Data innovation and technology are a much discussed but rarely successfully implemented in large financial services firms.  Despite $480 Billion spent globally in 2016 on financial services IT, the pace of financial innovation from incumbents lags behind FinTech which received a comparatively puny $17 Billion in investment in 2016.  What lies behind the discrepancy?

We provide a unique vantage point, having pushed for enterprise-wide innovation from inside Credit Suisse and having worked closely with a dozen major financial institutions to develop and train their big data and innovation talent at The Data Incubator.  Drawing on that experience, we have identified four consistent obstacles to adoption of data and innovation.  These obstacles are: organizational structure, constrained budgets, data talent gap, and legacy cash-cow businesses.

Organizational structure

Large bank’s organizational structures block digital innovation, which demands a re-imagined value chain or further, true platforms that cut across traditional functional and hierarchical divisions.  Functionally, a typical bank organization consists of IT, usually a cost center, a product/solution manufacturing department, and client-facing or sales units. In an digital born company, these divisions do not exist and the firm leverages  a single automated platform that operates seamlessly across these activities.

It’s not just divisions but bank hierarchies that can impede innovation. Visionaries at the top may see the threat but be too distant from the day-to-day to adequately address it.  Millennial employees at the bottom are eager but not institutionally powerful enough, and the largest population, the middle management layer, defend their hard-won positions, fearing job losses to automation.

Constrained IT budgets

We often hear the argument that banks’ multi-hundred million dollar IT budgets allow them to outspend FinTech upstarts operating with limited resources.  But observers fail to note that keeping legacy systems alive and compliant with regulations consumes 80-90% of those bank budgets.  This is particularly for banks that run on disparate systems, loosely glued together, built through multiple acquisitions (which is the majority). Despite large budgets, banks actually have very limited resources for IT innovation.

They also operate on a timescale incompatible with contemporary technological developments.  Many still rely on a sequential (non-iterative) waterfall model for software design designed in the same era as their computer systems.  Meanwhile nimble FinTech upstarts use agile development processes that center on iterative feedback, cloud platforms, open-source code, mobile-first approaches deploying a structurally cheaper technology cost curve to reach customers.

Data Talent Gap

Companies (especially legacy ones with tonnes of historical databases) often speak about data as a strategic asset.  But even more important than having lots of data is the capacity to derive actionable analytics from it.  Often, data sharing is inhibited by competing departments looking to protect their database turf or an overly-strict division of responsibilities where IT needs to pull data from the system before analysts can analyze it.  These problems are compounded by non-standardized database systems that are a legacy of multiple acquisitions.  In contrast, Fintech startups employ a “permissions on by default” philosophy that democratizes and breaks down barriers to data access.  They invest in standardizing their data systems and hiring and training the best data scientists.  These jack-of-all trade analysts are capable of handling both data extraction and analysis and embedded across the company, building a self-service culture that cuts out delays and potential sources of error in the analytics pipeline.

Legacy cash-cow businesses

Banks are reluctant to cannibalize existing high margin businesses threatened by automation. Digital businesses reconfigure value chains, and operate at 1/10 to 1/100 the cost. Prices for many financial intermediation services are falling broadly, and digital automation and programmable APIs are facilitating interoperability and adding fuel to the fire. Banks realize this, and will milk cash cows as long as they can rather than accelerate the transition to the disintermediated digital world. Further, they may even miss the strategic implications of automation by co-opting digital solutions to defend established businesses. For example, using a robo-advisor to distribute proprietary ETFs defeats the very purpose of the robo-advisor and defers the inevitable unbundling of mutual fund and ETF structures that are no longer needed in a digital world that can assemble optimal portfolios with fractional shares tailored to a client’s unique risk profile.

How financial firms can innovate

To overcome many of these barriers, companies need to stop viewing data and innovation as cost-center functions and start viewing them as potentially business transformative capabilities. We’ve helped clients at large firms successfully implement “Innovation Groups” or “BIg Data Centers of Excellence.”  Regardless of the name, these departments spearhead efforts to drive innovation and data literacy throughout the company, working with key stakeholders to defining internal best practices, hosting firm-wide trainings to increase data literacy and data culture, and sponsoring internal accelerators to identify and promote innovative ideas originating from throughout the company.  When new innovative projects are identified, they often need to be put into a new division to free them from traditional org-chart bureaucracies and legacy cash cow businesses.

