Democratization of Wealth Management

4×4 Virtual Salon featuring: Sid Sahgal (Product Manager at Hydrogen), Nikolai Hack (Head of Strategy & Partnerships at Nucoro), Qiaojia Li (CEO at Rosecut) and Michael O’Sullivan (author “The Levelling”, ex-CIO Credit Suisse).

Lively panel discussion featuring:

💭 Sid Sahgal (Product Manager, Hydrogen)
💭 Nikolai Hack (Head of Strategy & Partnerships, Nucoro)
💭 Michael O’Sullivan (author “The Levelling”, ex-CIO Credit Suisse)
💭 Qiaojia Li (CEO of Rosecut)

We discuss:

  • Changing consumer trends
  • Changing technology
  • New business models
  • New fitness landscape for wealth managers

This webinar was the first of two discussing some of the key trends from our upcoming report on “Digital Age Wealth Management“. For the next 4 x 4 Virtual Salon, we’ll be double-clicking on the topic of “New business models in wealth management“.

That will be on 18 Feb at 12 CET/11 UK/19 SGT and we’ll be joined by Chris Bartz, CEO of Elinvar, Christine Schmidt, Head of Strategy at additiv, Dmitri Panchenko, Head of Investments at Tinkoff Bank, and Bertrand Gacon, CEO of Impaakt. Sign up here. You won’t be disappointed.

Want to learn more about our enterprise software analysis methodology for the digital era?

Look out for the first report in our series, which will tell you everything you need to know about analyzing software for the wealth management industry. Coming out on February 16th, 2021. 

Register your interest by leaving your email address below.

Hard Truths about Digital Banking (#32)

Structural Shifts with Leda GLYPTIS, Chief Client Officer at 10x Technologies

We’re discussing with Leda Glyptis, a self-described recovering banker and lapsed academic, who’s worked in technology implementations for the last 20 years. Leda is one of the leading voices in banking and FinTech today, she has served as Chief Innovation Officer at QNB group, she was Director of EMEA Innovation at BNY Mellon, and most recently she was Chief of Staff at 11:FS. In this episode, Leda and Ben discuss what a Chief Innovation Officer actually does, whether innovation can come out of innovation departments, what most companies miss when they talk about culture, why emotions are holding back traditional and challenger banks from making money, why selling banking services like supermarket offers doesn’t work and what banks should be doing instead. For more information on Leda, look up the hashtag #LedaWrites on Twitter. She publishes an article every Thursday.

Leda recommends

 

  1. One book: “To end all wars: A Story of Loyalty and Rebellion, 1914–1918” by Adam Rothschild
  2. One influencer: if you don’t follow Bradley Leimer already, I don’t know what you’ve been doing and you don’t know what you’ve been missing
  3. Best recent article: ‘Can empathy be the cure’, by Theodora Lau
  4. Favourite brand: Converse All Star
  5. Productivity hack: I have ‘writing spaces’ — windows of time in spaces away from my desk where I write with no interruptions, no internet access and usually with a specific time box imposed by a friend arriving to join me in a café or park at a given time or by virtue of doing it on a flight or train ride.

One should only build the technology that is tied to their differentiator and partner or buy the rest

[00:01:28.12] Ben: Thank you so much for coming on the Structural Shifts podcast! I wanted to start off by asking you how one goes from studying social and political science to becoming a banker?

Leda: First of all, thank you very much for having me. The answer to that is ‘by accident’. I have always found it extremely impressive and confusing when I hear people talk about their careers and say, “You know, when I was 17, I decided I want to do this, then I had a plan, and I did it.” I don’t know who these people are. This was not me. Mine was entirely accidental. As I was finishing my Ph.D. with a series of deaths in the family which knocked me for six, I found myself sort of delayed and frustrated, ended up getting a job in, actually, private security of all things, and was my first taste of corporate life and working with technology investments — because the company was investing in non-weapons defense technologies at the time. And I found myself quite far away from academia, in a place that was interesting but didn’t make that much sense. And I chatted with a friend one day saying, “There are parts of my job I really like, parts of my job I don’t like, but I really don’t know what to do now, where to go next.” My friend said, “Well, we’ve built some software. We want to sell it into banks, but we don’t like people and things. You like people and things. Why don’t you join us?” It was an absolute audacity of your mid-20s. I thought, how hard can this be? And it turns out, it was quite hard, but it was also quite incredibly interesting. And I fell sideways into banking IT, and I haven’t looked back since, to be honest.

[00:03:02.08] Ben: I wanted to ask you: so, your last job in banking was at QNB and you were Chief Innovation Officer. What does a Chief Innovation Officer do? So, for example, is that a role that holds a budget, or is it one where you sort of seek to influence the rest of the organization and guide them towards some sort of digital future?

Leda: It absolutely varies. In some organizations, the Chief Innovation Officer is part of a marketing effort and they’re there to drive organizational learning in and organizational positioning out. In those cases, the job doesn’t have much of a budget, and it tends to be all about teaching the organization what they should know and helping the organization tell a story to the market about how they’re thinking about the future. Then, there’s another type of Chief Innovation Officer that it’s all about the third frontier of technology — so, the stuff that is really out there, that is not going to be useful or usable for the next 10 years but the bank should be thinking about them. They’re doing a lot of experiments, and they tend to have budgets for POCs, but not much beyond that. And then, there is the Chief Innovation Officer that is essentially the new technology IT person. So, I would say that my role at BNY Mellon was a combination of the first and second. So, while I was at BNY, my role was a lot about bringing learning into the organization and helping the organization position itself in a changing market, and running experiments with technologies that, at the time, were very new for us. My role at QNB was very different. It was, what are the things that we should be doing and we should be seen to be doing for the type of corporate citizenship we want to have in our chosen markets, both in Near East Africa but also in the sort of Far East subcontinent and beyond — Southeast Asia, where competition and technical literacy was extremely high. So, the Chief Innovation role for QNB was, “Come in and help us do the things we need to do fast, but also help us move the needle a little bit on the ways of working internally.” And I say ‘move the needle a little bit’ because a lot of Chief Innovation Officers are all about the internal workshops. This was, I would say, more indexed into doing things that were business focused and external-facing without changing the infrastructure of the bank. So, it was things that could either plug into that infrastructure or stay on the glass, and less about changing the ways of working. So, to answer your question, it could be anything, and my two innovation roles have actually been very different — but very useful in the sequence that they were in because a lot of the experiments we had done at BNY Mellon were the learning I needed in order to go straight into implementation at QNB.

[00:05:56.05] Ben: Do you think it’s a more important role than it was in the past?

I don’t think there has been a clear sense of where profitability will lie in the future.

Leda: Perversely, I would say no. Actually, somebody called me recently and said, “Would you take another innovation role?” I was like, “Nope.” I think it was an extremely important role early on because it both signaled internally and externally, that the organization is engaging with some hard topics. And also, it showed an acknowledgment that the way we work, the way we learn, isn’t right for the way that the market is moving, and therefore we need to change. Fast forward almost 15 years later, there are very, very few organizations that have moved the needle meaningfully in terms of either way of working or transformative technology use. Some have, but they’re few and far between. And even those that have, haven’t done it through their innovation departments. So, I would say that the function it represented as a department is more vital than ever — the new ways of working, the different deployment schedules, leveraging technology differently, all of that is more important than ever — but I would say that the structure doesn’t work anymore. What the innovation departments taught us is that we can’t do it through innovation departments. It has to be right at the heart of the business.

[00:07:10.10] Ben: And do you think that’s why those banks have found it so hard to introduce significant change? Because there hasn’t been this sort of CXO buy-in, other broader buy-in of management. And therefore, do you think it’s as much cultural as it is technological change that’s needed?

Leda: Yes and no. So, I think there is a cultural change that is bigger than the technical change — I think you’re right — but I think it’s much more systemic than saying people are resisting. I don’t think people are resisting. I think the structures we have created are not conducive to the type of decision making we need. Everything from the fact that you may be running an agile project in your part of the bank, but the testing schedules for the wider bank are waterfall and therefore you need to book in your testing before you’ve started building. It’s mad, right? It makes no sense. But it is how it is. Similarly, the risk matrices you apply, the way you measure success on a quarterly basis, the way that shareholders measure success, all of those things we bundle under culture change, but it’s actually much bigger than culture. It’s about how we build up the business, how the business reports success to the owners of the business, and how the business makes sure mistakes are not made. So, it is facile to say culture and dismiss all of those things as an attitude problem. It isn’t. I would say that the biggest challenge — when we started this journey, part of the question was, “Well, are these technologies real? Are they useful?” And we spent a lot of time in labs, testing and finding that the technologies are both real and useful. They’re robust, they’re scalable, they reduce the total cost of ownership, they do all the good stuff. But they also fundamentally transform the business model, both in terms of how they enable you to operate in a way that you’re not prepared to operate in — the speed of decision making that these technologies enable you to do, you don’t have the governance for. So there’s a big change piece that is around governance and approvals that is human, yes, but not just cultural; it’s organizational. The second piece is that cheaper infrastructure and faster infrastructure kind of requires a different business model because you can’t go charging the same for a very different service. Your customers are wise to the fact that you do different things and potentially less from a human perspective. So, I would say that the challenge hasn’t been technical for a while. It’s governance and monetization.

Maybe what we’re seeing is a transition to a world where retail banking is a public service utility. And I’m not saying it necessarily needs to be run by the government but it is approached by a utility, and therefore the profit structures become very different. And that’s something that your challenger banks don’t necessarily address

[00:09:46.03] Ben: On that topic of business models, banks, in general, know where they’re headed in that direction — you know, what the business model opportunities are — and if they know where they are, which one would suit them best?

Leda: I don’t think they do. I don’t think they do. And it’s not an easy thing. I don’t think there has been a clear sense of where profitability will lie in the future. I was recording a podcast with John Egan from BNP Paribas, recently, and he led with the statement, “Banks don’t know how to make money in the new situation. Therefore, what are the options?” And it’s very refreshing to hear someone say that from within a bank, although admittedly, he doesn’t sit on the traditional side of the bank. I think there are a couple of pieces there. One is the appetite of the market is shifting. Certain products that we were comfortable seeing being profitable, aren’t profitable anymore. Retail banking isn’t profitable. Mortgages, credit cards, institutional banking, transaction banking, investment banking, that’s all still profitable, but the regulatory pressure to change pricing and the way that money is made is definitely making it less profitable than it once was. It’ll be interesting to see how far the regulator will push certain things. I’m seeing banks change their infrastructure and invest in technology, not because they want to be seen as innovative, but because they want to lower their total cost of ownership. They’ve reached a point where growing their top line is much harder than it used to be, then, actually reducing your operating costs is the only way to increase profitability. So, we’re definitely seeing that shift. But I would say that monetization is a challenge for the challengers — funnily enough — not just the traditional banks, because the challengers, they are extremely well-capitalized, burning through cash, building up something that is very, very beautiful from a UX perspective, that is, challenging banks, the assumptions we had on how hard or easy it should be to do certain things, they have definitely reduced what has now come to be considered predatory pricing and all of that. But at its bare bones, their business model is not too different. I was at a panel a few months ago, and Nick Ogden turned to Anne Boden and said, “What challenger? Your business model is exactly the same as everyone else’s!” And Anne made some very interesting points around pricing and focus on the consumer. And she’s right in all of those points, but actually, at the level that Nick was raising the challenge, he is right. If you look at the challenger banking model, their proposition was, “We can make money the same way, but by being cheaper to run, we can also be cheaper to use. So we will pass that benefit to our customers.” The reality is, retail banking is not profitable, not in the same way it used to be. And the traditional banks are making money because they have universal banking. And the challengers are looking at their business model going, “Oops, that doesn’t make money.” You know, there are the Revolut’s of the world that do make money through crypto trading. There are other ways, but the traditional retail banking, as we knew it, is only profitable for the big banks, after the third or fourth product per customer, which is not a scale that your challengers have. And I went on for an hour here to answer a very straightforward question. I don’t think they know how to make money. And I don’t think it’s an incumbent problem. I think it’s a systemic problem. It’s banking, as we know it.

