The financial services sector is experiencing rapid change in terms of technological disruption and market structure. In this article we look at the major trends impacting the sector and explore how firms, new and old, can capitalise on opportunities while also preparing for the future challenges they face.

1. The Arrival of AI

In the rapidly digitising world, the integration of Artificial Intelligence (AI) across the financial services sectors presents immense opportunities. The global AI in insurance market size was valued at $2.74B in 2021 and is projected to reach $45.74B by 2031, growing at a CAGR of 32.56% from 2022 to 2031.¹ In banking the picture looks very similar. The global AI in retail banking market size was valued at $3.88B in 2020 and is projected to reach $64.03B by 2030, growing at a CAGR of 32.6% from 2021 to 2030.² The latest research is showing that investment in new digital technologies boosts productivity for early adopters while depressing productivity for slower firms, who may become less competitive over time.³ This impacts value chains and the traditional business models of financial institutions. The development of AI and the advanced use of data analytics also promise to disrupt traditional services.

According to the latest research from the World Economic Forum, over 74% of leaders see their organisations integrating Artificial Intelligence into their operations over the next 5 years.⁴ To keep up with this revolution, financial institutions must embrace cultural shifts and deal with systemic change. Leaders must also work on the integration between their innovation system and their overall corporate strategy while maintaining an opportunity-focused approach. The changing regulatory framework is also an issue of concern as it continues to govern the rules of the game and can greatly impact the activities of service providers. Therefore, a watchful eye is needed to keep up with regulatory change.

2. Dealing with Data

Big data will continue to impact financial services over the coming years. On one hand, it creates opportunities for financial institutions to understand customer behaviour. AI-based solutions use data to empower anti-money laundering (AML) capabilities and allow banks to increase innovation, accessing new markets through the provision of creative products and services. It is no wonder then that banks have been investing heavily in data collection and processing technologies.⁵ On the other hand, data privacy is a major concern and its use raises ethical issues that GDPR does not address. Transparency is important here, but financial institutions cannot always provide full transparency and disclosure. The algorithms used to drive AI-based technologies may also be unclear and can be difficult to communicate to users. As a result, it is important for leaders to work with regulators, towards the development of market standards and rules.

To take advantage of opportunities, firms must engage with other industry stakeholders to work on a common approach. This can be especially challenging when regulatory practices are fragmented across jurisdictions. However, if this is achieved it will help to create a framework around future innovation. Training and development are also important here, as organisations look to improve their capabilities. Similarly, leaders need to develop an approach to acquisitions that is targeted and aligned with the organisation’s overall strategic approach.

3. Cyber-Resilience in Shared Ecosystems

While new technology creates new opportunity, it also comes with its fair share of risk. Cybersecurity is of critical importance, at a time when attacks are becoming more frequent and attackers more capable. The variety of vulnerabilities are also growing in number as banks continue to outsource internal processes, shift services to the cloud and connect with customers through a range of digital channels. Internal fraud is also an issue of concern, especially in the context of slow detection times. Meanwhile, financial institutions are a target for more sophisticated criminal gangs with strengthening cyber-capabilities. With the average cost of a cyber-attack now standing at $1.67 million, these attacks can be significant.⁶

To address these challenges, providers must increase their cyber-resilience by implementing advanced application security protocols. Human error is often a factor, which can be minimised through training and adaptive systems development. A robust response to targeted attacks is also critical, including crisis management and the provision of technical expertise. Similarly, investment in recovery capabilities is key. This also creates new opportunities for providers of cybersecurity and developers of unique finance-orientated security solutions. Within this new financial ecosystem trust will be a crucial factor, as financial institutions, cybersecurity providers, retailers and consumers all connect and interact in new ways.

