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How to build a digital bank

In our previous blog post we explored the various stages involved in developing a winning business 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.

You might ask what is the difference between the business plan and the target operating model. In simple terms, the former will outline the kind of entity you want to create and the latter will give you the process for putting it all together.

A target operating model consists of blueprints that include information about how work is executed in the organisation and how information is exchanged (processes); systems and tools that are required to empower an efficient execution of the processes (technology & systems); organisational structure and roles and responsibilities (people & organisation); and the regulatory setup under which a bank operates (regulations – of which more in the next blog in this series).

The first step is to define the regulatory framework as generally all financial service providers must be licensed. In parallel, we detail the key activities and processes required to run the business. These activities and processes provide the required inputs to design the technology stack and systems. To complete the operating model, we detail the people capabilities and way of working to run the digital bank.

The key processes should be detailed in an end-to-end description of the process flows. In the case of an extensive and complex value proposition consisting of multiple products and services, it is common to use process mapping or workflow diagrams to represent multiple identified end-to-end processes such as customer onboarding, payment transactions, loan applications, and customer service.

Process mapping enables you to identify potential inefficiencies, complexities, and limitations of understanding. In addition, it is the first step into process automation driving operational efficiency and customer experiences. Therefore, it is crucial for digital banks to have a clear view on the processes and optimise them from the start.

Generally, the processes and activities of financial service providers can be grouped into three organisational domains: commercial; operational; and finance & risk.

End to end

The commercial domain, also known as the front office, is responsible for managing customer relations and product sales. This includes providing customers with information and advice, distribution of products and services, and customer service and is are coupled with supporting departments such as marketing, product management, innovation and business management.

Traditional banks tend to rely more on physical branches and human interaction whereas digital banks are built around technology, servicing customers via digital channels only with largely automated services. Digital banks usually opt to digitise their customer service (for example, by using chatbots), but may also choose to run a customer service department to be reached via phone, mail and/or chat.

Product management and innovation play an important role in bridging the gap between the front- and back-end domains. Their role is to manage and innovate the product portfolio throughout the entire value chain, with the goal of optimising the customer experience and operational efficiency.

The operational domain, also known as the mid-office, oversees and manages the bank’s infrastructure, operations and general administration. This infrastructure most importantly includes the IT systems and technology stack (architecture, hardware and software, computer networks), accompanied by related activities such as security and fraud management.

Operations includes the administration of customer onboarding, payment transactions, credit applications, and anti-money laundering among other services. General administration consists of staff functions such as general management, strategy, human resources, legal and audit.

The finance & risk domain, also known as the back office, is responsible for managing the balance sheet and related risk management. This includes supporting departments such as control, financial planning, regulatory compliance & reporting, performance management, and accounting.

Nevertheless, when growing the company and expanding into new product segments such as personal loans, it is crucial to acquire the right skillset to manage the credit risk and prevent large potential losses.

Core technology

With the ongoing digitisation of banking, technology and systems have become ever more important.

As technology forms the heart of digital banks, it is therefore vital to design a modern and well-functioning technology stack.

The technology requirements are derived from the value proposition and key processes. Typically, the main requirements for digital banks are to accommodate real-time and 24/7 on-demand availability of services, flexibility and scalability of infrastructure, a 360-degree customer view on their profiles through leveraging data from various touchpoints, and efficient omni-channel stage management.

Traditionally, banking IT architecture was designed from a product perspective resulting in a product-oriented service approach. However, in order to be able to deliver a superior customer experience, digital banks ought to take a client-centric approach in designing their IT architecture. Such IT architecture can be divided into three main layers, with the emergence of the API layer and (external) business applications.

The back-end includes all back office related processes, the core banking system or CBS, and client information. The back-end administers processes such as customer information, payment transactions, loan issuance and deposits.

The core banking system is the technological heart of a bank. Banks - both traditional and digital - typically leverage existing solutions from service providers as opposed to maintaining their own (proprietary) core banking systems.