This risks involved can be daunting, especially given the substantial investment required to see any new initiative through.  Managers can mitigate the risks by borrowing a page from the VC handbook: making scaled, strategic bets, looking for quick wins and doubling down on early successes while being disciplined about shutting down unsuccessful projects.  Today’s financial-services incumbents face a true innovator’s dilemma and they must make the hard decisions necessary to innovate, sometimes at the expense of their own businesses, or face extinction in a rapidly innovating environment.

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Interest in fintech disruption is at an all-time high, but who will be the winners and who the losers is far from clear. Banks themselves have been sending mixed messages. As a particularly high profile example, JP Morgan Chase CEO Jamie Dimon famously raised the alarm when he said in 2014 that fintech challengers “all want to eat our lunch. Every single one of them is going to try”. This year, however, he sounded more sanguine: “It will be a challenge for anyone to be better, faster, cheaper than us.” In the meantime, PWC reported that 95 percent of the bankers that it surveyed “believe that part of their business is at risk of being lost to standalone FinTech companies” – although we do not know which are the concerned banks, how exactly they think their business will be affected, and what they plan to do about it.

Individual bankers’ opinions are one thing, but if a publicly held bank is sufficiently concerned about the fintech threat, it arguably has a responsibility to inform its shareholders about this. In particular, U.S. listed corporations discuss competition in their electronic annual reports (also known as Form 10-K) which are mandated by the Securities and Exchange Commission. So, what do U.S. bank holding companies – of which there are over four hundred – actually say in their 10-Ks about competition from fintech? This is the question my co-authors Sinziana Bunea at the University of Pennsylvania and Benjamin Kogan at FinTxt and I set out to answer. The results surprised us.

First, given that fintech has been increasingly in the news since the financial crisis, we were surprised that the earliest mention of it was only this year – specifically, on February 17th, early on in the filing season. The identity of the first fintech-mentioning bank was also unexpected: Huntington Bank, an important regional bank headquartered in Ohio, but hardly a household name. The subsequent dozen or so filers kept mum about fintech. But on February 23rd, JP Morgan itself acknowledged competition from fintech, and this appears to have opened the floodgates. Over the following week a full ten banks mentioned fintech in their filings for the first time. By the time the dust settled, a group of 14 U.S. banks had explicitly informed their investors that they regarded fintech as a potential threat.

The composition of this 14-bank group is also puzzling. It includes three of the nation’s top-ten  banks (JP Morgan, BNY Mellon, and PNC) together with nine regional players with assets in the billions (Beneficial, First Interstate, Horizon, Huntington, Iberiabank, SVB, UMB, Umpqua and Zions) and even two minnows with under a billion dollars in assets (Hamilton and CSB). What do these banks have in common other than being the first ones to officially register their concern over fintech? On the surface of it, not much. To investigate further, we looked at what these banks actually say about fintech in their filings.

In fact, six of the banks merely mention fintech in a list of different competitor types including other banks, brokerages, insurers, credit card companies, and so on. The list includes five types of competitors for CSB and Umpqua, six for Beneficial, seven for BNY Mellon and Zions, twelve for First Interstate, and an impressive eighteen for JP Morgan (the banks’ wide disagreement about the number of distinct competitive threats they are facing is interesting in itself).

Three of the banks go beyond a simple mention of fintech, although what they say about it is not particularly insightful. Thus, PNC, SVB and UMB go on to note that fintech competitors offer services such as payments and lending.

More intriguingly, two banks evoke less obvious aspects of a possible fintech threat. Horizon appears concerned about “the migration of bank personnel” away from traditional banks and toward their fintech competitors, while Iberiabank warns that competing with fintech on technology “would result in significant costs and increased risks of cyber security attacks”.

Of the remaining two banks, Hamilton Bancorp, by far the smallest and the most recent filer, is almost gushing in its praise of fintech: “They offer user friendly front-end, quick turnaround times for loans and other benefits. While Hamilton is evaluating FinTech companies with the possibility of developing relationships for efficiency in processing and/or as a source of loans and other business, we cannot limit the possibility that our customers or future prospects will work directly with a FinTech company instead.” We may never know what prompted such an outspoken assessment, but the frankness is certainly refreshing.