4. Sustainable Finance – Setting the Agenda

The drive to promote sustainable finance is a significant development. It represents a major component of the European Green Deal, which itself is at the forefront of the EU’s policy agenda. ‘The Green Deal comes with important investment needs, which we will turn into investment opportunities,’ said Ursula von der Leyen on announcing the plan.⁷ ‘The plan that we present today, to mobilise at least €1 trillion, will show the direction and unleash a green investment wave.’ Investment banks have been keen to respond, with Goldman Sachs targeting $750 billion in sustainable investment growth by 2030.⁸

While tackling climate change is a major challenge, how we implement sustainable finance across markets and regulatory domains will have major impacts on all organisations operating in the financial services sector. For this reason, financial institutions must engage in the policy development process as early as possible, particularly around the setting of the sustainable finance agenda. Failure to do so could see the policies and eventual regulations around sustainable finance move in more restrictive directions that give rise to greater uncertainties and risks. Business models will also change as capital flows are reoriented into sustainable projects and providers must be prepared for the impact this will have on their strategic options going forward.

5. Regulatory Convergence & Market Consolidation

The global financial system is both deeply connected and yet also segmented into many discrete markets. For national providers of financial services, this has offered protection from foreign entrants for some time. However, improvements in electronic payments technologies and drives for more harmonised regulation are eroding these traditional barriers to competition. The Financial Stability Board says international regulatory and supervisory cooperation is an important precondition for integrated financial markets and cross-border financial activity.⁹ All of this comes at a time when government initiatives are seeking to stimulate greater competition through means such as open banking. The net effect of these factors will be the eventual shift to greater market consolidation.

In order to stay ahead of these shifts, there are several things leaders across financial institutions must do. Firstly, they must be aware of the positions which policymakers are adopting, and crucially, how these positions are being formed. This can be challenging as globally we are seeing more divergence, while across the EU there is still a strong drive for greater regulatory convergence. This creates a complex environment of multi-directional regulatory change which financial institutions must navigate, whether they are a global player or a national incumbent. In turn this place pressure on leaders to develop an integrated strategy that works now and is futureproofed for the unfolding change and opportunity to come. As firms begin to implement their new strategies, we will likely see an impact on the forms of M&A activity, from both traditional financial services providers and newer fintech players.

6. The Drive for Unified Capital Markets

Capital Markets Union (CMU) has been long in the making. Now that this initiative has been adopted in Europe, financial institutions are looking to finalise its implementation. The EU says that CMU will provide businesses with a greater choice of funding at lower costs, offer new opportunities for savers and investors and supposedly make the financial system more resilient.¹⁰ The integration that CMU offers could help to foster economic growth and banks are waiting to take advantage of this and the opportunities it brings.

However, to fully engage the opportunities that CMU will create, financial services provides must be ready to adapt quickly to the new ecosystem that will emerge. There are concerns that EU financial institutions will not be able to compete on the same footing as some of their larger international rivals as EU competition rules could favour foreign players.⁹ Tied up with this is the fierce political debate around the room for and emergence of regional champions. As CMU moves closer, organisations will have to adapt and move into new markets quickly to achieve scale. However, they must also be mindful of the relevant cultural, administrative, geographic and economic divergences that exist between new and home markets. This will necessitate modular approaches to business strategy across markets and regulatory domains and likely involve more engagement in local level innovation.

Conclusions

While the trends outlined above will impact the financial services sector over the coming years, they bring challenges and opportunities to traditional institutions and new fintech providers. In order to protect themselves against the risks associated with these trends, business leaders must work to develop a strategic approach that integrates innovation with new service offerings and financial products. This must also take place in the context of the ever-changing regulatory environment, where institutions work with policymakers to lead the way.

References

1. Beesetty Y, B. Pramod, and K. Vineet, AI In Insurance Market. 2022, Allied Market Research.
2. Pramod, B., K. Shadaab, and K. Vineet, AI In Banking Market. 2021, Allied Market Research.
3. Dedola, L., et al., Digitalisation and the economy, in Working Paper Series. 2023, European Central Bank.
4. The Future of Jobs Report. 2023, World Economic Forum.
5. Finextra, Big Data in the Financial Services Industry – From Data to Insights. 2019.
6. Neave, R., Cyber Attacks: Protecting the Financial Service Sector’s Data Centres. 2019: The Fintech Times.
7. Financing the Green Transition: The European Green Deal Investment Plan and Just Transition Mechanism. 2020, European Commission.
8. Dilts Marshall, E., Goldman Sachs Pledges $750 billion to Environmental Causes by 2030, in Reuters. 2019.
9. Board, F.S., FSB Report on Market Fragmentation. 2019.
10. What is Capital Markets Union? 2019, European Commission.