The Innovation Game

innovation-7-30-15.pngWhat would Amazon look like if it were run by a banker?

First, you’d have to go to an Amazon branch to buy a novel. When you asked for a novel, the teller would tell you that you weren’t signed up for any novels. When you asked to buy one, they’d tell you that you had to go over to the fiction department.

This critique comes from JP Nicols, formerly the chief private banking officer at U.S. Bancorp, now a management consultant. He was up at midnight in Hong Kong recently after a business meeting, Skyping and talking about innovation in banking, a passionate topic for him.

“The world is moving faster and faster, and the banking industry is not moving that fast,’’ says Nicols, the chief operating officer of Menlo Park, California-based Innosect. When bankers tell him that they are “fast followers” when it comes to technology, he tells them, “You’re only half right. There is nothing fast about what you’re doing.”

It’s a biting retort for an industry increasingly attuned to the threats and opportunities afforded by financial technology companies, most of them nonbanks. The giants, such as Apple, Facebook and Google, along with startups such as online lenders and peer-to-peer payment processors, may not make banks irrelevant, but they may certainly put many of them out of business. Some banks are realizing that they have to change to keep up, and are trying to shift their organizational structure and culture to become more innovative, and more focused on what customers want and expect in an increasingly digital age.

Some of the biggest banks have introduced innovation labs in the last few years to experiment and develop software programs and solutions that benefit customers. Some banks are buying tech startups, or investing in them. Banco Bilbao Vizcaya Argentaria Group(BBVA), possibly the most innovative big bank doing business in the United States, is revamping its entire organizational structure to get rid of silos inside the bank that create friction for customers. U.S. Bancorp has 25 people working in an innovation lab in Minneapolis experimenting with new ideas and technologies, and working closely with the bank’s management team to bring new products to fruition. The biggest banks such as BBVA and U.S. Bank obviously have the money to invest, but some smaller banks are trying to get into the game as well. For example, a mutual with less than $10 billion in assets near Boston is spending 1 percent of revenues, or $4 million this year, on research and development with the intent of spinning off technology-related companies for profit. They are all trying to make their banks more innovative, and in the end, keep themselves in business.

But what is innovation, and why does it matter? There is no one definition of innovation. For Nicols, it means putting new ideas into action that move the organization forward. It may mean coming up with a completely new business model, or introducing a product or service that no one has tried before. It may mean solving a problem in a completely new way. Banks are used to identifying, monitoring and mitigating risks, more so than they are adept at innovating. But an argument gaining increasing weight is the notion that banks really are technology companies and need to think more like a technology company. Terms such as “disruptive innovation,” popularized by Harvard Business School Professor Clayton Christensen, have become mainstream, and they portray companies as vulnerable to lower-margin startups with innovative business models that begin taking market share at the bottom of the market and eventually displace established competitors.

Companies such as Amazon don’t worry about “disrupting” themselves, as Amazon did when it introduced its e-book product, the Kindle, even though it would cannibalize its existing print book business. The idea is that companies have to focus on what customers want and expect, not the business’ legacy systems and products.

Investors outside banking are so excited about “disrupters” stealing market share from banks and other financial companies that global investment in financial technology startups jumped 201 percent between 2013 and 2014 to more than $12 billion, across 730 deals, according to New York-based data research firm CB Insights.

Banks have been busy making sure they meet regulatory guidelines and laws, says Somesh Khanna, a senior banking partner at McKinsey & Co. “Meanwhile, their customers’ preferences have changed dramatically, and nonbanks are offering very simple solutions.” There are payment processors who are essentially money transmitters and there are tech companies offering loans, and regulators may eventually catch up to them in the same way they already regulate banks. But according to Kenny Smith, vice chairman and U.S. banking and securities leader at consulting firm Deloitte, the nonbanks will adapt to regulations, and it won’t be as difficult for them because they are more niche-oriented than the banks are. Banks are trying to react by investing in startups and creating innovation labs. They are collaborating in many cases with the “disrupters,” such as online lender The Lending Club and Apple, in an effort not to get left behind. Banks are trying to adjust to the new environment by becoming more innovative, giving people the title “chief innovation officer,” and hiring from tech companies such as Yahoo, Amazon or Google.

