Inside European banking’s great digital experiment

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By:
Dominic O’Neill
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Bank chief executives in Europe are increasingly obsessed with their new or rebooted digital arms. These businesses promise to fend off new competitors and capture a next generation of clients, while piloting front- and back-office innovations. They could even offer the best chance of expanding in the eurozone, making banking union a reality. But will these investments merely play into the hands of the new rivals and hasten the banks’ decline?

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European digital banking
special focus

 Profiles
• Boursorama: SocGen goes for broke in French digital race
Openbank: Santander’s new blueprint for the future
• imaginBank: Europe’s coolest bank
• Hello bank!: BNP Paribas creates a pan-European digital brand 
• ING: Online first-mover prepares its next transformation
• Comdirect: How to make money in German retail

The rapid death of the high street is the latest manifestation of disruption from digital providers in consumer industries. Traditional banking brands, until recently, have appeared better protected than retailers. No online challengers have achieved real scale. The big banks themselves have either bought or launched most of the more successful products. 

But just as supermarkets are still grappling with the idea of launching their own internet challengers, are the conditions now right for banks’ digital offshoots to really take off? 

Benoît Legrand, ING’s chief innovation officer, talks in Copernican terms about the wider shift from branches to mobiles and laptops, and the greater freedom of choice that follows. 

“Banks were thinking that they were the centre of the universe and customers revolved around them,” he says. “Now the power is shifting from the institution to the customer.”

As Legrand admits, banking has high regulatory barriers to entry that have risen further since the 2008 crisis. Moreover, the savings, particularly in current accounts, have not always been so immediately obvious as to justify the hassle of trying low-cost online alternatives. Similarly, margins in current accounts and sometimes mortgages have been insufficiently attractive to attract disruptors. 

Big banks still enjoy some of their traditional reputation for solidity. However, the crisis and its aftermath continue to undermine the trust customers have that big, established banks will act in their interests. Reticence to do banking outside the branch because of safety has largely eroded, while smartphones have made digital banking more convenient and, in some respects, more tangible. 

Some of the banks’ online consumer platforms are now a couple of decades old, especially those that originated as telephone banks, like Germany’s Comdirect. But banks are reinvigorating them, making these platforms more important to them at group level and to their investor pitch.  


We start with small stakes and little by little we increase them. It’s a question of going step-by-step 
 - Francisco González, BBVA

ING’s own digital-only bank continues to grow more rapidly than its branch-based Benelux network – and it is by no means the only one. Banks are sprouting entirely new online brands, such as BNP Paribas’s Hello bank! and CaixaBank’s imaginBank. Others are effectively new, like Santander’s Openbank, relaunched last year. And some are the recipients of more group resources, such as Société Générale’s Boursorama. 

Nor is activity limited to the big continental economies. FirstDirect, which transitioned from telephone to online banking in the early 2000s, is owned by HSBC. It scores far higher than traditional banks for customer satisfaction, although its recent growth has been less spectacular than Boursorama, for example. 

Royal Bank of Scotland, too, is widely rumoured to be preparing to launch a new online bank, with the Sunday Times reporting in August it had mandated mobile-only challenger Starling Bank to assist, triggering speculation of a merger (Starling’s chief executive Anne Boden is a former RBS banker). Separately, Clydesdale and Virgin Money, who have already agreed a merger, have both worked on their own new digital banks over the last two years.

In the eurozone, however, these digital offshoots present a special opportunity because of their greater scope to expand elsewhere in the banking union than the main, often national brand. In addition, the opportunity for a new lease of tech-driven growth is even more of an imperative in eurozone banking, which has been crippled by negative interest rates and bad debts.

Take Comdirect, one of the few offshoots that is listed. Although it is not looking to expand abroad, simply based on its growth prospects in Germany its shares trade at more than 2.5 times book value, compared with just 0.4 times at Commerzbank.

Main threat

The other thing that concerns many bank chief executives, they tell Euromoney, is the ability to compete with newcomers. It is not just about seeing off mainstream banks entering from elsewhere in the eurozone or indeed funky fintech startups that they can usually buy anyway if they need to. The most worrying potential threat comes from the big US tech firms like Amazon, Facebook and Google. At the same time, in France, deep-pocketed telecoms firms, particularly Orange, are also looking to make an entry.

