rely on both explicit and implicit government guarantees. This fact points out
that entry in the intermediation business with new technologies will depend very much on
how regulation and government guarantees are applied.

True disruption may come from the full-scale entry of top digital internet companies. Indeed,
companies such as Amazon, Apple, or Google are already active in fintech, but have not
entered the market in a resolute way. Their potential is very large, however, because they
have access to massive amounts of customer data and they may control the interface with
them when it comes to financial services. They are growing quickly in payment services, with
close to 150 million users in the first semester of 2017. Amazon lending has been growing
steadily since its launch in 2011. Even social media platforms may cross-sell financial
services profiting on their knowledge of the characteristics of their users

3. The strategies of the players

An open question from the previous analysis is to what extent the use of information
technology and electronic banking (Internet, mobile) and the emergence of fintech
competitors makes retail banking more contestable. Two considerations are in order. First,
the lighter regulation of fintech providers will have an important bearing on the competition
between banks and the new entrants such as payment systems providers or crowd-funding
platforms
.
 Study of The Impact of Digitalization on The Banking Sector
However, conduct of business regulation may impair the access of new entrants to the
infrastructure run by incumbent banks (for example, third-part payment providers may face
obstacles because of lack of protection of customer’s data). Second, electronic banking is
subject to exogenous and endogenous frictions/switching costs. For example, institutions may
undermine the effectiveness of Internet search facilities with obfuscation strategies that
increase frictions and restore margins. In general, the enhanced price transparency brought by
digital technology may have ambiguous dynamic pricing effects. The strategies for new
entrants and those of incumbent banks will depend on whether investment makes a firm
tough or soſt in the competition and on whether competition in the market place involves
strategic substitutes or complements (that is, whether an increase in the action of a rival
induces a decrease or increase, respectively, in the action of the firm). Thus, depending on the
underlying industry characteristics an incumbent may decide to accommodate or prevent
entry. For example, in the presence of switching costs an established incumbent bank, which
cannot discriminate between old and new customers, will behave as a peaceful “fat cat”
because it wants to protect the profitability of its large customer base. This may allow an
entrant to enter and attract, for example, technology-savvy customers or even unbanked
consumers. On occasion, the entrant may want to commit to remain small so as not to elicit
an aggressive response from the incumbent. Peer-to-peer lending platforms may provide an
example of small-scale entry since they cater in part to unbanked segments of the population.
Those platforms, as we have seen, use information available in social networks that alleviate
adverse selection and moral hazard problems. A related strategy for an entrant is to form a
partnership with the incumbent or for the incumbent bank to co-opt the new competitor. One
of the reasons for the partnership interest of the incumbents may be regulatory arbitrage,
given the lighter regulation of the new entrants. A rarer case is the entry of new (licensed)
banks. The reason is that the setup cost and recurrent fixed costs of operation, including
compliance costs, are high. On other occasions, the incumbent may want to prevent or
foreclose entry. For example, new entrants may have to rely on the payment infrastructure of
the incumbent bank to offer complementary or differentiated services. The incumbent may
have incentives to raise the costs of entrants:
one possible way is to degrade the interconnection with the incumbent’s infrastructure. This
is similar to the incentives to limit compatibility by large banks in ATM networks.

The incumbents may use also bundling and tying strategies to compete. A stylized
representation would have an incumbent present in adjacent market segments—A and B—
with the incumbent having substantial market power in A (say current account and
mortgages) and facing competition in B (say credit cards and insurance). The bank may either
integrate those activities or try to leverage its market power in segment A by tying product B.
This makes sense only under certain conditions. It does not when the goods are independent
and B is produced competitively at constant returns to scale (this is the classical Chicago
doctrine). Tying may serve as a deterrence strategy or as an accommodating strategy. As a
deterrence strategy, it increases the aggressiveness of the incumbent and makes life for the
entrants more difficult, since the entrant has to succeed in both markets. Tying makes sense
to foreclose entry when it is irreversible and A and B are not very complementary, since then
the incumbent is more aggressive; when there are cost links between markets, or when entry
in B is uncertain since then tying makes entry more costly and uncertain since the entrant has
to succeed in both complementary markets. As an accommodating strategy, it may serve as a
price discrimination device among heterogeneous customers. Typically, tying by the
incumbent will decrease the incentives to innovate by the rival but increase those of the
incumbent. It is worth noting that innovations in payments systems are primarily generated
by nonbanks like PayPal, Google, and Apple. Banks may prefer accommodation of entry
 Study of The Impact of Digitalization on The Banking Sector
because they gain interchange fees paid to them by new service operators and because the cut
in revenues to banks for each purchase may be more than compensated by the increase in
aggregate transactions performed by customers.

