Banks Face the Imperative to Innovate


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I’ve seen enough to believe there are no barriers to innovation in banking. Certainly, there are speed bumps, gate crossings and rumble strips that banks will encounter on the road to innovation, but nothing that flat out prevents them from getting there. Indeed, there are a growing number of banks, including community banks, that have made important achievements that serve as good examples of innovation. (For a great list, see the Best of FinXTech Award Winners announced at Nasdaq this week.) Some innovation projects have been quite ambitious, others more modest, but they all spring from the same source—a recognition that banks need to begin simplifying and speeding up various aspects of their businesses to keep pace with (or at least, not fall too far behind) where the customer is heading.

Where is the pressure to innovate coming from? The popular boogeymen are fintech companies that compete with banks in payments, lending and personal financial management. But companies in that space are simply reacting to a much deeper trend, which is the profound way that technology is changing our lives. Banks must do the same, and a growing number of them seem to realize it.

On April 26, Bank Director hosted the FinXTech Annual Summit at the Nasdaq MarketSite in New York. The event brought together 200-plus bank executives, directors and fintech executives to explore how technology is changing the industry. Underlying themes were innovation, the opportunities for partnership between banks and fintech companies, and how banks can move forward.

I believe that most bankers understand the imperative to innovate around key aspects of their business, whether it’s payments, mobile in all its many permutations, lending, new account onboarding or data. What many of them lack is a roadmap for how to innovate. Actually, a “roadmap” is probably the wrong metaphor to describe what they need because innovation is really a process rather than a destination—something you do rather than a place that you go. So maybe bankers need something like a yoga chant (Om!) to help focus their energy as they stretch to innovate.

There are several issues that need to be dealt with, starting with a vision of what projects to undertake. They can’t change everything at once, so where should they start? Here are a couple of questions they should ask. What are the greatest friction points within their most important businesses? Where are they seeing the greatest competition, and how would digitalization tilt the competitive balance more in their favor? What has the greatest potential to positively impact their profitability?

Innovation costs money, so they will have to budget for it. Based on my conversations with bankers that have begun to automate key parts of their operations, they should expect their innovation projects to cost more and take longer than originally estimated. Innovation can be messy, so perseverance and patience are important. They also have to make sure that their bank’s culture will embrace change. When I say “culture,” I really mean people. Banks must ensure that their employees are open to new ways of doing things, because innovation will change job descriptions, processes and work habits, and many of their staff will feel threatened by this. It’s not enough that executive management teams and boards commit to a large project like a new automated underwriting platform for small business lending and allocate the necessary resources to make that happen. They will also have to sell this change to people in their organization whose buy-in is critical.

For most banks—and particularly community banks with a finite amount of money to spend—innovation isn’t something they can do by themselves, so banks will have to work in partnership with fintech companies that can help achieve their objectives. This is more complicated than it sounds, because banks and fintech companies have very different perspectives when it comes to how they do business. Banking is a highly regulated industry, so they need a partner who knows how to work within a prescriptive environment that has lots of rules. Fintech companies that have experience working with banks understand this and have learned how to manage change in an ecosystem that tends to discourage it.

The innovation imperative is real, and banks must act upon it. Their world is changing faster than they realize, and the longer they wait to embrace that change, the further behind they will fall.

Innovation Spotlight: BankMobile


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Dan Armstrong, Managing Director and Chief Digital Officer, BankMobile

In his role as chief digital officer, Dan Armstrong is responsible for co-leading BankMobile Labs, which houses BankMobile’s technology development team focused on user experience and innovation. In this interview, he discusses how BankMobile has taken ownership of its technology to provide a curated consumer experience. In early March, BankMobile announced its acquisition by Flagship Community Bank in Clearwater, Florida, for $175 million. Previously, it had been a division of Wyomissing, Pennsylvania-based Customers Bancorp.

Who helps execute the innovation strategy at BankMobile?
We have BankMobile Labs—a whole division of programmers, business systems analysts, graphic designers, onboarding and fraud specialists and more, all in-house. We also have a student labs division in New Haven, Connecticut, managing the BankMobile Disbursements business and the BankMobile Vibe app for students. We have so many people charged with innovation, and it’s pretty much the core of our consumer proposition.

How does BankMobile keep a pulse on changing consumer expectations?
I suppose the same way other banks do: media, conferences, trends, recommendations, reading and participating on panels. We have a very strong strategy of testing other fintech products in the market, too, to see what we can learn about making a better customer experience.