Investment in digital platforms such as Boursorama, and building up those brands’ reputation, can therefore be more important to the banks’ leaders than the chance to make money in the short term.

As Sophie Heller, BNP Paribas’s chief operating officer for retail banking, sees it, it is a long-term war for the best customer experience. 

“The big tech firms have reinvented customer experience,” she says. “They have set new standards of what customers expect in terms of personalization, autonomy, value, transparency and immediacy. That’s what we have to do too.”

Building up digital-specific brands, however, is not only defensive. It can be a way to attack competitors, perhaps taking clients from less profit-orientated local mutual or savings banks. 

Particularly in the case of projects like Hello bank! and imaginBank, the idea is that these separate offerings can deliver the best of both worlds: the perceived safety of a big bank and the better user experience associated with tech players. 

It is a model that ING has deployed with gusto. Its challenger banks in markets such as Germany and Spain gain net promoter scores way above its Dutch bank – if largely thanks to lower fees. Although this is not without challenges; ING is perhaps the most tantalizing example of how international digital offshoots can outgrow the original branch-based institution.

Prominence

Entering a country via a digital-only arm is now figuring much more prominently in many banks’ strategic plans than the cross-border acquisition of an established bank. Increasingly, the M&A option does not seem worth the hidden costs, the risks and the pushback from investors. This is bringing down the price of would-be takeover targets, particularly in less dynamic and more protected banking markets such as Germany. 

Yet EU passporting rules, as well as newer efforts to integrate Europe’s banking infrastructure, should make international expansion in the eurozone easier and cheaper for nimbler operators. 

Independent Berlin-based N26 already offers current accounts across the eurozone, for example.

Founded in 2013, the same year as N26, Hello bank! is another pan-European project, albeit making use of BNP Paribas’ various in-country licences and infrastructure. 

Passporting has allowed Commerzbank’s Polish subsidiary mBank – by some measures the continent’s biggest digital-only bank – to enter the Czech Republic and Slovakia. Commerzbank has even considered turning mBank into a truly pan-European digital lender. In August, it decided not to go ahead with the project (called Copernicus) to avoid extra complexity and to focus on more immediately profitable projects, but it did not discard the possibility in future. 

At Austria’s Erste Bank, chief digital officer Peter Bosek says the mostly centralized front-office development of its rapidly growing digital brand, George – as well as the relative ease of acquiring back offices – could allow it to launch more easily in future in countries where Erste does not currently operate. With around 2.5 million customers, George is already spreading to countries in the Erste network, starting with the Czech Republic and Slovakia last year. 


We have all this optionality in the market. We can use all these things in other jurisdictions if we want 
 - Kees van Dijkhuizen, ABN Amro

On a smaller scale, Italy’s Finecobank has used passporting rights and its Italian IT system to enter the UK – although Brexit now clearly poses a big problem.

As Brexit shows, there is so much uncertainty in all this that the term ‘optionality’ is one that is used a lot by the big banks about their investments in new digital arms, especially in the eurozone. It seems they are hedging their bets on whether or not a true banking union – as well as open banking and cloud-based back offices – will really fly.

One example is Moneyou, an online-only savings platform that ABN Amro launched in Austria, Belgium and Germany after the financial crisis, and which it is considering turning into more of a credit provider. ABN Amro also launched digital small and medium-sized enterprise lender New 10 in late September 2017, shortly before launching a platform for SME foreign exchange and payments called Franx. 

“We have all this optionality in the market,” ABN Amro chief executive Kees van Dijkhuizen told Euromoney earlier this year. 

Van Dijkhuizen also points to Prospery, an online mass affluent wealth manager ABN Amro launched in Germany late last year. “We can use all these things in other jurisdictions if we want,” he says, emphasizing the relative ease of transferring digital platforms abroad. 

BBVA’s interest in Atom Bank in the UK has a similar logic in terms of getting its foot in the door of a cheap and potentially large opportunity, particularly as the UK has already implemented the EU’s revised Payment Services Directive (PSD2). 

In March BBVA roughly doubled its investment in the Durham-based lender to £167 billion, reaching a 39% stake, after the startup attracted £1.3 billion in deposits and lent £1.2 billion to homeowners and small businesses in less than a year. Billed as the UK’s first app-only bank in its pre-launch marketing, it could either explode or remain a pin prick, but it gives BBVA exposure and a big say in the bank without legal control.


