Banks must invest in technology and not high cost branches

Consumer appetites for improved mobile banking services will be the driving force over the coming years

This is the last part of a report by Tariq Sayyid Jamal Al-Rifai, an External Consultant on the challenges facing Kuwait’s banking sector.

4. Global banking trends that are changing the future of the industry

As of 2017, there were 5 billion mobile users worldwide according to GSMA, an organization representing mobile operators, with 57% of users using smartphones. In the MENA region, there were 375 million mobile users in 2017, or approximately 64% of the region’s population. This figure jumps to 77% when only looking at the GCC region.

Needless to say, mobile use is extremely high in the GCC region with Kuwait having one of the highest mobile phone penetration rates in the world according to the GSMA. The use of social media and mobile applications in Kuwait are also among the highest in the world.

With the mass-acceptance of mobile banking in the country, banks will no doubt be forced to be at the forefront of mobile banking trends in the coming years as Kuwait’s young and tech-savvy population demand more mobile services from their financial institutions. a) Mobile banking Mobile banking began in the late 1990s with the launch of SMS services and later Wireless Application Protocol (WAP) services on mobile phones. Mobile applications or “apps” did not come to market until 2010 alongside the success of Apple’s iPhone and Google’s Android-enabled devices. It is no wonder then that the phenomenal success and use of mobile banking applications came alongside the explosion in smartphone use.

Today, over 43% of all banking customers globally use a mobile banking application on a daily or at least weekly basis. This is from zero percent only eight years earlier. In Kuwait, the statistics of mobile and online banking use vary from bank to bank. In 2018, mobile banking use in Kuwait ranged from 11% to 92% of total banking customers, depending on the bank. Whereas, online banking use ranged from 7% to 39% of total banking customers over the same period. What is clear, however, is that mobile banking use has become more popular than online (web browser) banking.

The appeal of mobile banking lies in its convenience, ease-of-use and overall better user experience than visiting a traditional bank branch. Banking customers today are looking for access to their accounts around the clock with the same services offered on their smartphone as are being offered at the branch. Over the next few years, mobile banking will continue to take on a larger role in managing customers’ experience while physical branches become of lesser importance. b) Blockchain The first live use of blockchain was in January 2009 with the launch of Bitcoin, the world’s first decentralized digital currency. There has been a lot of buzz in the market surrounding blockchain, however, much of it has to do with Bitcoin and other cryptocurrencies more than the underlying technology behind them – blockchain.

Blockchain in simple terms is a digital ledger. What is attractive about it is that by design, a blockchain is resistant to modification of the data. It is an open, distributed ledger that can record transactions between two parties efficiently. These transactions once recorded are verifiable and permanent.

Regardless of the hype and rapid volatility surrounding cryptocurrencies, blockchain is here to stay. Banks especially have been attracted to blockchain for its real-world applications and gamechanging potential. Here are four areas where we see blockchain making an impact on banking: i. Clearing and Settlement Currently, the cost of clearing securities transactions cost banks and stock exchanges billions of dollars per year. The current system is managed by an outdated and bureaucratic system of messages and manual reconciliation. This includes recording securities transactions such as loans, mortgages and other real estate transactions. There is a big opportunity for blockchain to revolutionize this industry. Using blockchain, these transactions can be cleared almost instantaneously, be verifiable, permanent and can be done at a fraction of the current cost. ii. Payments Over the past few years, central banks across the world have been exploring the potential for shifting parts of their payments systems to blockchain technology. Central banks are realizing the potential of blockchain to modernize their payment systems.

The banking industry, however, is not sitting idle waiting for central banks to decide on what blockchain technology to use. They have instead began experimenting with and using blockchain to settle payments using existing technologies, such as Ripple – a cryptocurrency designed for payment settlement, as well as developing their own technologies using blockchain as a backbone.

Swift, the bank-owned messaging system used for the settlement of international payments, has been testing Ripple to settle payments and has so far been pleased with its speed and lower cost. However, it said that the technology is not yet ready for mainstream usexiii. Switzerland’s UBS Bank has developed its own utility settlement coin, which aims to create a digital currency for use in financial markets by issuing tokens convertible into cash on deposit at central banks. iii. Trade finance Trade finance is another area that is still mostly based on paper, such as bills of lading and letters of credit. Blockchain seems like an obvious solution, especially since many parties are involved in such transactions including, banks, shipping companies, trade agents, freight providers, ports, customs and insurers. Most trade finance documents are currently being sent by post or fax.

