On Banking and Fintech
I don’t think you have to be part of the banking industry to have a fairly good idea of what they’re struggling with when it comes to servicing customers. While I am usually a huge fan of nuance, I think that on some level, it can be explained simply: Fintech’s are better at digital financial services than banks are.
When one digs into the meat of it, however, one inevitably finds that there are layers of complexity. On the top line, it looks simple, but the bottom line is that life is rarely as simple as it looks.
Fintechs have the luxury of focus. They can afford to do one thing and do that one thing very well. It’s not a new strategy in technology; Google, Facebook, Amazon all started with a relatively clear purpose and then expanded from there. Fintechs can afford to employ the same device. But the secret to their success is not doing one thing well, but rather focusing on one clear problem. Each of the aforementioned tech giants focused on one clear problem and became obsessed with solving it.
Banks, on the other hand, are generalists. They do a whole bunch of things and, at least for the last 300 years, they have done them fairly well. But presently, banks have been distracted by one major problem: margins. After the 2007/8 financial crisis, where the subsequent decade has seen their capital reserve requirements increase, interest rates drop below zero, and regulation after regulation add pressure to the already mounting operational costs, they have been forced to seek higher margins. Fundamentally, there are two ways of doing this: spend less money, or make more. One requires value and the other requires value creation.
The sharp amongst you will notice that both Fintechs and Banks are focusing on one problem, but the problem with problems is that you need to be focusing on the right one. Fintechs are focusing on problems for their customers, whereas banks are focusing on their own.
That is not to say that banks are out of the race. They know, better than us I might add, that they need to make some drastic changes to survive. They know that they need to be more digital (whatever that actually means), they know that they need to adapt faster, they know that they need to innovate, and they know that they need to do it all very, very quickly. Yes, they are constrained but contrary to popular belief, while the problem is with their technology, it is not a technological problem. It’s a people problem.
There are three fundamental misconceptions that make solutions difficult in general, specifically that:
- technology will solve all of banks challenges;
- the risk of change is higher than the risk of standing still; and
- Fintechs and Banks are mutually exclusive.
I’ll address the first two together because they are so intrinsically connected.
Systems are tools; they reflect the culture of an organisation rather than dictate it. Banks aren’t struggling to keep up because they have old technology, they have old technology because they are struggling to keep up. The difference is subtle but powerful.
Firstly, banks have an organisational challenge. If they don’t manage their hierarchy properly, the gap between decision making and operational data grows. While it seems obvious that the goal is to close that gap, it’s not easy.
Secondly, banks have an operational challenge. They are built to be stable, reliable, and secure. What does each of those adjectives have in common? Certainty. And what is the opposite of certainty? Risk.
Is it any surprise, then, that institutions that are literally designed to avoid risk and celebrate certainty, are bad at innovation? What’s more is that while there are a lot of institutional risks, it's not what’s preventing banks from changing. It is personal risk that throws the proverbial stick in the spokes. As a banking executive, if you make a bold decision, like changing the bank’s core banking system, and it fails, it’s your ass on the line. And given how far some of those decision-makers are from the data they need to make good decisions, risk increases exponentially. So they leave it for the next generation of executives. Why risk a golden handshake when they retire in 5 to 10, when the younger, more technical generation can solve the problem?
Thirdly, they have a cultural challenge. Because of the first two challenges, banks have a culture that doesn’t tolerate mistakes. Yet innovation requires learning and learning invariably involves some mistakes. Innovation is not something that just happens on its own, it is a complex process and a lot of hard work. The first answer is seldomly the right answer. But the first answer is a critical catalyst for eventually getting the right one.
Fintechs, on the other hand, are designed to be especially good at innovating. Sure they have the modern technology that allows them to adapt quickly, get products to market in record time, and do all of it at a fraction of the cost of their incumbent counterparts, but that’s not why they are doing it. Their decision-makers are close, often knee-deep, in operational data, they are designed to handle risk or at least have a higher risk appetite, and they are passionate about solving a problem for their customers. And their culture reflects it.
Initially, this mindset may have worked against them a little at first. Consumers were happy to test new products in other industries, but when it came to financial services, they preferred to rely on the institutions they trusted. But Fintechs iterated and got better. Their “risky” solutions became more stable over time and, eventually, they were simply too good to ignore. They started to win the trust of consumers, at least partly.
This dynamic is reflected clearly in the state of retail banking today. We have large incumbents spending millions trying to get their products digital, competent challenger banks (read: alternatives) spinning up everywhere, and we have consumers with one foot in both worlds: for the most part, they don’t trust challengers with their salaried accounts, but they don’t enjoy the experience of incumbent banking enough to use them on a day to day basis either. So consumers end up moving spending money from their salaried bank account at the incumbent to their spending account at their challenger.
