How is the definition of innovation evolving in the banking industry?
When corporations innovate, they evaluate what new products,services or delivery methods will be relevant to the current products, business lines and the future of the firm. At a high level, this could be a group strategic interest, or a product or economic play. Perhaps innovation is needed for survival. Banks are essentially large corporations. Even smaller banks are acting and being governed like large corporations. So while the considerations remain the same, products and service offerings become significant lifts.
Banking is the most highly regulated industry in the United States, more so than any medical products. As you think about the number of regulations, and the bodies you report to and must be compliant to, innovation becomes a vehicle to not only outsource research and development, but also get into the nitty gritty of the product.
Some examples of innovative products in the banking space include 0% interest rates, or Buy Now, Pay Later. Markets change, and consumers react in certain ways to certain products. As these are tested, you can go back and iterate on those. Yet I would view this type of innovation as being research and development for products rather than a prescriptive way of driving corporate change.
How do you innovate in such a highly regulated space?
In my opinion, regulations – yes, annoying at times – don’t mean that innovation can’t happen. When you know what the rules are, what tools you have, you are fully aware of the sandbox, the framework you’re playing in. This knowledge can create opportunities for innovation, although they might not be the most fun, sexy, rocket-to-the-moon type of innovations. Rather, you can focus on innovation that helps you to grow your business, onboard clients efficiently, improve access, and solve their addressable pain points.
What are some of the key factors that are driving innovation?
Retention of existing customers is always front of mind for banks. As they have surprisingly high customer acquisition costs, keeping their customers engaged and loyal becomes a really important part of the equation. A 0% balance transfer, for instance, is one example of banks innovating on customer acquisition. Indeed, much of the innovation on product so far has been around lending and increasing access because of the customer acquisition costs for banks.
On the other hand, you see a lot of affinity and niche based products in the fintech space doing well. Knowing your area and focus is crucial in driving innovation. For instance, you could be a neobank that’s completely digital first, competing with a traditional brick and mortar style bank. Or you could focus your innovation on products – you might look at being a differentiated lending company for instance, to tackle real issues such as student loans or family planning for the LGBTQIA+ community.
The money system drives those real business problems. So while offering financing for adoptions or IVF might not look like a fintech or financial innovation, it adds new customers with new relationships to the bank’s bottom line, whether for deposits or a bespoke product.
Innovation is evolution, not revolution. View innovation as incremental change rather than a total overhaul. That way, maybe five years down the line, you look back and realize that you’re now a fully digital bank or you now have a one day guaranteed onboarding time, as opposed to a four day onboarding time – something that reduces friction for customers. This is what innovation in banking looks like, and is often driven by the needs of the customers you serve.
How are traditional banks responding to the rise of fintech companies and challenger banks?
The biggest need for banks right now is to offer access. It’s certainly not about investing heavily into ventures that may or may not work just because it is topical to do so – Buy Now, Pay Later in 2021 for instance. Instead, there are interesting ways in which banks can collaborate with fintech partners to deepen and expand their customer base.
A good case study is that of First National Bank of Omaha FNBO – a midsize bank in the US that’s family owned, with around $25 billion in assets. Their innovation team is robust, and a lot of them have backgrounds in technology and product. FNBO built a brand within their bank to deliver Buy Now, Pay Later services off the bank balance sheet, but with a fintech partner who would provide the sleek user experience and user interface. By leveraging the fintech partner’s expertise, FNBO could update their look and feel to be modern and thus getting to play in the market segment. And they’ve replicated this success with mortgages and other loans as well.
By creating access through technology, FNBO has activated their customer base better, more deeply, while also attracting new customers. If you look at where GenZ places their trust – it’s not in the big four or eight banks! It’s in smaller regional banks they know, credit unions their employers are affiliated with, but largely it’s in fintech companies that are solving real problems that they’re facing today.
There’s also innovation happening in how banks are de-risking fintech partnerships. When I was at Barclays, we onboarded NayaOne, which is a middleware sandbox environment. NayaOne could be used to test potential fintech engagements, by taking bank data and letting it exist live and anonymized outside of the bank’s core systems. So if a fintech company wanted to partner with Barclays, of course they’d have to work through procurement and all of the steps that are required in order to sell to a bank. But they’d also have an added layer – we’d use NayaOne to make sure the partnership would work based on the data we currently had. That way, NayaOne was an enablement layer, not necessarily doing the dashboarding, reporting, or innovating on a product, but rather a gateway to de-risking the bank's utilization of partners.
