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The Rise of Digital Banking

Pete Larsen
Pete Larsen
November 9th, 2020

In 2015 a study made by FIS found that only 23% of customers believe their banks are fulfilling their expectations. Now, in the COVID-19 era, a recent survey conducted by PwC shows that even though consumers are happier with the banking services provided, the new risks of the industry are competitors and mostly non-traditional competitors. In fact, KPMG has stated that banks are encouraged to use channels that haven’t been prioritized in the past.

Starting with 1990, digitalization has been a constant in the financial industry. This trend that continues to grow is driven by new customer expectations. When today's consumer evaluates financial services, they don't compare banks anymore. They compare experiences. Thus, banks adopted new technologies to improve their services, and create smarter digital service offerings.

With a digital-first focus, the banking game has changed, as shown by the new disruptive proposals that appear in the industry. The latest of which, is virtual banking.

Nubank is a Latin American unicorn that is changing the future of the retail financial industry in emerging markets. Launched in 2013 in Brazil, it is now expanding to other Latin American jurisdictions. The company offers a complete financial service entirely through a phone App, without any paperwork or physical venues. Furthermore, they provide credit cards with lower management fees than their traditional banks competition.

The new virtual banks have created a blue ocean for themselves as they generate an uncontested market space and capture new demand – from both businesses and consumers – while making the competition irrelevant. This new business model has disrupted the entire industry abolishing the bureaucracy that stood in the way of access to finance and contributing to economic growth through financial inclusion.

Parallel to this trend of digitalization, we are at a turnover point in our history where we no longer identify physical stores as safe spaces. The COVID-19 pandemic has highlighted the benefits of a fully digital bank more than ever before.

To start with, the advantages rely on users not having to leave their homes to enjoy any financial assistance or acquire new products, thus being able to comply with confinement while enjoying the bank services. Secondly, there is a significant cost reduction since there is no need to pay for major labour forces or real estate assets which allows the organization to provide more accessible services.

Furthermore, for consumers and businesses alike, time is the ultimate commodity. Allowing your customers access to their finances at the click of a button is one of the largest benefits of digital banking.
Additionally, in the last 5 years, large banks have been closing their branches at different rates across the world. Particularly, in the United States, the number of branches declined by 7%. Moreover, analysts have predicted that 20,000 bank branches or more could close after COVID-19. Credit unions have manifested that the increase in online transactions has strengthened the plans to downsize the branch size to refocus on online services.

Consequently, shifting operations from physical venues to phone Apps seems very tempting to traditional banks and new competitors. Nevertheless, one should ask what are the risks of an entirely online bank operation? The aforementioned needs to be analysed from a business viability and legal perspective. In the first place, banks must ask themselves if consumers are ready for entirely digital services. According to Deloitte, financial clients prefer branches over digital channels for acquiring new accounts or products. In this sense, as Deloitte argues, when shifting to online operations banks must encourage human touch in the digital experience. Other studies have stated that while consumers would rather buy in physical stores, the use of digital wallets has increased during the pandemic. In addition, in emerging markets, online financial products can encounter barriers since most stores only allow traditional payment methods and there is a big informal commerce sector in which it will be harder to implement this innovative way of payment. Additionally, organizations must take into account what type of population segments they are capturing and which ones they are leaving behind. Lastly, there is a risk of malfunction of the online systems caused by poor use or monitoring.

In the second place, from a legal perspective, in most countries there is a lack of normative concerning virtual banks. In consequence, some loops could be misused, or certain practices could be condemned by tribunals, likewise the legal use of cryptocurrency through block chain technologies, lack of formal requirements for electronic contracts, or data transfer across borders, even though there is no legislation in some jurisdictions about the matter creating great uncertainty for the new companies. As well, banks could be subject to competitors stealing their intellectual property and operating systems and hence requiring patents. Further, virtual banks are exposed to a higher risk of high-tech crimes such as financial theft and abuse, identity theft, data and documents forgery, computer sabotage and espionage or hacking, among others. As a matter of fact, the United Nations has stated that during 2020 Cyber Crimes have increased by 350%. Equally important, abolishing the bureaucracy associated with the financial industry can result in great benefits of increased access to finance and growth, but it can also constitute big risks for the organizations. For example, money laundering practices can be hard to detect when there are no previous studies of where the money to be deposited is coming from. This problem could be evidenced in modalities in which third parties considered as mules receive money in cash and deposit it in the virtual bank without further study.

However, there are strategies to mitigate these risks and accomplish a successful transition and growth of online operations. First, fintechs need to establish commercial agreements with sales chains to achieve an adequate use of their products, either on physical or online platforms, and to avoid consumers encountering barriers once they decide to use them to guarantee a good experience and client retention. Along with, education programs about security and online banking to include the older population segment in the digitalization transformation. Besides, if organizations implement AML/CFT policies in their strategies, or even create compliance departments supported by specialized firms, digital banks can even help prevent crimes through constantly monitoring their software and clients’ activities.

Finally, transforming ineffective automatic customer attention in online platforms to a more effective interaction suchlike video calls or artificial and cognitive intelligence bots can help mitigate the absence of human contact while providing the customer with fast and useful information.

It must be clarified that virtual banks can provide many benefits and innovative practices that contribute to the world and economic development. As mentioned before it allows companies to reduce costs and use data, favouring expansion, while generating financial inclusion of excluded populations as has been previously stated by the World Bank. On that account, it is required for governments to provide legal regulation and for companies to apply best practices to guarantee the successful development of this business model, benefiting not only organizations but social development.

We are facing a transition to an entirely online financial industry. This trend that has been growing for a long time has now been speeding up with COVID-19. Therefore, when closing branches and shifting to online operations the recommendation is to adopt the strategies showcased previously and evaluate the possible risks to avoid future controversies. Even if there are challenges, the world is asking for a digitalized retail financial industry which means virtual banks, not just digital products.

This fundamental shift in how business gets done, and how banks connect with customer, means that staying relevant in the financial world means becoming an active part of a customer’s digital life. FLI regularly advises clients on corporate portfolio management and strategy, with a key focus on global roll-outs and investments. With over 17,000 lawyers worldwide in over 100+ jurisdictions, FLI benefits its clients by providing access to local industry and jurisdictional experts. If you would like to discuss how this may relate to your outside counsel requirements or to explore how FLI may render assistance to your firm both domestically or in cross-border matters, please feel free to get in touch with Daniel Casares-Lauritsen at dcasares@first-law.com

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Pete Larsen

Pete Larsen

Pete Larsen brings more than fifteen years of experience as corporate in-house, litigation-management across the country involving banks and financial institutions, commercial real estate law, title, commercial leasing, and litigation related to residential, multi-family and commercial real estate.

Prior to joining FLI, Pete served as Associate General Counsel for a premier commercial real estate and loan and financial advisory services company, Situs. He primarily supported Situs’ loan-servicing and special servicing business units, providing legal expertise within commercial the commercial mortgage servicing industry, including servicing and securitization.

His responsibilities also include complex contract preparation and negotiation, litigation-management, banking and finance, legal department management, mergers and acquisitions, risk assessment and insurance.

In October 2011, Mr. Larsen was the lead attorney on the purchase of loan servicing rights of approximately 9.7 billion Euros, more than doubling the company’s European assets under management at that time.

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