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BBVA chairman Francisco González


“We start with small stakes and little by little we increase them,” says BBVA chairman Francisco González. “It’s a question of going step-by-step.”

Even in the eurozone, however, banks still grumble about the huge disincentive of continued ring-fencing of capital and liquidity by different supervisors, especially in Germany. 

This has been particularly problematic for ING. Pushed by national regulator BaFin’s desire to keep its deposits in Germany, ING has had to look for German-based ways to deploy the deposits it gathers through ING DiBa, including those from wholesale banking. 

“Banking union has not made much difference,” complains Aris Bogdaneris, head of ING’s growth and challenger markets, which includes Germany. “We still can’t move liquidity and capital between local subsidiaries… Countries don’t want you to be just a branch, they want to have control over the banking sector.” 

Scope

Yet the chance to expand abroad quickly, without acquiring a complex and culturally entrenched legacy branch-based system, is also part of Santander’s ideas for the future of Openbank. International expansion is just one of the options available to banks as they invest more in online subsidiaries. It is also about trying out back office innovations and piloting new core banking systems. 

For Santander, in particular, the scope for core-banking agility and experimentation is a major part of Openbank. It is one of the first banks around the world to already operate on a cloud-based IT infrastructure. As Openbank serves more than one million customers, but with only about 135 staff, it is an accelerator, or a speedboat to the main bank’s supertanker, says Santander chief executive José Antonio Álvarez – using a metaphor bankers often employ for initiatives like this. It also relieves the burden on the main bank’s systems.

“It gives us plenty of optionality,” Álvarez explains, discussing Openbank. “We can open relatively quickly in a new market in a fully digital way and, perhaps in time, use the new core banking system for the supertanker. It is very scalable.”

The speedboat metaphor is also one that Comdirect’s chief executive Arno Walter uses to describe its role in the Commerzbank group. “Comdirect can innovate quicker,” agrees Comdirect chief financial officer Dietmar von Blücher. Recently, Comdirect announced it had become the first bank in Germany to work through the Google home assistant and Amazon’s cloud-based Alexa service. So far, those services offer little more than updates on balances or stock prices, but it seems the tech firms might have learnt to appreciate Comdirect’s nimbleness relative to older banks. 


It’s our sandbox. It’s a great tool to try new things 
 - Gonzalo Gortázar, CaixaBank

As a transformation vehicle, creating a challenger bank can be less complex and employ fewer people than trying to reform the core business and systems, says Boston Consulting Group’s Michal Panowicz. “The investment in the new challengers can be fairly modest compared to a big bank’s budget,” he adds.

The 2017 launch by Israel’s Bank Leumi of digital offshoot Pepper might be another example. It uses the existing back office but is more targeted at millennials, possibly making it easier to migrate those customers to a new back office later.

Part of the problem with creating a new digital challenger bank, according to Panowicz, is that banks’ complexity – risk and liquidity management, reporting requirements and IT systems – means that duplicating those functions can be costly. “If a bank is successful in developing a digital roadmap to transform its core systems, there shouldn’t be a big business case for developing a de novo challenger,” he says. On the other hand, he points out, very few banks have succeeded in doing so.

The strong growth of western European banks between the 1960s and 1980s in terms of their back-office and organizational models has lately proven a burden, says Panowicz, which is partly why some Polish and Turkish banks have advanced further in digital banking in the 21st century. Indeed, mBank (where Panowicz used to work) is Poland’s fourth biggest bank by assets and has 5.4 million retail clients.

Other bankers and consultants say the launch of a new brand can also help readjust processes built around products rather than client segments, making for a more user-friendly front end, even if the core banking system remains the same. Bosek says this is the case at George, which like Hello bank!, uses the group’s existing back offices in its various countries but allows Erste to do marketing more targeted to the individual (not just the blanket pushing of mortgages after Christmas, for example). 

Despite piggy-backing on CaixaBank’s back office, imaginBank, launched in 2016 is also useful to its parent as a test site for front office app-based innovations, according to insiders. This is because, despite having more than one million customers, its balance sheet is relatively small and it only has a handful of staff dedicated to it. Last year imaginBank launched what it said was the Spanish banking sector’s first chatbot, with text and voice conversations using artificial intelligence. 


