Interview with Prof Dr Stephan Paul, Chair of Banking and Finance, Ruhr University Bochum

Professor Paul, Bill Gates prophesied in 1994 that “banking is necessary, banks are not”. Do we have to admit in 2018 that he was right? Will his prediction come true in the next few years?

With respect, but this black-or-white debate was and is too superficial for me. What we are experiencing are metamorphoses, the type of processes of change we have already observed in other industries. The end of books and newspapers was prophesied two decades ago, for example. Despite all the economic problems, they still exist, but they have changed under pressure from digitalisation. It’s the same in the banking industry: banks have already adapted their internal and external processes to a considerable extent, but they still have a long way to go to remain sustainable. My forecast is therefore that banks will still exist in 25 years’ time, but that they will look completely different than they do today.

Which technology do you consider to be the decisive game-changer in banks’ journey into the future?

The analysis of very large data volumes using artificial intelligence – Big Data Artificial Intelligence, or BDAI – is certainly having the most serious impact. In the area of investment advice, for example – the expansion of which many banks are now championing in light of depressed interest income – we can see that BDAI-based “robo-advice” can be a very effective and efficient solution for basic retail portfolio management requirements. Personal consulting is increasingly becoming the second-best alternative in this area, for both cost and quality reasons. BDAI will probably revolutionise banks’ internal processes to an even greater extent: take the example of credit checks in the lending business.

What about blockchain technology?

This is an area where we are seeing the first suppliers building their business model on this technology: effectively “Fintech 2.0”. Especially where security is concerned, this is undoubtedly a technology with future potential. But when I consider how much energy blockchains use and how time-consuming the transactions are, I think the current hype is overdone. By contrast, expertise in BDAI is already crucial today for stealing a competitive edge. And the banking industry must take care here not to fall behind the data giants from other sectors.

Established banks and insurers are using agile methods in their own labs in an effort to copy fintechs and insurtechs. Do you think they will be able to make good the technology lead and stay in the market?

These labs are popping up like mushrooms at the moment, but simply setting them up is not enough. What matters most is how the signals coming from these think tanks impact the existing organisation and change traditional corporate cultures. The lab can’t be an isolated island. As many bridges to the mainland as possible must be built so that it can become the organisation’s innovation driver. Even then, not every bank will succeed in riding the peak of the digitalisation wave. That would also be too uneconomical. Instead, as is already evident today, there will be more and more alliances between banks and insurers on the one hand and fintechs/insurtechs on the other. The established players and the newcomers will enrich and change each other – in the sense of metamorphoses.

As a first step, the digitalisation of business models requires standardised data and processes. But this standardisation naturally also means sacrificing flexibility. How critical do you see this loss of flexibility for the market as a whole, and are approaches already emerging that could solve this problem?

As far as basic requirements in both retail and corporate banking are concerned, standardisation is already well established, and digitalisation is actually accelerating this trend. This is a situation in which not every bank can still go its own way. However, similar product offerings based on similar IT and management systems, possibly sourced from only a handful of suppliers, run the risk of homogenisation, which ultimately also constitutes a systemic risk. But because this trend can no longer be reversed, it is all the more important for me to ask where the bank in question can still preserve its individuality in future and demonstrate expertise and relevance to its customers. This will be the only way to achieve sustainable competitive advantages.

And where could that be?

In the corporate banking business, it would clearly be in providing support and advice for customers to help them grow their business models in the digitalised world of Industry 4.0. We are experiencing the strongest process of upheaval in decades in almost all sectors of the economy. What this means for corporate finance, however, has not yet been properly thought through. If the practical formula “financing must fit the business model” applies, then the disruption of business models and innovative forms of organising and managing value chains mean that the challenges to corporate financial executives when it comes to raising liquidity are also facing radical change.

The intensification of cross-company alliances between value-adding partners, for example, raises the question of what the credit rating in the context of the bank rating should ideally be based on in future. What is happening is that traditional corporate finance is increasingly becoming project finance – uncoupled from the company as a whole. Individual loans are being transformed into value chain loans. This refers to larger investments that are increasingly being implemented in networks of multiple companies across different stages of the value chain, and whose success depends on the quality of the partners involved. The success of the project, and hence the ability to repay the loan, is no longer the responsibility of a single actor, but of the network of actors – some of whom may have different credit ratings. Industry 4.0 is also leading to changes in collateral, which often still underpins loan agreements, at least for small and medium-sized enterprises: in the wake of digitalisation, corporate investments are focused less on traditional fixed assets and increasingly on intangible assets, in particular software and patents (intellectual property), as well as on support, maintenance and training costs. In many cases, these intangible assets are so company-specific that calculating lending values and limits can only rarely be based on the sort of generally accepted market prices that we know from commodities, vehicles or even real estate.

Advising clients in this process of transition is a tremendous opportunity for banks, but will require business client advisors to massively expand their skill sets.

What about the retail banking business?

The majority of Generation Z, i.e. tomorrow’s customers, self-critically admit that their general economic education is not sufficient to build up adequate retirement savings without help. Especially because empirical studies have shown that younger people, too, appreciate a personal contact person, this is a great opportunity for banks. The personalised retail sales network proves to be an important strength, making proximity to customers a factual and emotional experience. However, it also significantly increases requirements for expertise – in particular where investment advice is concerned. Banks will only be able to achieve competitive advantages over fintech companies if the advisors are also superior to progressively improved robo-advisors. The personal, local sales presence therefore has a future, albeit at fewer locations and with staff who are more highly qualified.

Professor Paul, thank you for the interview!