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Virtualization of financial services: A balancing act between innovation and security

Financial institutions are becoming more software-based, which can increase cybersecurity risks.

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Quantumrun Foresight
July 25, 2023

Insight highlights

The financial services industry is gradually adopting software-based solutions, enhancing contactless functionality, and transforming devices into point-of-sale (POS) terminals. This transformation, accompanied by emerging trends such as virtual branches and AI-driven virtual assistants, is reshaping customer interactions and boosting personalization. However, this shift also brings potential risks from quantum computing, the need for new regulatory frameworks, and increased reliance on artificial intelligence (AI) and big data.

Virtualization of financial services context

The financial services industry, traditionally known for its risk aversion and conservative IT practices, is shifting towards more software-based security measures. Financial institutions have historically relied heavily on hardware-based security features, including physical air gaps between systems and secure element chips isolated from all other phone hardware. However, the opening up of these secure elements to third-party access has been slow, with Android leading the way through Google Wallet and Apple gradually offering limited access for applications such as hotel and car keys.

This evolution is changing the landscape of contactless functionality, offering opportunities for integration into customer experiences and data sources. Notably, in 2022, Apple introduced a "Tap to Pay" feature transforming any Apple device with a near field communication (NFC) system into a software-based point-of-sale terminal (softPOS). Software-based security solutions, such as those offered by companies like V-Key, are becoming powerful enough to replace expensive, custom-built hardware, thus changing how secure terminals are deployed.

This shift benefits merchants as it reduces or eliminates the need to purchase and maintain costly POS hardware. However, the evolution to software-based security is not without its challenges. The advent of quantum computing poses potential risks, given its powerful decryption abilities, raising questions about the future necessity of physical security barriers. As these changes unfold, the financial services industry needs to continue to balance innovation with the ongoing need for robust security measures.

Disruptive impact

Aside from e-wallets, one of the emerging trends in financial service virtualization is the virtual branch. It goes beyond providing simple online banking facilities by offering real-time interactions with bank staff. This feature allows for a more personalized customer experience and the delivery of tailored, value-added services accessible from the comfort of one's home or office.

Moreover, the use of virtual assistants and chatbots powered by conversational AI is rising as the frequency of branch visits by customers decreases. It's becoming commonplace for many financial institutions to develop their own AI-driven virtual assistants, either independently or in collaboration with tech providers. The COVID-19 pandemic has acted as a catalyst, fast-tracking the adoption and approval of chatbots and virtual assistants. When combined with other technologies, these tools offer the potential for personalized services and interactions, enhancing the customer relationship.

Another area that is significantly enhanced by virtualization is customer data. Data visualization, a process that allows financial institutions to consolidate data from varied sources in real-time, facilitates the creation of customized financial products and services. It provides a holistic view of customer information gathered from core banking systems, enterprise databases, online platforms, and mobile apps, improving the understanding of customer behaviors and preferences. Beyond customer-facing benefits, data virtualization enhances internal processes like risk management and compliance by offering a comprehensive picture of risk exposure.

Implications of virtualization of financial services

Wider implications of the virtualization of financial services may include:

People in remote areas or underprivileged communities having access to financial services.

A reduced need for physical branches, leading to cost savings for institutions which can result in lower fees, increasing competition in the financial services sector.

New regulatory challenges around cybersecurity, data protection, privacy, and cross-border transactions, requiring new international legal frameworks and cooperation between countries.

A worsening digital literacy gap. While younger generations who are digital natives might readily embrace virtual financial services, older generations might be left behind.

Increased reliance on AI for risk assessment, customer service (chatbots), and fraud detection. Similarly, the importance of big data will rise as more data points are available for financial institutions to make decisions.

Job losses in traditional financial service roles, particularly face-to-face interactions, such as tellers or customer service representatives. Conversely, it could also create jobs in cybersecurity, data science, and AI in the finance sector.

A positive environmental impact by reducing the need for physical infrastructure, paper-based processes, and commuting to banks. However, increasing energy needed to fuel data centers might offset these benefits.

More innovative products and services like peer-to-peer lending, crowdfunding, microloans, digital wallets, and cryptocurrencies, democratizing finance but also creating instability if not properly regulated.