In summary, the incumbents may partner with the new entrants, buy them up partially or
totally, or decide to fight them. The details of each segment of the market will matter for the
decision as well as the extent of legacy technologies in each institution. Indeed, the response
of institutions is likely to be heterogeneous according to their specificity. The new entrants
may decide to do so at a small scale and grow from there or, in particular, the Internet giants
may attempt large-scale entry by controlling the interface with customers.

4. Regulation and financial stability

First of all, let us note that digital technologies can also be applied to solve regulatory and
compliance requirements more efficiently. This is known as “RegTech.”

The challenge for regulation is how to keep a level playing field between incumbents and
new entrants so that innovation is promoted, and financial stability is preserved. New fintech
entrants should not become the new shadow banking, outside the regulatory perimeter, that
contributed so decisively to the 2007-2009 financial crisis by hiding systemic risk under the
rug. One issue to monitor according to the Financial Stability Board (2017) is the enhanced
prospect for systemic problems arising out of operational risk and cyber risk with fintech
activities. However, fintech startups may be able to work with less leverage than traditional
banks.57 At the same time, the growth of shadow banking (helped by fintech) in mortgages
in the US post crisis has relied on the guarantees provided by government sponsored
enterprises (GSE) since those shadow banks unload the loans they originate onto the GSE.
We see therefore the reliance on government guarantees also in the new non-bank entrants.

The outcome is that to maintain a level playing field between incumbents and entrants will
not be easy since a light regulation of fintech to encourage entry, to balance the build-in
funding and “too-big-to-fail” advantages of incumbents, should account for the risk of
developing a new shadow banking system that increases systemic risk. The European
approach is to have the same rules and supervision for the same services independently of
who is providing them.58 However, current regulation and supervision is geared towards
institutions rather than products and services. One reason is that institutions may fail,
generating systemic problems. The present tendency to regulate new services provided by
fintech is to offer a “regulatory sandbox” in order for fintech firms to experiment without the
heavy regulation of the banking sector and for regulators to discover the best way to keep the
activities safe. Consumer protection issues, in particular with regard to data privacy and
cybersecurity, raise to the forefront. The tendency is to give customers more control of their
data. This can be seen in the Payments Services Directive II (PSD II) and the General Data
Protection Regulation in the EU, initiatives such as Open Banking in the UK, and the
emergence of commercial banking aggregator models in the US.

In summary, fintech has a large and potentially welfare-enhancing disruptive capability.

However, in order for the new technology to deliver the benefits for consumers and firms
without endangering financial stability, regulation needs to rise to the challenge.
 Study of The Impact of Digitalization on The Banking Sector

TECHNOLOGICAL DEVELOPMENTS
IN INDIAN BANKING
Digital Collaboration
We will be part of our not-so-distant future when we expect driverless cars and robots, it
should be equally direct for us to visualize a future banking system with its own form of
artificial intelligence (AI). AI-enabled tools such as chatbots have been already implemented
by banks to interact with customers, but that is just the point of what isto come.AI has the
potential to modify organizations on an extraordinary scale, from virtual financial assistants
to computerized credit scoring and predictive analysis. Mr. Jones explains: “From a customer
point of view, machine-learning is starting to enhance their experience in smart ways, quickly
and efficiently resolving their problems. Machine-learning and AI will allow banks to spot
outlines and solve customer problems at a segment of the current speed in a very cost-
efficient manner. This second wave of interruption will have a powerful influence,
transforming the banking industry and with it the customer journey. Banks should seize the
opportunities, when technology presents to shift to the next gear. Because time does not wait
for any organization, people including banking sectors.