Spanish-based BBVA purchased a design firm and a variety of startups, including online banking services provider Simple, whose founders promised it was nothing like a bank. BBVA Ventures makes small investments in startups and introduces them to BBVA management across the globe. The company’s commitment to innovation really comes from the top. Earlier this year, the BBVA board announced it had reorganized to focus on technology in the company, and appointed D. Carlos Torres Vila as president and chief operating officer, a man who had been global head of digital banking and has an electrical engineering degree from the Massachusetts Institute of Technology.

“You’ve got enough bankers in banking. We don’t need more bankers,’’ says Brett King, the author of the books Bank 2.0 and Bank 3.0, and the founder of Moven, a mobile phone application that allows you to track your savings and offers you credit for purchases. “BBVA will be more tech than banking,’’ King says. “[Chairman and CEO Francisco Gonzales] realizes that. They are trying different models. They aren’t married to one way.” Just like a tech company, “they are trying different things and seeing what works.”

Already, the company had tinkered with its organizational structure to get rid of banking silos between departments, silos that didn’t really benefit customers. Jeff Dennes, the chief digital banking officer for BBVA Compass Bancshares Inc., the U.S.-based bank, is charged with digital integration of the bank’s products and services, including online banking, mobile banking, payments, a good portion of information technology and data analytics. He says the bank is “totally committed to investing in digital capabilities” that allow clients to have easier access to money, along with real time advice that helps them make sound decisions with their money.

The $85.5 billion asset BBVA Compass has a development center that employs 500 people in Birmingham, Alabama, according to Dennes. The company renovated an existing operations center into an 80,000-square-feet, open-floor office space that employs teams of five to nine people. They work in two week sprints to develop working software, compared to a more typical timeframe of six to nine months for software development. The compressed time frame creates a different environment. “The energy is off the charts compared to any other area of the bank,’’ Dennes says. “Every day, developers have to stand up and say what they were going to do yesterday, whether they got it done, and what they intend to do that day. It has a way of focusing you,’’ he says. But innovation is also transforming the rest of the bank as well. Even risk management needs to get creative, Dennes says. The vision of creating a digital bank “requires everyone to think differently,’’ he says. “If that was just one guy saying it, it would be tough. But you have senior leadership talking about it, and people tend to get on board.”

U.S. Bancorp’s approach is slightly different, but it has spent a long time making its bank forward-thinking. It has had an innovation group for more than eight years, with the original intent to look at long-term trends in the payments business. The bank realized early on that innovation was happening, and competition was coming from nonbank competitors, says Dominic Venturo, executive vice president and chief innovation officer for the Minneapolis-based bank with $403 billion in assets.

“It’s difficult to run a business as well as our business leaders do today, and at the same time focus on [the] long term and try to decide what’s important,’’ he says.

Nicols, who worked at U.S. Bancorp, says CEO Richard Davis decided shortly after becoming CEO in 2006 that he needed to make the bank more innovative. “Richard drew a line in the sand and said, ‘We’re going to be an innovative bank.’’’ Davis decided to invest heavily in the payments business. As a result, U.S. Bancorp was one of the first to introduce mobile photo bill pay, in early 2013. It signed up early for Apple Pay and Android Pay, Google’s rival to Apple’s phone-based payments service. U.S. Bancorp is consistently recognized as a leader in mobile banking for the variety of services it provides. The innovation lab has experimented with Google Glass and augmented reality, the concept that reality can be enhanced by computer inputs, such as images or information displayed in your glasses. Two years ago, Venturo published a paper on the privacy implications of the Internet of Things, which involves connecting everything mechanical, including such things as cars, TVs and refrigerators, to the Internet. The bank created a mobile shopping app called Peri that partners, such as retailers, could use to help people shop and compare prices using their smartphones.

But the innovation team isn’t cut off from the bank’s goals. Twenty-five people work on the team in the bank’s headquarters offices. Staff meets regularly with the heads of the four major business groups: wholesale and commercial banking, commercial real estate, trust and wealth management, and payments and consumer banking, which tell the innovation team what their problems are and their customers’ problems. The innovation team then works on solving them collaboratively with the bank’s management team. The team also brings in customers to the lab to collaboratively develop software that meets their needs.