When it comes to implementing a fintech solution, would you rather buy, build or partner?
In May 2015, BankMobile set up a fintech software and services development division, so we build 90 percent of our technology in-house. We do have vendors for elements of our solutions, like cards, remote check deposit, photo billpay and P2P payments, as well as risk, fraud and credit-scoring—but they are all integrated into our in-house technology, platforms and apps. We don’t put vendor/partner technology directly in the hands of customers, as we strongly like to create and curate the customer experience, and differentiate where possible.

How Collaboration Is Taking Shape


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Banks and fintech firms are increasingly working together to create new and innovative solutions-developing a new products and services, or generating efficiencies for the traditional banking industry. How will these relationships continue to take shape in the near future? In these short videos, three members of the FinXTech Advisory Group share their thoughts.

Sima Gandhi, Plaid

—Sima Gandhi of Plaid shares why the best way for community banks to proactively invest in technology for the new digital age starts with partnerships.

Jim Hale, FTV Capital

Jim Hale of FTV Capital discusses where the significant investments and advancements for innovation lie for the banking industry.

Tom Brown, Paul Hastings LLP

Tom Brown, partner at the Paul Hastings law firm, shares why many early stage fintech companies fail, and how they can set themselves up for success.

Innovation Spotlight: BankWest Community Bank


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Vincent Tyson
Deposit Accounts Manager, BankWest

Vincent Tyson oversees deposit generation and retention for the South Dakota-based bank, including product development and process changes. He works closely with branch managers, the regional president and CFO on rate changes and deposit pricing. In this interview, he discusses the practical dynamics of staying relevant and assessing customer needs outside of the traditional bank environment.

How have you been able to stay innovative at BankWest?
We have a dedicated project team that works with our vendors to integrate vendor solutions into our product mix when we believe that our markets are ready for it. We aren’t bleeding edge, but sometimes we will be first in our markets. For a South Dakota bank, we’ve been able to stay innovative with the remote solutions we offer our customers. With such a large agricultural customer base, our products and services need to be in the fields, barns and on the ranches where our customers are. Despite our 127-year history, our innovation is the ability to remain relevant in our customers’ lives, no matter where they work, live or play.

When it comes to implementing a fintech solution, would you rather buy, build or partner?
At this point, we’d rather partner. We’re not big enough to buy and don’t have enough resources to build. Like most banks of our size ($1 billion in assets), we prefer to —buy in’ to new technology and roll it out as part of another service/sales channel. Investing too heavily could be dangerous, and bringing in resources for development could be hit and miss.

As consumer expectations in banking change, how do you stay engaged with this audience?
Lots of research, especially among our existing customers. We also invest heavily in staff education, keeping key personnel up to date with relevant technology and making sure all of our staff members are trained and ready to launch new technology as it becomes available. South Dakotans tend to be up-front with their needs, vocal about their opinions and pretty focused on where they see value from their bank. We make sure that we hear their voices by keeping in touch, making sure that we are in the places where our future customers are learning and asking our existing base what they’ll need tomorrow. This is done through engaging face-to-face meetings, either in our branch network or out at the customer’s property or place of work. We have many touch points, as well as surveys that allow us to track trends and focus resources where needed.

Not All Innovations Are Disruptive, But This One Could Be


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I was listening to a financier talking about fintech companies the other day, and he claimed that their work products are all sustaining innovations and not disruptive. He was referring to Clayton Christensen, a Harvard Business School professor and an expert on disruption. In his research and writings, Christensen has pointed to various markets that were disrupted by outsiders, including the American car industry, disrupted by cheaper Japanese car manufacturing; fixed line telephone firms, disrupted by cell phone makers; and the mainframe computer industry, disrupted by PC manufacturers.

Rubbish.

There is a flaw in Christensen’s work, which is that incumbents often fail to respond when challenged by outsiders, which makes their situation worse. That was true of Kodak and Nokia, where the change was fast and the management teams were weak. American car firms—Ford, General Motors and Chrysler—have not disappeared because of competition from Toyota and Honda; instead, they responded proactively and survived. AT&T, with $168 billion revenues in 2016, is hardly dead either. And IBM, with $80 billion revenues, is still going pretty strong.

Equally, Christensen points to industries that produce commodity products such as phones, cars and computers, where there may be giants, but the giants are not protected by layers of law and regulations like banks are. That is why banking has not been disrupted to date, and is unlikely to be in the future.

Christensen does make an important point, although it’s not as radical as those who refer to his work believe. If a weak competitor enters the bottom-end of the market, he argues, they may have the opportunity to disrupt the market if the incumbent does not respond. That is true, and that was the case with Kodak and Nokia. Ford, AT&T and IBM did respond and survived the change.

