Are traditional banks living on borrowed time?

When banking safety took center stage

The narrow banking concept emerged as a political and regulatory response to early 20th-century America’s volatile boom-and-bust economy.

In the wake of the 1930s Great Depression, economists at the University of Chicago proposed the “Chicago Plan,” which replaced the fractional reserve system with 100% reserves on demand deposits, what we now call “narrow banking.”

The idea was for banks to hold only liquid, safe government bonds instead of loans or other equities, preventing bank runs by avoiding speculation with depositors’ money.

Under this plan, banks would stop making loans; instead, loan funds would handle lending, allowing investors seeking risk to channel money through these funds.

The digital sprint that’s leaving classic banks behind

Digital banks are sprinting ahead, and modernization is the key remedy for outmoded processes and systems. Banks founded in the 20th century or earlier (C20 banks) must modernize fast to compete. AI solutions are part of the answer, but they’re insufficient in isolation.

Today, bankers are free to make risky bets (loans) with risk-free money (deposits). But reality bites. Banks must comply with pervasive, post-credit-crunch regulations. Capital adequacy means they must hold 8% Tier-1 capital for the risk-weighted assets on their balance sheet, so decision makers must carefully consider any loans they choose to hold.

Private credit takes speculators’ money and deploys it in interesting ways. Its MO traces that of the loan funds as proposed way back in 1930. If people want to risk money for a handsome return, here’s a smart way to do it. In fact, private credit is oversubscribed, with investor money eclipsing investment opportunities.

By making loans and offloading them to private credit, traditional banks are quickly becoming little more than client acquisition engines, a role they’re not built for.

What keeps customers loyal to traditional banks?

Why do clients stay with traditional banks when new digital banks provide a better customer service and offer equally fine products at lower interest rates?

Until now, banks have been protected because of consumer apathy when choosing financial partners. However, new entrants are already finding ways to combat this entrenched passivity. A great example is Chase UK, which launched in 2021 and was voted Best Bank 2024.

Legacy technology and processes make competitive innovation harder to achieve. Digital banks have taken advantage of this by offering improved customer experience and capturing new clients.

However, they frequently fail to provide the same range of financial products. As private credit becomes the ultimate holder of consumer debt, digital banks can introduce a product range equal to that of traditional banks. 

So, what’s the answer?

First, change is well understood but processes begin to calcify and stagnate as soon as they’re introduced. Breaking out of these restrictive operating models requires a deliberate shift from a culture of change aversion to one of embracing transformation.  Executive sponsorship, enterprise digital twins, silo removal, and proactive communication are essential to making change stick.

Second, AI creates new opportunities to accelerate technology modernization. While AI-driven code conversion is common, advanced teams now use AI for full end-to-end system delivery—not just line-by-line translation. Systems once limited by time and cost can now be fully modernized.

Narrow banking by stealth is both a crisis and an opportunity. With the right twin approaches, C20 banks can remove the outdated processes and systems holding them back and regain their competitive edge.

Go deeper

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• DXC and Thought Machine launch solution to speed banking modernization [DXC Newsroom]
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