[00:13:26.04] Ben: If retail banking becomes some sort of a lost leader almost, to around which you have to bolt on more profitable businesses, what does a more radical business model look like? One that accepts the premise that, you know, retail banking is not inherently very profitable.

Leda: I would start with the proposition that maybe it doesn’t need to be. Maybe what we’re seeing is a transition to a world where retail banking is a public service utility. And I’m not saying it necessarily needs to be run by the government but it is approached by a utility, and therefore the profit structures become very different. And that’s something that your challenger banks don’t necessarily address because, in order to have a credit card and an affordable mortgage and an affordable consumer loan, you tend to have a balanced book, underwriting, repacks, and investment vehicles that move that debt around and leverage it in instruments that are highly complicated and have nothing to do with retail banking. And that is how you make mortgages more affordable. That’s how, allegedly and theoretically, you make credit cards more affordable. Now, I think there are two questions inherent in the question you just asked. One is, can you create retail banking that is systemically independent from institutional transaction investment corporate banking? And I would say not with the current pricing models that we’re used to because things slosh about and move around. And the second is, can you create a business model that says, “It won’t be particularly profitable, we will do it at cost and we will perceive it as a utility.” It is possible. The technology we have to do it would allow for the running cost and maintenance cost to be lower. But I would say that the cost of lending will probably go up, or you will have to pay for a current account, which in some societies already happens, and people wouldn’t even blink. But in places like Britain, people were like, “Whoa, what’s that all about?”

even if it makes perfect sense to focus on the thing you’re best at or the thing customer comes to you for and leave other things to others who are better at them, there is an emotional blocker there

[00:15:30.03] Ben: Do you think we’re seeing the first indications that that’s actually happening? In the sense that the manufacturing balance sheet part of the banking is becoming more and more heavily regulated and I guess less and less profitable? And then secondly, because we’re already starting to see big bank mergers, which would suggest that we’re moving into a phase now where institutions are trying to just maximize economies of scale, which is what’s at play here. Would you say we’re already heading in that direction or we’ll take a more direct intervention from governments or regulators to make it happen?

The challenger banks measure their success in terms of accounts or in terms of being primary accounts, but the number of people who close their high-street bank account is minimal. The whole notion of being multi-banked is a given now.

Leda: It’s too early to tell, actually, is what I would think. We’ve definitely seen, as you rightly point out, some mergers and consolidations. But in the world of banking, those mergers and consolidations — or de-mergers — are part of how business is done. We have not seen big banks exit retail banking, which I bet is tempting. But actually, bankers, not to bash them as cynical, but I have never met a bank CEO who didn’t feel a sense of duty towards the community they serve. And even though no bank CEO’s retail arm is where the money is made, they all feel extremely strongly about retaining that. And I can’t stress that enough, there is no bank out there that I can think of — actually no, I lie; there are a couple in very particular circumstances — but for the vast majority of banks, their retail division either breaks even or loses some money. But no one ever considers killing it, because they do feel a sense of duty and responsibility to their communities. And they don’t need the regulator to tell them that. They actually do that themselves. So, to answer your question in the negative, the obvious thing would be to kill your retail banking and focus on the profitable stuff, but people don’t. And I don’t think the regulator would permit it, even if people were inclined to go that way. I think there will be a couple of things: there will be consolidation, as you say, because there’s definitely profitability in scale. I think we will see an acceptance that certain products will become less profitable, and that will become the new normal. And I hope — but I have seen very little indication of that — I hope that people will start making the hard decisions to invest in the infrastructure of the core entity, not the greenfield captives, not the small experiments, but really create an overhaul of the infrastructure of the bank, that will mean that the cost of ownership and the cost of doing business will go down. And therefore, yes, you know, the return on equity will be terrible for a few years. But once they’ve paid off the cost of build, then actually, they will have a much lighter infrastructure. So the fact that certain things are not as profitable won’t matter as much, because they’ll be much cheaper to run.

[00:18:26.28] Ben: I want to come back to that point about how banks should transform technology. And so, I’m going to come back to that, but just in the meantime, I wanted to ask you: so, if retail banking doesn’t necessarily get split off from other types of banking, do you think you’ll have different players doing the manufacturing from those that do the distribution? Because, as you say, the manufacturing part is capital intensive, it’s not very profitable, but the distribution part seems to be where you could achieve network effects and where you could achieve much higher margins and potentially very low cost of customer acquisition and so on.

No one will ever enjoy buying banking services. One of the things that the banks have to accept is that you can make it as snazzy and fun and cute as you like, it’s not going to change the way people feel about it.

Leda: Well, you speak sense, and that should be the direction of travel, right? Whether it will happen or not, will depend on a lot of things. Regulation is one — we don’t have a clear direction of travel from the regulators, but there is an increasing push for separation clarity and demarcation lines between different pieces of the life cycle that the regulator is pushing towards. So, that may be a factor. But what is holding banks back from doing this is emotional, it’s not practical. I mean, over the years — I worked in a transaction bank and custody bank and I kept saying to them, “Plumbing is amazing! Why do you care about the sexy stuff?” Like, plumbing is where you can make money, you’re needed, but it is unsexy and people emotionally want to do the more exciting stuff, the client-facing stuff. So, even if it makes perfect sense to focus on the thing you’re best at or the thing customer comes to you for and leave other things to others who are better at them, there is an emotional blocker there. So, you see, for instance, quite a lot of the traditional high-street banks who don’t actually drive profitability through their retail businesses, should say, “I’ll tell you what: open banking has landed, I’m not very good at this digital journey stuff. But people still want to have their money in a place that feels secure, so why don’t you, Mister Startup, create all your propositions on top of my platform and account, your customers’ money will be in an HSBC account, but they won’t even see HSBC, they will see PensionBee and Revolut. Neither of them is doing that, and there are many reasons for it. For the challengers, it’s both the independence that you get from having your own license, but also the feeling of being a grown-up and sitting at the grown-ups table, and not just being a little app that sits on top of another system. The traditional banks are convinced from the old way of running relationships, that owning the customer is important, right? If you sit inside a traditional bank, there are usually fights between departments about who owns the customer. The notion that you need the customer touchpoints, you need to own the customer, that’s where profitability comes from, is actually complicated, convoluted, and in some cases, entirely misled.

Leda: The point is that you have the challengers spending a lot of time and money creating infrastructure that, to your point, should be created by someone else and it should be sold as a utility to all banks. The traditional banks are spending a lot of time trying to create propositions and user journeys that they’re not very good at. Meanwhile, they don’t make any money from them and they could just sit back, take the deposits, let other people be creative. They were symbiotic relationships that could have been explored and haven’t. And I think we’ve reached the point now, where none of what exists makes sense at scale. All of the various banking players will need to think about scalable and robust infrastructure. And, as part of that same discussion, they will need to think, “What am I for? And do I need to build all the bits that I will use to be that?” And my personal view is one should only build the technology that is tied to their differentiator and partner or buy the rest because it means that you carry less legacy, you carry less need for dependence on know-how, and if technology moves on and your provider doesn’t, then great, you change providers.

[00:22:37.11] Ben: So if we think about, I don’t know, eCommerce, right? You’ve got Amazon as an aggregator, and Shopify as a platform, right? How do you think it plays on banking? Do you think banks can be aggregators? Or do you think they’re destined to be platforms?

the data that you need for timely, intelligent, embedded financial services is there, but nobody is doing it yet

Leda: That’s a very good question, and I think it depends on two things. One is the economics of it. So, the way that financial relationships are monetized right now makes it very hard to go down, actually, either of those paths, because the way you make money is hard to unbundle. It’s not a case of, “Okay, now you will be doing 30% of that process, so you get 30% of the revenue.” It’s sadly not how it works. The second challenge is, which bank has the technology to actually even start thinking about that? The people who are quietly, but interestingly, doing quite a lot of that work is Standard Chartered. They are looking at the types of work they have historically done and creating partnerships to allow them to retain their usefulness. So, it’s less about, are you an aggregator or are you a platform? And more about, in what you currently do, where do you retain brand relevance? And where are you still actually a meaningful part of the puzzle? And who can you partner with upstream and downstream to make that piece where you’re still good, bigger? And the only bank I’ve seen do that to any meaningful scale, actually, so far is Standard Chartered.

[00:24:08.19] Ben: The big advantage that the incumbents have, as you say, is every challenger is spending hundreds of millions of dollars on trying to acquire customers that the incumbents already have.

Leda: That the incumbents already have and don’t lose, right? Because it’s actually a false statistic we see. Because you are absolutely right. The challengers measure their success in terms of accounts or in terms of being primary accounts, but the number of people who close their high-street bank account is minimal. The whole notion of being multi-banked is a given now. I don’t know a single person who has one bank account.

[00:24:43.27] Ben: Yeah. So, you’re almost saying that that’s not a meaningful statistic anymore, right?

Leda: No. So, I’ve done a very informal survey of a few friends of mine who took the leap, so to speak, and started paying their salary into a challenger. And so, rather than having your traditional bank for your salary to be paid into when you’re spending money, playing money in your challengers, they actually started paying their salary into their Starling, their Monzo, their N26. But you ask the next question, if the vast majority of them sweep what they don’t expect to use immediately. So, actually, the deposits, which is where the money is made from a banking perspective, still go to the traditional institutions, either because they offer better interest rates, or because they offer higher protection, better security. The motivations are multifaceted, but if you say that the main thing that a banking player will monetize is deposits, then even the people who pay their salary into the challengers — and I would say that that number is nowhere near as high as the total number of customers, obviously — even these guys don’t leave their deposits in the challenger in any meaningful sense.

we will see much more embedded finance, much more embedded payments, actually much more complicated financial transactions being embedded in the commercial activity, but it won’t be driven by finance. It will be driven by the consumer need and the consumer opportunity.

[00:25:57.29] Ben: And do you think that’s like some sort of proxy for trust? And do you think trust is the key attribute to be able to do aggregation? I.e. I’m going to introduce you to other products and services you might find useful and value-added, because you’ve given me your trust?

Leda: Trust is absolutely vital. However, I think the main thing is that people don’t want to think about any of these things unless they absolutely have to. So, the proactive up-and-cross sell the banks are trying to do is noise. Nobody says, “Do you know what I’m gonna do today? I’m gonna pick a car loan. This is my plan for the afternoon.” People will say, “I have to renew my mortgage and I hate it, and I’ve been putting it off.” No one will ever enjoy buying banking services. One of the things that the banks have to accept is that you can make it as snazzy and fun and cute as you like, it’s not going to change the way people feel about it. The second thing is, people want these things to be available when you need them. So, I keep getting mortgage offers from my bank — my high-street bank — even though my mortgage is paid for out of that bank; but I get first-time buyer offers on a weekly basis. So, the data that you need for timely, intelligent, embedded financial services is there, but nobody is doing it yet. And I mean, from the standard banks. And I would say that the challenges are not doing as much of it as they could.