Unlike BBVA, the bank doesn’t have a venture capital arm, and although it does partner with other companies or hire vendors to jointly create solutions, it doesn’t tend to invest in them or buy a lot of startups. Venturo himself has a banking background, having worked 15 years for U.S. Bancorp. Before that, he was with Bank of America Corp., and has worked stints in payments and as a commercial banker. He tends to promote from within U.S. Bancorp.

“One of the misconceptions about innovation is you have to go bring in a bunch of disrupters who don’t know anything about your business to think differently, but I think it’s more helpful to bring in deep domain expertise and give them permission to think differently,’’ Venturo says. “They are more likely to come up with an idea you can actually do.”

Community and regional banks may have a tough time affording an innovation lab, whether they come from in-house or the technology industry. Many of them already struggle with attracting and retaining talented people, and will largely have to rely on vendors to provide many of their technological platforms and services. Just because small banks often are focused on commercial clients, that doesn’t mean they don’t need to stay relevant to those commercial customers. “Those who want to be innovative have to have a plan in place that is executable, to make sure their technology presence is relevant and stays relevant, even if the business line focus is commercial,’’ says Ryan Rackley, a director at Cornerstone Advisors in Scottsdale, Arizona. Moven’s King advises banks to be very careful about picking a core platform vendor, and any technology vendors that they use on top of that. Since they are so dependent on vendors, they must choose wisely.

But a few banks are going beyond picking vendors and are experimenting with in-house innovation as well. After a merger in 2007, Eastern Bank Corp. president Bob Rivers noticed a huge drop-off in branch traffic, which has continued to this day. (The mutual’s busiest branch did 60,000 transactions per month back then, and it’s now half of that.) Rivers began to think, ”The world is changing radically, and if we don’t do something quickly, we are going to be left behind.”

With the support of management and the board, Rivers began networking around Cambridge, near the bank’s headquarters, where there was plenty of technology talent surrounding the Massachusetts Institute of Technology. “We knew we needed to make investments in new technology,’’ Rivers says. Rivers ended up recruiting the former executives of PerkStreet Financial, an online financial services provider with a rewards checking account tailored to each individual’s spending habits. The business ceased to operate after it failed to raise new capital. One of Eastern Bank’s recruits was Dan O’Malley, the enthusiastic, nobody-is-doing-what-we’re-doing co-founder of PerkStreet and now, chief digital officer at Eastern Bank with a team of about 20 to 25 innovators.

About a year ago, the bank put O’Malley and his team in charge of the customer call center, gave them access to a mass of data on the bank’s customers, and let them “build cool stuff, buy cool stuff and change our culture,” according to Rivers. The team’s goal is to spin off technology companies that make the bank a profit. Rivers said Eastern Bank’s directors didn’t need to be sold on the idea. “I would have to say, the board was more enthusiastic about it than management was here, by and large,’’ he says. Last year, when two members reached the retirement age of 70, the board brought in new expertise, including Joe Chung, a venture capitalist, and Bari Harlam, an executive vice president at BJ’s Wholesale Club in charge of membership, marketing and analytics. With such support from the top, the bank already has rolled out voice recognition software for the call center, so customers don’t have to answer a series of maddening questions to verify their identities. “The amount of friction we took out was huge,’’ O’Malley says.

Not all banks would have shareholders supporting long-term investments in research and development. But as a mutual, Eastern Bank doesn’t have the same pressure to meet quarterly earnings estimates that public banks have, and has more ability to invest, O’Malley says. Recruiting talent is always an issue, but O’Malley thinks the bank does have a leg up compared to a startup. The bank has a trove of data that can be harnessed to improve services and build new products. It already has a huge number of customers. It’s not trying to build capital and customers. It already has them. O’Malley is bringing in developers who have never worked for a bank. The head of the data center is an MIT-trained scientist who has been published in Science and Nature magazines. “You need people who know how to build stuff,’’ O’Malley says.

He feels strongly that banks need to adapt or they will lose business. “If we don’t do this right, we are going to lose chunks of our business. There are online lenders who will lend to small businesses within a day. Our traditional process takes a month, and they’re doing it in a day.” He thinks for many banks in the country, the situation is dire.

