24 May 2016

The case for disruption in retail banking

There are two reasons to believe this spirited band of digital upstart banks will achieve mass-market success. Firstly, the smartphone is still underexploited as a tool in various facets of everyday life. The other is that big banks can’t innovate. It’s this second sentiment that appears to be the bigger driver in the case for proper disruption than anything the startups have up their sleeves.

Assume something new in banking is coming – the smartphone and collection of data is making things more phone based, more transparent, faster and facilitating more stuff. And also assume that people will want this, especially among the under thirties. Why wouldn’t those extraordinarily well-financed established banks, rich with experience and talent not be able to keep pace, let alone lead a transition to digital banking?

The argument comes down to three things: culture, politics and computers.

DSC_0718edPervading culture

The theory goes that the culture of box-ticking and fear of the compliance police is the most dominant and defining characteristic in the big retail-banking groups. An oasis of innovation may exist in a cordoned-off office in some faraway corner of the organisation, with all the trappings of a kooky startup but their efforts are up against a pervading corporate culture steeped in caution and ultimately steered by ensuring things don’t go wrong. Concepts such as transparency, collaboration and service design (fundamental to successful digital products in the modern era) simply aren’t stitched into the fabrics of these organisations.

At a recent European conference on the future of digital banking, a young hacker revealed to the audience that he had broken into a bank’s systems and went on to politely ask questions about innovation and security. An attendee described the atmosphere instantly turning ‘utterly toxic’ among the assembled delegates at this revelation before the hacker in question was ushered out. None thought it worth snapping up the hacker’s services, let alone cornering him for his observations and advice.

The CEO’s dilemma

It’s a fair if blunt rule that corporate politics grows proportionally with the size and age of the organisation. Vast and ruthlessly protected departments slug it out in internal turf wars, an explanation into why things appear far from seamless for customers moving between even a single bank’s products, or even why a company such as Transferwise still hasn’t been squashed by the big banks.

These organisations are, of course, gravely aware of the coming risk from digital challengers. Many observers, even those inside the big banks, believe the smart strategy – the only real strategy – is to boldly rip things apart (IT systems, business models, departments) and reinvent what they do. To do so would mean a chief executive and board accepting a nosedive on their income for the short-term, risk a level of upheaval and panic throughout their organisation and it might not even guarantee success. Who would want that on their CV? And with history showing that big companies tend to collapse slowly, then very suddenly, there is little incentive for a CEO to put his reputation (and bonus) on the line to overhaul the firm’s entire culture and IT systems.

IMG_9935‘Archaic and entangled’

It’s the IT that presents the most seductive picture for the challengers. The computer systems that form the backbone at the big banks were typically established in the 1960s and 1970s and have been tinkered with since then. A person who has worked with several of the major banks echoed the view of many, describing IT systems as ‘horribly archaic and entangled’. HSBC is thought to spend near £3bn a year on its IT, while Lloyds is reported to spend £1bn, but both allocate near 70 per cent of their IT budgets on maintenance and regulation, illustrating the challenge they both face in modernising their computer systems. 

One person familiar with the systems of big banks said: ‘The challenge these guys have is your smartphone is more sophisticated than their mainframes.’

The Australian bank Commonwealth spent £7bn last year on a complete IT overhaul that is understood to only have been a partial success, according to someone with knowledge of the project. It raises concerns of the prospect of an even older bank with more complicated systems undertaking the same exercise. The digital challengers can build new banks fit for the modern age with none of the legacy, using the fashionable lean and nimble principles powering virtually every modern digital startup.

Way of the Valley

It’s not just in making things where the Valley modus operandi can be copied and pasted. The marketing job for the new digital banks means squaring up to the vast advertising budgets of the retail banks. They all say they will adopt the low-cost advocate and viral schtick that’s been used time and again to bring companies like Uber, Spotify and Airbnb into public consciousness.

The retail banks’ concerns aren’t confined to little digital upstarts, monsters like Apple and Google, and their own IT systems. The UK banking regulators, the Financial Conduct Authority, and the Bank of England are also making life difficult for the incumbent banks. Even before the 2008 banking crisis, the FCA tried to instigate more competition. Now it’s keener than ever to break the sense of too-big-to-fail that pervades among the small cabal of dominant banks.

Breaking their clutches

An announcement by the EU last November to open up payments from the banks’ hitherto guarded clutches sent shockwaves through the major players. The directive will mean competitors to big banks will be able to muscle in on a bank’s customers and offer cheaper, simpler or even more secure alternatives. It is part of a growing belief that the walls big banks have erected around pricing will break open new options to consumers.

The new digitally conceived banks nevertheless believe their take on bank accounts won’t just open up daylight between them and what’s already being offered, but will be obviously and explicitly seen by normal people as little short of life-enhancing. 

DSC_0400_1_brown copy

Seven reasons why the digital startups think you will switch

The challengers hope that a sum of smaller benefits rather than a ‘killer feature’ will tempt consumers to break free from their existing current accounts.

IMG_9971Live balance and payments

Expect instant updates, rather than waiting up to two days for banking to be processed. Payments and transfers can be made faster through the app, too. Real-time data hasn’t been deployed by any of the big banks so far.

What did I spend on lunch this month?

Inspired by health-tracking apps, this kind of personal-finance micro- management is supposed to help people compare their spend over time, giving control and even identify where they’re being unnecessarily wasteful.

International roaming

The frustration of cards not working when abroad and banks’ insistence to inform them before travelling should come to an end as a phone and debit card can be pinpointed by a digital bank to be in the same country. Several startups also promise not to profiteer from foreign-exchange rates.

Card protection

Cards will easily be blocked and unblocked through the smartphone app, rather than a laborious and anxiety-inducing call to the bank’s call centre followed by a subsequent call when the wallet is ultimately found by the barman at your local pub.

Help me save for that holiday

Digital banks want to help customers under 30 make big purchases. The aim is to try to step into the saving process by setting up a target and breaking down the chunks needed every month and even reacting as spending goes up and down. 

Third-party utility auctioning

Imagine if your bank shopped around for your mortgage provider instead of you having to do it. Digital banks want to provide this service as well as comparing gas, healthcare and mobile providers, while – using what they know about you and by analysing prices on the internet – supermarket comparisons might follow, too.

For some of the digital banks, not being weighed down by various business divisions and building a technical infrastructure afresh means they can plug into best-of-breed financial services
from third parties they have no wish to compete with.

This story originally appeared in Courier April/May.