Figure:2.1 (Technological Developments in Banking)

 Study of The Impact of Digitalization on The Banking Sector

Few Trends and Opportunities:

1. Changing consumer behaviour in favour of digitalization

As the market is exposed to unsettling digital services, it is now putting its hands on changing
client preference from traditional banking to its digitalization. Also, India’s demographic
share is well
suited to switch to digital behaviour, with the median age of an Indian expected to be 29
years by 2020 and 900 million population falling in the age group of 15- 60 years by
2025.People have enthusiastically started using technology to do banking transactions and
benefit other services because they want more suitability at the cost of giving extra price.

2. Unpenetrated areas and government initiatives

Around 50% of the non-banked population is directed and developing towards the goal of
financial presence. Due to some government initiatives, banks have incredible opportunities
and advantages in implementing digital infrastructure. With Rs. 500 billion being targeted to
be transmitted directly under DBT (Direct Benefit Transfer), around 160 million accounts
have been opened under PMJDY (Pradhan Mantri Jan DhanYojna)

3. Leveraging increased smartphone usage and

mobile penetration
Mobile phones are likely to lead the digital growth in India, because the youth of India prefer
to use smart phones rather than stand in long queues to avail banking services. Mobile
perception of around 90% is likely to drive financial insertion. The existing and predictable
widespread reach of smart phones in the country provides a disruptive and low-cost medium,
to extend the reach of banking and payments services. Refer the graphs below:
 Study of The Impact of Digitalization on The Banking Sector
Figure: 2.2 (Number of Mobile Internet Users)

Figure: 2.3 (Smartphone Penetration (in percent)

Figure:2.4 (India’s Mobile Banking Opportunity) Figure:2.5 (Mobile banking user)

forecasts

As per the report of FICCI, BCG, and IBA; 17% of the users were unaware about bank’s
digital offerings, 35% were aware but were not using, 7% were unhappy user and 42% were
fulfilled users. The challenge here is to convert alertness into practice.

 MSMEs 70% and shopkeeper transaction’s 90% were done through cash &cheque, only
8% MSMEs collect orders online, and only 4% agree payments online. This is completely
improper in a digital world and thus becomes a challenge.

 24% do not know how to use Mobile banking apps, 16% don’t know about bank’s app and
12% of them have fear of hacking.

Despite the huge possible and well-established promise of digital financial services, there is a
need for the users to adopt a general approach on -going digital and combining business
 Study of The Impact of Digitalization on The Banking Sector
strategy with all the elements of their operating ecosystem to create a significant customer
experience.

Indigenous Banking:
The exact date of presence of indigenous bank is not exactly known. But it is sure that the old
banking system has been functioning for centuries. Some people suggest the presence of
indigenous banks to the Vedic times of 2000-1400 BC. It has excellently fulfilled the needs
of the country in the past. However, with the approaching of the British, its failure started.
Regardless of the fast growth of modern commercial banks, however, the indigenous banks
continue to hold a noticeable position in the Indian money market even in the present times.
It includes seths, shroffs, chettis, mahajans, etc. The indigenous bankers give money; act as
money changers and finance internal trade of India by means of hundis or internal bills of
exchange.

The main defects of indigenous banking are:

1. They are disorganized and do not have any communication with other sections of the
banking world.

2. They associate banking with trading and commission business and thus have presented
trade risks into their banking business.

3. They do not differentiate between short term and long term finance and between the
purposes of finance.

4. They do not give receipts in most cases and they charge out of proportion interest in regard
with other banking institutions in the country.