That is the case with any change however. As Charles Darwin noted: “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.”

How true.

We really need to understand the difference between sustainable innovation and disruptive innovation in order to see if there is any disruptive change in banking. According to Matt West:

Sustaining innovation comes from listening to the needs of customers in the existing market and creating products that satisfy their predicted needs for the future. Disruptive innovation creates new markets separate to the mainstream; markets that are unknowable at the time of the technologies conception.

Sustaining innovation improves what is there today; disruptive innovation replaces what is there today. Hmmm. I blogged about this over on The Next Web, stating that there are three streams of fintech innovations:

  • Those that serve markets that banks don’t serve
  • Those that improve the customer journey by removing friction
  • Those that work with banks to eradicate inefficiencies, for example, in customer onboarding

Obviously, the latter two categories are sustaining innovations, as they improve what is there today. The first category is interesting though, as it is creating and serving new markets. In my blog, I pointed to SME financing and crowdfunding, but that’s not a true example of disruption. That is an extension of what’s occurring today.

However, I do see one example of disruptive innovation out there. I think about this one often. It is clearly disruptive, but is it noticed by the incumbents? Have they responded?

Not yet.

What is it?

I’m tempted not to say, but that would be rude. It’s financial inclusion.

There’s loads of discussions about financial inclusion and the use of mobile wallets in Sub-Saharan Africa to provide cheap and simple money transfers between people without bank accounts. This is serving the bottom end of the market, and Christensen defines disruptive innovation as: “A process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves up market, eventually displacing established competitors.”

Oooh. We have one. Are the banks noticing?

Departing Administration Leaves Gift of Fintech Principles


fintech-1-16-17.pngIt may strike some as odd that President Barack Obama’s National Economic Council just published a “Framework for FinTech” paper on administration policy just before departing, but having been a part of several conversations that helped to shape this policy perspective, I see it from a much different angle. Given that traditional financial institutions are increasingly investing resources in innovation along with the challenges facing many regulatory bodies to keep pace with the fast-moving fintech sector, I see this as a pragmatic attempt to provide the incoming administration with ideas upon which to build while making note of current issues. Indeed, we all must appreciate that technology isn’t just changing the financial services industry, it’s changing the way consumers and business owners relate to their finances—and the way institutions function in our financial system.

The Special Assistant to the President for Economic Policy Adrienne Harris and Alex Zerden, a presidential management fellow, wrote a blog that describes the outline of the paper.

I agree with their assertion that fintech has tremendous potential to revolutionize access to financial services, improve the functioning of the financial system, and promote economic growth. Accordingly, as the fabric of the financial industry continues to evolve, three points from this white paper strike me as especially important:

  • In order for the U.S. financial system to remain competitive in the global economy, the United States must continue to prioritize consumer protection, safety and soundness, while also continuing to lead in innovation. Such leadership requires fostering innovation in financial services, whether from incumbent institutions or fintech start-ups, while also protecting consumers and being mindful of other potential risks.
  • Fintech companies, financial institutions, and government authorities should consistently engage with one another  . . .  [indeed] close collaboration potentially could accelerate innovation and commercialization by surfacing issues sooner or highlighting problems awaiting technological solutions. Such engagement has the potential to add value for consumers, industry and the broader economy.
  • As the financial sector changes, policymakers and regulators must seek to understand the different benefits of and risks posed by fintech innovations . . .  While new and untested innovations may increase efficiency and have economic benefits, they potentially could pose risks to the existing financial infrastructure and be detrimental to financial stability if their risks are not understood and proactively managed.

A product of ongoing public-private cooperation, I see this just-released whitepaper as a potential roadmap for future collaboration. In fact, as the fintech ecosystem continues to evolve, this statement of principles could serve as a resource to guide the development of smart, pragmatic and innovative cross-sector engagement much like then-outgoing president Bill Clinton’s “Framework for Global Electronic Commerce” did for internet technology companies some 16 years ago.

Departing Administration Leaves Gift of Fintech Principles


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It may strike some as odd that President Barack Obama’s White House’s National Economic Council just published a “Framework for FinTech paper on administration policy just before departing, but having been a part of several conversations that helped to shape this policy perspective, I see it from a much different angle.Given that traditional financial institutions are increasingly investing resources in innovationalong with the challenges facing many regulatory bodies to keep pace with the fast-moving fintech sector, I see this as a pragmatic attempt to provide the incoming administration with ideas upon which to build while making note of current issues.Indeed, we all must appreciate that technology isn’t just changing the financial services industry, it’s changing the way consumers and business owners relate to their finances—and the way institutions function in our financial system.