However, in order to modernize and digitize trade finance, all parties involved must also digitize their process, including the banks. The market is moving in this direction as the time and cost benefits are clear to all parties involved. It will, however, take several years to develop and implement. ix. Identification Know-your-customer (KYC) is a vital for banking. Regulators hold banks responsible for checking customers’ identities in order to prevent illegal activities, such as money laundering, and hold them accountable (i.e. fine them) if they are any breaches in this process.

Banks have been trying for years to set up shared digital records of customers’ identities and keep them updated. So far, they have failed to find the right formula. Blockchain experts believe that blockchain is the solution because of its cryptographic protection and its ability to share a constantly updated record with many parties. Technology giants, such as Microsoft are working on blockchain solutions for identify verification. Here too, expect testing and implementation of such programs to be a few years away.

In the meantime, banks are proceeding testing and implementing data analytics using artificial intelligence (AI) machine learning to stop patterns and discrepancies in customer KYC data. Data analytics can complement blockchain identification and we expect both will gain wide-spread use in the coming years.

c) Non-bank competition/disruption

Over the past ten years, the biggest disrupter in the banking industry has been the migration towards mobile banking. The second most significant disputer has been the rise of competition – start-ups from both inside and outside the industry. In a recent interview with CNBC, Deutsche Bank CEO John Cryan, said that he spends most of his time thinking about how his bank can remain competitive with companies that are not banks. How, for example, can a bank be competitive in payments versus companies that purport to make payments, but are not regulated by financial regulators?

Companies such as PayPal are already known for their payment capabilities and are being used by millions of people around the world. Newer start-ups, such as TransferWise, are also looking to transform the industry by increasing the speed and reducing the cost of payment transfers. PayPal, which already has a strong market share in this sector has been looking to reinvent itself amid rising competition for newer companies with newer technologies or processes.

On the other side of the industry, there has been rising competition from new banks and financial institutions who are capitalizing on the rise in popularity of mobile banking. This allows them to forego investing in a capital-intensive branch network and instead, focus on investing in technology and attracting customers through their lower cost structures.

Goldman Sachs, for example, successfully launched an online retail bank called Marcus in 2016 in the US. Within two years, Marcus was able to attract 1.5 million customers with deposits of over $23 billion. The success of this paved the way for the bank to launch Marcus in the UK in September 2018. The bank attracted over 100,000 customers in the first three months since it opened.

Several other online-only banks have launched in the UK, including N26, Smile, Moneta, Monzo and Revolut. So far, they have been experiencing similar success as Marcus. Monzo, for example, reached 1 million customers in its first year and has been reporting that it is opening 20,000 new accounts per month, with little advertising. These online start-ups pose a big threat to traditional banks as they choose to invest in technology over building a branch network. The mass-acceptance of mobile banking has made this possible.

5. Are Kuwaiti banks embracing these trends?

The competitive landscape in Europe and the US is much different than in Kuwait and the rest of the GCC. There are currently no online-only banks in the country, nor does there appear to be a push by the CBK to allow for such banks. In fact, there is no sign of any new entrants coming to the market soon. Kuwait already has a well-banked market and rules on foreign banks in the country have eased somewhat allowing for them to open new branches.

The key market disrupter for banks in the country has been mobile banking. This move has come primarily as a result of the country’s young population who have been quick to adopt new technologies. There has also been a push by the Kuwaiti Government to modernize the economy and utilize the latest technologies as it moves towards more e-government services.

In recent years, technology has truly changed the way Kuwaitis bank. From mobile banking to contactless payments, technology is reshaping financial services industry as we know it, and financial institutions are coming under increased pressure to adapt to their clients’ rapidly evolving tastes. A recent EY survey of 2,000 Kuwaiti banking customers found that 89% would be prepared to switch banks in order to have a better digital experience. The survey also found that they would also be willing to pay more for digital convenience.

Though Kuwait’s banks have been rolling out new mobile banking services and utilizing social media to connect with their clients, the challenge for them will be in how quickly they can adapt to the rapidly changing demands of their customers. a) The Central Bank of Kuwait Banks in Kuwait have been facing the same challenges as banks in Europe, the US and Asia have been facing in terms of keeping up with changes in technology and customer preferences. The Central Bank of Kuwait, for its part, has taken on these challenges head on. Instead of reacting to the rapid changes in banking technology, it has decided to be at the forefront of new innovations and developments. This can be seen by three recent developments within the CBK; instructions for the regulation of electronic payment of funds, the launch of the Regulatory Sandbox Framework, and the development of the necessary infrastructure required to support a digital currency – Digital Dinar.