Another example of how banks are partnering with fintechs is through strategic investments. A small community bank in New Jersey called Valley Bank has set up a venture function. Valley Bank is a mature bank for its size and scale, and is growing steadily thanks to visionary leadership that believes in the importance of innovation. Valley Bank has also embedded NayaOne. In addition, they’ve also invested in the platform, using that investment to de-risk all of the innovation: enabling the outsourcing of R&D, and working with partners in startups. That narrative becomes a great flywheel for banks and for bank partners, and is a great example of how you can work together to kind of drive innovation.
What can fintech companies do to collaborate better with banks?
Fintechs started during the Great Recession as an alternative to banks – digital first, acting with empathy. Yet in order to deliver true value to your customers, you have to run a profitable business. Today, fintech companies see banks as partners. Compared to 15 years ago, fintechs and banks both recognize that they need each other to move forward for their consumers. From a fintech company’s perspective, banks today have big balance sheets, but they’re also willing to explore opportunities to develop, because the risk of not doing so is going to threaten their core business.
To be clear, a bank doesn't need to build an accelerator program, make direct investments, hit every conference, or build a Fund of Fund strategy right away. But having a strategy to address the issues they’re facing is crucial, and that strategy will likely involve working with a partner. I always say that in 2023, you as a bank shouldn’t be building anything. Connect with partners, and make sure you have the compliance layer such as SOC2 and GAAP in place to keep them accountable. But with the right guardrails in place, the partnership will thrive because in today’s world it is mutually beneficial for both parties.
Are there any significant trends that will have an impact on how the banking industry evolves?
The evolution of the banking industry is going to be a function of the macroeconomic environment – the investment banking layer, Wall Street, the Fed. Beneath that is the banking layer where consumer banks sit. These could be regional banks, community banks, credit unions, or super regional banks. So when the macroeconomic environment changes, so do the needs of these businesses.
Down the funnel for fintech startups or innovators selling to banks, this creates a different environment. It’s about identifying real needs of the moment instead of just looking at what has worked for others in the past. For instance, instead of being another fintech lending company at 0% interest because that was the environment from 2012 to 2021, you need to be focused on core product, for instance, selling into banks around their compliance and HR stack. How are they managing the workforce in the remote world? If you're on the consumer side, instead of just re-bundling loans, you could work on a family iOS product. What does it look like to be the operating system of a family? This could be a financial tool, blended with calendars and scheduling. A lot of these needs that emerge are driven by the financial system. Identify the needs that your business can address, and find ways to deliver differentiated value through innovation so you can meet people where they are in the market today.
What is your advice for banks who want to embark on a successful innovation journey to remain competitive?
You have to do something. That doesn’t mean spending a lot of money or hiring lots of people. But you do need to understand that in order for people to know who you are, you need to show up with your innovation to start the conversation.
Let’s look again at an example from Valley Bank. They developed a way of processing cannabis payments when it was challenging to do so: cannabis wasn’t legal everywhere, what the legality was was constantly in question, what distribution and legal selling looked like varied from state to state. So from a product perspective, addressing this business vertical that was just coming out of restriction was truly innovative. They built products and capabilities to have recorded deposits and track the business behind the balance sheet of a cannabis distillery at a time when it was topical, controversial, and sexy.
Importantly, people noticed and talked about it, which worked in Valley Bank’s favor. This was around two years ahead of launching the Venture group I mentioned earlier, and people already knew who they were – Valley Bank was winning business bank relationships on the back of this innovation. I also want to point out that this innovation was still true to their core – they were still doing what banks do, just in a different way.
My advice for banks is to be forward about your innovation. Gone are the days that if you build it, people will come. You need to talk about how you’re innovating, get marketing and sales involved. Align your innovation with a clear, targeted view of the world that matters to you as a business.
The partnership opportunity is huge at the moment, and I’m not just talking about M&A or buying a fintech company. If you’re looking to use partners to drive innovation in your organization, start with a list of problem statements. Then, find people who are working on solutions – this could possibly be a Fund of Fund relationship. You could outsource your R&D dollars into VCs who could find the companies who could then do roadshows for you a few times a year. There are a couple of funds in particular whose strategic limited partners are medium sized banks. So not only are these banks getting access to these innovative companies, but also investors are only investing in businesses that would be interesting to the banks. So identify partners down the funnel who can help you do the diligence so you can focus on your strengths as a bank.
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