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Elizabeth McCaul
Board Member

Supervising the future of banking: navigating the digital transformation

Blog post by Elizabeth McCaul, Member of the Supervisory Board of the ECB

Rome, 10 March 2023

Technological progress has been shaping banking for centuries – from the first wire transfer between Boston, New York and Chicago in 1871 to the unveiling of the first ATM in Enfield, north London, in 1967, and the rise of online and mobile banking in recent years.

Today we have a truly unique situation that stems from a combination of three factors.

First, customers are increasingly calling for digital solutions to conduct their daily banking activities.

Second, today’s accelerated pace of technological development makes it easier and more cost-effective for banks to digitalise their operations and processes and extract value from data to gain a competitive advantage.

Third, and related to this age-old challenge of gaining competitive advantage, new market entrants are intensifying the ever-present competitive pressures.

In the face of these three trends, digital transformation is now widely considered to be both a strategic imperative and a strategic risk for banks. So what is the role for us as supervisors in this digital transformation of the banking sector?

Tommaso Padoa-Schioppa, with whom I had the honour to work in the past, once famously said that it is not the supervisor’s task to prevent Darwinian selection in the financial system, nor to protect dinosaur banking from extinction. Indeed, it is not our task to defend banks’ market shares. However, it is in our interest to make sure our supervision encourages banks to develop and implement sound digital transformation plans, especially if these plans make the banks more cost-effective, as this increases their profitability and thus improves their overall business models.

But I fear that many banks may be underestimating the speed of technological innovation and the urgency of digital transformation. We just have to look at the developments in artificial intelligence (AI) in recent months, where a generative AI language model has demonstrated its potential to be a real game changer for many businesses. While banks are already making changes, it is the nature, speed and extent of their transformation that will determine how they manage their business models and strategic risks, as well as their operational resilience.

Last year, we launched two major initiatives to deepen our understanding of the digital transformation of the European banking sector. We engaged with stakeholders, including banks, technology companies and consultants, to gain insights into major market trends. We also surveyed 105 large banks to assess the status of their digital transformation. The following results are based on these banks’ self-assessments.

Almost all of the banks we surveyed now have a digital transformation strategy in place. The core focus of these strategies is to improve profitability, either by enhancing customer experience or improving operational efficiency. Yet the average budget that these banks dedicate to the digital transformation is still limited, accounting for only 4% of their operational costs in 2021.

Banks also report that half of their customers already appear to have gone digital. On average, the surveyed banks were concluding 46% of their loans via digital channels, with 36% of their customers using mobile banking and 21% using online banking.

As part of their digital transformation strategies, banks tend to rely on outsourcing and external partnerships. However, as they open up their IT infrastructures to such arrangements, third-party dependency and cybersecurity risks are increasing.

When it comes to how these banks are using technology, we see a mixed picture in the survey results. Almost all banks are using some form of cloud and application programming interface, while 60% of them are using AI, with more use cases in development. Less than 20% of them use distributed ledger technologies, and when we checked for crypto activities specifically, we found that these were insignificant for the surveyed banks. However, considering bank customers’ heightened interest in investing in crypto-assets, the topic requires further attention.

In my view, we need more regulatory convergence and cooperation at the international level to close any potential gaps in oversight with regard to crypto activities. Individual regulatory regimes based solely on individual jurisdictions may no longer be sufficient. The new developments in digital finance are shining a spotlight on the need to have a more integrated global framework in place. Without it, regulatory arbitrage will increase the risk of customer losses, and may even threaten financial stability.

As part of our supervisory priorities for 2023 to 2025, we plan to continue our work on digital transformation. Through targeted reviews and on-site inspections we will look at governance, technological and operational aspects, banks’ overall strategies and the impact they have on business models and profitability. But the digital transformation of banks’ business models is only one side of the coin – banks must also adapt their governance, risk management and overall steering capabilities accordingly.

This blog post was published as an opinion piece in Il Sole 24 Ore (Italy).