Banking now and then

 Study of The Impact of Digitalization on The Banking Sector
Figure: 2.6 (Details of Payment System)

Expanse of digital banking:

According to the RBI Report in 2016-17 there are 2,22,481 Automated Teller Machines
(ATMs) and 25,29,141 Point of Sale devices (POS). Implementation of electronic payment
system such as ECS (Electronic Clearing Service), NEFT (National Electronic Fund
Transfer), RTGS (Real Time Gross Settlement), Mobile banking system, Debit cards, Prepaid
cards, Cheque Truncation System, Credit Cards, have all gained wide recognition in Indian
banks. These are all notable innovations in the digital revolution in the banking sector. Online
banking has changed the face of banking and brought about a notable change in the banking
operations. National Electronic Funds Transfer (NEFT) is the most frequently used electronic
payment method for transferring money from any bank branch to another bank in India. It
operates in half hourly batches. Real Time Gross Settlement (RTGS) is largely used for high-
value transactions which are cantered on 'real time'. The smallest amount to be remitted
through RTGS is Rs. Two Lakhs. There is no upper limit. Immediate Payment Service
(IMPS) is an immediate electronic funds transfer facility presented by National Payments
Corporation of India (NPCI) which is available 24 x 7.

The usage of Prepaid payment instruments (PPIs) for purchase of goods & services and funds
transfers has improved greatly in recent years. The value of transactions through PPI Cards
(which include gift cards, foreign travel cards, mobile prepaid instruments, & corporate
cards) & mobile wallets have jumped drastically from Rs.108 billion and Rs. 85 billion
respectively in 2014-15 to Rs. 279 billion and Rs. 535 billion respectively in 2016-17 Table
below shows Increase in volume related to RTGS, RECs, Debit card, Credit cards, prepaid
payment instruments and Mobile banking:

Table:2.1 (Increase in volume related to RTGS, RECs, Debit card, Credit cards,
prepaid payment instruments and Mobile banking)
 Study of The Impact of Digitalization on The Banking Sector

Understanding and applying Blockchain technology in

banking: An Evolution –
If 2015 was the year in which blockchain was the financial sector’s buzzword, 2016 is set to
be the year when the industry starts to cut through the hype and work out how useful
blockchain will actually be. The year 2015 saw an evolution in the financial sector’s thinking
about blockchain, which is best known as the technology that underpins the cryptocurrency
Bitcoin. That thinking moved from: ‘Is Bitcoin a threat?’ via ‘should we be looking at the
technology underlying Bitcoin?’ to: ‘we have to explore how blockchain technology can be
of value for customers, processes and in the financial industry in general’. ING recognises,
however, that for blockchain to become an important part of the financial system,
collaboration across the industry and along the value chain is necessary. This is in line with
the recent trend for large market players to come together in an attempt to speed up, influence
and understand the spread of the technology. Having spent 2015 talking about blockchain,
this is the year that the technology will be put to the test. Uses have been and willstill be
tested throughout 2016 and some of them have already fallen and others have succeed.

What is blockchain and what can it do !

Blockchain technology was designed to solve four problems:
• Double spending
• The issue of trust
• Consensus on the latest correct version of the transaction history
• Preventing anyone from making a change to an agreed chain of transactions

The blockchain is a constantly updated public ledger of transactions in a given system (Figure
1). It logs any transaction within a peer-to-peer network in such a way that it cannot be
altered or tampered with. It is transparent, allowing transactions to be processed in a
decentralised manner and removing the need for a central authority to verify trust and the
transfer of value (eg money).Its best-known application is as the technology underpinning
Bitcoin, which had financial institutions scrambling to understand its implications when it
first emerged. Interest in Bitcoin has waned because of high price volatility, however, a low
level of acceptance and the fact that bitcoins are often instantly being converted to fiat
currency, among other reasons. But this declining interest in and fear of Bitcoin was coupled
with a growing interest in the technology behind it and its potential to create new
opportunities for banks as well as new threats to their business models. Santander Innovators
the FinTech investment arm of the Spanish bank, has identified 20 to 25 applications of the
 Study of The Impact of Digitalization on The Banking Sector
technology and estimated that it could cut banks’ infrastructure costs by up to US$15bn to
US$20bn a year by 2022.

There is clear potential for blockchain applications in a variety of banking and finance
contexts, including securities and trade settlement, internal transacting, e-identity and also as
a backbone for connected devices. Even though the technology is very new, there have been
enough examples and tests that show it can work. The main question the industry is facing at
the moment is if and how it will work. The industry is still unsure exactly when and where
blockchain will get its first foothold.

