Unpacking the AI puzzle

A FIERCE battle for the consumer is ahead in the financial industry, as the use of artificial intelligence (AI) will bring about speedy commoditisation of the service, punishing the incumbents who loathe collaborating with new data-driven players or who are too slow to innovate.

But the path ahead is far from certain when it comes to AI strategies, as the long-term impact on competitive advantage from collaboration in the data economy remains murky.

Meanwhile, cybersecurity risks from the concentration of services lurk.

These are some conclusions on the impact on AI according to the World Economic Forum, which prepared in collaboration with Deloitte a comprehensive report on the state of play in the use of AI in financial services. The report was published in August following more than 200 expert interviews and 10 months of research.

Here, the report defines AI as a suite of technologies enabled by adaptive predictive power and exhibiting some degree of autonomous learning.

Such AI technologies have helped to advance businesses' ability to use machines to automate and enhance works in the areas of pattern-detection, customisation, decision-making, and customer interaction.

Radical

"Over the past year, we have engaged in what may be the largest study of its kind into AI in financial services. And through this process, we have discovered that the long-term impact of AI may be even more radical and transformative than we first imagined," the report said.

"Indeed, the central thrust of the document that follows is that the very fabric of the financial services ecosystem has entered a period of reorganisation, catalysed in large part by the capabilities and requirements of AI."

One major theme is the urgent need for financial services to differentiate themselves from one another, or face the clear risk of being a middling business that can be swallowed up by the competition.

"The economics of AI will push market structures to extremes, favouring scale players and agile innovators at the expense of mid-sized firms," the report said.

It further pointed out that information technology has always driven firm structures to market extremes, in part given the winner-take-all dynamics. AI accelerates this phenomenon.

For one thing, AI can improve search and database technology, and create customised products to meet the unique needs of customers who were previously underserved.

"AI makes niche products cheaper to build: As AI automates back-office processes, new products and offerings have a low marginal cost, improving the economics of offering niche products," the report added.

It also improves the returns to scale. As search costs are cut, scale players would have a natural advantage in offering the cheapest products.

"Aggressive competition will lead to consolidation among scale players. In order to retain the favour of recommendation algorithms, scale players will maximise their economies of scale, focus on key products and divest from non-core activities in order to improve price and performance metrics."

What should also emerge from such competition is more diversity in terms of product offering.

"As more niche players enter the market and try to fill unique and underserved needs, consumers will have access to new and different products that better fit their financial requirements."

Even where there is no such consolidation, the report warned that margins will be squeezed for institutions that do not build new ways to differentiate themselves.

"Institutions that are slow to implement new ways of differentiating their products face an uphill battle maintaining margins, especially after traditional metrics such as price and speed are normalised due to technology."

Related to this, the report noted that self-driving finance will "upend existing competitive dynamics".

"This will push returns to the customer experience owner while commoditising all other providers," it said.

"Ownership of customers will be sticky as self-driving agents become more accurate as they learn and collect more data. This will allow owners of customer experiences to exert market power and accrue the lion's share of profits available."

Furthermore, a large reduction in risk from mis-selling is anticipated, as sales activities will be performed through self-driving agents rather than human sales staff.

But the report also pointed out in the same breath that in the event of misconduct, it will be on a much larger scale due to the connectivity of AI.

'Frenemies'

Meanwhile, the rise of AI will bring about an era of uneasy data alliances between technology firms and the incumbents, the report noted.

"Data partnerships emerging out of necessity will have winners and losers as some firms are pushed to the periphery and others emerge as ecosystem hubs.

"In order to access the full benefits of AI, institutions will be pushed to enter into data partnerships for short-term opportunities."

But there are risks on the horizon.

For one thing, institutions that become dependent on data flows from partnerships may become locked in "unfavourable" relationships, the report said.

"Partnerships are proliferating across the financial services ecosystem, but only time will tell if these relationships drive sustained value.

"We observe that data partnerships are currently in the early stages of being formed, but are not yet at the stage where tensions have major impact.

"By positioning themselves as the critical link across the ecosystem, firms can turn other participants into commoditised service providers. Tensions arising from this may limit the longevity of emerging alliances."

The report also noted that global data regulations are undergoing a period of unprecedented change.

Among other things, the new Payment Services Directive of the European Union came into force in January to prompt more innovative payments across Europe.

This comes alongside the General Data Protection Regulation, which means institutions have to "carefully balance requirements to share data with third parties against the risk of substantial penalties in cases where data is mishandled", the report said.

Control

In the years ahead, governments will have to look into managing a digital ID system to spur more innovation in this area.

"Digital identity systems will be critical to managing personal data flows. As consumers gain increased control over how their data is used, they will need a consolidated point of control to easily manage consent and authorisation," the report added.

Finally, the report flags the possible short-term pain that will come from the use of AI.

"In the immediate term, there is risk that unemployment rates rise: As AI digitises and automates routine roles, there will be a net displacement of talent unable to rejoin the workforce with their existing skills.

"The initial rise in unemployment will create the perception that AI is worsening society rather than improving it.

"For society to overcome these harms and embrace AI, the technology must be developed to a level where it is pervasive. Although this may be technologically feasible, there will need to be a shift in priorities to encourage innovation and longer-term thinking, within and outside formal institutions."

The report thus called for a new social compact between society and businesses for the long term.

"The benefits of AI will be maximised only if societal structures and processes adapt to support new ways of working.

"By aligning with and enabling AI innovations, while working to address challenges, institutions and social structures will likely see prosperity that justifies AI-driven growth."