On Nov 26, 2018, the CBK launched the Regulatory Sandbox Framework. A regulatory Sandbox is a framework under which financial institutions can live test their new product and service innovations on a small scale, while being closely monitored by regulators. The purpose of this Sandbox is two-fold. First, it allows financial institutions to test the latest financial technology (fintech) in a real-world, yet controlled, environment. Second, it provides regulators an opportunity to better understand the nature of the product or service. This will determine whether the existing regulatory framework is sufficient, or if new regulations are needed.

This Sandbox is part of the CBK’s efforts to support and regulate the fastpaced innovations taking place in banking technology. It also puts forward its objective of serving the local economy while at the same time, protecting users of these products and services against any risks arising from abuses or security breaches.

As for the development of a digital currency, the CBK has announced that development of a Digital Kuwaiti Dinar is in the works. Alongside this is the development of e-wallets to hold Digital Dinars. The benefit for the CBK to work on such a project would be to facilitate digital payments and exchange against tokenized assets. With the rate at which digital currencies and digital payments are advancing, the CBK is taking the right steps today to be ready for the future.

In addition to the Sandbox and Digital Dinar initiatives, the CBK is investing heavily in analytics and artificial intelligence (AI). The objective of this would be to help the CBK gain a smoother, faster understanding of information and facilitate the move away from paper and manual transactions. This will affect the way the CBK interacts with other entities, reduce expenses and improve overall efficiencies. b) Commercial banks Kuwait’s commercial banks have also taken a leap forward and have been rolling out new digital products and services aimed at fulfilling their customers’ growing demands. In addition to opening new smart branches in key areas, banks have been improving their overall digital offering, which places them at or above the level of their regional peers. The following are some of the latest technological advances in the Kuwaiti market: i. Smart Branches Several banks have launched ebranches or ‘smart branches’ in recent years, most notably, Kuwait Finance House (KFH) and National Bank of Kuwait (NBK). In November 2018, KFH unveiled its KFH-GO: Digital Self-Banking Station”. It is the first fully-automated 24/7 e-branch with an advanced range of self-service instruments using the latest banking technologies. The branch highlights the fundamental shift in the image of bank branches going forward towards more convenience, offering simplicity and speed for customers. KFH views this launch as a first step towards opening similar branches as part of its future plans for enhanced e-banking services to cater to its young customers.

The new e-branch is not permanently staffed and contains state-of-the-art XTMs, or smart ATMs, with the capability of communicating directly with the telephone service personnel in audio and video calls via XTM machines. Customers can access more than 30 services, including cash withdrawals without a card through the mobile phone using QR codes. Other services available at this branch include applying for Murabaha business transactions, requesting credit cards and prepaid cards, updating data and phone numbers, activating bank cards, and opening new accounts.

National Bank of Kuwait has also been opening e-branches and digital customer care centers. The digital customer care centers are different from e-branches in that they are designed more as an enhanced sales center for banking products as well as serve existing customer needs. The centers are equipped with iPads for customers to access information about products and services as well as access their Online Banking. Customers also have the option of using the iPads to conduct day-to-day transactions. In addition, there are also voice services for visually impaired customers including text-to-speech functionality in English and Arabic. ii. Blockchain Payments Kuwaiti banks have also been embracing blockchain in international payments. In December 2018, National Bank of Kuwait (NBK) started offering a new remittance service using RippleNet’s blockchain technology. Ripple, also known as XRP, is a real-time gross settlement system, currency exchange and remittance network created by Ripple Labs Inc in the US. It has gained strong acceptance among banks globally for its low cost and instant payment transfers. NBK is currently using Ripple under the name “NBK Direct Remit,” which is only available in Jordan for the time being.

In January 2019, KFH has started operating an instant cross-border remittance service, known as “Instant International Transfer,” using Ripple’s Blockchain technology. There are zero fees for these remittance transactions, one of the benefits of Ripple and Blockchain, and the service is currently only being offered to customers transferring money in Saudi Riyals via KFH’s partnership with Al-Rajhi Bank. The bank plans on expanding this service to include more countries and in different currencies. Plans are also in the works to offer the service using the mobile application or through KFH online. iii. Online Financing Banking customers can now apply for financing without having to go to a branch. Existing banking customers at KFH and Boubyan Bank, for example, can apply for Murabaha financing online or through smart branches, mobile applications and smart ATMs. iv. Enhanced customer experience Over the past few years, Kuwaiti banks have been rolling out new and enhanced services to keep up with the latest advances in banking technology. This includes;

Virtual credit cards and e-wallets – This allows customers to store specific banking cards on their mobiles or have online-only cards for better safety and securing while making online purchases.