Judd Caplain, a banking advisory industry leader for the consulting firm KPMG, agrees that banks that don’t make changes will lose business. “As long as banks reinvent themselves, they will continue to exist,’’ he says. “Those that do not risk becoming dinosaurs.” Of course, banks have heard that before. The Internet was supposed to mean the death of branches, and yet they are still a powerful new customer acquisition tool, and a place to solidify a presence in the community. But Brett King has noticed a change. Bankers two years ago downplayed his predictions about a revolution in mobile banking, and countered that the Internet didn’t kill branches. Now, he doesn’t hear that anymore. “Banks are saying, ‘You’re right, it is changing, and we’ve got to do something now,’’’ he says. “It’s real this time.”

How Young and Hungry Fintech Companies are Disrupting the Status Quo

fintech-7-30-15.pngIn 2004, Blockbuster was a vibrant company that employed 60,000 people and provided home movie and video game rental services through a network of 9,000 retail stores throughout the United States. Then everything got disrupted.

Two Blockbuster competitors—Netflix and Redbox—began experimenting with alternative forms of distribution, Netflix through the mail and Redbox through, yes, red boxes located at grocery and convenience stores. These low cost delivery systems gave Netflix and Redbox a significant competitive advantage. Blockbuster, slow to respond to the disruptive impact on its brick and mortar business model, went into a downward spiral that eventually led to bankruptcy in 2010. The company was later acquired by Dish Network Corp., which closed the last of its Blockbuster stores in 2014. Today, the brand name survives only as video streaming services to Dish customers and the general public.

Is there a lesson to be learned here for the banks? You better believe it. The digital financial services space is exploding in activity as new technology companies push their way into markets and product lines that traditionally have been the banking industry’s turf. Usually, these so-called fintech companies focus on one or two product lines, which they distribute online at a significantly lower cost than traditional banks because banks still are holding on to their expensive branch networks. And doesn’t that sound a lot like the Blockbuster scenario?

Blockbuster did try to expand its distribution channels to include mail and streaming video, but it probably waited too long to make that change. There are in fact countless examples of disruptive business trends in U.S. history (airplanes taking passengers and trucks taking freight away from trains, or mobile phone carriers supplanting traditional telephone companies), and they share a common theme: The incumbents often responded to disruption too slowly and either failed, like Blockbuster, or managed to survive but at a permanently reduced state, like the railroads.

Often the disruptors were initially dismissed by the incumbents as not posing much of a threat, and you have to wonder if we’re seeing a similar scenario playing out today in banking. “Banks look at these upstarts with a kind of, hey, they are nice little experiments but what the fintech companies are doing isn’t really relevant,” says Anand Sanwal, chief executive officer at New York-based CB Insights, which tracks investor activity in the fintech space. “The problem is, today’s nice experiments are tomorrow’s disruption.”

In a March 2015 report on the emerging fintech sector, Goldman, Sachs & Co. estimated that over $4.7 trillion in revenue at traditional financial services companies is at risk of disruption by new, technology-enabled entrants. In a report two years ago, the consulting firm Accenture saw an equally challenging future for traditional banks. “A number of emerging trends—including digital technology and rapid-fire changes in customer preferences—are threatening to weigh down those full-service banks that limit themselves to products and services that get distributed primarily through physical channels, particularly the branch,” the report said. “Given the scale of these disruptions, our analysis shows that full-service banks, as a group, could lose 35 percent of their market share by 2020.”

Disruption is not new to the banking industry. It has been occurring in the payments space where companies like PayPal, Google, Square and American Express Co. have developed alternative payments systems that threaten to chip away at the banking industry’s market share over time. But it isn’t clear whether most banks see payments as a profit center or just the necessary plumbing to facilitate transactions. However, since the financial crisis there has also been a great deal of activity by fintech companies in the lending space—which is squarely where most banks make most of their money.

The new fintech lenders fall into two general categories. One group is made up of those companies that focus on consumers and small businesses and hold some loans on their balance sheet. These are often referred to as direct lenders and examples include Kabbage and CAN Capital. (See interview with Kabbage CEO Rob Frohwein) A second broad group, often called marketplace or peer-to-peer lenders, originate consumer and small business loans and sell them to investors, and increasingly banks, instead of keeping them on their balance sheet. Companies that fall into this category include Lending Club and Prosper Marketplace Inc.

