With IT giants like Apple and Google pushing into the mobile payments business, financial services companies are going on the offensive. How? By acting like venture capitalists.
By most accounts, financial services institutions have done a poor job keeping up with the increasing demands of their customers. Mostly, banks have been slow to roll out digital banking products and upgrade their virtual storefronts. According to a study by Capgemini and the European Financial Management Association, only about a third of global banks offer front-office services that boast advanced levels of digital maturity. Back-office capabilities are even less impressive. Barely 15% of banks’ back-office functions are digitally advanced, Capgemini and EFMA say.
Exceptions do exist. Bank of America’s mobile service, for instance, has some 17 million users and is getting 15,000 new sign-ups each month. Barclays Bank’s Pingit virtual payment product targets consumers and businesses. In Korea, Hana Financial remains a pioneer in mobile banking.
But the barbarians are at the gate. Technology companies are pushing into the banking space, stealing customers from traditional financial services companies. Mobile wallets such as Apple Pay and Google Wallet are quickly gaining in popularity. New banks pose a big threat as well. Number26, a start-up in Germany, boasts advanced mobile banking services. Meanwhile, venture capitalists are pouring 10% of their investments into fintech (financial technology).
Don’t think the encroachment doesn’t worry bankers. More than 83% of the financial services executives polled by Capgemini and EFMA said consumers are comfortable banking with Internet and technology companies. Only 68% of the respondents said consumers are comfortable doing business with banks.
Facing this threat, some banks are taking a page from their new rivals. They’re going to the source: investing and nurturing fintech entrepreneurs who are developing promising products. The launches of these so-called incubators, accelerators and labs are not limited to global banks, either. Regional and even community banks are courting tech start-ups in a bid to stay ahead of potential digital disrupters. As Dan O’Malley, chief digital officer at Boston-based Eastern Bank, says: “Banks have to respond offensively.”
CODING AS SPECTATOR SPORT
Certainly, old business models may no longer work. Banks lack the nimbleness of start-ups. As Vik Sohoni, a principal in the Americas banking and securities practice at McKinsey, points out, bankers “are conservative by nature due to the risks they face. They now have to move at the speed a digital world demands while maintaining safety and soundness.”
At Eastern Bank, company executives are looking to pick up the pace. The 200-year-old thrift with $8 billion in assets signed a partnership in April 2014 with a small team of managers who ran PerkStreet Financial, a now-defunct business that offered virtual checking accounts. The management group, backed by a $4 million investment from the bank, has since put together a tech innovation unit called Eastern Labs.
O’Malley, who was CEO at PerkStreet and now heads the lab, sees a tremendous opportunity in the mountain of data generated by banks and their customers every day. “Banks have incredible digital assets,” he says, “but they don’t look to monetize it.”
One example: A test project from the labs identified small businesses that have a relationship with Eastern but have never borrowed money from the bank. When pitched, more than fifty of those companies took out loans from Eastern. “You’re going to see smart banks commercializing these new technologies, selling them to other banks,” O’Malley predicts.
Turning incubators and accelerators into profit centers could be a stretch, some industry watchers say. Beyond capital and mentoring, sponsor banks typically provide the start-ups with office space and corporate services. A company in an incubator can stay there as long as it needs; start-ups in accelerators face a time limit, often three to four months. It’s unclear what metrics—if any—bank CFOs are applying to investments into the initiatives. And the failure rate for start-ups is notoriously high. Warns Bob Gach, global managing director and capital markets practice lead at Accenture Strategy: “If banks think they’re setting up the equivalent of Bell Labs, they’ll be highly disappointed.”
As Sohoni points out, banks are also gaining access to new, more agile methodologies for testing concepts and turning ideas into products. Moreover, well-publicized projects to attract top technology talent can alter the public’s perception of a bank.
That’s exactly what happened at First National Bank of Omaha. The $19 billion-in-assets financial services company has conducted two hackathons—typically, a two- or three-day gathering where outside computer programmers are given a business problem to tackle. Until recently, hackathons have been the domain of the technology sector, which first hatched the idea.
First National held its hackathons at the company’s headquarters in downtown Omaha. Angela Garrett, vice president of innovation and enterprise solutions at First National, says the bank’s executives have been surprised by the buzz generated by the events. “Who knew coding could be a spectator sport? It’s given us an image in the marketplace.”
Another unintended consequence: Employees at the bank soon wanted in on the action. First National has since hosted two internal innovation events. In one, 57 workers pitched 38 ideas, which were later presented to senior managers. Eventually, management greenlighted development of five of the ideas.
“The financial services industry has been good at looking at what other banks are doing,” says Garrett. “We need to look at what other industries are doing.”
IF YOU CAN’T BEAT ‘EM
Some industry observers wonder if products hatched in a collaborative, free-spirited climate will work in the regulated environment of a bank. Says Christopher Paquette, a principal at McKinsey: “There must be room for innovation, but within the bounds of economic, regulatory and risk controls: Let ideas grow quickly, but kill them soon if they don’t meet hurdles. If an employee has to prove ahead of time that an idea will work, it can stifle creativity.”
That seems to be the thinking of executives at scores of global banks. Standard Bank of South Africa partnered with the University of Johannesburg to launch a business incubator focusing on manufacturing and rapid prototyping. Spanish giant BBVA set up BBVA Ventures in San Francisco. The outfit has invested in 500 Startups, a Silicon Valley seed fund founded by former PayPal and Google Execs. BBVA has also backed, among others, Taulia—a San Francisco start-up specializing in supply-chain finance—and SumUp, a four-year-old German company offering services for credit card payments on mobile devices.
In August, Wells Fargo announced it was getting into the game, setting up a start-up accelerator. The six-month program provides funding—up to $500,000—and mentoring for early-stage companies working on fintech products. One, Bracket Computing, specializes in Cloud computing for large enterprises. Down the road, the company’s technology could help Wells and other banks handle spikes in data traffic.
Braden More, head of enterprise payment strategy at Wells Fargo, says bank executives aren’t necessarily looking at the program as a way to generate revenue. Rather, the company is aiming to uncover new ways of solving problems. “It’s kind of a tractor beam to connect with outside innovators,” he explains.
It remains to be seen if banks will stay the course or whether financial services incubators will go the way of eToys. But information technology is now a much larger part of the banking business. As such, surprises could prove to be extremely painful. “It’s like driving at night,” More says. “You need your high beams on. You need to see what’s ahead.”