Leda: There was a proposal I saw recently that N26, was going to be doing this. I don’t know whether it actually went live or it got delayed because of COVID. But essentially, it was, if all your movements take place within your N26 account, N26 says to you, “Hey, leader, you pay this much for rent, you qualify for this kind of mortgage, and you can afford an apartment in the neighborhoods you do most of your spending in. So, in the neighborhoods where you spend your life, you can afford to buy.” Those data points are actually available, either publicly or through your own protected account. Now, that is a useful service, right? That is intelligent, embedded finance. But I don’t think that my mortgage provider saying “Do you want a credit card? You can afford one.” Or, my high-street bank saying, “Would you like to buy a house? We can help you.” is in any way helpful. Trust or no trust — because, of course, I would trust them to execute — but it’s not like the supermarket where you will buy your favorite shampoo because it’s an offer even though you don’t need it. And yet, the way financial products are promoted is exactly like your supermarket offers. People will see it and buy it. No, it doesn’t work that way. So, intelligent embedded finance is technically possible. It’s absolutely possible from a data perspective. When it becomes the way we offer services, then the people who do it best will be the people who read the situations best, not the people who have the best pricing.

digitization is not about allowing the banks to dominate this conversation. It’s about allowing them to stay compliant and relevant with the way people live

[00:29:01.18] Ben: So you’ve mentioned the term ‘embedded finance’, which is something that’s become, I think, really quite fashionable, over the course of 2020. Do you not think that it will be embedded into products and services that aren’t financial at all in nature, i.e. those that have the highest engagement? Because that always seemed, to me, the problem, as you said, which is, I only go into my banking app when I need to do banking, whereas, you know, I’m in WhatsApp all day. So, isn’t it easier to try to engage me with financial products and services through apps and services that I’m regularly using, and in which I have the pool of engagement?

Leda: I would expect so, but I think that the starting point would be interesting. So, for instance, the Uber example is a very interesting one, right? By taking away the process of payment, they’ve given you back, what? Two minutes of your life? And yet, it felt like a revelation the first time it happened. Uber didn’t create embedded payments to help MasterCard make money. They did it to create a proposition that would make them more attractive to the user. So, I think we will start seeing embedded finance for that purpose. And it will put everything on its head. I was speaking to someone who works for Experian, and they were saying, “Creating a good credit footprint has become second nature. We all know you need to brush your teeth and have a good credit score.” But the reality is that assumes you need to enter the credit system. That’s an assumption that we have made without even thinking about it. But is that the right thing? Is that something we should be encouraging new generations to do? So, for me, the interesting thing is, we will see much more embedded finance, much more embedded payment, actually much more complicated financial transactions being embedded in the commercial activity, but it won’t be driven by finance. It will be driven by the consumer need and the consumer opportunity.

[00:30:56.12] Ben: If I were to summarize, you’re saying that it will be more intelligent, more useful, and it will be pull not push, right?

Leda: Yeah.

[00:31:03.25] Ben: Changing the topic slightly, do you think that open banking is the catalyst to move us to this world of pull not push, and intelligent and useful embedded banking services?

the consumer will not choose the bank that has the best user journey; they will choose the bank that gets out of their way the most

Leda: I was asked a similar question not too long ago, and we had been talking about dance earlier and something entirely unrelated. And I used the analogy in a way that was relevant in the moment, but I think it still works. And what I said is, gravity is essential for dancing. But nobody thought, “Gravity is great. How could I use it? Let me invent dancing.” And the thing that has been frustrating for most big organizations that open banking came, and the banks kept looking at it until the eyes bled, and couldn’t figure out how to make it work for them, how to make money through it. And I heard equally a lot of startups looking at it and going, “There’s an opportunity in there but I don’t know how to monetize it.” And I think that if you stop staring at it, and you start going down the path of solving real problems, then open banking will be an enabler, a facilitator, and an accelerant to things that you can do to solve real problems. A little bit like you couldn’t dance without gravity, but the two are not… You know, nobody came up with dancing or slides by thinking I need to use gravity for something.

the boat that said ‘digitization is your key to future profitability’ has sailed. The boat now says ‘digitization is a key to survival and compliance’

[00:32:20.16] Ben: It seems to me that the whole digitization of the industry banking, is the new driving force to embedded finance, all these other downstream applications that will be super useful and value-added. But it doesn’t seem like open banking itself is actually that relative to everything else that important. Or do you disagree? Do you see it as being really quite significant in pushing us towards this?

Leda: I think open banking is going to be significant in enabling solutions that wouldn’t have been possible before. But it’s for the consumer, and for the creativity that the industry will see. It’s not for the incumbents. I think that, as I said earlier, embedded finance, and those truly empowering capabilities won’t come from the banks. They might be powered by the banks, but they won’t come from the banks. So, the revolution and the truly transformative pieces won’t be because the banks finally found a way of doing this. It will be because somebody thought of something that is now possible because of open banking. So, digitization is not about allowing the banks to dominate this conversation. It’s about allowing them to stay compliant and relevant with the way people live. So, for instance, at my high-street bank, you can’t set up an international payment on the app. You can only do it online. Now, if you’re not a banker, you either don’t question that, or you assume it’s for security purposes. If you are a banker, you know that’s because their systems don’t talk to each other and the online bank is on an entirely different infrastructure than the mobile bank. The reality is that a time will come — and that time is not far away from us — that the challengers and some of the incumbents will solve some of these problems. So, the consumer will not choose the bank that has the best user journey; they will choose the bank that gets out of their way the most. And by getting out of their way equally means not bombarding them with products they don’t want, but also enabling them to do things on-the-go. I remember a few years ago, I was here, in Athens, visiting my parents, and I needed — it was a routine KYC check for my mortgage. I couldn’t do it remotely. I had to go in-person into the branch that has changed in the intervening time. So, there are things that are hygiene factors these days, both because the customers expect them and because the regulator expects them, but I think that the boat that said ‘digitization is your key to future profitability’ has sailed. The boat now says ‘digitization is a key to survival and compliance’.

[00:35:06.26] Ben: I suppose asking the question a different way, do you think that… So, open banking kind of creates an obligation to share customer data. Customers, as we observe in other realms, they’re happy to share their data where they perceive there’s a utility for doing so. So, do you not think that this will happen anyway, as the right use cases emerge?

Leda: I don’t think that use cases will come from the banks. Now, I think open banking is not an obligation to share data, it’s an obligation to share infrastructure that enables the sharing of data, should the customer consents to it. And the onus was on that consent mechanism, because banks would allow you to screen scrape in the past, which is extremely insecure, but cheaper to do. I think creating that infrastructure for consent and control has been what? Has been a sort of a point of contention, because it was expensive, and the banks couldn’t figure out how to make money with it. But I firmly believe that the creative solutions that leverage open banking are not going to come by people who look at open banking and think how can I make this — make money? They will come from people who are solving problems and go, “Oh, look! With open banking, it’s much safer and easier to do that.”

[00:36:18.12] Ben: What effect you see COVID-19 having on banks, on B2B FinTech companies, and then on the B2C challengers?

Leda: I think it very much remains to be seen. I’m extremely skeptical of all the triumph of, ‘this has sealed our digital efforts and accelerated and…’ I don’t see that. What I see is, banks that knew they had challenges and problems in their infrastructure faced those problems by throwing more people at the problem, the people working extremely hard to create bridging solutions, and delivering for the clients and the bank being extremely proud of their people — as they should be. And then, the conversation of whether they should actually challenge change, restructure being not even started. So, I would say that the banks have done well in the midst of COVID because of sheer hard work, creativity, and determination on their human sides. But not because their systems were up to scratch. And I’m not seeing anyone saying “Okay, our systems were not exactly up to scratch, and I should do something about that.”

you can’t change systems without changing the supporting economics and surrounding governance. Which means that if you’re doing the slow refurb process, you’re going to have a schizophrenic organization for quite a long time

[00:37:30.03] Ben: What about, do you think, they’re investing more in B2B FinTech solutions to help them to digitize faster or to, at least, service customers digitally faster than they were?

Leda: There is some loan disbursement work that has gone ahead. But honestly, what happened when COVID hit is that people went into panic mode because they needed to deploy quick solutions for particularly loan holidays for both businesses and individuals. The systems were not set up to do that. And the reality was that if you have a COBOL-based system to change an interest rate is two months’ worth of development work. The reality is they threw the people at it, they made the change, but the system is still COBOL-based.

[00:38:13.24] Ben: And then, what about the B2C FinTech companies? Because there was a piece that was written by McKinsey, I think it was called, “Rerouting Profitability” or something, and they made the point that all of these challenges in the unit economics of some of these businesses have been laid there, and now they’re struggling to raise new funding, and the FinTech sector is an existential crisis. How do you react to that kind of comment?

Leda: I’ve heard about the existential crisis before. I saw that report. And they were saying the FinTech sector is an existential crisis, then the FinTechs responded all over Twitter and LinkedIn, “You’re the one, an existential crisis”. And the reality is, no one is an existential crisis. This is a long game. It’s a long game. And in the last 15 years, everything is moving in the direction we said it would, but because it’s not moving as fast or as radically and because the startups that were around at the beginning are mostly not still around, therefore, the winners and the losers are not as black and white, people are feeling a little bit more relaxed than they should. But we said 10–15 years ago, the economics of banking are changing, the significance of technology is changing, the world will be more connected, service orchestration will be the name of the game, unit economics will change. All of that is happening. It’s just happening slowly, as you should expect, and therefore, I don’t understand people who are trying to find comfort in these radical revelatory moments of, “We fixed it” or “This was wrong” or “This is right, and that is wrong”. It doesn’t go that way. There is a direction of travel and we’ve been very much moving in that direction for 15 years. Certain events accelerate certain parts of the journey — regulatory moves, certain mergers, the rise of the Chinese giants, COVID. But it’s not a pivotal moment after which everything is different.

[00:40:10.02] Ben: What about payments? Do you think the impacts on payments from open banking has been more transformational?

Leda: I mean, my answer when it comes to open banking is, it is what it is, right? There’s no change. Payments are in an area that has had a lot of focus and has had a lot of innovation over the last 10 years. It hasn’t been transformative, because the monetization relationships are similar. But we’ve seen incredible speed in payments, particularly cross-border. So, payments, I would say, is a place where we’ve had so much innovation and creativity, that unless the rest of the banking infrastructure starts catching up in terms of the build of the systems that can support, there’s only so much more that we can see in payments, because there’s a little bit of saturation.

[00:41:00.10] Ben: I want to go back to something you said earlier on. If we think about this, there’s typically been a few approaches to technology transformation. One is the Big Bang approach, which I think is becoming increasingly less viable or palatable. And then you’ve got this progressive…

Leda: People lose their jobs when they do that, right?

Ben: Yeah. I mean, I just think it’s just, the time to value is too long, the risk to value is too high. And so, we’ve seen people moving to more progressive renovation type renewal strategies, and then also, as you said — I think you used the term ‘greenfield captives’ — but this idea of building a new digital bank, and then trying to migrate customers and books of business to that new bank. So, first of all, I’m sort of inferring you’re a bit of a skeptic when it comes to this build and migrate strategy. So is progressive renovation the right approach to technology transformation, or do you see another option?

