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Digital innovation in the banking sector: pay-offs and perils

Speech by Andrea Enria, Chair of the Supervisory Board of the ECB, at the Spanish Banking Association Conference organised by the Latin American Federation of Banks (FELABAN) and the Spanish Banking Association (AEB)

Frankfurt am Main, 21 September 2021

The pandemic has turbo-charged digitalisation

In the aftermath of the great financial crisis, former Chairman of the Federal Reserve System Paul Volcker made no secret of his belief that innovation in the banking sector had brought more harm than good, famously arguing that the most important financial innovation he had seen in the past 20 years was the automated teller machine (ATM).

During the coronavirus (COVID-19) crisis, our experience has been decidedly different. Innovation in the banking sector has proved its value to society. And it is innovation much in the mould of the venerable ATM. It makes banking more convenient and time efficient. It enables completely contactless banking in times of physical distancing, and it offers bank employees the possibility to work remotely. Digitalisation is not confined to the banking industry, of course. But it has already left a strong imprint on banks, and all signs point to even more sweeping changes ahead.

In Europe, the share of consumers using digital channels and products went up from 81% to 95% as a result of the pandemic – a rise that would have taken two to three years in most industries at pre-pandemic growth rates. The banking sector, which already boasted the highest proportion of digital users in Europe, has recorded an increase of 23% in first-time digital users since the onset of COVID-19.[1] Globally, remote digital payments shot up by about 50% when physical distancing measures were introduced, according to a sample from the Bank for International Settlements.[2] Similarly, PayPal transactions conducted globally increased by 45% between the first quarter of 2020 and the second quarter of 2021.

The pandemic has also led to significant changes in retail payments. After the outbreak of the pandemic, the use of contactless cards roughly doubled in advanced and developing economies alike.[3]

And there is more to come. I will argue that banks will have to adapt to changes from the outside – shifting customer preferences and competition from fintech and big tech market entrants – and on the inside, harnessing the potential of digital technologies to increase cost efficiency. If banks pass up these opportunities, their business models will become more and more vulnerable.

As I have just outlined, most people today are acquainted with online or mobile banking. Therefore, it does not seem plausible to assume that retail banking will revert to its pre-pandemic, branch-centred days once the virus is fully contained. This changed environment creates opportunities for banks to boost revenues: the customer base can increase without the need for a physical presence. New digital products and services could be offered at very low marginal cost, and pricing could be improved through advanced data use.

Digital banks can be more cost-efficient

Seizing the opportunities afforded by digitalisation is imperative for banks everywhere. But it is particularly pressing for European banks. For quite some time now, European banks overall have not been able to earn their cost of equity. Cost efficiency is one of the factors contributing to this structural underperformance. Going more digital can be an important and permanent cost-transformation strategy, as long as it is underpinned by effective internal governance and the necessary structural changes. This applies especially to banks operating in countries with dense branch networks. And while in principle it should be easier for larger banks to shoulder the costs of IT investment, there have been examples of smaller and medium-sized banks making great strides in cost-efficiency. In these cases, standardised and thus affordable digital solutions have been used, or IT development costs have been shared through cooperation.

Branch closures and staff cuts are often the most expected corollary of a more digital bank. Autonomous Research estimates[4] that many global banks could potentially close down up to 75% of their branches, and that they are about halfway there. Cost saving from branch closures is largely down to reducing staff expenses, with direct costs of real estate playing a comparatively minor role. Some banks are lagging behind when it comes to cost reduction, having adopted a “wait-and-see” approach and placed their hopes in a long-awaited normalisation of the cycle. Others did indeed reduce branches and staff, but focused solely on cost-cutting, neglecting their income generation capacity. Their cost efficiency hasn’t structurally improved. But there are many banks that are using digitalisation for cost transformation purposes. This involves reducing operating costs while at the same time investing in staff with the necessary technological expertise and in infrastructures in order to transform banks and achieve sustainable cost efficiency.

The potential efficiency gains from digital technologies in fact go beyond trimming the branch network. They can enable banks to provide more integrated platforms, data repositories and distribution tools across their groups. There are examples of banking groups developing one single payments platform to be used worldwide. But there are also cases where non-integrated IT systems of the parent company and its subsidiaries hinder data aggregation, effective risk management and internal controls. And digitalising control functions should not only aim to cut costs, but to improve monitoring capabilities too. This is as important as the digitalisation of the front end of the business – or even more so as digitalisation leads not only to reduced costs and/or increased revenues, but also changes the bank’s risk profile, which has to be addressed.

For digitalisation to really deliver on efficiency, the digital strategy needs to be part of a wider reshaping of the business model and a streamlining of internal organisation. It comes down to the steering capacity of the bank’s management, the choice of the products offered, the legal entities maintained, the regions where the bank should focus its activities, and the ability to implement simple and integrated legal and IT infrastructures at the group level.

Digital banks could make more effective use of the Single Market

In Europe specifically, digitalisation could allow banks to make more effective use of the existing opportunities the Single Market offers. Digital solutions could enable them to rely more extensively on branches and the free provision of services, rather than subsidiaries, to develop cross-border business within the banking union and the Single Market.

