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How to build a digital bank

In our previous blog post we explored the various stages involved in developing a viable plan. Now we will look at how to go about building your digital bank with particular emphasis on the target operating model, processes and activities, technology & systems, human resources, and implementation.

The starting point for this section of our guide is to distinguish between the business plan and the target operating model. The best way to explain this distinction is that while the business plan addresses what kind of digital bank to build, the target operating model provides the building blocks for how to build the digital bank.

There are several elements to the target operating model – these include:

  • Plans that detail how work is undertaken within the bank and the process by which information is exchanged, which we can refer to as ‘processes’
  • The systems and tools that are required to enable processes to be executed efficiently, which we can call ‘technology & systems’
  •  The organisational structure of the enterprise, including the positions that have to be filled and the areas of responsibility for these positions - ‘people & organisation’
  • The regulatory environment in which the bank will operate, which we will cover in more depth in the next blog

Defined regulatory framework

While the regulatory framework is being defined – an important step since financial services is one of the most heavily regulated industries – you must also make a list of the activities and processes without which the business would not be able to operate.

This information will be fed into the design of the technology stack (which can be described as a list of all the technology services used to build and run one single application) and the various systems the bank will run. The final stage in completing the operating model is to specify the human skills required and how these people will work.

In summary, we not only describe how to design the organisation (i.e. the target operating model), but also how to manage the implementation.

There are many types of financial services, with the range of activities depending on the proposition. For example, providing digital payment services requires different activities from providing digital credit issuance.

A detailed breakdown of the process flows must include a considerable amount of information on the key processes. For entities with large scale and sophisticated value propositions encompassing a wide range of products and services it may be helpful to use process mapping or workflow diagrams to represent customer onboarding, payment transactions, loan applications, customer service and other end-to-end processes.

Financial service providers’ processes and activities are commonly divided into commercial; operational; and finance & risk domains.

While functions exist in all financial organisations, their form can differ depending on the type of services provided, operational set-up (such as in-house or partnerships), distribution model (for instance, digital-only versus omni-channel), and differentiating factors.

End to end

The front office or commercial domain handles product sales and customer relations, where tasks include supplying information, product/service distribution and customer service. Related services include marketing, product management, innovation and business management.

Digital banks (unsurprisingly) have a strong focus on servicing customers through digital channels rather than physical interaction. For most services the emphasis will be on delivery through digital tools such as chatbots, although in many cases banks will also offer customers the option of contacting them via phone, email or chat.

In digital banks, product management and innovation is typically delivered by business developers with understanding of both customer needs and technology.

The mid-office – otherwise known as the operational domain – is where infrastructure, operations and general administration are overseen and managed. In addition to technology, this section of the bank will also have responsibility for related activities such as security and fraud management.

Compared to their traditional counterparts, digital banks have a larger share of process digitisation and straight-through processing (STP), which means a larger reliance on IT versus human administration. Conversely, digital banks tend to be lighter on general administration.

As digital banks are more likely to focus on transactional services such as payments, foreign currency exchange or investment brokerage as opposed to balance sheet products (i.e. deposits or lending), many operate under a partnership model so the finance & risk department tends to be lighter than at traditional banks.

However, the danger of potentially large losses from lax credit risk management means that digital banks require people with the skills to handle a rapid expansion of business as well as the introduction of new lending services.

Core technology

Technology drives business capabilities and customer solutions, with a high impact on both the customer experience and operational efficiency. As a result, an efficient and effective technology stack is a prerequisite.

There are a number of demands placed on digital banks arising from their value proposition and key processes. They are expected to support round-the-clock access to services, develop infrastructure that is sufficiently flexible to adapt to the changing demands of the business, generate a holistic view of their customers, and manage omni-channel access effectively.

Digital banking shifts the focus of banking IT infrastructure from the product to the client. The emergence of the API layer and (external) business applications means it can be separated into three distinct layers.

The major components of the back-end are the core banking system and client information. This layer of the bank has responsibility for administering payment transactions, loan issuance and deposits.

Traditional core banking system providers such as IBM, Infosys, Temenos, Oracle, Avaloq and Sopra are used by large incumbent banks. These require heavy on-premise installations and required investments can exceed €100 million.

However, the growing influence of digital banks has led to the introduction of core banking system providers who provide platforms that are flexible, scalable and support interconnectivity at a fraction of the cost of the traditional providers.

Next generation providers include BPC, solarisBank, Thought Machine, and Mambu. They typically charge a monthly subscription fee based on utilisation instead of one-off project and installation costs.

Budgets for set-up, configuration and running can start from as little as €500,000, with a similar amount of yearly fees (depending on the structure of the deal and degree of one-off versus use-based pricing).

These services are delivered through the cloud, which makes it easy for digital banks to scale their operations as their business grows and to implement new services quickly. They also consolidate the activities of bank customers, helping digital banks optimise the customer experience.

Tying it together

The middleware plays a vital role in connecting the back-end with the front-end and business applications. Technology providers like Backbase and BPC can provide such middleware and operating systems, including related business applications for payments, card issuing, real-time notifications and other services.

The final layer – the front-end – is what the customer sees since this is the layer through which their interactions with the bank are managed. This is the part of the business that manages mobile and online banking channels as well as external channels including ATMs and payment gateways.

This layer can be either developed in-house using internal resources or built on solutions from external vendors where the bank simply rebrands the solution.

Third party applications can be connected via the API layer, which has become an increasingly important element of the digital banking business since the introduction of open banking and composable banking (which can be defined as the self-service discovery, provisioning and creation of new banking services by ecosystems both internal and external to the bank) as well as ‘superapps’.

Another important feature of this layer is that it enables banks to test potential products and services in a controlled environment before they go to market. Immediate availability of the API and clean and concise documentation are therefore important for optimal capitalisation of (future) partnerships.

The skills required by a digital bank are different to those of a traditional financial institution. Most notably, they need people who understand the opportunities presented by technology, who are able to adapt to new developments and leverage advances in areas such as machine learning, blockchain or distributed ledger technology and big data.

There are also benefits in employing people who have the ability to manage different types of partnerships as well as a deep understanding of behavioural economics.

Agile work practices

The extent to which digital banks are driven by technology – coupled with the need to bring new services and products to market quickly - requires an approach to development based on agile principles.

In the software world, this translates into a strong focus on the people doing the work and how they work together, enabling solutions to evolve through collaboration between self-organising cross-functional teams.

One of the key aspects of agile is the segmentation of development processes in short sprints with specific incremental goals where cross-functional teams get together and iteratively improve the product and operations while maintaining a functional environment.

This replaces the lengthy back-and-forth rounds between departments that were common in traditional banks and allows for quick and efficient decision-making and product development. The process typically accelerates processes and enhances success.

In addition to the right skills and expertise, the core team must also fully understand the value proposition, the technology and the business model.  This team can gradually scale up to include more staff from technology departments.

Timelines and key milestones should be detailed in a comprehensive project plan overseen by a dedicated manager. Examples of key milestones include securing the first round of funding; obtaining the regulatory licence; launching the MVP; and acquisition of the first customers.

At the same time is it vital to keep a close eye on expenditure since negative cash flow will limit the scope for implementation.

As a rule of thumb, a start-up bank should have sufficient funding in place to get it through the licencing process, build the technology and launch the MVP. At that point it should be possible to raise further funds.

Coming up

In the next blog in this series we will look at the regulatory framework required to provide financial services.