The Special Assistant to the President for Economic Policy Adrienne Harris and Alex Zerden, a presidential management fellow, wrote a blog that describes the outline of the paper.

I agree with their assertion thatfintech has tremendous potential to revolutionize access to financial services, improve the functioning of the financial system, and promote economic growth. Accordingly, as the fabric of the financial industry continues to evolve, three points from this white paper strike me as especially important:

  • In order for the U.S. financial system to remain competitive in the global economy, the United States must continue to prioritize consumer protection, safety and soundness, while also continuing to lead in innovation. Such leadership requires fostering innovation in financial services, whether from incumbent institutions or fintech start-ups, while also protecting consumers and being mindful of other potential risks.
  • Fintech companies, financial institutions, and government authorities should consistently engage with one another… [indeed] close collaboration potentially could accelerate innovation and commercialization by surfacing issues sooner or highlighting problems awaiting technological solutions. Such engagement has the potential to add value for consumers, industry and the broader economy.
  • As the financial sector changes, policymakers and regulators must seek to understand the different benefits of and risks posed by fintech innovations.While new and untested innovations may increase efficiency and have economic benefits, they potentially could pose risks to the existing financial infrastructure and be detrimental to financial stability if their risks are not understood and proactively managed.

A product of ongoing public-private cooperation, I see this just-released whitepaper as a potential roadmap for future collaboration.In fact, as the fintech ecosystem continues to evolve, this statement of principles could serve as a resource to guide the development of smart, pragmatic and innovative cross-sector engagement much like then-outgoing president Bill Clinton’s “Framework for Global Electronic Commerce” did for internet technology companies some 16 years ago.

Recoding the Bank


technology-11-25-16.pngIn 2009, a former Google engineer and his wife decided to buy a little bank in tiny Weir, Kansas. At the time, the bank had less than $10 million in assets. Why would a tech guy want to get into banking, with all its regulation and red tape—and do so by buying the textbook definition of a traditional community bank?

Money is a very fundamental invention,” says Suresh Ramamurthi, the ex-Google engineer who is now chairman and chief technology officer at CBW Bank. (His wife, Suchitra Padmanabhan, is president.) “The best way to understand the [changing] nature of money is to be within a bank.” So Ramamurthi learned how to run every facet of the bank, and then set about fixing what he says was a broken system. The bank’s new-and-improved core technology platform was built by Yantra Financial Technologies, a company co-owned by Ramamurthi.

Ramamurthi and his team “recoded the bank,” says Gareth Lodge, a senior analyst at the research firm Celent. Many banks rely on their core providers for their technology needs, but CBW, with Yantra, wrote the software themselves. The bank’s base technology platform allows it to make changes as needed, through the use of APIs. (API stands for application programming interface, and controls software interactions.) “What they’ve created is the ability to have lots of different components across the bank, which they can then rapidly configure and create completely new services,” says Lodge.

The bank has used this ability to create custom payment solutions for its clients. One client can pay employees in real time, so funds are received immediately on a Friday night rather than Tuesday, for example, decreasing employee reliance on payday loans. Another client, a healthcare company, can now make payments to health care providers in real time and omit paper statements; by doing so, it cuts costs significantly, from $4 to $10 per claim to less than 60 cents, according to Celent.

The bank created a way to detect fraud instantly, which enables real-time payments through its existing debit networks for clients in the U.S., at little cost to the bank, says Lodge. CBW also makes real-time payments to and from India.

Today, CBW is larger and more profitable, though it’s still small, with just $26 million in assets, and still has just one branch office in Weir. The bank now boasts a 5.01 percent return on assets as of June 2016, according to the Federal Deposit Insurance Corp., and a 26.24 percent return on equity. Its efficiency ratio is 56 percent. In 2009, those numbers were in the negative with a 140 percent efficiency ratio.

Not only has its profitability substantially changed, but its business model has too. Loans and leases comprise just 9 percent of assets today, compared to 46 percent in 2009, as CBW increasingly relies on noninterest income from debit cards and other deposit-related activities. CBW found opportunities in partnerships with fintech firms, long before the rest of the industry caught on. CBW provides the FDIC-insured backing for the mobile deposit accounts of the New York City-based fintech firm Moven, and also issues the company’s debit cards. “Every one of these opportunities is a learning opportunity,” says Ramamurthi.

