Paradigm shifts in the financial industry

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The rise of the digital economy as well as the increase in the usage of smart devices are rapidly changing the global financial landscape. The same can be said for Malaysia.

With a broadband penetration of 84.5 per cent, the nation is embracing changes in its lifestyle to incorporate the inevitable involvement of technology in their daily lives.

Traditional sectors such as the financial industry has to keep up by recognising the impact of fintech, cryptocurrencies, and the need to improve and innovate its digital service and system.

Bank Negara Malaysia (BNM) has already recognise this change as a positive force capable of encouraging competition in the financial industry and pushing the development of innovative financial solutions which could reach a wider segment of society.

“Technology is the catalyst. The great equaliser. This will open up a vast spectrum of possibilities for new entrants.

“Conventional wisdom holds that banking business is intricately tied to economies of scale. Size, scale and barriers to entry are thus traditional key determinants of competitiveness. This conventional wisdom or axiom is very much dated.

“In the future, competitive advantage will come from those who are able to harness the power of technology and be bold enough to venture into uncharted territories.

“The rules of the game have been reset, and more players are getting into the game. Regulators around the globe are very mindful of this trend and are willing to take calculated risks on innovative ventures, going beyond the banking system for solutions.

“There is thus, a more level-playing field and more business opportunities for non- traditional companies that are responsive and effective in meeting the financial services needs of consumers,” BNM Governor Tan Sri Muhammad Ibrahim said in a dialogue session on ‘The Future of Finance’.

Already the growth of the digital economy has already disrupted industries as diverse as media, music and transportation.

EY had highlighted the growth of the digital economy and smartphone penetration have already enabled an explosion in nontraditional financial services over the last decade, spurred on by the need to service new forms of interaction between individuals.

“Banks are facing increased competition from a range of new market entrants, including digital banks, fintechs, institutions offering high-touch and high-tech branch services, e-commerce and telecommunications firms, and in some markets, platform banking providers.

“Such challengers have emerged in response to rapidly changing customer expectations and behaviors, and are forcing banks to invest in customer technology to prevent customer leakage and preserve their value chain,” EY said in its ‘Global Banking Outlook 2018’ report.

“Critically, banks also need to realise that the competitive threat will continue to evolve and that only striving to match today’s challengers means they are not sufficiently anticipating future banking disrupters,” it warned.

Such disruption is not restricted to emerging markets that lack traditional banking infrastructure as banks in developed markets are equally at risk, EY pointed out.

While the rise of fintech is still at its early stages, with the rate of how technology is fast evolving and adapted by the general population, it holds boundless of promises and excitement in the years ahead.

Shifts in consumer needs and expectations will also play a key part in the revolution of the financial industry.

“91 per cent of Malaysians today have a smartphone and 83 per cent will look on the internet to research new products and services. Finance and business models will need to be redeveloped

around changes in consumers’ lifestyles and expectations,” Muhammad Ibrahim said.

He added, “Advancement in technology will enhance financial inclusion by addressing information asymmetry and reducing the cost of extending finance to previously underserved groups. This could grant access to around two billion people globally who remain unbanked today, enabling them to save, invest and uplift their livelihood.”

With that, BizHive Weekly looks at what lies ahead in the realm of digital finance and the many possible evolution paths of financial transactions.

The ‘cashless’ trend

The penetration of thousands of financial technology (fintech) into all segments of the financial industry has now brought a new revolution of disruptions to money itself.

“It’s a development that will increasingly blur the distinction between money and data. To some degree, this has already happened.

“The growth of e-commerce and apps for ordering taxis or paying for restaurants means that the physical act of paying is already somewhat forgotten.

“As the internet of things enables a new round of machine-to-machine transaction growth in the years ahead, payment virtualisation will intensify, with the potential for a proliferation of new stores of value to escape the cost, complexity and regulatory rigidity of traditional money,” EY said in its report titled ‘The future of money – Back to the future: The internet of money’.

While the concept of virtual money or the usage digital currencies are not new, the volume digital transactions and the automation of the payments have grown exponentially, in line with the growth and expansion of technology.

“In this new, digital-only world, the concept of physical money is fast becoming redundant. The transaction – whether a payment or other form of virtual exchange – is increasingly invisible,” EY said.

ePayments and mobile wallets

As the cryptocurrency trend rises, most banks and financial institutions have reacted by either developing their own or collaborating with fintech companies to form mobile wallets or an ePayment system whereby users can opt to use eMoney as an alternative to physical cash for transactions beyond online retail.

In Malaysia, the issuance e-wallet is on the rise. Spurred on by the government’s call to embrace the digital economy, BNM has taken various step to enhance the e-payment platform, hence moving the country towards a ‘cashless’ society.

BNM has embarked on the 10-year e-payment road map in 2011 and since 2009, the industry has invested RM893 million to enhance the e-payment infrastructure and will invest a further RM346 million to expand the point-of-sale (POS) terminal network and RM40 million to develop the real-time retail payment platform.

