When a bank that is solely in the virtual world takes care of global payments, P2P fund transfers, contactless Mastercard with no transaction fees added, and a change to purchase and exchange cryptocurrencies like Bitcoin, Ethereum, and others, the financial society blazes in response to it.

The COVID-19 pandemic has had a sudden influence on the digitalization of business activities for all types of businesses. Banking is no exception. During the last few years, the number of consumers who visit the bank branch and do their banking transactions has dropped sharply. This article aims to illustrate the enhanced impact of digital banking on the finance world.

When one thinks about the digitalization of global banking systems, the first term that comes to mind is “Internet banking.” How is offline banking different from online banking? Sometimes people do not use the word strictly, as they often mean other things that are different from the definition of the word. This is why, for most people, the terms digital banking and online banking are often used interchangeably.

In reality, they are two separate concepts, each with its own legal and ethical issues. As for online banking, the core activity of a bank involves being online. These consist of deposits, withdrawals, money transfers, and bill payments. However, it is not possible for more advanced transactions to be performed without actually going to a branch. Consequently, online banking belongs to the category of tools that work hand-in-hand with its branch-based peers.

In the case of digital banking, the entire banking service is made available through the internet. You can access the digital bank through an app or its website. All operations that a consumer avails of through a traditional bank branch can be availed of through the app. It embraces automated processing of requests from consumers and removes the hassle of paperwork completely. Digital banking  involves a high degree of process automation that involves programming interfaces (APIs) for cross-institutional services. This financial data can be accessed via desktops, mobile phones, and ATMs. 

“Technology is having a huge impact in driving the banking sector forward to provide a better service to more users.”

• Schuyler Weiss 

Digital banking has grown rapidly, but customer behavior hasn’t shifted much. Only a small fraction of customers rely on their main bank for various financial products. Additionally, a significant portion of British adults have opened accounts with online-only banks.

Financial institutions such as N26, Starling, Monzo, and Allica Bank have completely disrupted the norm of banking the traditional way. With no legacy systems to contend with, this space has been more nimble in responding to changing consumer behavior, shifting the focus to digital banking instead. Despite challenges in funding and valuation, fintech investment remains robust, with traditional financial institutions increasingly acknowledging the competitive threat posed by digital challengers.

To compete effectively, traditional banks are exploring innovative strategies. One approach involves leveraging low-code tools to rapidly develop new services, reducing reliance on legacy systems. Collaboration with external partners is also critical, enabling traditional banks to reach new demographics and reshape their brand image.

However, trust remains a cornerstone for traditional banks. While their long-standing reputation for financial stability offers a competitive advantage, they must also cultivate trust in digital channels, where modern consumers interact most frequently. Despite this, conventional banks remain strong with their diverse range of service offerings, although new contenders are progressively diversifying their offerings through collaboration deals.

The evolving banking landscape presents both challenges and opportunities for traditional institutions. While competition intensifies, it also drives innovation and forces traditional banks to modernize and adapt. Success in this dynamic environment hinges on embracing change and investing in strategies to remain relevant in an increasingly digital world.

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Among all the banking service and over-charging stories you hear about, there is an even bigger concern. Will you ever see your money again? 

Conventional banks not only seem to have challenges serving digital businesses well, while charging them top dollar, but continuing bank failures show that they are also putting their deposits at risk.

Come to think of it, why do we even need the things we call “banks” today? This is a call to get back to the basics – banks with a cost-effective transactional business model that removes the need to put clients’ funds at risk by chasing high returns, and keeps those funds in the safest place possible – central banks – should the worst happen.

Bank failures are more common than you imagine

You may think that your bank deposits are safe because they are insured by government-backed  deposit schemes. But the recent spate of bank failures shows that banks are not inherently safe, and that deposit guarantee schemes have their limits. Even when deposits are guaranteed, it can take months to get your money. 

