Innovation in banking and fintech startups. Fear or complacency?
I spent about 18 years in investment banking, long enough to understand that the financial industry is not naturally inclined to innovate. Why this? I see four main reasons.
The financial industry is self-referential. My friends working in finance and most of their collegues, seems to be far less curious and open to the rest of the world than people in other sectors. People in finance tend to be stereotyped, they dress and behave the same, they have the same interests and hobbies, they go on holiday in the same places, most of their curricula look so similar. Greed and commitment seem to be a predictor of success in banking, much more than lateral thinking or creativity. People in finance don’t use social networks (usually they say that they don’t have time or that is forbidden by their employers) The truth is that they don’t like socials. Banks seem to channel the creativity of many bright people in building exotic investment products.
Technology in banks is not a core function. Banks have very big IT budgets, but most of the money is devoted to comply with regulation and to increase the efficiency of the operational functions. People in technology are very well paid, but they seem kind of frustrated, since they are perceived as outside of the core business, in a place where the core business is making money out of money.
Regulation is overwhelming. Financial institutions are literally overburdened by regulations that change so often to affect the entire operational structure with the unpleasant feeling of being always lagging behind. This is even worst for financial institutions operating in several countries, since, despite the hopes we are all pinning on the recent European Banking Union, the reality is, that regulation is quite fragmented, such as the legal and tax contexts.
Banks IT legacy contexts are a nightmare. Large retail banks often rely on outdated technology. Different modules and technologies have layered over time, regulation after regulation, acquisition after acquisition. The typical result is non-standardized solutions that take a lot of time and money to maintain. Adding new product features or simply keeping up with innovations in consumer technology (e.g. mobile banking, digital wallets or microcredits) consumes an exponential amount of resources. Standardizing a core banking platform from a third-party specialist is not something without risk.
The outside world is evolving fast. For lean and agile startups, it’s much easier to innovate and import into the financial world the new patterns that are already affecting consumers’ behaviour in other industries.
Banks are not dull, however, they know they need to innovate and that the size of the opportunity is huge. A recent report by McKinsey warns banks that the digital revolution can wipe out a substantial portion of their revenues. As we all know, banks heavily rely on companies like McKinsey as the “good word” to legitimize what is obvious in front of their boards.
Banking is a peculiar industry, naturally protected from incumbents by two main factors:
1) Banks benefit from rewards of position. Banks can afford to be less efficient than most firms in other industries. Banks cannot simply fail, they enjoy state support, since the impact of a bank’s default on the economy can be devastating.
2) Heavy regulation is clearly a burden for a bank, but also a strong defence against competition. Being part of a regulated industry is complicated and expensive, but at the same time it represents a strong barrier to new entrants.
The cost of innovation in fintech is high, much higher than in most industries, since startups have to play in a regulated environment and fight rewards of position. Innovating in the banking industry is much more expensive than anywhere else.
It’s no coincidence that the only firms posing a serious threat to the rich payments industry, are the big tech companies dominating the arena of the mobile payments devices, like Apple and Samsung.
My view is that banks are deliberately complacent towards the outsourcing of innovation to fintech startups. Some banks proactively foster innovation by cooperating with startups in Innovation hubs, or by creating their Venture Capital funds or accelerators. Banks that are sitting back and watching now, will probably make acquisitions in the future.
The big capital injections from the banks’ venture capital funds in blockchain technology, are nothing else than testing laboratories for the financial technologies of tomorrow.
We might like it or not, but banks are not facing extinction. Banks are not really scared by fintech startups as competitors, they are mostly afraid of lagging behind other banks, more successful in embracing innovation.
Many influential voices are warning that the money flowing to the fintech sector is excessive, my view is that the cost of innovating the banking system from inside, would have been much bigger.
“We cannot solve a problem by using the same kind of thinking we used when we created them.” Albert Einstein
Founder of AdviseOnly