Leda: There are many options, right? One is Big Bang, the other is refurbish as you go, and the third is build and migrate. We have not seen the migrate part happen yet. Some of the greenfield builds have failed to provide the skills. So, First Direct is a good example, right? Everyone who uses First Direct loves it. Why am I still on the old HSBC systems? I don’t know. But they haven’t migrated. Now, I would suggest that it’s too late now because even though First Direct customers are very happy, the technology is almost 20 years old now. But even with a successful challenger, no migration took place. Then, you have situations like RBS’s Bo where, for whatever reason, they pulled the plug on the effort. Now, a lot has been said, and a lot of criticism has been piled on top of RBS for killing Bo. I actually think that I don’t know enough about the ins and outs of it, but I think if you think something isn’t working, having the courage to say, “Pivot, move” is actually brilliant, is what we should be doing as well. That’s what we said our innovation departments were for. And the fact that quite a lot of the technology is being redeployed elsewhere shows that the experiment was not a failure. But the whole idea of build something at arm’s length and migrate didn’t work there.

Leda: There’s currently Mox in Southeast Asia, which looks to be an immense success — they’re onboarding a new customer every minute. Will Standard Chartered migrate customers on to there? No idea — remains to be seen. So, the build and migrate thing is brilliant as an idea and lower risk. It’s just that the migrate thing never seems to happen. The Big Bang approach doesn’t work, and we’ve seen a lot of very good CTOs stop being very good CTOs — in fact stopping CTOs at all. It’s the fastest way to end your career, right? So what are you left with? You’re left with slow refurbishment. And the thing about slow refurbishment is that it has two massive challenges. One is, it’s a long game, and people lose momentum and focus. It’s a long game. Like, if you start doing that, it’s going to take 10–15 years. And in year three people start going, “Are we still doing this?” And the answer is “Yep. And we’ll be doing it for quite a lot longer.” So people start losing focus, it stops feeling like a top priority, it feels like an endless log in a bottomless pit. The second challenge is that you can’t change — and we touched on it earlier — you can’t change systems without changing the supporting economics and surrounding governance. Which means that if you’re doing the slow refurb process, you’re going to have a schizophrenic organization for quite a long time, where part of your organization will have a different governance model and a different pricing model and that creates immense tensions, both in terms of the operating model viability, but also in terms of humans. Imagine a team that sits in the same office opposite to each other, half of them have transitioned to a new system with new governance with real-time approvals from risk and compliance and a different pricing model. And the guy sitting opposite you has to go to the risk committee. And if they miss their slot, they have to wait for three months. But that’s the reality: if you’re doing a slow migration, you have to change the system, the pricing, and the governance for each part of the bank, and then move on to the next one. And it’s not just the cost of running two parallel infrastructures until you can migrate and switch off. It’s the fact that you’re gonna have to be running two different organizations, from a governance and pricing, etc. perspective.

[00:45:26.24] Ben: One idea that I hear more often is, you know, as you said, I don’t believe there is a silver bullet — but this idea that maybe you can put some sort of orchestration platform in between channels and record-keeping, which enables you to deliver better customer experiences, and sort of buys you time to replace those record-keeping systems, which is where the real complexity and the real legacy lies. So, how do you react to that idea of introducing a new orchestration layer?

Leda: Bring it! Great! But you still need to fix the human governance, which seems to fall off everyone to lift.

[00:46:10.21] Ben: And do you think it’s issues of governance that are ultimately the reason why these greenfield captives don’t become the bank at large?

Leda: That’s a very, very good question, and ‘I am not sure’ is the answer. I would suspect the answer will be different in every captive. And it would depend a lot on whether the captive is expected to run on the existing bank infrastructure — in which case, it’s not just the governance, it’s also the infrastructure — or whether you have your own board and you’re essentially not just a separate entity name, but you’re genuinely a separate entity, in which case your decisions can be different. I think it varies. It could be lack of conviction, it could be the fact that nobody has successfully done it yet. It could be a case of, when is it big enough? Or when do you know? So, Mox is very young, so it’s easy to pick them as an example — Mox is succeeding by every metric right now, but it’s extremely early. Assuming that the plan is if Mox succeeds — and I hope they will, and I think they will — if the plan is, well, we expect that some of the traditional bank customers will choose to go to Mox, great! But if the plan is, we will migrate the customers when Mox has achieved size and scale, I bet you that nobody has specified exact numbers for that. It is so far into the future. But then it becomes a question of, okay, what is big enough? How long do you wait?

[00:47:37.16] Ben: And it’s not obvious that all customers will want that kind of service. And it’s not also obvious, to me, at least, that the regulator will allow it, because what happens to rural areas? What happens to non-digital customers?

Leda: The answer to that will be many-fold. I haven’t seen a regulator yet force banks to have branches. So, that could be a very interesting legal case that says, “If you allow Revolut, and Monzo, and Starling to have a banking charter without the responsibility to maintain branches, why are you putting the onus on me?” It’d be extremely difficult to have rules for one and not for the other, right? So, there is currently no obligation to serve the rural areas, there’s currently no obligation to have branches, there’s currently no obligation to serve the elderly. So you could see challengers that emerge that cater to those communities or you could find that actually, the way things go, they become even further underserved and marginalized. But with no obligation to retain a physical presence and the mounting cost of retaining a physical presence, I am not sure that the considerations you raised would carry the day — valid as they are.

[00:48:52.22] Ben: I guess there’s another reason to move fast, otherwise, you’re left with this sort of rump of hearts of expensive-to-serve customers. And I think it also maybe depends on something you said at the start, which is, whether this ultimately becomes some sort of public service utility, in which case, maybe there does become requirements about serving rural customers and things like that. A slightly different topic. So, I think we’ve been through the hype cycle with everything to do with cryptocurrencies, and digital assets, but it feels like we might be back into some sort of slope of enlightenment. What do you see is the role of digital assets in banking?

Leda: There are three different pieces there, right? And when this whole thing started, we couldn’t imagine them separate to each other. One is digital assets, the second is crypto assets, and the third is distributed architectures. I would say that distributed architectures and what we understood as smart contracts were a revelation, it blew our mind. But there are now ways of doing them that are much kinder to the environment than a traditional blockchain. There are ways of having a distributed architecture that isn’t DLT. There are reasons why you might still choose DLT, but you can have a distributed architecture in immutable records without DLT. So you would need some good reasons to have DLT that would go beyond those basic functionalities that, for a time, we couldn’t fathom outside DLT, but now we can.

Leda: The second thing is digital assets. And I think we were going in that direction anyway but the advent of blockchain and other digital assets forced us to create security of holding and transacting in assets that don’t even have any magic, physical representation. Because we have been dealing in digital assets and digital ledgers for a long time, but the assumption was that there was capital adequacy, that if I make a transfer to you, if the bank has that physical cash or that physical gold somewhere in its coffers, that doesn’t exist anymore. So the transition to regulating and understanding digital assets and creating a certain degree of complexity is there and is now also decoupled from crypto cash and crypto-assets. Which means that crypto has become its own segment, where part of what you’re doing is creating the distributed architecture and crypto and digital assets with the added layer of not having that provenance and ownership — essentially becoming a bearer asset, like money would be in the physical world, but in the digital space. And I think it’s not a space I personally have a massive interest in anymore. That’s not that I don’t find it interesting, is that there are only so many hours in the day. But I do find that for the industry, decoupling those three things has been helpful because then you can have the benefits of the architecture and the benefits with digital asset without getting into the moral and regulatory conversations around the crypto side, unless it’s absolutely what you were trying to achieve.

[00:51:59.13] Ben: Yep. Okay, last question. So, we’ve got this far and we haven’t talked about the technology giants — Google or Apple — moving into banking and finance. What’s the role of those mainly American and Chinese technology giants in banking in Europe?

Leda: I would say that the Chinese giants and the American giants represent a very different type of challenge because the Chinese giants have a very well-developed financial proposition. It’s not just payments, it’s investments — if you look at the two big Chinese entities, they started with payment, sure, but that’s not where they stopped. So, I would say that them coming into Europe presents a very interesting challenge because they’ve worked out how to become financial services provision players and they don’t need to build scale in Europe to become profitable, because they can leverage their scale in Asia. They already have scale. What will be interesting is how the regulator will treat their entry point, whether they will expect a lot of infrastructure separation — in which case they would need to rebuild their support, and their infrastructure in Europe in order to have that scale — or whether they would allow them to cross leverage. But I think it’s a very interesting thing with the Chinese giants in particular, that their regulatory framework has very much allowed those entities to grow because of how the regulatory framework is in China. You don’t have anything of that size in Europe, and that’s not an accident. That’s partly because the regulator is pointing growth in a different direction. From a US perspective, the giants that are being looked at as potentially entering our space are only dabbling in payments. So, they’re looking at extending whatever it is they’re currently doing into the next step, as we were talking about — the embedded infrastructure makes it natural for these entities to offer payment services, and facilitate some of those. There is no indication that the deeper credit lending and investment pieces are being addressed. The only pieces we’ve seen have been through partnership — you know, that short-lived partnership between Amazon and Wells Fargo and then more successful, but equally limited for now partnership between Goldman Sachs and Apple. We’re not seeing an appetite for those guys to become regulated financial services providers the way that Alibaba and Tencent have.

[00:54:33.01] Ben: Where do you think the bigger challenge comes from?

Leda: If you’re talking about the biggest challenge to profitability for banks in Europe, actually, I think it comes from the regulator, who’s increasingly demanding unbundling and transparency and simplicity and pushing for technology transformation without allowing the banks to pass that cost on to their customers. The business models that both of those two geographic units of giants represent would have to be tweaked a little as they enter Europe, but from a bank, multiple payment providers that sit on top of their infrastructure doesn’t provide an existential threat. Neither does a Chinese tourist making all payments through WeChat. It’s what happens about pushing them up and down the value chain, and how they monetize the place where they land, which is why I find the model that Standard Chartered is doing very interesting, because they’ve had to deal with those Chinese giants and have taken, to me, the logical path of, there are certain battles that are not worth fighting, because we weren’t winning them before these guys appeared. Therefore, let’s focus on the things that we’re still needed for, that we do well, that we have scale for, and then we can even still partner with those guys and give them depth where they don’t need to build infrastructure. Because one of the things that both the Chinese and American giants have in common is the fact that they are clear as to what it is they’re for. And what it is they’re for may be multifaceted, because they have many different business lines under their umbrella, but they’re clear as to their purpose, and they don’t carry unnecessary infrastructure if it’s not aligned to their purpose. So I think it’s important for European entities to learn that lesson.

[00:56:18.08] Ben: If an incumbent is clear about what they stand for, and they align around that, and potentially also pursue some sort of ecosystem-based model, then there’s no reason why banks can’t surf this wave of digitization and emerge on the other side with happy customers and profits.

Leda: I mean, I am not going to foretell such a happy ending for anyone because they’re potentially too many banks, and what passes as profitability for the average bank is possibly not to be seen again in the market. But I would say that anyone who refuses to do that will definitely not have a seat at the table. Consumers — and I don’t just mean retail consumers, I mean, customers across all value chains — and regulators are much more demanding, and rightly so, in terms of service provision, focus, transparency, and pricing. And therefore, unless you really know what it is you provide, what it is you’re for, you can become overwhelmed by options. Think about it, you can revamp your lending infrastructure in 10 different ways. If you can’t decide whether lending is important to you, how will you know what the best way of revamping is?

Ben: Thank you very much, indeed, for your time. That was great.

Leda: Absolute pleasure. Thank you so much!