This isn’t sustainable for either side: challengers are struggling to make a profit because credit is easier to give when you have access to a customer’s salary and, let’s face it, credit is what puts bread on the table. Incumbents, on the other hand, are struggling with customer satisfaction and access to transactional data.
Which brings me to the last misconception. It’s easy to pit Fintech and Incumbent banks into this winner-takes-all fight to the death, but that is usually not how reality works. Reality is far messier than we make it out to be—I wrote about this at length here—and it’s definitely not as binary.
Fintech and banks can work together, indeed, they should. There is a huge amount of opportunity there. And in the last couple of years, we have seen this start to happen. Larger banks are starting to see the value of working with innovative startups and those startups are seeing the value of having access to a large customer base.
But it’s not happening enough. Fintechs, for the most part, struggle to integrate with the legacy systems (and mindsets) at incumbent banks. And they generally do not have the time or the resources to wade through that mess. Even Open Banking and PSDII is not doing what it intended yet. In Europe, 40% of banks missed the deadline and those that made it are dealing with slightly different standards in Switzerland and the United Kingdom.
So what is the answer? If we look at other industries, it’s actually pretty clear: platform banking. But what does that mean? Well, it’s difficult to say because it doesn’t really exist properly yet. But I think however it manifests, it should follow some principles. Principles are great because they define a goal without constraining how to achieve it. That being said, I’ll add some suggestions.
Customers
Customers should be at the center of product decisions. Solving their problems is the key to generating value. What is critical, though, is understanding that those problems will shift and evolve. It’s a process. One that is simple in theory but far from it in practice.
Data is the key to solving problems. Not only does this mean listening to what customers want, but examining what they do. Do you know how you often find that people don’t really know what they want in life? Yeah, it’s the same with banking. Focusing on what people say will take you as far as solving obvious problems, but it’s not a one-way ticket to innovation land. Trial and error, on the other hand, is.
This platform should make managing customer feedback data, as well as customer behaviour data, easy and accessible (to the authorised persons). The data should be used to generate hypotheses that can be tested. It, therefore, needs to be flexible enough to enable rapid testing of products.
Connection
Platform banking should facilitate, enhance, and coordinate the connection between incumbent banks and Fintech. Banks should be able to choose from a market of solutions provided by Fintechs, and “plug” them into their stack instantly. Fintechs, should be able to do the same with banking products.
This creates an environment where the barrier to solutions is lowered while managing the loss of movement. Here, a Fintech that has focused on a single customer problem (and has gotten really good at solving it) can simply be plugged into an incumbent bank with active customers. The bank wins because it is providing its customers with innovative solutions, the Fintech wins because their customer base increases significantly, and the customer wins because they are getting the best of both worlds.
Additionally, this model will drive up competition between Fintechs, and banks themselves, which would drive up the rate of innovation. Suddenly, a developer with a good idea can have a ticket to play without needing to raise huge amounts of capital.
Complexity
Platform banking should absorb complexity as much as possible. I don’t just mean complexity on the consumer’s end, but also on the operational side. Regulation should not be so costly to manage or change and it shouldn’t be so difficult to comply with in any event.
Having regulation and compliance embedded in the system in such a way that an institution could simply select a territory from a dropdown list is a great "true north". That’s it. Something so simple that an intern could manage it. I go into a lot more detail about what financial institutions and regulators can start doing about regulation and compliance here.
The platform should also handle commercial relationships between the Fintechs and the incumbent banks. There should be no contracts but rather a policy managed by the platform that both parties agree to at the beginning. Commercial activities should then be automated. The producer sets the price for other institutions, and the institutions consuming the product set the price for their customers.
Costs
Resources that all institutions use should be shared. Now before you start throwing things at your screen, hear me out. Let’s use the Word Processor as an example. At first, we all got our own copy of the tools that helped us write. Each copy had the same tools, sure, but it was copied over and over again. In fact, the only thing that was unique was the license. But then the model evolved and we got shared online documentation applications like Google Docs. At first, there were concerns around privacy and utility but, eventually, it became normalised. And it was far more efficient — one framework upon which many people could privately create documents.
This has happened over and over again across industries. The introduction of the Software as a Service model has given rise to massive global products like Netflix and Spotify. All of these products leverage technology to share the elements that everyone uses while ensuring the uniqueness of the elements that differ from customer to customer. Not only does this mean that the business can release innovations across the customer base easily, the operational costs are also reduced significantly.
Once regulation allows it, this model would create an unprecedented progression in the banking industry. This makes me wonder if banks are more afraid of big tech's access to customers or their data, or are they actually afraid of their immense experience with scalable business models.
I am the first to admit that these principles are somewhat idealistic and maybe even naive. But that doesn’t mean that we shouldn’t strive for them. Surely there is value in identifying the best-case scenario and working towards that adjusting as we go?
As an industry, we need to focus on the process of getting better, because being better will inevitably follow.