The prize for the depth of disclosure would have to go the pioneer. Huntington Bancorp, the first-ever U.S. depository institution to mention fintech in its annual report, also goes the furthest in discussing its competitive strategy in this regard: “Financial Technology, or FinTech, startups are emerging in key areas of banking.  In response, we are monitoring activity in marketplace lending along with businesses engaged in money transfer, investment advice, and money management tools. Our strategy involves assessing the marketplace, determining our near term plan, while developing a longer term approach to effectively service our existing customers and attract new customers. This includes evaluating which products we develop in-house, as well as evaluating partnership options where applicable.” It will be interesting to see what fruit this strategy will bear – and whether other banks will become as open about their fintech strategies as Huntington.

So, are these fourteen banks indeed particularly vulnerable to fintech competition, as taking the disclosures at face value would suggest, or are they simply more familiar with fintech than their non-fintech-mentioning peers? Looking at the banks’ actions, we find that at least five fall squarely into the latter category, led by the three giants. For example, JP Morgan has launched a residency program for fintech firms, invested in fintech firms such as Motif, and formed a partnership with OnDeck; BNY Mellon has set up fintech innovation centers; and PNC has invested in Digital Asset Holdings, a blockchain technology company. Of the smaller banks, SVB (which stands for “Silicon Valley Bank”) has made equity investments in Lending Club and Nvoicepay and hosts a fintech conference, while Umpqua is establishing a fintech subsidiary in Silicon Valley.

What about the other nine? It’s harder to tell. Which brings us to the question, why is such a disparate group of banks suddenly talking about fintech in their official filings? One possible answer is, in the words of 2016 Nobel Laureate Bob Dylan, “Because something is happening here, but you don’t know what it is”. It is plausible that, uncertain about what is happening and what to do, banks were taking cues from one another, a phenomenon economists colorfully refer to as “herding”. Under this interpretation, once Huntington went first (perhaps prompted by its acquisition of FirstMerit, a 171-year-old rival and neighbor, certainly a thought-provoking event), JP Morgan may not have wanted to be left far behind. Others would then have followed in reaction to JP Morgan’s filing, given that bank’s stature in the industry. However, once it became clear that only a few of the largest banks chose to mention fintech, the others’ proclivity to do so would have been greatly diminished. I stress, though, that the above is only a possible interpretation of what happened.

So what will happen in the next filing season? Will the number of fintech mentioning banks stay the same? Will it double or quadruple? Will the disclosures become more informative? Will some banks copy their wording from others? How will banks’ words correlate with their actions? And, most importantly, will banks’ fintech-related disclosures become a leading indicator for the bank-fintech dynamic?

Watch this space.

The study, titled “Banks vs. fintech: At last, it’s official” was published in the 44th volume of Journal of Financial Transformation, and can be downloaded here  

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Image: Chris Brown, CC By 2.0

The Fintech revolution powered by Smart Data is happening. Startups are disrupting financial technology that remained unchanged for decades. The new non-bank lenders adapt to emerging technologies and manage to integrate them into risk management, customer relationship management and pricing in order to enhance the service. The Fintech revolution is not about killing the banks, it’s rather about significantly improving the long-existing service by focusing on ever-growing customer needs for speed and inclusivity. And, due to increasing customer expectations and the ability for Fintech entrants to match the demand, there is no doubt that it will reshape personal finance and the way we look at it.

Better risk assessment

The new technology-enabled Fintech entrants are not afraid to experiment with technology when it comes to underwriting. They come up with new, clever ways to assess the risk. Data-driven lending has clear advantages: the service in many cases is supported by self-learning algorithm, which minimizes the need of human interference in decision making. That translates into better risk assessment and decision making. By utilizing self-learning technology in risk assessment, companies become more automated, disrupting existing banking and credit systems. That’s why Fintech is sometimes referred to as algorithm-based banking.