The strategy of most fintech companies is to focus on a specific activity rather than compete with traditional banks across the full spectrum of their consumer and business product lines. So while fintech companies individually might pose little, if any, threat to banks, in the aggregate—and across all their full range of activities—they are doing everything that banks do. The infographic on the facing page, provided by CB Insights, shows many of the fintech companies that offer the same products that are provided today by San Francisco-based Wells Fargo & Co.—the country’s fourth largest bank at approximately $1.7 trillion in assets—and brings to mind a modern Gulliver who is under assault by the Lilliputians. “They are being attacked on all these fronts now by companies with new technology,” says Dan Latimore, a Boston-based senior vice president in the banking practice at the consulting firm Celent.

The emergence of such a large and vibrant fintech sector is driven by a variety of factors, beginning with the widespread acceptance among borrowers of conducting financial transactions online or with their smart phones. “Consumer behavior is changing pretty rapidly,” says Halle Bennet, a managing director at the investment bank Keefe Bruyette & Woods in New York. “Technology is now involved in everyday life and financial services is part of that. People like convenience and expediency and that is almost antithetical to conventional banking.”

It’s also true that the banking industry has been distracted by a series of events during the last several years while the fintech revolution was unfolding, first by the financial crisis and Great Recession and later by tough new laws and a more vigorous regulatory environment that forced them to raise capital and focus more of their attention on compliance. The result was a pull back from some consumer and small business markets just when newly emerging fintech companies were beginning to focus on them. “It would be hard to overestimate the extent to which banks pulled back from small business and consumer lending,” says Brendan Dickinson, a principal at Canaan Partners, a New York-based venture capital firm that invests in technology companies including several in the fintech space.

There are actually two kinds of investors in the fintech companies. One category, like Canaan Partners, provides debt and equity funding to the companies themselves, where they see an opportunity to leverage advancements in technology and create a significant competitive advantage in the marketplace—especially since the banking industry has been slow to embrace the fintech revolution. “There is a lot of money going into fintech startups,” says Sanwal. “Investors see a massive industry where there has been a lot of incremental innovation but not a serious shift in how things are done. Banks are pretty terrible at innovation.” To Sanwal’s point, banks have incorporated new technologies like mobile into their distribution system, but the system itself hasn’t changed all that much. The branch is still the focal point for most banks.

A second group that has shown a great deal of interest in the fintech space is comprised of institutional investors who see consumer and small business loans as an attractive asset class in the current low interest rate environment, where the search for yield has forced them to broaden their horizons. “Fintech companies have developed a fundamentally less expensive way to originate loans while giving investors access to an asset class that they want,” says Dickinson.

It’s not surprising that fintech companies are very tough competitors in their product niches. Advances in technology have given them several very important advantages over traditional banks, including significantly lower costs, super-fast decisioning and simplicity. “At the end of the day, what the customer wants is a product they can understand at the lowest possible cost,” say Jeff Bogan, head of the institutional group at Lending Club, a marketplace lender that offers unsecured personal loans from $1,000 to $35,000 with three- or five-year terms, and more recently, unsecured business loans up to $300,000 with repayment terms between one to five years. One of the earliest fintech companies in the consumer loan sector—the San Francisco-based company launched its service in 2007—it has also been one of the most successful. Lending Club went public in 2014 and is listed on the New York Stock Exchange.

Bogan believes there are two components that have helped drive Lending Club’s success: operating cost efficiency and the customer experience. “I really think that is the core behind our growth and why we’ve been so successful,” he says. Lending Club has focused on providing a positive user experience built around its easy-to-use website, simple application process, transparency of loan terms and fees, and quick response time. Bogan contrasts Lending Club’s approach to that of most banks, which he says tend to offer “a clunky online user experience.” “That alone is a huge source of competitive advantage relative to the traditional banking system,” he adds.

Just offering a good user experience isn’t enough, and Lending Club also tries to exploit its significant cost advantage compared to most banks. One metric that the company uses to measure efficiency is operating expense as a percentage of its outstanding loan balance, which Bogan says is 2 percent and declining. Capital One Financial Corp.’s unsecured consumer loan business operates at 7 percent, according to Bogan. “The way we run our business, there’s substantial operating efficiency,” he says. “It’s really a combination of both of those elements that has driven the success of Lending Club today.”

This significant cost advantage is something that is common to the entire fintech space. “The cost of origination is a fraction of what it costs the banks,” says Ethan Teas, a managing director based in Australia at the consulting firm Novantas. “They have figured out how to keep costs super low.”