Digital Age Banking Systems and Architectures

4×4 Virtual Salon featuring: Paul Taylor (CEO and founder, Thought Machine); Andra Sonea (Head of Solution Architecture, FintechOS); Ron Kersic (Enterprise Architect, Technology Strategy & Innovation, ING); Ryan Battles (Banking & Capital Markets Technology Delivery Leader, EY)

Lively panel discussion featuring:

  • Paul Taylor (CEO and founder, Thought Machine)
  • Andra Sonea (Head of Solution Architecture, FintechOS)
  • Ron Kersic (Enterprise Architect, Technology Strategy & Innovation, ING)
  • Ryan Battles (Banking & Capital Markets Technology Delivery Leader, EY)

We discuss:

  • New Banking Business Models
  • Digital Banking System Architecture
  • Digital Age Banking Systems
  • Enabling change

To turn Adversity into Advantage, Banks need to Renovate in Winter

Crisis is not the time to stop all IT projects, but to double down on the ones that really matter.

Don’t pull up the drawbridge

Beware risk and opportunity cost

Bag some quick wins

Enterprise Software Stack Systems of Intelligence
How the Banking Enterprise Software stack is splitting

Consider Impact on the future

The Future of Banking
The Future of Banking and the Strategic Imperative

This a data play. It requires understanding customer context (interaction preferences, financial situation, needs) and be able to match to the right offering. In the first instance, financial services companies will do this for their own labelled services, but increasingly — to maximize utility and convenience — they’ll need to do it for third-parties services as well (requiring an extensible product catalog) and intermediating and bundling if necessary (which necessitates managing real-time risk). As a third phase, these same institutions can then orchestrate value between the different parties on the platform, stepping back from intermediating and becoming a system of collective intelligence.

Don’t waste a crisis

Articulate the change narrative

Use stop/go triggers

In summary

Do Traditional Banks Really Still Own the Customer Relationship?

Conversations and sessions at FinTECHTalents last month covered many hot topics, but one theme dominated: the customer relationship is at stake.

Banks continue to draw a false comfort from retaining customer current/checking accounts, without realizing that data, engagement and monetization opportunities are seeping away to other players.

Despite many banks having already embarked on digital transformation projects and despite many having launched an array of fintech/tech partnerships and initiatives, more is needed for them to prosper in the digital era. During FinTECHTalents, Jim Marous put it frankly:

“Banks have willful blindness; they don’t realise that they are losing business. Just because bank customers don’t switch doesn’t mean that they love you.”

Jim Marous, Digital Banking Report CEO, The Financial Brand Co-Publisher and Forbes Contributor speaking to Ben Robinson of Aperture.co

This ‘blindness’ comes from studying attrition rates which don’t show the bigger picture. Jim explains how this gives false comfort by talking about his own banking arrangements: “With my business bank, I still give deposits and get withdrawals, but most transactions are handled by PayPal, they understand my business intimately. PayPal can offer me a pre-approved business loan instantly. If I went to my bank, it would probably take me 4 maybe 5 days to get approval and that’s assuming that they will approve it at all. I can get this immediately from PayPal. My bank may have my business, but they don’t have my relationship.”

This view was further reinforced during the keynote session on Day 1 of the event when Aritra Chakravarty, Founder and CEO of Project Imagine and Dozens highlighted that:

”The number of customer accounts a bank has doesn’t reflect customer behaviour. People change partners more regularly than their bank; just because you have a large customer base it doesn’t mean that they are engaged and profitable.”

In short, then, for the incumbent banks, headline customer might hide the extent to which their business are being disrupted by new competition. So, what is needed for banks to truly engage with the millions of headline customers?

“We spend 3 hours a day on our mobile phone. On average we look at our phones around 80 times. We scroll through 300 feet of news-feed every day, that’s the equivalent height of Big Ben!” said Russell Pert, Industry lead, Financial Services at Facebook on Day 1 of the conference before concluding:

“people want to do their banking through the services where they live their lives.”

The point being made here is a profound one. It is easier to embed financial services into a service where customers already have a lot of engagement than trying to create engagement in a banking channel. Think how many times you visit, say, WhatsApp (another Facebook property) compared to your banking app.

Also, where banks are using artificial intelligence (AI) to understand customers better, they’re often introducing more, not less friction into the customer relationship. As innovation and entrepreneurship professional at RBS, Roshan Rohatgi said in the Behavioural Science panel,

”Stopping a card transaction due to a possible fraud risk may protect the customer, but can lead to embarrassment and negativity with the bank.”

Bradley Leimer and Theodora Lau, Co-Founders of Unconventional Ventures speaking to Ben Robinson of Aperture.co

And it has never been easier to embed banking into other services. Open Banking opens up access to customer transactional data, creating a unique opportunity for third-parties not only to serve embed banking into their services, but also to do it more personally by meshing up contextual and locational data with bank data. As Bradley Leimer put it to us,

“The promise of open banking to a High Street bank is a degradation of their relationship with the customer. For a fintech, it’s an inroad into a relationship. For a tech provider, it’s a way to take more data in, understand and profile a customer better, and further entrench them into the ecosystem.”

So should banks despair? Not all, sometimes the answer is to go back to basics, rather than to try to emulate Facebook or WeChat.

Roger Vincent, Chief Innovation Officer at Trade Ledger pointed out there is a global funding gap of £1.2 trillion, defined as the shortfall between the capital SMEs require to grow their businesses and what they receive in lending, and that gap continues to grow.

Roger Vincent, Chief Innovation Officer at Trade Ledger

The problem, says Roger, is that

“the economy is becoming increasingly intangible, but banks aren’t yet comfortable lending against these intangible assets, which requires them to capture and process new datasets in real time.”

But taking advantage of new datasets to get credit flowing to SMEs is exactly the kind of opportunity banks should be seizing with digitization.

Likewise, helping to create financial services that are better moulded around people’s changing lifestyles is another major opportunity. As Dharmesh Mistry put it, the way to create a deeper relationship with customers is give them “everything they need for a given context”.

He used the example of a freelancer: banks should adapt their own services, for example, by giving access to credit to top up volatile incomes, but in addition they should provide all of the ancillary services that a freelancer might need such as filing taxes, raising invoices, submitting expenses and so on.

James Perry of BUD at FinTECHTalents
James Perry, Head of Client Delivery at Bud speaking to Ben Robinson of Aperture.co

This might entail a move to more of ecosystem-based business model, but platforms are emerging to facilitate these models. Trade Ledger is building a platform that could easily facilitate this, while Bud is doing this now. As James Perry, Head of Client Delivery at Bud, says:

“We open the platform where banks don’t have to do procurement for 8 to 10 providers, you only have to do it with Bud. We open the door to a network and allow lots of different providers to come “

But going back to basics even further, the route to more meaningful customer interaction may lie simply in helping customers to make better decisions.

Banks sit on rich datasets, but when they’re used well (if at all), it tends to be in the pursuit of up-selling and cross-selling. In part the issue is that customers might get the wrong products for their needs and also that they might find it intrusive — as Poojya Manjunath from Lloyds Banking Group said within the Behavioural Science panel,

“when a personalised message forces the client into a transaction/money exchange that’s when the customer will often back off.”

But the issue is bigger, the products might end up reinforcing bad behaviours.

Like the Facebook algorithm that serves us up more of the content we like, serving up more loans to an over-spender can perpetuate their problems and amplify the cognitive biases from which we all suffer. Instead, banks should help customers to understand themselves better and help them to achieve their long term goals.

Dr. Peter Brooks, Chief Behavioural Scientist at Barclays, put it well on the Behavioural Science panel,

“If our customers aren’t managing their money well, it is our job is to help them to manage it better. The result is that they will become better customers and their lives will improve and they will become stronger economically which helps both banks and society as a whole.”

And he went on to say that the problem often sets in with the product design, “the typical focus of a product manager is about delivering the end product and launching, rather than how to design it in the first instance. You need to get the design right first. Look at the customer journey, look at how the customer uses the product and ask if it encouraging positive behaviours.”

Pol Navarro, Digital Director at TSB with Ben Robinson of Aperture.co

In terms of using data to put the customers’ needs first, Pol Navarro, Digital Director at TSB, used a good example from the SME space.

“There are lots of opportunities to anticipate things. Imagine with Open Banking where you can easily get data from all your accounts wherever they are, and combine that with your accounting software in the cloud, banks can easily help customers predict their cashflow, for example, saying that in two weeks there are all these payments coming but you do not have sufficient funds and therefore something must be done whether it be taking out a loan or bringing money in from another account to avoid an impact in your cashflow.”

The imperative to make this shift to helping customer make better financial and commercial decisions was underlined starkly by Bradley Leimer, who sees it as the existential challenge:

“Banking is an industry today that continues to take profit rather than give profits. It’s a value proposition that’s about how much value I can derive from you rather than how much money I could derive for you. That to me is the biggest opportunity — along with a long term view — that the industry needs to shift or it will completely give up and recede the relationship entirely to big tech and a series of platforms that banking itself will no longer be a part of.”


Any bank looking at headline customers numbers and giving itself a pat on the back should be wary that disruption continues to abound. There remains the big threat, heightened since the advent of Open Banking, that the large technology platforms will eat their lunch.

But the challenge seems to be at one more profound and simpler. Banks more than anything need to change philosophy by promoting customer need above their own. Practically, this means using data to help customers understand themselves better and, in turn, helping introduce them to the services they’ll need and the banking services to support it. Trying to be Facebook won’t work, just try to be better banks.

To see the full interview with James Perry from Bud click here.

Digital Era Banking Systems

The banking software market is reconfiguring around the demands of the digital economy — and value is accruing to new systems of intelligence

In Clayton Christensen’s Law of Conservation of Attractive Profits, he talks about the “reciprocal processes of commoditization and de-commoditization” that occur in technology value chains when product architectures change:

“The law states that when modularity and commoditization cause attractive profits to disappear at one stage in the value chain, the opportunity to earn attractive profits will usually emerge at an adjacent stage.”

Our view is that this same process of commoditization and de-commoditization is playing out in the market for banking software. Changes in technology (cloud and AI) as well as changes in regulation (real-time payments and open banking) are causing a formerly integrated system to become modularized and new players are emerging to exploit this shift— new core banking systems but also new systems of intelligence that, akin to operating systems, orchestrate value across their networks.

A brief history of banking software systems

When we look at the technology debt in the banking industry, we might forget that banks were once IT pioneers. Banks were among the first industries to use software, adopting branch accounting systems to keep records of customer bank balances as well as to calculate interest, fees and tax.

But, because banks were such early adopters, they wrote their own applications — there was no software industry at that time from which to buy applications. This might not have been a problem except that 1/banks didn’t stop writing applications when commercial software arrived and 2/they have kept and extended those same branch accounting systems ever since — producing the kind of unwieldy system architecture depicted below.

A typical universal bank system architecture (source BCG)
A typical universal bank system architecture (source BCG)

Smaller and newer banks (from the 1980s onwards) skipped the branch accounting system and instead moved to packaged software, integrated core banking systems. These systems had many advantages: they could run on much cheaper hardware (and software) than S/360 mainframes; they could keep separate records based on parties and products (so that it was possible to have the same customer across branches and products and to provide consolidated views of customer holdings); and, they were integrated front-to-back — from the teller to the general ledger — meaning that changes could be applied across the whole system, reducing significantly both the run-the-bank and change-the-bank costs. And so banks running integrated core banking systems were in a position to achieve scale economies as well as to cross-sell effectively and, when product builders were added, to launch new products to market quickly.

System S/360

Bank systems in the internet era

With the arrival of the internet, banks opened up proprietary channels (apps and internet portals) which allowed customers to query their own bank records and set up payment instructions. But that was the extent of the upgrade: neither branch-based accounting systems nor integrated core banking systems were significantly re-architected in response to internet banking. In fairness, some core banking systems were already real-time and most have been scalable enough to cope with the rise in customer interactions. But the situation is changing.