Fingerprint and facial recognition – This allows customers to log-in to their mobile banking services using their fingerprint or facial recognition, bypassing the need to type in a password.

Online credit card issuance – This service lets customers apply for credit cards online or using the mobile application without the need to go to a branch.

Cardless cash withdrawal – This service allows customers to withdraw cash for ATMs without the need for their banking cards. Customers instead can use their ID cards along with codes sent to their mobile phones for identity verification.

Connecting to customers – Banks have proven to be successful at connecting to their younger customers by using their preferred choice for communication – social media. This includes using popular services such as Twitter and Instagram, and also includes oneon-one messaging applications such as WhatsApp.

6. Challenges Kuwaiti banks face that are impacting their ability to prepare for the future

The transformation of the financial services industry over the past decade has been mainly driven by customer demand for new and improved services and experience. This will continue to be the leading factor of change in the industry over the coming decade. There are, however, other factors that are impacting banks’ ability to prepare for the future. This includes, regulatory challenges and the pace at which technology is changing the industry dynamics and customer preferences. a) Regulatory challenges The CBK has traditionally been cautious about enacting new regulations or allowing new technologies into the industry without fully studying their impact. This approach can at times put Kuwaiti banks at a disadvantage with their international peers. The biggest challenge facing the regulator today is the rising demand from customers for new products and services. As banking migrates online, the need for branch visits will slow down dramatically. Alongside this shift, customers will be looking for new banking products to match their lifestyles, such as mortgage financing and other financing tools. The speed at which mobile banking is developing is also forcing banks to launch new products at a faster rate. The regulator must be prepared to address these new demands to ensure banks are able to satisfy their customers’ growing needs. The CBK is already mitigating this challenge by launching its Regulatory Sandbox Framework. b) Market and economic challenges The banking industry faces internal and external forces, many of which are driven by trends in the global economy. Kuwait’s economic dependence on oil has placed it in a volatile situation. The price of oil has collapsed by more than 60% twice in the past decade and by 45% in the last quarter of 2018. These sudden price drops directly impact the economy.

The national economy is highly dependent on two factors for growth; government spending and consumer spending. Over the past decade, the government has had to drastically reduce its spending in light of collapsing oil prices. This has had a negative impact on the economy leading to recessions in both instances (2009 and 2017). What has supported the economy since 2010 despite the volatility in government spending has been the steady and consistent growth in consumer spending as can be seen in Figure 12. This steady rise in consumer spending is the main factor behind the financial sector’s resilience over the past three years in spite of lower government spending.

Consumers, however, are not immune to economic contractions. In fact, consumer spending dropped in 2009 and 2010 as a result of the Global Financial Crisis. During this period, the financial service sector in Kuwait experience its worse performance in recent memory. Thus, another period of lower government spending coupled with lower consumer spending would negatively impact the financial services sector.

c) Threats from start-ups looking to disrupt the traditional banking model

As stated earlier, there are currently no licensed stand-alone online banks in Kuwait and the GCC. The threat for Kuwaiti banks in this area would come primarily from changes and disruptions taking place in other markets such as Europe and the US. As banking becomes borderless and digital, banking customers in Kuwait may find it advantageous to use international online banking platforms for their daily banking needs.

Cryptocurrencies are already held by Kuwaiti citizens and this digital money is being held outside the CBK’s jurisdiction. As digital payment networks and cryptocurrencies become more widely used, we can expect to see more money migrating from traditional regulated banks to online payment networks residing in other countries. This is one reason the CBK decided to develop its own digital currency in order to be equipped when the time is suitable to issue a digital currency. 7. Conclusion The biggest changes to the banking industry over the past decade have come from advances in technology. This, coupled with the high demands of customers for a better banking experience, which includes around-the-clock account access and mobile banking services.

The traditional banking model, which calls for growth through and expansion of branches networks is no longer viable. In today’s highly competitive environment, banks must invest in technology and not high cost branches. Customer appetites for new and improved mobile banking services will be the driving force in the industry over the coming years.

Banks in Kuwait are embracing these changes and are sufficiently prepared for the future, however, challenges still remain. Much of it has to do with the speed at which advances in technology are taking place. This places a lot of pressure on banks to adapt quickly and direct their investments towards new technologies over physical branch expansion. The banks that are best prepared for the future are the ones that have the capital necessary to invest in the latest technology. The high cost of such investments may affect the performance of smaller banks more than the larger banks. Kuwaiti banks overall are small by international standards and investment in technology will drive up their expenses, at least in the near term, as they prepare for the future.