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CaixaBank chief executive Gonzalo Gortázar


“It’s our sandbox,” says CaixaBank chief executive Gonzalo Gortázar, discussing imaginBank. “It’s a great tool to try new things and move those that work onto CaixaBank.” 

Others say plugging new digital products into older IT systems creates inefficiencies it would be better to avoid. IT bills for legacy system upgrades can run into the hundreds of millions of euros, notes Brian Ledbetter, a financial services consultant at McKinsey, so experimenting with an alternative is worth the effort. Some first generation internet banks in the UK, for example, have nothing very modern about them “under the hood”, says Ledbetter.

By contrast, digital banks based on entirely new systems, like Openbank, could make it easier to migrate customers to a cloud-based platform and eventually run down the legacy system. Compared with replacing the core bank in one go, as Nordea is doing across its countries, this kind of gradual transition might be a slower but more realistic project – especially for a bank like Santander, with much larger transaction volumes than Nordea.

“Running a cloud native operation can cost a fraction, maybe half, of what it might be in a legacy IT system,” Ledbetter says, noting the security can be better too. “Putting a new bank on the cloud could be a platform hedge for some banks.” 

UK-based independent Starling Bank is another example of a digital-only lender using a cloud-based IT platform, in its case from Amazon. Bigger banks have also started switching to cloud platforms particularly for app-based services, says Ledbetter. 

The recent IT debacle at TSB has alerted regulators to the dangers of Big Bang-style IT switchovers, so they might prefer banks to do it slowly and cautiously. The tight hold on the market by Amazon and Microsoft could be another concern for regulators, although there are alternatives. For example, ABN Amro’s New 10 uses Berlin-based Mumba, which also provides a cloud-based IT system to N26.

Corporate cannibalization

Although banks continue to invest heavily in new online brands, some say this can dilute the focus on the core business and even risk debasing one’s own market. This is a particular risk where it is possible for customers to have accounts with both the parent and the offshoot, which is usually true when they operate in the same country. 

The UK’s Cooperative Bank has recently broached the possibility of closing Smile – its online offering – to new customers, as it tries to boost its own brand. This could spell the end to the growth of one of Europe’s biggest digital bank offshoots.


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To use an airline parallel, these concerns might bring to mind British Airways’ ill-fated budget experiment Go, in the 1990s – one of the UK’s best-known examples of corporate cannibalization. However, in a sign that big companies are still grappling with the idea of beating new rivals at their own game, last year IAG launched its own budget long-haul airline, Level, after the BA and Iberia holding company failed to buy Norwegian Air.

One of the world’s best-known banks for technology, BBVA, has tried to avoid these kinds of risks. In fact, just as its main domestic rivals CaixaBank and Santander have in the past two years sprouted or relaunched digital brands in Spain, two years ago BBVA folded its old Spanish online arm, Unoe – set up in 2000 and with 1.6 million customers – partly to avoid competition in the group for digital resources, including tech-savvy talent. 

With those clients integrated into the main bank, BBVA’s González says its digital development is less of an external project. “We are the most advanced bank in the world on the digital journey,” he boasts.

BBVA has invested in separately branded digital banks, but generally only in countries where it does not already have a big presence, such as the UK. In Finland it bought online SME bank Holvi in 2016. BBVA’s San Francisco-based venture capital firm Propel invested $22 million in May in what it said is Brazil’s first fully digital bank, Neon, gaining 600,000 customers since its launch July 2016. 

Cannibalization is also less likely in projects such as George, which essentially just reframes Erste Bank products, particularly current accounts and payments. Customers usually know it is the same old reliable silver, albeit newly polished, and Erste is phasing out its purely Erste-branded online banking. There is no Erste app other than George. 

At other banks the degree of cannibalization depends on the business model and often the extent to which they have a separate identity and operating model.

Finecobank, like its multi-channel peers that originated as online stock brokers such as Boursorama and Comdirect, is one of those more distinct from its parent. Now billing itself to investors as the direct multi-channel arm of UniCredit, more than half its customers today use Fineco as their main transactional bank, spurred by a 2008 merger with Xelion Banca, another UniCredit subsidiary. 

“We are competing with UniCredit in the same way that we compete with other traditional banks,” says chief executive Alessandro Foti. He says they exchange knowledge and skills. 