Integrated to Internet Banking

The open banking era

In most industries, product manufacturers have a choice about whether or not they sell through distributors. In banking, in Europe and an expanding number of other places, this agency is being lost. Open Banking legislation is forcing banks to put their inventory online by obliging them to share customer transactional data with third parties (where customers give consent). In effect, banks face a stark choice: become aggregators of own-labelled and third-party products or risk being disintermediated by other aggregators, whether from inside the industry or outside (e.g Amazon or Alibaba).

The Open Banking era
CB Insights showing the spread of Open Banking legislation across the globe

In addition to open banking regulations, most jurisdictions have enacted — or are enacting — legislation related to real-time payments. This will likely have a profound impact on value chains outside of just banking — for payment schemes, for instance — but in banking it will usher in an era of not just higher volumes, but lower fees per transaction, requiring a step change in scalability if banks are to be able to keep up — and to do so profitably.

In response to these two changes, the integrated nature of most banking systems is unsustainable. If banks are to distribute third-party as well as own-labelled products, they will need a separate system for distribution. If banks are to cope with the demands of ever-increasing payment volume as well as continually rising interactions, they will need to separate channels from manufacturing to boost straight-through processing (STP). To put this last point in context, if a bank moves from 99% STP to 99.9% STP, this would likely translate not to a 1% reduction in costs but more likely a 10x reduction in costs.

The future model for banking systems could be the retail industry where the major players have all created distribution systems independently of accounting systems. But there is precedent that is much closer to home: when regulators pushed for higher STP in capital markets in the early 2000s, the industry very quickly split between front office (the buy side) and middle office (the sell side) and systems were re-architected accordingly. And, whereas in capital markets there was a push for faster transactions, in banking there is both a push for faster transactions and a push to open up the industry to new competitors. As such, this split seems all but certain.

Systems of intelligence

At the moment, there is a tendency to try to put more and more logic into banking channels, but this is flawed. Proprietary banking channels are likely to disappear as banking becomes more “embedded” in other products and services (such as WeChat), making these investments increasingly pointless.

Instead, this logic needs to sit somewhere else, where it can be used to produce a high level of engagement across multiple channels, where it can be combined with data from multiple other parties and systems, and where it can handle inquiries independently of orders and order entry asynchronously from order execution. This somewhere else is a system of intelligence.

Systems of Intelligence Basic.png

We borrow the term “system of intelligence” from this seminal article from Jerry Chen, a Partner at Greylock. In his article, Jerry describes how application software is splitting into three layers: systems of engagement, systems of intelligence and systems of record. If we apply the same taxonomy here, customer channels are the system of engagement (although we prefer to use the term system of interaction because we see these as thin clients, integrated using REST principles); core banking systems are the principal system of record; and distribution systems are the systems of intelligence.

In Jerry’s article, he highlights the importance of technology changes in creating the opening for new systems of intelligence. One is cloud in that it adds a new level of scalability on which to build these systems, but the more important is AI, which fundamentally changes the amount of data we can process and the insights we can draw from it. Echoing Clayton Christensen, Jerry Chen says that, because of AI, 

Systems of intelligence in banking

In Jerry Chen’s article, he makes the point that providers of systems of record often have an advantage in creating systems of intelligence because they have privileged access to their own data. This is true for banking also, although open banking removes part of this advantage (for transactional information). A bigger advantage for incumbent banking software comes by dint of serving hundreds or, in some cases, thousands of banks; creating the pull to attract other data sources to mash up with data from their own system of record.

The playbook for incumbents, regardless of industry, remains Salesforce. A lot of people get excited about the Salesforce AppExchange, a marketplace for complementary applications, since it created a platform business model with two-sided network effects. But at least as important in amassing the data to become a system of intelligence are Force.com (now the Lightning Platform), its platform-as-a-service on which third-parties build native applications, and Mulesoft, its API integration platform, which allows third-parties to integrate their existing applications and datasets. Lightning and MuleSoft don’t just provide a route to data but lock-in and switching costs around that data. And then, working on this data and giving an additional incentive to share the data is Einstein, the Salesforce system for artificial intelligence, deriving insights for Salesforce and its customers. We would argue that it is ensemble — MuleSoft, Lightning, AppExchange and Einstein — that makes up the system of intelligence.

Salesforce’s system of intelligence

And so in banking it is unlikely that creating an AppExchange equivalent will be sufficient to create a system of intelligence.

It is likely to need all of the above components: an API platform, PaaS, AI and an app store. And let’s not forget that because of open banking, the distribution play for a banking system of intelligence goes further than distributing apps — to helping banks distribute third-party banking services.

This extends the list of necessary capabilities to include, for example, order management and an extensible product catalogue, as well as customer engagement tools that, among other things, would help identify the right content and services to offer up to customers at the right time and over the right channel.

In addition, we believe a key component of successful systems of intelligence will be to share intelligence across their ecosystems.

The idea, very well articulated in this blog by Peter Zhegin, is that the source of competitive advantage (the moat) is constantly shifting. Processes— and software — are declining in importance relative to data. And within data, Peter argues that the moat is moving away from data collection — amassing the largest possible data set with which to train a model that benefits the company’s product — to improving the collective intelligence of the network.

In banking software, therefore, advantage is moving from having the best application to having the most value-added ecosystem around that application (app store) to helping customers make smarter decisions (system of intelligence) to helping the whole ecosystem perform better (a system of network intelligence).

As a practical example, this could mean moving from providing independent banks with the best credit scoring model to facilitating an open banking network.

Commoditization and de-commoditization — the emerging vendor landscape

As in any market where the value chain is being broken up, there is likely to be a significant shake-up in the competitive landscape for banking software. The keenest fight will be to dominate the market for systems of intelligence, since this is where value will accumulate. But we are also seeing new entrants into the core banking market.

Since the system of intelligence aggregates logic away from the system of record, the system of record is required to do less. Effectively, the most important characteristics of the system of record will increasingly become speed and cost.

As a result, these systems will be re-architected for speed (into microservices) and they will be deployed in the public cloud. And it is no surprise, therefore, that we are seeing the arrival of new cloud-native core banking systems such as Mambu, one of the first and the most successful so far.

Furthermore, as the need for scalability increases, we predict that we may even see these systems further fragment, with the accounting capabilities (fees, limits, etc) splitting from the manufacturing capabilities, which, incidentally, seems to be how Thought Machine is architected.

Digital Banking to Real-time Banking

As regards the systems of intelligence, we foresee a three-player race.

The first players are horizontal systems of intelligence. Insofar as the system of intelligence is like an operating system (nCino actually calls itself “a revolutionary bank operating system”) — providing a consistent set of interfaces, mashing up and running analytics on multiple data sets — these systems do not need to be as domain-specific as systems of record.

Accordingly, there is the potential for horizontal players to make bigger inroads into banking software — such as Salesforce, which already has good traction in wealth management and is pushing aggressively into retail banking.

The second players are the incumbent providers of systems of record. Many are well-positioned — having the pull of large customer bases and investing in the tech infrastructure. Finastra, for instance, has assembled many of the underlying components of a system of intelligence — an app store (Fusion Store), a PaaS (Fusion Operate) and an API platform (Fusion Create). The bigger question is likely to be whether management at these companies will place enough importance on a platform strategy to be able to overcome the immune system challenges.

The third set of players are the new entrants. With a couple of exceptions, such as nCino, these are chiefly vertically focused: for example, additiv is focused on wealth management (and increasingly credit), The Glue is focused on retail banking, and Trade Ledger on lending. While there are likely many more shared than vertically-specific components in banking systems of intelligence, which makes a cross-banking strategy possible, an initial vertical focus makes sense to build a network quicker (the micromarket strategy to overcoming the chicken-and-egg challenge) and conforms with the pattern of disruptive innovations, which are typically commercialized first in smaller and emerging segments.

To sum up…

In response to regulatory and technology changes, the banking market is undergoing a digital upgrade with new networked business models emerging.

The most successful banking technology companies will be those that align themselves with — and enable — this change.

Our bet is on those that can create the best systems of intelligence.

What is a Challenger Bank for?

The last couple of months have seen JP Morgan close its digital bank Finn, as well as BPCE close the UK arm of its digital bank, Fidor. This has led to a lot of speculation about whether it’s possible to run a disruptive business within an incumbent organisation. But, it also raises a simpler point. When does it make sense to launch a challenger bank?

Challenger banks are definitely in vogue. In the aftermath of the financial crisis, regulators sought to introduce more competition into their domestic banking markets. One of the most progressive was the UK regulator, which lowered capital requirements for start-up banks as well shortened the application process, leading to a influx of new competitors. But many jurisdictions, including the UK, also introduce Open Banking legislation, which obliges banks to share customer data with third-party providers, also increasing competition.

The Open Banking era
This graphic from CB Insights shows the spread of Open Banking legislation across the globe

In addition to the regulators’ efforts, technology has also lowered barriers to entry. Infrastructure services like AWS have reduced start-up costs while smartphones have opened up distribution at the same time as making possible new digital features, such as remote, paperless customer onboarding.

The result has been an explosion in the number of new companies offering banking services — 17% of all companies having been created since 2005, according to Accenture.

Accenture Beyond North Star Gazing Open Banking
Source: Accenture, Beyond North Star Gazing
Challenger Banks a Global Phenomenon

But digital banks are not just banks without branches. They are offering something different. Part of this is about customer experience — they have built their offerings from scratch, taking advantage of new technology to mould their services around people’s lives. But part is also around business model.

A look at the latest Monzo annual report illustrates this well. It has over 2m customers, but it makes significant losses. It has over 2m customers, but makes net operating income of only £9.2m (£5.7/customer). The majority of its money comes from fee income, not interest income. And, despite heavy losses, it is ramping up marketing expenses (up 700%) and pushing forward with international expansion.

Note: Monzo reported 2m customers as of May 2019. However, most of the metrics above are calculated based on the total number of customers (1.6m) at the end of fiscal year, Feb 2019

In this regard, Monzo — like the other challenger banks — is operating a classic digital-era business model. In contrast to traditional banking models, it recognizes that distribution is not the primary point of differentiation in the value chain; but, instead, customers are.

Number of Customers per Challenger Bank

It is this desire to maximize customer numbers that explains why, despite a historical customer acquisition cost of less than £3, Monzo is engaging in TV ad campaigns. This explains why its investors are prepared to cover its losses and fund its international expansion. And lastly it explains why most income comes through fees, not interest income. Because this is a business where, with low customer acquisition costs, low churn (NPS is +80%) and low cost to serve (GBP30 per account at present and falling fast as scale economies kick in), the incentive is to maximize lifetime value.

Valuation per customer Challenger Banks

Monzo, like other challengers, will seek some direct customer monetization for sure — Monzo is now offering loans — but this is likely to be levied on those who can most afford it, in the shape of premium subscriptions, ensuring that most services remain free (current account, foreign ATM fees) to attract as many new customers as possible. Instead, most of its monetization will be indirect, using the pull of its large customer base to bring in third-party fees. At present, most of its fee income comes from interchange fees as its customers spend money using their Monzo debit card, but over time other routes will make more meaningful contributions. Monzo has said that it wishes to become its customers’ “financial control centre” by introducing them to the best possible third-party financial services and, although the resulting commissions from these introductions are small at present (just £85k), this will grow as two-sided network effects materialize.