Effective July 1, 2018, BNM announced the instant transfer fee of 50 sen will be waived for up to RM5,000 per transaction by individuals and small medium enterprises (SMEs).

To date, BNM has approved five banks and 28 non-banks as e-money issuers.

Most major banks have already introduced their own form of mobile wallets while major telecommunication companies such as Axiata Group Bhd (Axiata) and Digi Telecommunications Sdn Bhd (Digi) have followed suit by introducing e-wallets to cater to their large and growing number of mobile subscribers.

Beyond private institutions and banks, governments are also joining in the ‘cashless’ trend as Sarawak became one of the first states in Malaysia to introduce a cashless mobile payment solution with the launch of Sarawak Pay.

Licensed under PaymentGalaxy Wallet and governed by BNM, users can top up their Sarawak Pay e-wallet balance up to RM3,000, through online banking or credit card.

Cryptocurrencies: Risks and rewards

Blockchain technology and digital currencies, or more commonly known now as cryptocurrencies, are no longer an uncommon concept in the trading and financial world.

Since mid last year, the words ‘blockchain’ and ‘cryptocurrency’ often headlined news worldwide as the method saw a drastic surge in its popularity, led on by what most experts believe, a huge demand from tech-driven countries.

As a crucial part of blockchain technology, cryptocurrencies are more often used as a convenient way of moving value across a transaction made via a blockchain system.

However, the absence of regulations to cushion the speculative aspects and risks of trading in cryptocurrencies has been the centre of numerous disputes and discussions between central banks, financial agencies, banks, fintech companies, and governments as they weigh on the benefits and challenges of this new form of currency.

A ‘leashless’ currency

“The opportunities are limitless, but the obstacles to creating, managing and regulating a proliferating array of digital forms of money are substantial.

“These challenges raise questions that will be difficult to answer until the new reality of the internet of money dawns — questions that will reshape the role of the regulator and, potentially, how governments define themselves before their citizens,” EY said in its ‘The future of money, Back to the future: The internet of money’ report.

EY added, “Establishing the right regulatory template for the advent of digital money is crucial. The implications of this complex, multiparty world of digital financial services for banks, governments and regulators are far-reaching.

“Indeed, regulators everywhere are concerned about the systemic impact of non-regulated entities that operate in parallel to established banks, particularly for retail financial services customers.

“As nontraditional methodsof payment and virtual currencies proliferate, and issuers of digital currencies get closer to real money in the decade ahead, their cries will get louder.

“Although too early to determine exactly how such a template should look, some governments are taking the steps to lead the way.

“With blockchain technology and cryptocurrencies turning value into just one more type of data, enabling money to flow as freely as data in the process, it’s hard to know where the regulator’s line should be drawn and which parts of the existing financial services industry should be protected.”

Without proper regulations to tether the movement of the industry, cryptocurrencies will remain a speculative tool.

For Malaysia, BNM has announced that it will not regulate digital currencies, despite the rise of its popularity in the region. Due to its speculative manner, it also stated that it has not recognised cryptocurrencies as a legal payment method and therefore, users of cryptocurrencies would not be protected under Malaysia’s current system.

However, aware of its trend amongst tech-savvy Malaysians, the central bank is working on ways of ensuring that parties involved in the exchange between fiat money and cryptocurrencies are transparent with their reportings.

It is also working on ways to ensure that interested investors are fully aware of the risks and returns of investing in cryptocurrency.

Late last year, it announced released an exposure draft on the invocation of reporting obligations on digital currency exchange business as reporting institutions under the Anti-Money Laundering, Anti-Terrorism Financing and Proceeds of Unlawful Activities Act 2001 (AMLA) which aims to ensure that effective measures are in place against money laundering/terrorism associated with the use of digital currencies and to increase the transparency of digital currencies activities in Malaysia.

Earlier this month, it announced that based on the outcome of  that it is working on a concept paper on crytocurrency which is expected to be published this month.

“The proposed policy sets out the legal obligations, requirements and standards that digital currency exchangers which will be defined under the First Schedule of the AMLA, must carry out as reporting institutions.

“This includes transparency obligations which are intended to provide relevant information for the public to better understand and evaluate risks associated with the use of digital currencies. Increased transparency will also serve to prevent the use of the digital currencies for criminal or unlawful activities,” BNM said.

It also pointed out that if the digital currency exchanger fail to declare its details as reporting institutions or comply with the reporting obligations, BNM might subject the digital currency exchangers to the enforcement and non-compliance actions as provided under the AMLA as well as the potential termination or denial of use of its financial services in Malaysia.

“We need to prepare ourselves, as according to many pundits, digital currencies will become the new norm. The advent of digital currencies as some have forecasted, will mark the beginning of a new era in the financial sector.

“As authorities, we cannot be oblivious to these developments. As such, BNM has initiated the foundational work for the development of a regulatory structure for digital currencies.