At the top of the hype cycle

Using the methodology of Gartner’s ‘hype cycle’, the blockchain is right at the Peak of
Inflated Expectations, having risen very quickly up the agenda in 2015 (Figure 2). Everyone
was trying to figure out what blockchain is and what its impact might be. At this early stage,
all possibilities were open. Now it is set to slide into the Trough of Disillusionment, which
will see the possibilities narrowed down and a new realism return to the discussion. The
discussion during the course of this year has been set to move on from ‘Why Blockchain?’ to
‘How can the technology solve our problems?’
 Study of The Impact of Digitalization on The Banking Sector

Figure: (The Blockchain Technology ⚙ )

The next stage is the Slope of Enlightenment, where the applications that will really take hold
start to show their potential. Once these applications are bedded in, the hope is that
blockchain will move on to the Plateau of Productivity and become an established part of the
industry

And in practical terms, this means . . .

Because a blockchain can be shared within a network but not tampered with, participants
have insight into the status of transactions at any given time. On top of that, blockchain
allows any party to add a transaction to the ledger, but only according to strict rules and if a
majority of participants agree that it is valid. This means that everyone can directly send
something of value (eg money) to anyone on the network without the need for a central
controller or central clearing. This, in turn, should make transactions much faster and
cheaper. But there is another benefit. Blockchain allows the creation of ‘smart contracts’.
Chunks of code can create a logical
pathway that allows certain actions to happen automatically once certain conditions are
fulfilled—for example, payment of goods can be authorised once they arrive at a port The
potential applications of blockchain are not limited to the financial sector. In general,
blockchain technology has potential when:
• Proof of ownership is important and this ownership needs to be transferrable.
• There is a lack of trust between parties.
• There are many bilateral relationships and parties on a market.
 Study of The Impact of Digitalization on The Banking Sector
• There are different types of assets that interact.
• These assets move across organisational boundaries.
• Processes are highly manual or paper-based.
• Processes have many steps, intermediaries and handovers.2
Suggested applications include bringing transparency to global supply chains, particularly for
high-value and/or potentially controversial products such as diamonds. Ever ledger is a
permanent ledger for the certification and transaction history of diamonds; it can track
diamonds that have been stolen or mined in conflict areas such as the Democratic Republic of
Congo. The technology could also be used to ensure that food products are organic, to create
digital assets ranging from stocks and bonds to frequent flyer miles, audit trails for
healthcare, to create tamper-proof digital identities, and to keep track of electricity production
on a distributed grid where homes are both producers and consumers of energy. It could even
be used to make elections harder to rig. Nonetheless, it is the finance sector that is set to see
some of the biggest impacts from blockchain. Blythe Master, the former JPMorgan banker
who helped develop credit default swaps and is now chief executive officer (CEO) of
blockchain developer Digital Asset Holdings, told an investor conference in 2015: ‘You
should be taking this technology as seriously as you should have been taking the development
of the Internet in the early 1990s’.

Four-stage roll-out
McKinsey, in a new report called Beyond the hype: Blockchains in capital markets, says the
mainstreaming of the technology will advance in four stages, starting with internal purpose-
built distributed ledgers that operate within enterprises. This would be followed by the
adoption of blockchain by a small subset of banks as an upgrade to manual processes, starting
with assets that are traded infrequently and manually over the counter. This would help
participants agree on standards and protocols for booking and transfer with relatively little
investment. Next would come the conversion of inter-dealer settlements, which would help
solidify the standardisation of products, followed by large-scale adoption across buyers and
sellers in public markets, which McKinsey says ‘would be a great leap forward and would
depend on large-scale conversion of existing systems and adoption by a large number of
market participants’.

McKinsey makes four recommendations for immediate action:

• Assess the impact on your business and plan for the long term.

• Participate in consortia and work with regulators. The pay-off for cooperation over co-
opetition may be industry utilities and faster development cycles.

• Capture the internal ledger opportunity: this would give individual firms the opportunity to
test new technology on systems already being revised and develop expertise without concern
for network issues.
 Study of The Impact of Digitalization on The Banking Sector
• Go after post-trade and manual processes. These can yield significant workflow benefits
and be less disruptive to business models.