Banks have so far made little use of the basic freedoms of establishment and remote provision of services that were made available with the creation of the Internal Market back in 1992, when the Second Banking Coordination Directive was transposed into national law across the then 15 Member States. So far, banks that wanted to expand their business to other Member States have done so mostly by setting up new subsidiaries or by acquiring local credit institutions and integrating them into a cross-border banking group. Choosing subsidiaries instead of branching out may have made it easier to enter a new market. This way, local expertise and knowledge of the market could be used, not to mention the advantage of brand recognition among local customers, especially for retail business. But maintaining subsidiaries also brings with it all the complications of a separate legal entity: a separate board and separate support staff, local capital and resources, separate annual accounts and treasury and finance functions and, of course, a strict application of all the local regulatory requirements on an individual entity basis.

Potential obstacles to the free provision of services across borders remain, ranging from cultural differences and different levels of financial literacy, to divergencies in national legal requirements and insufficient regulatory harmonisation at European level. However, the digital transformation process has progressed substantially in the last few years, contributing to changing consumer preferences and making them converge further. Leading technology companies outside the finance domain have shown banks how consumers worldwide can be offered uniform technology-based products and services. Fintechs and digital banks are making their customers increasingly accustomed to the use of technology in financial services. As I argued at the beginning, the pandemic is accelerating change in consumer preferences and reducing the importance of local presence. A changing business environment could allow banks to take a different approach to cross-border expansion in the near future.

The analogy that often comes to mind in this context is the experience with container shipping, which drives the integration of the global economy. It was the liberalisation of international trade that made this integration possible. But it wasn’t until the container was invented that shipping costs fell dramatically and open tollgates could be put to optimal use – estimates suggest that current trade levels would decrease by about a third without container technology.[5] By the same token, digitalisation could boost the impetus for branching out and reaping the potential rewards of economies of scale without the need to set up subsidiaries in every Member State a bank provides services in.

ECB Banking Supervision remains neutral with respect to the specific organisational structures banks choose to adopt, including when providing cross-border banking services. We remain focused on the supervision of risks that each business model and corporate structure may entail. However, I believe we should do all that is possible, within our remit, to ensure that all avenues to growth, diversification and sustainable profit generation remain available to the banks under our supervision, as long as these avenues do not threaten prudential robustness and financial stability. This is crucial in the light of the long-lasting low profitability issue that has affected the sector for longer than a decade now, and of the transformational challenges that lie ahead.

Digitalisation can make banking markets more competitive

Digital technologies can provide new answers to fundamental and pressing questions. At the same time, they pose new challenges to banks too – as they do to regulators and supervisors. For example, the fact that customers are increasingly adopting digital financial services can disrupt banks’ value chains. Banks are under mounting pressure as new competitors are entering the market: fintech firms in the form of tech-savvy, small and agile start-ups, unburdened by legacy IT systems, but also large tech companies with access to vast amounts of data and a sizeable customer base. Both these small fintechs and large big techs often specialise in specific parts of the value chain and might be able to deliver services more cheaply and efficiently than established banks that continue to offer the full range of products and services.

Many banks, especially the largest institutions under European supervision such as global systemically important banks, are reacting by cooperating with third-party providers or by acquiring fintech firms to provide a wide range of services and products – mainly in the retail banking area, but also beyond banking. We see different forms of partnership between banks, big tech and fintech firms, such as white labelling or outsourcing. There is also a trend towards integrating interfaces into the banks’ infrastructure. But let me stress again that very large banks are not the only ones that may face and react to competitive pressure from fintechs. Joint ventures and partnerships are possible, allowing banks of all sizes to offer technology-based services. In Spain, to take an example very close to this conference, I look with interest at the partnership that all the main lenders of the country entered into a few years ago in order to offer mobile phone-based payment services to individuals. This trend seems to be growing to encompass an increasingly wide range and number of products, also spurred by the pandemic-induced acceleration I have just discussed.

If competition from new entrants like fintech and especially big tech leads to overall efficiency gains, it can improve welfare. Technological progress increasingly makes it possible to unbundle and re-bundle the financial services value chain, which promotes competition in the banking market. But it also permits fintech and big tech players to provide financial services in the value chain, such as payment services, without being covered by the Capital Requirements Regulation and Directive, or to bundle the non-banking activities in separate legal entities while bundling the banking activities in others.

Banks argue that this treatment is asymmetric and puts them at a competitive disadvantage. When it comes to prudential regulation, however, the objective of financial stability must always take precedent over other considerations, as important as they might be. The structure of bank balance sheets with long-term assets and short-term liabilities always harbours the possibility of a bank run scenario. And this fundamental feature of banks might be exacerbated rather than alleviated by digital tools. Depositors nowadays can switch banks in just a few clicks, as opening an account at a digital bank can take less than ten minutes. Relaxing banking regulation and supervision can therefore never be an option. And while fintechs that only compete in specific parts of banks’ value chains, such as payment services, are not regulated as banks, they require a banking licence as soon as they engage in core banking activities such as lending and deposit-taking. This means they are subject to the full scope of banking regulation and supervision.