“Beginning 2018, Bank Negara Malaysia will designate persons converting crypto currencies into fiat money currencies as reporting institutions under the Anti-Money Laundering, Anti-Terrorism Financing and Proceeds of Unlawful Activities Act 2001.

“This is to prevent the abuse of the system for criminal and unlawful activities and ensuring the stability and integrity of the financial system,” BNM Governor Tan Sri Muhammad Ibrahim.

While the decentralised manner and vulnerability of cryptocurrencies are some of the risks may seem to outweigh its benefits, financial agencies as well as certain banks view it as a positive disrupter to the financial industry.

In its recently released report, Standard & Poor’s (S&P) said, “If cryptocurrencies become an asset class, the impact on financial services firms will be more gradual. That is because we believe that their future success will largely depend on the coordinated approach of global regulators and policymakers to regulate and enhance market participants’ confidence in these instruments.

“More importantly, we believe that blockchain technology – which is what underpins cryptocurrencies, enabling the creation of a shared digital transaction ledger – could be a positive disrupter for various financial value-chains.

“If widely adopted, blockchain could have a meaningful and lasting impact on the celerity, traceability and cost of financial transactions.

“The financialmarket infrastructure segment might also see medium-term benefit from cryptocurrencies and blockchain through the launch of new income-generating products, such as futures or exchanges based on cryptocurrencies, or the replacement of current practices by new ones based on blockchain.”

The future of digital currencies and mobile payments

While indeed, the usage of electronic money and digital currencies are on the rise, this ‘internet money’ will not likely be the ‘to-go-to’ form of payments for most societies in the near future.

Nevertheless, its exciting growth could mean various changes in the financial industry.

According to EY, the internet of money could revolve serving unmet, and quite likely still unidentified, financial needs as the borderless digital universe expands, and on exploiting the opportunities it creates.

“As more businesses straddle both virtual and physical worlds, the potential for creating experiences that can take advantage of this new reality will increase.

“In some cases, this may need to be complemented by transactions, whether as tokens or other forms of cryptocurrency that can be traded or redeemed in return for a digital good or service,” it said.

Whether this is a wallet or token for gaming applications, or blockchain and distributed ledger technology for back-office and commercial transactions to create an indelible record, EY believed that the internet of money will be less concerned with “creating one coin to rule them all” than it will be about finding “one rule to coin them all”.

It added, “Adapting to this brave new world of proliferating virtual currencies will require an open mind and the institutional framework to adapt to the shifting landscape by banks, payment service providers and regulators alike.”

Technology as catalyst for banking

Whether cryptocurrencies take off or not, S&P believes that banks’ role in the payment business might change materially in the next decade.

“Some market participants are challenging the benefit of blockchain, arguing that the technology was created a decade ago and has not yet disrupted the financial system in a meaningful manner.

“That said, we project that, because of this technology and the growth in other peer-to-peer services, smaller and more innovative market participants could have more opportunities to challenge established banking groups’ existing product offering,” it commented.

Meanwhile, in terms of the rise in fintech, and the need for banks to adapt and grow, EY believes that the rapid evolution of new technology means many banks could struggle to keep up in an innovation arms race.

“Further, the risk of getting big bets on new technologies wrong is high, and failure will prove costly. As such, banks need to do more to embrace the shift from innovating in a silo to participating in an innovative ecosystem and collaborating with partners and peers.”

Overall, it pointed out that banks that successfully embrace innovation-led change will be better positioned to address all these issues and deliver sustainable returns on equities even when the economic cycle turns.

However, in executing this shift, it is crucially important that banks don’t try to drive all technology and process innovation internally, it advised.

“To successfully insulate themselves against the impacts of future downturns on financial performance and business continuity, banks must complete the transition from regulatory-driven transformation to innovation-led change.

“This will require banks to avail of the ecosystem externally and become more digitally enabled. They will need to make meaningful investments in end-to-end processes and infrastructure aimed at driving real efficiencies across the entire organisation, as opposed to spending their innovation dollars on tactical projects and frontend customer interfaces.  In other words, they will need to become more digitally mature,” it explained.

EY further pointed out that banks’ investments in customer technology to date have largely been focused on front-end interfaces, reflecting their response to changing customer behaviors and competitive pressures.

“However, there is little evidence that such tactical initiatives have materially grown the business, as opposed to simply stemming customer leakage. New channels and products can often be replicated, and in many instances being a fast follower may be better than being a first mover.”

Therefore, it said: “We believe that digital maturity is not simply a function of the types of technologies in which banks choose to invest, particularly when few organizations have the resources to invest in all technologies across all functions.

“Instead, digital maturity also means that banks have a clear ambition for the type of organizations they want to become, a plan to get there and, critically, enough self-awareness to understand that they can’t do it alone.

“Implementing this ambition requires banks to step outside both traditional lines and agile lines of project management, and define new best practices for bringing about innovation-led change in their organisations.”