Prosper, also based in San Francisco, bills itself as the oldest peer-to-peer lender, having started operations in 2006. The company offers unsecured personal loans from $2,000 to $35,000, with repayment options of either three or five years. To date the company has made over $3 billion in loans, and derives its revenue from loan origination fees that it charges borrowers, and loan servicing fees that are paid by investors. CEO Aaron Vermut says that when banks scaled back their consumer lending during the financial crisis, it left high interest credit cards and payday lenders as the only loan options for many consumers. And one of Prosper’s goals, as Vermut puts it, was to “democratize credit.”

Like many fintech lenders, Prosper takes a broader approach to credit underwriting than most traditional banks, which tend to rely heavily on credit scores. Vermut says that Prosper uses credit scores as a “guardrail” to keep itself within certain parameters, but not to determine the final decision. The company’s underwriting process relies on over 400 data points including such factors as the applicant’s relationship with suppliers, shipping companies and credit card processors, e-commerce activity and cell phone records.

CAN Capital, a New York-based direct lender that offers up to $150,000 for business loans and merchant cash advances based on future credit card receivables, also takes other information into consideration during the underwriting process to identify those applicants that might have a lower-than-optimal credit score but have a track record of making good business decisions. “A credit score is a blunt instrument that is based more on personal credit than on business performance,” says CAN Capital CEO Daniel DeMeo.

The underwriting process at all of these fintech companies is driven by algorithms that can make quick decisions with little, if any, human intervention. CAN Capital’s approach is “faster, quicker and has a higher yes rate” than most banks, says DeMeo. “We can do our job in a day if we can get all of the information that we require.”

Given the vibrancy of the fintech sector and the vast amounts of investor funds that are pouring into it, how should traditional banks assess the competitive threat posed by the new upstarts? Unsecured credit, whether it’s to consumers or small businesses, is not a market that most banks—especially smaller community banks—are all that focused on these days. It would be difficult for them to offer a similar consumer or small business loan at a competitive price because their costs are too high. And this might explain why many banks view the fintech sector as something of a sideshow, a phenomenon that does not impact them directly since they are more interested in auto loans, first-lien home mortgages and home-equity loans—and on the business side—commercial real estate and commercial and industrial loans secured by collateral.

And yet there are two reasons why banks should pay close attention to what is happening in the fintech space. At a time when they are experiencing severe margin pressure due to low interest rates and intense competition for good commercial loans, banks should consider working with fintech lenders and see them as collaborators instead of competitors, particularly since most of them don’t have a good unsecured loan product of their own. And for their part, most of these fintech lenders—including Lending Club, Prosper and CAN Capital—would be happy to partner with banks and in effect become an outsourced loan origination platform, selling them the loan in return for a fee. The consumer and small business markets in the United States are massive and the banking industry serves only a relatively small part of it. Goldman Sachs—a high end Wall Street firm with a long roster of corporate clients throughout world—thinks so much of the opportunity that it plans to start a new online consumer lending business next year.

Some fintech lenders are already working closely with banks, including Lending Club. “You’ll find that the products that we’re very successful in are small balance loans where you need the data algorithm and significant scale to make the economics work,” explains Bogan. “So the banks that work with us today don’t have a great personal loan product because they can’t efficiently underwrite it and don’t understand it. Their approach is essentially, if you haven’t had a bankruptcy in the last few years and you have a 700 FICO score or greater, you’ll get a loan at 12.99 percent. That’s the extent of their sophistication in the personal loan business. We can bring significant value to them.” Lending Club, which doesn’t have a balance sheet, gets fees for originating and servicing the loan while the bank gets an earning asset with an attractive interest rate and quite possibly a new customer relationship.

There’s another reason why banks need to pay close attention to the fintech revolution. Technology is beginning to alter some of the basic economics of the lending business and to redefine the customer experience—and banks are being impacted by those changes. Kabbage CEO Rob Frohwein says that 95 percent of his company’s customers start and finish their loan application online with no human intervention. And Bogan says that the demographic makeup of Lending Club’s customer base is quite diverse. We tend to assume that fintech’s growth is driven by the entry of millennials into the economy as spenders and borrowers, and while there’s considerable truth behind that assumption, the acceptance of online financial services today is widespread. Bogan says that Lending Club originates loans across a broad cross section of the U.S. population. “We actually have very few 18 year olds because they don’t have the credit history necessary to get a loan,” he says. “And we probably have very few 70 year olds. If you look at our customer base, it’s really correlated with the general U.S. population.”

