Digital innovation in financial services is placing a premium on efficiency and opening up competition that will continue to drive disruption across banking business segments, including payments, lending, capital markets and wealth management, Moody's Investors Service says in a new report.

Agile incumbent banks, that consistently assert digital leadership, will thrive and prosper, while laggard banks that lack the vision or resources to develop competitive digital strategies will be disrupted. Aging legacy financial platforms have created opportunities for new nimble entrants to capture a portion of banks' profits by offering more customer-focused, responsive and efficient channels.

Moody's says the bank of the future will cater to high and rapidly evolving customer expectations by harnessing key enabling technologies, leveraging increasingly mature and dependable digital distribution channels, and applying these tools across multiple businesses and product segments. Customers will gravitate to providers that best meet their demands for convenience, personalization and affordability, with privacy and data security a growing competitive differentiator. Amid the shifts in technology and consumer demand, competition will stiffen among banks, big technology companies and small fintechs.

"In the face of these threats, successful incumbent banks will be those that, either on their own or in collaboration with others, pursue aggressive digital transformation to become more efficient and responsive to evolving customer demands," Fadi Abdel Massih, a Moody's analyst and co-author of the report says. "Disintermediation of the customer relationship would be a threat to this business model if it ends up reducing banks' pricing power by transforming them into providers of a 'back-office' balance sheet for customer-facing apps/businesses."

Digitization will offer efficiency enhancement opportunities for incumbent banks through the optimization of branch networks, data collection, analysis and reporting process but not without high initial investment.

To date, regulatory requirements have been a moat protecting incumbents. The traditional, more regulated banking model -- reliant on cheap, sticky deposits -- retains a significant advantage for incumbents over non-bank platforms. However, recent regulatory initiatives signal increasing openness to fintech. "Regulatory sandboxes and open banking initiatives indicate a shift in authorities' willingness to encourage innovation and competition," Megan Fox, a Moody's assistant vice president-analyst and co-author of the report says.

Competitors may opt to avoid regulatory barriers by relying on a bank partnership to satisfy regulation. In this disruptive scenario, banks would remain subject to all regulatory requirements, while "white labeling" their products, and big tech partners will hold the key customer relationships and avoid regulatory barriers.