Is it possible to duplicate CBW’s approach to innovation? The bank’s model and leadership is extremely unique. A large bank may have the technology expertise in-house, but completely changing a complex organization is difficult. On the other hand, while it’s easier to make changes to a small, less complex bank, these institutions often can’t attract the necessary talent to facilitate a transformation. To further complicate matters, many banks are working off older core technology, and their partnerships with major core providers limit their ability to integrate innovative solutions, according to Bank Director’s 2016 Technology Survey.

CBW, on the other hand, is nimble enough to transform seamlessly, due both to its size and its custom core technology. It also has leadership with the ability and the interest to implement technology that can help better meet clients’ needs. “They’re providing things that nobody else can do,” says Lodge. “It’s not just the technology that distinguishes them. It’s the thinking.”

 

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.”

Committees Can Foster Innovation: Here’s How


innovation-7-3-15.pngBoston-based Eastern Bank Corp. has quickly ramped up its ability to invest in and deliver innovative products and services. The $9.7 billion asset mutual holding company started changing its culture in 2014, through the creation of its innovation lab. In June, the bank began using voice biometrics in its call center, so customers now can access accounts using just the sound of their voice.

This year, Eastern dedicated $4 million to research & development—1 percent of its annual revenue, says Bob Rivers, Eastern’s president. The additional investment meant that Eastern’s board needed to increase its involvement and oversight, so Eastern created an innovation advisory committee to guide and support the bank’s innovation investment. The committee is staffed by four board members and four members of Eastern’s management team, and meets quarterly to discuss innovation within the company. “It’s really to give the board visibility and oversight with respect to that investment and focus,” says Rivers.

Financial institutions today are increasingly reliant on technology and the delivery of innovative products and services to drive organic growth. Boards must be ready and willing to engage in discussions on innovation and technology. An advisory board can be a great way to drive innovative thinking, but the board may instead focus on innovation within a board-level committee.

Innovation comes from diverse perspectives, ages, experiences and cultures—not just from individuals with a technology background, says Edward Stautberg, managing director at PartnerCom, a New York-based board advisory firm that helps corporations create advisory boards. Advisory boards have their benefits. They can be comprised of businessmen who may not be a good fit for the board but may have the right expertise to advise the bank, and directors and executives can take their input with a grain of salt. Food and beverage conglomerate PepsiCo Inc.’s ethnic advisory boards are tasked to create products for the company’s diverse worldwide customer base. According to Stautberg, one of these boards came up with the idea to add chili and lime flavors to some product lines, such as Lay’s potato chips and Doritos tortilla chips. “That was a direct result of a diversity in thinking,” he says. Digital advisory boards are a growing trend for Fortune 500 companies such as Target Corp. and General Electric Co., reports The Wall Street Journal.

But banks can choose to focus on innovation in a board-level committee, which sends a message throughout the organization that the board is truly dedicated to the issue. “It shows that you’re actively discussing innovation at the board level and that it is something that the board is engaged on,” says Stautberg.

Huntington Bancshares Inc., the $68 billion asset bank holding company headquartered in Columbus, Ohio, founded its board-level technology committee in 2014. Among the many technology-related duties listed in its charter, the committee oversees whether the bank has the technology in place to push innovation, and monitors innovation trends that impact Huntington’s strategic plan. Peter Kight chairs the committee, which he says was created to address two of the board’s biggest concerns: Cybersecurity and digital delivery. “A financial services [company] is an information based business, and information is digital today, which means our business is a digital services business,” he says. “Are we going to be able to innovate fast enough to be able to be one of the survivors, and in fact one of the winners?”

At its most recent board meeting, Huntington’s technology committee brought in a venture capitalist who focuses on financial technology. The discussion provided the board with direction about which startup companies they might want to work with, and helped identify threats in the financial technology marketplace. Trends in digital lending were also discussed.

The technology committee isn’t staffed with technology experts. While Kight has a background in financial technology—he was the founder and chief executive officer of CheckFree, and after its 2007 acquisition by technology services provider FiServ, he served on FiServ’s board for five years—he doesn’t believe a technology background is necessary. “Who’s really driven to want to learn in this space?” says Kight. “What we need are people who understand the need to look for this innovation and drive it within our culture and to drive it within our strategy, both in management and at the board.”

Huntington doesn’t lack for board members committed to innovation. Finding four board members to staff the bank’s technology committee wasn’t a challenge, because every board member wanted to join. Not only did the focus sound “cool,” Kight says, but the board believes innovation is critical to the success of the company. 

“If we keep thinking like bankers, in five years, we won’t be bankers, because banking isn’t going to be done in the same way,” says Kight. “We absolutely cannot continue to run the bank the way we have run it in the past, which means we have to, at a strategic level, drive for innovation.”