In recent years a new generation of core banking system providers has emerged, more tailored to the needs of digital banking. Serving both fintech start-ups and incumbent banks, these modern providers typically offer more flexibility, scalability and interconnectivity at significantly lower cost.

Modern core banking technology is cloud native, enabling automatic scaling capacity, continuous development and software deployment, and instant creation of new environments via code. In addition, it offers a single view of the customer, separate from core banking platforms or data warehouses.

This enables a more effective and personal customer experience, together with better insights into business and product performance. Furthermore, the technology is reusable across all channels, creating ‘product factories’ with clean, standardised integration.

Connecting it up

The middleware is the software layer that helps connect the back-end with the front-end and business applications. Middleware acts as a system orchestrator, connecting all layers and reducing the need to involve the core banking system in every single customer interaction.

The front-end is the visual layer through which customers interact with the bank, providing the customer experience. This includes, for example, mobile and online banking channels, together with third party channels such payment gateways, financial market places, and ATMs.

Digital banks can develop their front-end fully in-house or in-source solutions from external software and BaaS solution providers who typically offer customisable white label solutions. The choice of in-sourcing depends on the level of customisation required as well as timing, cost and flexibility.

The API layer is an alternative layer to connect with external third party applications providers to seamlessly integrate their services. With the advent of open banking, composable banking and so-called ‘superapps’, third party integration has become an integral element of banking and has led to heavy API layer investments.

The API layer also typically functions as a sandbox to test new services in an isolated environment. Third parties can test responsiveness in the sandbox before moving on to full integration.

Traditionally banks have relied on financial advisors, loan application experts and customer service specialists with extensive (financial) product knowledge. Due to their customer- and technology-centric nature, digital banks leverage a different skill set.

Most importantly, digital banks require people with a deep and thorough understanding of technology and the ability to utilise the opportunities that come with it, now and in the future. Key areas of expertise include artificial intelligence (AI), machine-learning, blockchain or distributed ledger technology, cybersecurity, cloud-computing, big data, and data visualisation.

The most important skills are customer-centric thinking, UI/UX design, programming, agile working, and decision making. Core capabilities enabling this include cognitive flexibility and adaptation, emotional and social intelligence, accurate judgement, analytical thinking, and structured creativity.

In addition, digital banks benefit from strong relationship skills capable of managing a variety of partnerships; digital marketeers with a deep understanding of behavioural economics; and product owners with a customer-centric mindset coupled with business development skills such as programming.

Agile work practices

With a heavy reliance on technology, digital banking also adopts a different way of working; agile is the prevailing approach. With its roots in software development, it aims to improve agility by rapidly developing solutions and iteratively improving them in cross-functional teams with a customer-centric focus.

This way of working is necessary as the pace of technological innovation is increasing and time-to-market is ever more important for achieving success.

Traditionally, banks would focus their agile efforts mainly in IT and operational departments. However, it should be embedded across the entire organisation to fully reap the benefits.

After designing the organisation, structured project management will allow you to successfully set up the digital bank. This requires the right project team and tight control of the budget and planning.

The core team building the digital bank should have a solid understanding of the value proposition, the technology and the business model, combined with the skills and expertise to run the project. This includes full-time members as well as temporary involvement from experts in critical areas, such as regulatory compliance.

A project plan should address the timeline and key milestones with a project manager overseeing realisation. Key milestones typically include securing the first round of funding; obtaining the regulatory licence; launching the MVP; and acquisition of the first customers.

In parallel with timelines and key milestones, it is vital to keep track of the budget and cash flow management since the absence of revenues, negative cash flows will be the limiting factor in realising the plans.

The financial runway for a start-up bank should typically accommodate the first 12 months in order to obtain the licence, build the technology and launch the MVP. After achieving these milestones, it should be feasible to secure new funding.

Coming up

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