The financial crisis of recent times was arguably triggered by innovation in the financial services sector around creative financial instruments. These so-called CDOs and ABS’ ended up being unhinged from the underlying ‘assets’ that defined them and as such allowed a bubble of securities and subsequent contractual trades by professionals and institutions creating ‘value’. The fact is that this innovation probably started with the various rounds of deregulation of financial services, including the repeal of the Glass-Steagall Act in 1999. While some argue that this deregulation actually prevented a worse meltdown of the financial system, I would argue that regardless it allowed the creation of innovative financial instruments that ultimately led to the creation of a new class of speculative bubble – as if we need more excuses for those.
“The academics who dominate modern central banking were ideologically committed to the notion of efficient markets and to exclusive reliance on inflation targetting regardless of imbalances arising from easy credit and soaring asset prices – a spectacular case of one-club golfing.”
John Plender – Financial Times
When you talk to bankers about innovation, this is what typically comes to mind either product innovation or financial instrument innovation. These have long been held as the staple of bank value creation as it is essentially all about creating margin and margin comes from either capital appreciation, smart hedging bets or from new products that are heavily differentiated. What doesn’t immediately come to mind for most bankers is customer innovation or more specifically, innovation in serving and reaching customers. When it comes to innovation in, let’s call it, the engineering or mechanics of financial services – institutions have rightly led. So much so that now products are so innovative that they are simply impossible to explain to the average layman.
The amusing thing is that on the front of customer innovation banks rarely lead, in fact, in most cases they are dragged kicking and screaming into new ways and means of interacting with customers. Just take a look at a couple of quotes that illustrate the point:
“I thought in rural Tennessee we would not be confronted with Internet banking in my lifetime. I was wrong…”
John L. Campbell, CEO of First Community Bank of East Tennessee, 1997
“The do-it-yourself model of investing, centered on Internet trading, should be regarded as a serious threat to Americans’ financial lives.”
Merrill Lynch Vice-Chairman John “Launny” Steffens, Sep 1998
In the last 10 years significant disruption has occurred within the retail banking sector from both a transactional and revenue perspective. Firstly, the internet created a dramatic shift in just a few short years turning the mix of transactions on its head – to the point where internet banking transactions exceed branch transactions by 2003 in most developed economies. Secondly, increased mobility is now leading customers to do so much more of their banking on the move, and yet the vast majority of banks still don’t support mobile banking in any way, shape or form. The reliance on physical distribution channels is a severe restriction in the ability of retail banks to create real change, but customers are pushing ahead this time – without banks.
Initiatives like PayPal which now makes up 48% of online payments, but didn’t originate with Visa or Mastercard, and to this day is rarely supported by traditional banks. New payment mechanisms like Jack Dorsey’s Square, Incase, Verifone, Mophie that are seeking to fill the gap in retail payments where the card providers and banks have just been too slow to adapt. Online social lending networks like Prosper and Zopa, creating non-bank lending opportunities for those who are fed up with the brutal approach to lending approvals championed by the big banks.
The next 10 years disruption in retail financial services will rapidly accelerate. The likelihood that we will see a complete deconstruction of retail banking is fairly certain. While a banking license remains the barrier to entry currently, Richard Branson has shown that such licenses are simple commodities in the burnt husk of a banking sector that we have post-GFC. In the more ubiquitous arenas of payments where cheques and credit cards have dominated, banks are suddenly going to find their part in the value chain disappear – along with physical cheques (or checks), credit cards and cash.
The solution is simple, but will be painful for banks who are like slow moving glaciers in an era of accelerating climate change. Unless we see organizational reform to rebuild banks around customer engagement and interaction, it doesn’t matter how advanced the financial mathematics and instruments get – in the end if your customers are finding ways to work around your inadequacies you might just find you have no business. In markets like the US and the UK the long-held ‘tradition’ of banking is actually frustrating change. This is not something that can be regulated – it is a mind-set, a philosophy. Anytime bankers think they can do what they like without listening to the voice of their customers it is just further evidence that they have lost touch with those that matter – customers who generate revenue and shareholders that fund growth.
Customers are no longer willing to wait for banks to innovate, and as a result they are moving on and looking for workarounds that simply don’t include the big institutions. Some have said banks are too big to fail…well quite obviously they are too big to innovate where it matters.