But as Fineco’s growth outpaces that of the traditional banks, Foti thinks it will still gain fewer clients from the big systemic lenders, which he thinks will emerge as overall winners as they transition to a multi-channel model, thanks to their better resources and as the Italian sector consolidates. “The main losers will be the small and medium-sized regional banks,” he says. “Those are the banks most seriously affected by the crisis in Italy.”

The mid-tier banks have launched their own Fineco-like combinations of online banking and financial adviser networks, most notably Banca Monte dei Paschi di Siena’s Widiba, which has more than 150,000 clients.

But even if the number of customers they take from their own firm is not significant, the biggest problem might be the impact on pricing in the market as a whole. This is the most worrisome trend – familiar to airlines and the retail sector – that analysts from Berenberg pointed to in a recent report criticizing Santander’s digital strategy.

For an airline, launching an offshoot can be a means to free itself from a strong trade union in the legacy business, which was previously part of Ryanair’s advantage. This is something some banks’ senior management might also like to achieve.

More progressively, McKinsey’s Ledbetter says banks can launch a new brand to target a different client sub-segment or an entirely new market. This is the case with Marcus, the US-focused digital-only retail credit firm that Goldman Sachs launched in 2016 and which it is reportedly going to launch in the UK. 

Young and urban

European banks’ new brands such as Hello bank! and imaginBank are particularly keen to market to 18 to 28-year-olds, partly as banks feel that demographic is most at risk from fintech rivals.

Even Santander’s Openbank, which had a relatively old customer base prior to its relaunch, is targeting what chief executive Ezequiel Szafir says is: “A whole new segment of young urban professionals.” Turning to his favoured car industry comparison, he likens it to BMW’s ownership of Mini, a young and urban brand. 

As Open Banking rules do even more to boost the competition – laying bare incumbent banks’ relative cost versus the quality and feel of their service – some banks are even more concerned to buff up their brands in this way, especially where they have suffered reputational damage. 

It is hard not to see RBS’s rumoured plan for a new digital bank in this context. The same might be said of Dutch SME startup New 10, given the reputational damage caused by its parent’s SME interest rate derivative sales, for which ABN Amro was fined by the Dutch regulator and forced to pay compensation. 

A new brand might not just make a bank more appealing to younger clients. It can also help attract the kind of young developers who might find it distinctly uncool to work for a big established bank, with all the rigid hierarchies that implies. Bosek says this is the case with Erste’s George. 

And just as appealing for many banks, the orientation to millennials – typically a generation less asset-rich than their predecessors – comes with the need and the possibility of lower costs thanks to technology. 

A more cynical observer might conclude these new digital arms are merely a means to cut staffing needs by shutting branches to lower-income customers – often the younger ones anyway. At imaginBank and Hello bank! most customers were previously customers of the traditional bank and much of the rest did not have a bank before. Now 18-year-olds are automatically directed towards the digital offshoot.

While the new outfits often give customers the benefit of lower fees, the advantage for the bank is that they must do their banking away from the branches, which they can then shrink and focus on higher-end clients. 

Despite a lack of day-to-day banking fees, imaginBank is already profitable, says its director David Urbano, partly because its customers can only do their banking via a mobile phone app. In CaixaBank there are less than 50 people dedicated purely to imaginBank. “The goal is not just to catch customers from other banks but also to stop them moving and make them more profitable,” he says. 

This is not to suggest the banks would rather not have these customers at all, however. When Gortázar talks to Euromoney of imaginBank’s more than “one million millennials”, he evidently does so with pride. 

The typically social-media savvy client of Hello bank! in France, similarly, suggests an upwardly mobile, urban professional customer base, even if that might be a relatively poor one today. It is the same with Boursorama, one of the cheapest banks of its kind in France, which has maintained a tilt towards cities (more than a third of its clients are Parisians, compared with about 18% in the wider population) even though its recent growth push has attracted a higher proportion of young people.

The longer-term question then is, what happens to those customers when they mature and when more of the wealth of the Baby Boomers and Generation Xers starts being passed on to them? 

Even if new digital brands like imaginBank and Hello bank! are just a stage on the route to a mortgage at the main bank, they are also a reflection of wider corporate concern – as with the car makers and big brewers – about missing out on the millennials as a consumer market.