Even if they don’t partner with fintech companies, banks at least need to pay attention to how the technological innovations they are pioneering are changing their industry. They can’t afford to fall behind their fintech competitors in the innovation race. “Banks have processes and procedures that are very slow to change,” says Teas at Novantas. “And they look at what’s happening in financial technology and say it’s not big enough to be interesting. But when it does become big enough to be interesting, you’ve missed the boat.”

Will Nonbanks Impact Bank M&A?

Bank-manda-6-16-15.pngBank boards should be particularly mindful of shadow banking’s strong growth. Earlier this month, FT Partners, an investment bank, presented its “CEO Monthly Securities and Capital Markets Technology Market Analysis.” Focused exclusively on the financial technology (FinTech) sector, the company lays out investor interest and pricing expectations for FinTech companies. When it comes to values assigned financial technology companies, there is quite a juxtaposition when compared to traditional banks, brokerage firms and trust service banks.

FT Partners also lists recent funding announcements with details on each FinTech company.

With lots of money—and potential customers—at stake, I believe more banks should consider aggressively growing one’s franchise through M&A than in previous years. Competition comes in so many shapes and forms that sitting idle while others take market share does not bode well. This is especially true for the 5,705 banks under $1 billion in assets as challengers offer tools and products designed for small businesses and borrowers—two key sources of revenue for community banks.

Among the most well known stealing market share from banks are Lending Club and Prosper, online lending marketplaces that offer loans to consumers and small business alike, funded by private investors and institutional money. On a side note, Goldman Sachs just entered the fray, announcing plans to offer an online lending platform to compete with the online lenders.

Although the biggest banks are not—and can’t be—pursuing an acquisition, this does not mean they are not aggressively trying to grow. Many continue to explore opportunities by making deals for smaller product/technology/capability-based companies, investing in analytics and expanding digital offerings.

With competition coming from both the top of the market and from non-traditional players, it is imperative for community banks to focus on improving efficiencies and enhancing organic growth prospects. The corollary to this is as big banks invest in customer acquisition, and non-traditional players continue to eat away at earnings potential, bank CEOs and boards need to think about what a successful deal looks like—and when such a deal can be executed.

Yes, I realize small banks are becoming more willing to consider a sale as the future operating environment, regulatory standards and valuations remain uncertain. However, being open to the idea and aggressively pursuing opportunities are two different business philosophies. Building an institution with the ability to generate earning assets at relatively high yields will become increasingly valuable. Positioning a bank with diverse revenue streams not just builds value but provides a buffer from nonbanks looking to steal customers.

Many small banks in the country simply don’t have the currency to do acquisitions, and they’re unwilling to sell. I believe many of those banks are in trouble.

At a time when retail banks are facing increasing pressure from non-traditional entrants that offer retail banking services, now is the time to think bigger, not just because of the economics of a deal, but because of the competition lining up.

Leaders In Bank Innovation

Banks of all sizes are implementing innovative technologies to grow their organizations but which ones are doing it right? Filmed during Bank Director and NASDAQ OMX’s inaugural FinTech Day in New York City, four financial technology providers offer their perspectives on which financial institutions are leading the way with the latest technologies.

BNY Mellon: Creating a Culture of Innovation

The fabric of the banking industry is changing as new technology players continue to emerge in the marketplace.  In this short video, Declan Denehan, managing director for strategy and innovation at BNY Mellon, shares how a financial institution that is over 230 years old embraces innovation by empowering new ideas and partnering with the FinTech community.

What to Look For When Selecting a Technology Partner

With the rise of many innovative technology companies, financial institutions can find themselves overwhelmed when it comes to selecting the right technology partner for them. Four financial technology providers share some advice for bank boards selecting a third-party vendor. The video was filmed during Bank Director and NASDAQ OMX’s FinTech day in New York City.

Technology Solutions That Drive Revenue Growth

What technologies should every bank have on their radar to improve organic growth? In this video, filmed during Bank Director and NASDAQ OMX’s inaugural FinTech Day in New York City, we asked four financial technology providers to share what solutions are being implemented to help banks improve customer experiences, increase market share and grow revenue.