Monzo customer contribution margin

For incumbent financial institutions, it is difficult to match the challenger bank model. Their businesses were created for a different age, where distribution was the choke point in the value chain. The need for a costly and difficult-to-achieve banking licence plus a network of physical branches kept out new entrants, meaning banks could push undifferentiated, expensive products to captive clients. And now it is extremely difficult for banks to change course and match challenger banks like-for-like — they don’t have the cost base, the financial incentives or innovation capabilities to do so. And so many banks are starting to launch challenger banks themselves.

Incumbent Banks Offering
The now defunct universal business model where banks were able to mass produce undifferentiated products

However, the bank-within-a-bank model is also difficult to pull off.

Firstly, as Aperture-subscriber John Hagel so eloquently describes in this piece, you have the problem of the immune system fighting off anything that threatens the business model and revenue streams of the body corporate (what in more successful companies might be described as the Innovator’s Dilemma). This likely contributed to closure of Fidor UK and explains why the rest of the business is up for sale. But the challenge to incumbents is very real. As the following table from Citi shows, banks’ RoE is much more sensitive to falls in revenue than reduction in costs, meaning that with stubbornly high costs — and in the absence of business model change (see below) — it will be difficult for banks to countenance a strategy that cannibalizes existing revenue streams.

Source: Citi GPS Research

Assuming that the immune system can be countered — by creating a completely separate organization, with different people, processes, tech, brand, incentives and reporting directly into the CEO — then you have the problem that innovation is hard. This seems to have been more of the root issue at Finn. Built on the bank’s existing IT infrastructure, its objective was more around putting a new UX on traditional products than using the virtues of digital to create a unique offering. As a result, it didn’t manage to attract large numbers, let alone introduce viral features that leverage the power of networked consumers, as Revolut has successfully done.

Revolut

The last problem is one of strategic intent. If a bank launches a digital bank because its strategy is a) to defend itself against challenger banks; b) to lower cost to serve by using digital channels; c) to improve User Experience; d) to capitalize on Blockchain/AI/IoT/Cloud or e) to change its perception among younger customers, it’s probably going to fail.

Launching a digital bank is about launching a digital era business model, which goes way beyond changing brand perception, user experience or moving customers onto cheaper-to-serve channels. As noted above, it is about maximizing customer numbers and engagement to activate demand side economies of scale. This requires clear strategic intent because, in turn, it requires organizational transformation. Launching a challenger bank can be a (faster and less disruptive) route to digitization, but it is neither an easy option nor a panacea.

Our view is that a challenger bank strategy has a higher likelihood of success if is underpinned by one (or more) of the following six objectives.

It is interesting to see Goldman Sachs’ digital bank Marcus referenced in so many of the articles on Finn. For us, it is very different. For instance, it is built on a new technology stack. But most importantly, it moves Goldman into a completely new space, consumer finance, where it does not have the cannibalization concerns that trigger the corporate immune system. This allows it to operate under very different constraints and, like other new entrants, challenge the status quo with a proposition that includes market-beating interest rates, no origination or late fees as well as customizable payment dates and payments. And it’s working: Marcus had 4 million customers and $46bn in deposits at the end of March 2019, two and half years after launch.

In the same way as entering new markets allows the new business to operate more freely, so does entering new countries. It is also a less risky strategy than M&A, which made sense at a time when distribution was the barrier to entry, but now encumbers the acquirer with all of the legacy issues they inherit. And this is why the challenger-led strategy is being pursued by many banks, including DBS, which has launched digibank (“a bank in a smartphone”) in India and Indonesia with already over 3m customers — and why it is looking to do the same in Vietnam.

Launching a challenger bank with the purpose of bringing banking to the unbanked is by definition the antithesis of cannibalization — because no one was providing these services in the first place. And, as banks like CBA in Kenya have shown with M-Shwari and now Stawi, when you combine mobile distribution with low costs and intuitive user experience, you can succeed in bringing financial services to millions of people. But, as demonstrated below, while countries like Kenya and China have very successfully leveraged digitization to tackle financial inclusion, there still exists massive scope to do the same in populous counties like Egypt, Indonesia or Pakistan.

The Financial Inclusion Opportunity

Another reason for launching Marcus was that Goldman Sachs can use retail deposits to lower its group cost of capital. But a business where this is more transparently the objective is EQ Bank in Canada. It is a subsidiary of Equitable Bank, which provides residential and commercial real estate lending services, and the bank uses EQ customers’ savings to fund its lending, allowing it to start to increase its net interest margin (now at 1.6%) in a low interest environment. Structuring the group like this not only creates complementarity between the bank and its challenger brand, as opposed to a cannibalization threat, but also reinforces incumbency advantages. EQ Bank can sustain its above-market deposit rates thanks to its parent’s large lending book.

Equitable EQ Bank Funding Mix

Another reason to launch a challenger bank is to attempt lower-risk and faster-to-value technology renovation. Banks sit on decades of technology debt, batch-based legacy systems built around products not people that have been continually added to over time, resulting in massive cost and massive complexity. If banks are to compete on price and on user experience with digitally-native challenger banks, then they will have to address this technology debt. But doing so is expensive and risky, which why it is tempting for many banks to start again — create a new bank with new technology.

A typical universal bank system architecture (source BCG)
This BCG image shows the mass of interdependent systems and interfaces within a typical universal bank

This “build and migrate” strategy is still somewhat unproven , even though it looks like some banks like Santander, with Openbank, may be going down this route (its annual report states that Openbank is “the testing ground for our future technology platform”).

For banks considering this strategy, they should be mindful that they will have to run two IT platforms in parallel for a good while (it is unlikely that regulators would let incumbents close all branches — or indeed the bank itself — for a long time). They should also be aware that there will be customer attrition in the base business as they divert investment into the new bank and also likely attrition when they try to move across customers to the new bank. In addition, they should start small, that is, with a single product offering like savings, which will enable them to test the market proposition before committing big expenditure, get fast RoI on the initial capital expenditure and minimize the risk of rejection from the corporate immune system — at the same time as probably lowering cost of funding (or, in the case of one challenger bank we consulted, whose first product will be to lend boomer savings to millennials, increase asset yield). Furthermore, if the technological renovation is successful and the bank creates a great platform, then, as Starling, OakNorth and Ant Financial have done, it can sell this to other banks — the “make yourself the first customer” model of creating an exponential software business.

Oak North, a unicorn SME challenger bank, sells its lending analytics platform to other banks

The counterargument to the “build and migrate” strategy is two-fold. Firstly, modern core banking systems are modular, meaning that progressive renovation is possible — replacing systems one by one — to combat risk and speed up time to value. In our experience, however, these projects tend to more complex than they seem and subject to the same issues as all in situ transformations, such a scope creep. A better argument for not executing a build and migrate strategy is that it is increasingly possible to achieve what banks want — improve customer user experience, launch digitally-native products, run advanced analytics and open up to third-parties — without replacing all of their back-office systems, as vendors like Additiv and The Glue are helping institutions to do.

In a blog we wrote last year, we set out what we thought were five viable banking business models for the digital age. However, at least three of these new business models were off limit to banks given their organizational constraints. Launching a challenger bank removes those constraints and allows banks to unbundle themselves by launching a narrowly-focused digital proposition (in terms of product offering as well as demographics) and then to rebundle themselves around this proposition. This is what fintech companies like Transferwise, Robin Hood and Zopa have done successfully and we are starting to see banks do the same — like Imagine Bank from Caixa which successfully attracted a new customer demographic with a convenient and high margin savings product and has since rebundled a whole set of own label and third-party services.

Unbundle to Rebundle

There is also the possibility to do this unbundling to rebundling via a holding company model. This represents the digital equivalent of the traditional universal banking model but where each product offering is run by a separate subsidiary. Doing this keeps each unit nimble enough to compete to respond to market shifts, permits partial customer acquisition, but also allows the overall group to achieve economies of scale (both supply-side, like IT, and demand-side, like customer data insights). In banking, the best example of this seems to be Pepper from Bank Leumi, which is building up a set of discrete product propositions.

If an incumbent bank chooses not to launch a challenger bank, what are its options?

It could choose to do nothing, essentially pursuing a mix of tactical options like cutting discretionary spend, shrinking risk-weighted assets and lobbying the regulator to slow, or reverse course on, new legislation. But, even though this might get management through to its next stock option vest, this isn’t a long-term remedy.

Another option could be to go upstream. We see this a lot in wealth management. Since HNWIs want a somewhat bespoke service and interaction with a relationship manager, then a lot of banks are moving to serve exclusively these HNWIs and UHNWIs where they think they can earn good fees for the foreseeable future. However, since many banks — as well as independent asset managers and family-offices-as-a-service focus on the same market — fees are gradually eroding. But more importantly, it leaves the banks open to classic disruptive innovation as the providers who now serve retail and mass affluent customers with digitally native services start themselves to move upstream.

In our view, for the banks that don’t want to launch challenger banks, there are only really two options. One is to become a bank-as-a-service, offering their back office and compliance to other banks and fintech providers, as banks like Bancorp in the US have done. But, this is a low-margin business. A better option is what we call the thin, vertically-integrated bank, where a bank starts to offer third-party services alongside some of its own products, capitalizing on its advantages —a bank licence, trust, the pull of a large customer base — to give its customers more choice. The challenge here is, of course, that this is a radically different business model which is likely to activate the corporate immune system.

Vertically integrated digital bank

So, the conclusion seems to be: if a company can dismantle the corporate immune system for long enough to adapt its existing business, then a challenger bank might not be the right option. Otherwise, it probably is.

Firms need Business Model change, not Blockchain

When Jimmy Song, a venture partner at Blockchain Capital, took to the stage at Consensus two weeks ago (wearing a black cowboy hat), he launched an attack on the blockchain-is-the-answer-to-everything mentality. He said,

“When you have a technology in search of a use, you end up with the crap that we see out there in the enterprise today.”

Jimmy Song
Jimmy Song

Jimmy was clearly trying to be provocative and burst the bubble of blockchain fanatics, but he has a point. It’s not so much about blockchain per se (although this may be where the worst offences are committed) but about the focus on technology in general. Every day we are bombarded with articles about the need to digitize or about how [Blockchain/AI/APIs/Cloud/Mobile/IoT] will transform or disrupt such and such an industry. But we forget that technology in the absence of new business models never changed anything.

UBER Business Model, by Tim O'Reilly
UBER Business Model, by Tim O'Reilly

It wasn’t the internet that transformed retail or music. It wasn’t the smartphone that created Uber. Instead, it took business model change which exploited new technologies. In retail, it was the Amazon business model of one-click checkout, marketplace and next-day delivery. In music, it was the iTunes model of unbundling music to let us buy individual songs and then the Spotify rebundling model of all-you-can-listen streaming subscription service. And Uber didn’t just use the smartphone to let people order cabs (as many of the incumbents did), but instead uses the power of GPS to allow anyone with a car to become a taxi driver, transforming supply in the course of transforming user convenience and experience.

And so in banking we can safely predict that it won’t be blockchain or APIs or AI that transform the industry. Instead, it will be new business models empowered by those technologies.

Implementing technology without a clear plan risks making matters worse

In fact, we could probably go further and say that implementing new technologies without a clear idea of the future business model may make matters worse because it could well entrench existing practices.

The reason for this is that these new technologies will be implemented in support of existing business models rather than in pursuit of new ones. This means — as we have seen so often in banking — that digital technologies are used to digitize analogue products, rather than reinventing them for the digital age. But, it means more importantly that these technologies will be used to double-down on scale.