Cost-cutting

Fintech disrupters are not burdened by legacy IT systems or branch networks, giving them an advantage over banks. The new entrants are also not overwhelmingly big which makes them flexible for change whenever needed. Such tendency to promptly adapt to changes and integrate technology into risk management and customer service is reflected in service level of companies and overall economic efficiency. The outcome – cheaper, faster and better quality personal finance services resulting in a larger population of satisfied customers.

More diverse credit landscape

Banks usually position themselves in one location before they expand, whereas Fintech firms can start lending despite their initial placement. The lack of geographical concentration allows the new Fintech disruptors to expand into a more diverse credit landscape and scale. Simply put, the new players have an opportunity to offer credit products to parts of the market that have been underserved by the big banks.

Higher customer reach

Online presence of the new Fintech businesses makes service more accessible, quick and user-friendly since customers can easily navigate, choose and compare the offers online regardless of location or time. Keeping in mind the efficient use of technology, decreasing costs of web-based technologies and an ability to match ever-increasing customer expectations on speed of service, attracts even greater amount of customers. Trouble-free and straightforward process of non-bank personal lenders is yet another favourable addition that sways a great number of customers, out of whom a large chunk is underbanked.

Matching ever-changing customer expectations

The changing way of doing business with the help of technology shapes customers’ expectations: they expect that anything can be done online through mobile devices and are seeking for personalized products with a simple application that can be performed in a speedy manner, such as a “one-click” loan. E-commerce and digitalization of services have shaped customer expectations and therefore has put pressure on banks to match the offer. Big organizations, however, are usually too big to change, whereas the new entrants are both able and willing to adapt to changes to meet customer demands for speed and access. It’s obvious that Fintech revolution is changing the way personal finances are being handled and such change affects both businesses and customers. Fintech companies are successfully implementing the change, the main question is – will the banks keep up?

The report by Celent– ‘IT Spending in Banking: A North American Perspective’, analyses and contrasts the IT spending patterns of US and Canadian banks. Most of the funds will be directed towards maintenance but a major chunk will go to new initiatives including retail banking services. Mobile banking is still a priority with focus on building existing smartphone and tablet apps. Self-service initiatives, digital banking, projects/overhauls, branch transformation initiatives, and omnichannel endeavours continue to get significant attention as well according to the report.

“The figures point to another strong year; 2015 is poised to build on the growth experienced last year,” says Jacob Jegher, a research director with Celent’s Banking practice and author of the report. “Investment in technology will of course continue to be a critical requirement as banks work on maintaining their existing systems and work on incremental improvements and innovations.”

The 22- page report examines the regional breakdowns of retail versus wholesale spending, internal versus external spending, and maintenance spending versus new investments. The report also points to several key North American banking technology trends and growth areas for 2015.

Of the total investment in IT in 2015, 73% goes towards maintenance, about $45.2 billion. Of these funds, £39.7 billion will be spent by US banks and $5.4 billion by Canadian banks. At best, new investment spending in North America will account for 27.4% of the total budget in 2015.

Maintenance will be declining slightly as a proportion of the whole, and is expected to account for 2% less spending by 2017 than in 2015. This marks a positive trend in the following years.

Retail banking is expected to comprise the majority of bank spending this year (62.5%), reaching $38.9 billion. This number represents a 4.8% increase in spending. Corporate banking is also set to continue climbing and is expected to be $17.1 billion for this year. Canadian corporate banking is particularly expected to experience strong growth this year, at 5.6%. A further $6.2 billion is estimated to be spent by North American banks on other areas of banking such as investment management.

With more fraud cases cropping up, security remains a primary concern. Banks will be required to invest in new authentication tools to protect both the bank and its customers. This includes alternative authentication tools like biometrics, internal controls, education and training.

External spending will increase as opposed to internal spending in the coming years. To tackle the situation banks might try to cut down on workforce and focus on core competencies and use inexpensive storage and outsourcing. External software spending, as a result, is expected to rise by 8.1% in 2015 reaching upto $11.4 billion in the US. This year external spending is expected at $17.5 billion which will be in balance with an internal spending of $17.6 billion.

Canadian banks will follow a similar trend initially, increasing external software spending by 7.5% but they are expected to focus more on internal development over the next few years. Canadian banks are expected to spend $3 billion on external services this year – an 8.1% overall increase.

(image credit: Bob Mical)