Payments:

Using blockchain to disrupt the payments business is an obvious area of interest. Many have
started thinking about blockchain technology with payments use case in mind. Experience
has, however, shown us that it is not that easy to change this very complex, and sometimes
costly, business. Before we see any implementation of blockchain technology in payments,
we will need to solve a number of ‘market problems. Many experiments have shown us that
technically a great deal is possible. Yes, we can connect and share ledgers. Yes, we can
instantly send and verify a transaction. Yes, we can create payments chains that cut out
several intermediaries. But the difficulty with payments is that the asset ‘money’ is one of the
most regulated assets we have in the world. These regulations are part of the reason current
processes are what they are, and simply introducing a new technology with disruptive
potential will not change the requirements for banks. Many regulations are also there for a
good reason, to manage risks between parties, to manage risks that are of a larger scale
(systemic risk), and so on. What blockchain technology does is show how things could be
different and force us to have those discussions. But, in the end, it all boils down to the
acceptance of whatever virtual currency, or virtual representation of a fiat currency, is traded
on a blockchain— acceptance not only by regulators but also by other banks, by
organisations and consumers. In the world of cross-currency payments, the model is complex.
As the distributed FinTech company Ripple says: ‘International interbank funds transfers rely
on a series of correspondent banking networks which introduce multiple layers office,
counter party risk and settlement delays.’7 This is mainly due to the fact that trust relations
need to be created by banks bilaterally. A blockchain brings the advantage that banks can
create trust towards an entire network. Adoption will happen in several phases, where inter-
bank payments solutions are being adopted before full peer-to-peer solutions. In part, this is
because a certain level of trust already exists between banks and other financial institutions,
while that trust has not yet been established in the peer-to-peer economy. Where trust exists,
blockchain can improve transparency and bring operational efficiencies. Further, we can
distinguish between use cases that we, as banks, can influence ourselves and try to lead the
market, while there are also cases where we need other parties along the value chain
(including regulators and central banks) on board. So in this area we need to look for use
cases that are, at the moment, very costly, have a high tendency to fail or are highly complex
(like international payments with the many correspondent relationships) and that have the
potential to be scoped in such a way that banks can actually have an influence or solve the
issue themselves. These use cases might be feasible in the short term. Finally, we are looking
for what brings the highest value to solve first, whether that is by cutting costs, increasing
simplicity or creating whole new business opportunities. One reason why payments will not
be the first area that benefits from the blockchain is its relative simplicity, at least in the euro
area, where there are well-defined standards and rules under the Single Euro Payments Area
(SEPA) regulations and a single regulator in the European Central Bank, creating an
environment of trust. The processes are fully straight-throughprocessing, and the number of
parties involved is limited and includes a proficient 02_Buitenhek_JDB_V1.2.indd 116
19/09/16 5:57 Blockchain technology in banking: Evolution or revolution?
central clearing and settlement mechanism. The product offering is mature and on par with
client demands, so the advantages of implementing a blockchain are less obvious. Having
said that, the idea of an industry-wide payments and settlement infrastructure based on trust,
 Study of The Impact of Digitalization on The Banking Sector
cryptography and transparency has an immense attraction. Therefore, you see that many
banks are working on use cases in this area. Both defining what this ideal end state could be,
while at the same time defining what intermediary steps we can already take. To do this, the
market has to assess the technological maturity on the one hand and the ‘market maturity’ on
the other. There are, however, many inherent advantages to using blockchain for payments.
In general, the technology offers lower transaction and operational costs, increased
processing speed, risk reduction, transparency and traceability. More specifically, in an ideal
situation,

these are some economic advantages for the Euro payments system, including the following:

• It removes the need for a central clearing mechanism.

• It removes the need for Target 2 settlement if the regulator accepts the blockchain positions
as real money and adopts the blockchain as its payment system.

• Banks’ liquidity positions are continuously updated and banks and regulators can create
automated business rules in the form of smart contracts, leading to more control.

• Full real-time view on all transactions for the regulator instead of aggregated reporting
afterwards.

• Potential for a peer-to-peer payments system where the entire four-corner model is on the
blockchain.