I think instead that the level playing field concerns raised by banks are more justified in the area of anti-money laundering controls, where there may be differences, in particular when it comes to crypto-assets service providers. The recent legislative proposals of the European Commission aim at higher level of harmonisation within the Union, including in the area of customer due diligence and reporting suspicious transactions by all types of obliged entities.

COVID-19 has thrown cyber risks into relief

More generally, we have to ensure that the overall regulatory and supervisory framework remains adequate for the evolving financial market landscape. The initiatives taken at the European level in the context of the digital finance package are therefore important and welcome. They include the draft legislative proposal on crypto-assets, the proposal on market infrastructures based on distributed ledger technology and the Digital Operational Resilience Act (DORA). The proposals currently under discussion could also lead to supervisory scrutiny of operational resilience being extended to relevant non-bank entities, as their failure to ensure continuity in their services may trigger major disruptions in the provision of financial services.

The issues of operational resilience and cyber risk have only become more salient in the context of COVID-19, as coronavirus-themed fraud attempts have become more common. These fraud attempts try to exploit themes such as government support, vaccination, COVID-19 restrictions and information. Remote working may also expose bank employees to malware infections that could be more easily prevented in an office environment. In addition, the increased reliance of bank customers on online banking channels raises the potential for high-impact cyberattacks or incidents that disrupt the availability of those channels. Distributed denial of service (DDoS) attacks are a case in point. They aim to make an online service unavailable to users, often by temporarily interrupting or suspending the host server. In some cases, attackers seek to extort legitimate market players by threatening to launch such an attack unless a ransom is paid.

Thankfully, on the whole, ECB Banking Supervision did not observe any major disruptions to the provision of banking services in 2020 despite an increase of 54% in the number of cyber incidents reported compared with 2019. Many of these incidents were intended to cause disruption. Therefore, this increase in cyber risk merits particular attention.

As digital technologies remodel banks, they can also be a bonanza for bank supervisors

As supervisors, we have to be attuned to the new operational and business model risks that digital technologies may pose for banks. But there is a great deal of potential in digital technologies for banking supervisors as well. They can help us to get the most from the large amounts of data available, thus helping us gain a quicker and greater understanding of the risks facing the banking sector. What’s more, digital solutions can drive automation that will allow us to focus our time on the aspects of our work that will have the biggest impact.

This is why we have created a dedicated unit, the Suptech (supervisory technology) Hub, to facilitate all innovation work and to better connect IT and supervisory experts. It is our ambition to become a digital innovation house based on the four building blocks that we outlined in our Single Supervisory Mechanism (SSM) Digitalisation Blueprint: an effective innovation model, a digital culture, an innovation ecosystem and, most importantly, successful delivery of advanced technology use cases tailored to our supervisory needs. With the Hub our approach is similar to that adopted by commercial banks when integrating technologies at group level: we bring together the ECB and all the national competent authorities (NCAs) to jointly develop new tools, aligning our approaches and leveraging the expertise of every institution.

This spring we also set up interdisciplinary innovation teams that bring together IT and suptech experts, data scientists and artificial intelligence (AI) experts from the ECB and many of the NCAs.

To cultivate an innovation ecosystem, we organise training for our staff, for instance in the area of AI, and actively engage with academia, start-ups and other authorities, such as the Bank for International Settlements Innovation Hub. Currently there are over 100 suptech tools under development across European banking supervision.

Most importantly, we want to provide frontline supervisors with concrete and impactful tools that use state-of-the-art technology. Natural language processing techniques allow us to structure and assess large quantities of text and flag irregularities to supervisors. Advanced analytics and applications help us to get the most from large quantities of data.

We want technology that makes life easier. Our strict rules require us to keep thorough and accurate records of a large number of discussions, so a speech-to-text tool that automatically converts human speech to written text saves supervisors a lot of time. And we also want to make life easier for bank employees. For example, we have simplified the way we interact with banks by introducing a digital portal for banks to submit documents and communicate with us directly.

Our efforts have been recognised through the Techforward Award presented to us at the Central Banking FinTech & RegTech Global Awards. We take this as encouragement to further explore the ways in which digital technologies can enhance our supervisory work.


Let me conclude. When Paul Volcker chastised banks for taking the world to the brink of economic disaster, he contended that financial innovation developed by the banking sector did nothing to raise the overall productivity of the economy. This time around, in the midst of the pandemic, digital innovations have already shown their worth. Digitalisation comes with its own challenges and risks, but it offers genuine potential for banks to create new services and to improve cost-efficiency. And the more effective the use of technology becomes across the banking sector, the more society can reap the benefits offered by superior service and reduced costs – the hallmarks of truly successful innovation.

  1. McKinsey (2020), “Europe’s digital migration during COVID-19: Getting past the broad trends and averages”, July.
  2. Bank for International Settlements (2021), Annual Economic Report, June.
  3. Bank for International Settlements (2020), Annual Economic Report, June.
  4. Autonomous Research (2021), "Bankosaurus Techs: Running Out of Patience", 16 July.
  5. Cosar, K. and Demir, B. (2017), “Shipping inside the box: Containerization and trade”, CEPR Discussion Papers, No 11750.

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