Economies of Scale Illustrated

The industrial economy was all about scale. Once a company had come up with a winning product, the challenge was to exploit economies of scale as fully as possible. This allowed unit costs to be minimized and allowed firms to undercut rivals, seeing them gain more market share and scale and thereby locking in their leadership position. So all investments were aimed at maximizing scale — mass marketing, mass production, mass distribution — and business were organized into centralized, hierarchical structures to make this possible.

But these investments in scale in the digital age are quickly moving from sources of competitive advantage to sources of competitive disadvantage.

Technology and platforms have neutralized scale advantages

In their recent book, , Hemant Taneja and Kevin Maney talk about how the technologies of cloud and AI have turned scale economies on their head.

In the world of cloud computing, IT resources are available cheaply to everyone meaning that — other than for the platform providers like Microsoft— scale doesn’t matter. A business can rent as little or as much IT as it needs, conferring little scale advantage in running massive operations.

But it’s not just IT resources, the same model is being applied everywhere. Take human resources, it is becoming increasingly easy to contract the people a company needs at the time they need them through platforms such as Malt and through a new breed of companies like  and .

In economic terms, technology has lowered the minimum efficient scale of production to a point that is within the reach of most SMEs. And with a monolithic business structure, diseconomies of scale kick in sooner and are more material.

Artificial Intelligence is also having a profound impact on scale. If new technologies and platforms make it possible to manufacture profitably without scale, AI is making it possible to know what each and every customer wants — so that product and service can be tailored to everyone.

While the slight flaw in the unscaled argument is that more scale leads to more data and more data leads to better AI, it is nonetheless the case that any company offering undifferentiated products at scale will soon lose market share and scale. And so we see white space for new kinds of business models, where firms — or platforms — are able to take advantage of these new technologies to offer mass customization at scale.

The incumbents’ challenge

The incumbents challenge is, therefore, how to move away from this heritage of scale. This is likely a bigger challenge than it seems. Many companies in the industrial age missed shifts in consumer trends, but because of scale they could in many cases afford to catch up — copying rivals, buying rivals, etc.

In this digital age, the scaled business model is likely to lead to the double whammy of failing to spot new trends and the impossibility of catching up. Moreover, scale is so deeply embedded — across company structures, performance metrics, remuneration, processes, employee skillsets, cultures — that it will be so difficult for incumbents to make the transition.

Number of investments in tech companies by country — source Atomico
Number of investments in tech companies by country — source Atomico

And it’s not just an issue facing companies. Take Germany, for instance. For so long, its industrial sector has been admired all over the world for consistently high quality engineering. But, the German economy is struggling to make the transition to the unscaled, digital world. It doesn’t (yet) have a  from which the new unscaled models are emerging and the .

But there is hope. We do see many incumbent companies, including in the banking industry, adopting new, unscaled business models for the digital age.

New banking business models for the digital age

In many ways, the following section is an update  ago looking at how technology and new regulations, particularly PSD 2, were likely to lead to new business models. Where back then we identified 4 business models, now we identify 5 (but now fully discount the universal banking model as a relic of the industrial age). And where back then we framed the choices around asset intensity and profitability, we now frame the choices around the size of the demographic a firm wishes to serve and the number of products it offers to this demographic (although profitability is likely to improve in correlation with these factors).

Let us consider each in turn.

The unbundled start-up

This is the model that most B2C fintech companies have pursued until now. They spot a niche, which could one of: a product that wasn’t previously offered (e.g Coinbase), a demographic that is un- or underserved (e.g Lending Club), a much better experience (with likely cheaper pricing), combining tech and design thinking (e.g Transferwise) or all of the above(e.g. WealthFront).

It is very much the embodiment of an unscaled model: using cloud infrastructure to operate at low volumes and using AI to serve small segments of the market. However, given it is both targeting a niche and targeting the consumer directly, it is often difficult to make this model profitable. The low infrastructure costs are more than offset by high customer acquisition costs which, because these tend to be single product companies, cannot be spread over many revenue lines. There are exceptions, of course, where the regulatory costs are low and the market is large (e.g WorldRemit), where there is a virality in the product design that lowers acquisition costs (e.g Revolut) or where the product solves a big issue in a big market such that it becomes a very large company (PayPal, M-Pesa, Stripe).

The unbundled startup
The unbundled startup

But the much more likely outcome is that successful unbundled start-ups start to bundle multiple products under the same brand.

The rebundled start-up

Once a start-up has found a strong product/market fit, it is logical for it to offer multiple products in order to boost its return on capital by cross-selling and upselling to its existing clients. It effectively moves from a single, unbundled product offering to rebundling a full banking service over time. However, it is different from a traditional universal banking model in a number of ways, such as the fact that it is digitally native but more importantly because it remains focused on serving the same demographic. In that sense, it doesn’t engage in mass marketing and production, but sticks to a narrow target market. Were it to begin to offer all products to all customers, it then risks becoming the victim of unbundling itself.

Unbundle to Rebundle
Unbundle to re-bundle strategy

Examples of successful unblundled to rebundled start-ups include Zopa, Transferwise and Revolut.

The platform model

The platform model is somewhat of an anomaly in this list since it is essentially a scale play. However, it is likely to be an enduring model since:

1/ it is underpinned by strong network effects in a way that the universal banking model isn’t;

2/ it is often executed as part of an unscaled holding company strategy (see later); and,

3/ it is offered in the service of (and helps to make sustainable) the model of unbundled start-ups.

The platform model is simple. Banks rent out their back office as a service to others. For the unbundled start-ups who would be clients, it offers the advantage of not having to undertake a bunch of low value-added regulation and IT activities and it helps them to go beyond just renting IT infrastructure to renting IT applications and compliance. For the banks, it helps them to spread the largely fixed costs of IT and compliance over much larger volumes, improving economics.

Infrastructure Play
Infrastructure Play

The challenge, as pointed out in the last blog, is that this is a difficult model to scale across borders, limiting its profitability potential and meaning that there will be likely only one or two platform players per country/geo.

Examples of this model we have seen so far include Wirecard, Railsbank, Solaris and Bancorp. And it is no surprise that they are cropping up in the largest banking markets first where potential for scale economies is greatest.

The aggregator model

The aggregator model is where a firm uses its grip over distribution to introduce the consumer to the right unbundled services. Effectively it uses AI and machine learning to understand the customer’s financial affairs and preferences and to anticipate their needs so that it can make the right service recommendations at the right time. With the introduction of PSD 2 — and similar regulation across the world — this model becomes easier to operate since it forces banks to share customer data. And, theoretically, it becomes possible to operate this model without engaging in any product manufacturing or without having a banking licence or any compliance team — as firms like Centralway Numbrs are trying to implement.

The Aggregator Model
The Aggregator Model

Nonetheless, our view — consistent with the blog from two years ago — is that this model will be thin, open but vertically integrated. By this we mean that aggregators will work with many different unbundled start-ups, but because of the nature of banking, they will likely manufacture some products — like current accounts that require a banking licence. And because of the need to deliver exceptional customer experience, they will end up having to become more vertically integrated. We , such as with Amazon and Netflix, and now we observe the same thing happening in banking. When unbundled fintech start-ups rebundle, they tend to become more vertically integrated — witness Transferwise’s move off the Currency Cloud platform or N26’s move off Wirecard.

Vertical Bank Business Model
Vertically-integrated, thin digital bank

And so it is not a surprise that the aggregator models we are starting to observe in banking are thin and vertically integrated, such as M-Shwari and Starling Bank.

However, there are a couple of potential issues with the aggregator model. The first might arise from regulation. Will regulators allow banks that offer own-labelled services to aggregate services from third-parties and trust them to do so completely impartially? Especially given the marked tendency for aggregators to move from . Moreover, there may be a business model challenge in that, as , models like Starling’s rely on third-parties while seeking to internalize the network effects, especially around data.

Aggregators vs Platforms
Aggregators vs Platforms adaption of Ben Thompson's diagram

So, while we continue to believe that this is a sound model, aggregators of this type will need to look to empower the ecosystem by externalizing network effects and may seek to use arms-length intermediaries, like Bud, to avoid potential pitfalls around regulation.

And, where these potential issues are not addressed, aggregators leave themselves open to the threat from rebundled start-ups and from holding company models.

The Holding Company Model

The holding company model attempts to replicate the universal banking model — or conglomerate model in other industries — for the unscaled world and in a way that confers competitive advantage on the subsidiaries, especially by dint of network effects.

There is probably no “standard” for the holding company model. Berkshire Hathway is a great example of how a holding company structure can create competitive advantage across the group companies, in its case by using the cashflows and very low cost of capital of its insurance business to provide the cheap cash for investing.

Amazon is another great model to study and probably more relevant for banking. Jeff Bezos made a decision in 2002 to standardize the way information is shared across Amazon using APIs. It was a brilliant move in how to achieve control at scale. Essentially, the inputs and the outputs of every team were measurable in real time, such that their performance was instantly calculable and all other teams would get the information needed to conduct their work without bottlenecks, but it still allowed the teams autonomy in how to execute. The upside of this API model, so well documented in this , was manifold:

  • it allowed the different teams to operate autonomously so that that those business could be opened up to work with third-parties (as happened with AWS)
  • It allowed each unit to be kept focused on its own KPIs, which essentially means that they are forced to remain close to customer trends. As , the genius of Amazon’s customer obsession is that it forces every part of the business to innovate at the same time as making it practically impossible to overshoot consumer demands.
  • It critically allows every business unit to stay focused on its niche (essentially an unscaled model) but allowing for scale at a group level (e.g IT resources, distribution and brand), positive working capital flows, and the exploitation (internalization) of network effects across group companies.

This is what makes Amazon such a formidable company. It has figured out how to make the conglomerate model work in the digital age — through a holding company structure. And, furthemore, in its digital form, it overcomes one of the key shortcomings of its industrial age predecessor — it can achieve increasing returns to scale thanks network effects.

In the financial services space, the best example of this holding company structure is Ant Financial. Where Amazon has figured out how to adapt the conglomerate model for the digital age, Ant Financial has figured out how to recreate the universal banking model for an unscaled world. Its hub and spoke model sees the group leverage data, brand and distribution while the subsidiaries remain narrowly enough focused — on unsecured lending, investing, money market funds — to remain nimble and adaptive in the face of changing technologies and customer trends.

Ant Financial Holding Company
Ant Financial's Business Model as a Holding Company

The Holding Company as a model for reinvention

We see a strong trend in banking for incumbents to launch new digital banks. The examples abound, such as BNP Paribas’ Hello Bank. While this model to reinvention is in many ways sound — it allows these banks to transplant customers and trust into a new digitally native version of themselves — it risks creating another universal banking model, albeit one built on digital foundations. A better way of going about reinvention would seem to be a holding company model. This might be built on a Berkshire Hathaway model, as seems to be the case with Equitable Bank’s creation of its , to create a sticky, low cost source of funds for its lending business. Or, probably more likely, it would be an Ant Financial model of having individual subsidiaries target different business lines, which is the approach that Bank Leumi seems to be taking with Pepper Bank.

Pepper Bank, by Leumi

Conclusion

There is a clear danger that with the constant hype around technology, banks miss the need to redefine their business models before embarking on major technology renovation. In fact, technology renovation in the absence of business model renovation may well make things worse because it would entrench existing business models based on selling undifferentiated products at the greatest possible level of scale. The digital age calls for something else — products, many of which will be new, targeted on specific demographics, made possible now thanks to technology change. In this blog, we have presented 5 models which would work in this new paradigm, of which the holding company offers perhaps the best route to success — especially for incumbent organizations looking to reinvent themselves.