In March 2023, Silicon Valley Bank (SVB), the 16th largest commercial bank in the US and the preferred bank for nearly half of all US venture-backed technology and life science companies, collapsed in the US banking system’s third-largest failure. About 89% of the bank’s $172 billion in deposit liabilities exceeded the maximum insured by the FDIC (Federal Deposit Insurance Corp) and would have been wiped out without exceptional authority from the US Treasury to guarantee all deposits.

In the same month, Signature Bank, a regional bank based in New York with $63 billion in assets, also failed after being hit by a wave of withdrawals and lawsuits related to its involvement in several fraud and money laundering scandals. The FDIC was likewise forced to guarantee all deposits at Signature Bank. But do these latest exceptional measures to protect deposits only serve to encourage yet more reckless behaviour by banks in the future? 

This is far from theoretical. There are many cases around the world where depositors have lost some or all of their money due to bank failures. In fact, more than 550 US banks shut down from 2001 to 2023, according to the (FDIC). And as inflation reemerges as a feature of global economies, the risk of future bank failures is considerable.

Banks are not efficient

You may think that your bank offers you a range of useful services. But do you really need all of them? And do you know how much they cost you?

The reality is that banks’ costs are escalating as regulatory requirements increase. Anti-money laundering (AML), know your customer (KYC) and counter-terrorism financing (CTF) precautions impose costs that have to be passed on to customers. Banks are not known for their operational efficiencies to offset these costs. They have legacy systems, complex structures and high overheads that make them slow and expensive. These additional costs not only strain businesses’ already-tight budgets but also hinder their ability to grow and thrive. 

In search of additional profits to cover these costs, banks offer an increasing range of peripheral add-ons that further increase their costs and make their business models unwieldy. They can also be tempted into business areas where margins and risks are higher, such as derivatives, cryptocurrencies and subprime mortgages. These activities expose them to market fluctuations, credit defaults and regulatory fines.

Even where banks are not taking on higher risks, things can still go very wrong, as SVB demonstrates. SVB was holding a lot of safe, interest-bearing US treasuries. But, as the Federal Reserve increased interest rates, the market price of those treasuries dropped so much that SVB was no longer able to cover all withdrawal requests if it were forced to sell them in the event that all its depositors demanded their money. 

The result is that the traditional banking model is neither safe nor efficient. The base services are priced low but topped up with high “optional” fees for services that digital businesses may not need or want. And, to cover loss-making base services, the model puts depositors’ money at risk, regardless of whether banks adopt high- or low-risk strategies to generate income.

What digital businesses need

So what is the alternative? What digital businesses need is a stripped-back form of banking where the institution is licensed and protected by its home central bank but where its focus is simply transactional: enabling businesses to receive and make payments. Let’s call it a transactional bank.

This is already possible in certain jurisdictions. In Lithuania, where Nexpay is located, the central bank has been progressive in providing central bank infrastructure access to new banks and EMIs (Electronic Money Institutions). Because Lithuania is a member of the Eurozone, the funds held with the central bank are ultimately held by the ECB, which is about as secure as it gets. 

Businesses still need to be selective, of course. A neobank with ECB protection can still be bloated with unnecessary products and costs. But there are now solutions out there offering protection and low-cost payment solutions across Europe and beyond, using innovative technology and streamlined processes. Such operators do not offer any other services that would increase costs or risks. They simply enable their customers to move money safely and efficiently, avoiding exposure to risky activities and invoking the peace of mind that comes from knowing that deposits are backed by the ECB. 

It is high time we considered a new banking model that prioritises safety, cost-effectiveness, and simplicity, enabling digital businesses to thrive without unnecessary frills and risks. This is a call for a stripped-back form of banking where the institution is licensed and protected by a credible central bank, ensuring the ultimate guarantee of deposits. By shedding all the unnecessary bells and whistles that conventional banks have accumulated, transactional banks can deliver a cost-effective, secure service tailored specifically to the digital economy.