The average small business owner uses technology every day to run the enterprise—and the same is expected of the financial institution, explains Chris Rentner of Akouba Credit. Banks that adopt technology will have a competitive edge in the market.
Why Banks Should Explore Fintech Partnerships
What Small Business Customers Expect From Their Bank
There was a plaque in my father’s office that is attributed to the late David Ogilvy, often called “The Father of Advertising. It read, “Search the parks in all your cities, you’ll find no statues of committees,” which I always interpreted to mean, “YOU need to make something happen; don’t wait on others to get going.”
But going it alone in the banking industry is extremely difficult because of the complexities around regulation, underwriting, competition and the thousands of vendors that serve it. Combine that with record breaking investment in financial technology and the next few years may very well serve as our “big bang” and usher in a new era of banking.
I’ve observed how companies seeking to make a real impact within the industry rarely do it alone. While we need committees in business, maybe what we need more is a “virtual committee,” or community of fintech players, to better understand the nuances within the landscape. The value of this fintech community is to provide industry intelligence, serve as a sounding-board for new ideas and foster relationships to move you faster in achieving your organizational goals.
The fintech community should also include thought leaders, published research and reports—and most importantly, peers from outside your organization. Even competitors can be valuable resources for your company and contribute to your personal development.
The banking segment will likely see more action than the rest of the economy. In the future we will probably witness the following:
The adoption of a new fintech charter
A relaxation of the regulatory burden
Improved bank earnings, helped in part by rising interest rates
Increased customer expectations
Individuals and organizations that embrace the industry as a community and foster relationships will have a competitive advantage.
Why Dramatic Change in Banking is Hard
Many of the products and services that banks offer are mature, even bordering on commodity status. Technology advances we see in our industry tend to fall into a few categories:
How banks deliver products (channel)
Customer insights and recommendations (managing their money better)
Ease of doing business (speed, simplicity and service)
Tweaks to traditional business models (sources of funding, hyper-focused segmentation)
Operational improvements (automated processes, enhanced security and improved regulatory compliance processes, to name three)
Many of the platforms we used today are in the process of being either rewritten or replaced. According to one vendor, the life cycle of fintech moving forward will be five years or less on average.
The technology that the vast majority of financial institutions use today is a result of decisions spanning over many years and engagements with a lot of vendors—typically from dozens to hundreds of relationships.
Media, fintech executives and investors have a tendency to focus on new and shiny technology without an appreciation of how hard it is to run a technology company in the financial industry, much less what it takes to achieve long-term success.
Agents For Change
Vendors looking to grow their businesses seek focused education and networking opportunities. Organizations such as the Association for Financial Technology, or AFT, enable vendors to learn about technologies, which organizations are doing well, and gain industry insights that help provide a perspective for decision-making. This particular fintech community includes companies of all sizes that have implementations in virtually every U.S. financial institution.
Ultimately, people do business with people, and fintech advances won’t happen until two people or two companies agree on a shared vision. Finding your community, and being a good citizen within it, will enable you to grow professionally and help your company succeed and make a positive impact.
The wealth management industry has been a significant source of fees for many banks in recent years. As innovation in the sector has resulted in the development of a plethora of digital asset management solutions, including so-called robo-advisors and data aggregation applications, a number of banks and other financial institutions (FIs) have taken steps to participate in this emerging market via partnerships or acquisitions. Recent activity in the sector includes Ally Financial entering the space by buying TradeKing, Northwestern Mutual buying LearnVest and BBVA partnering with FutureAdvisor. Leading robo-advisor firms Betterment and iQuantifi have also taken part in the trend by inking partnership agreements with banks.
Some large FIs have taken a different approach to entering the market, choosing to build their own fintech applications instead of buying or partnering. Firms taking this tack include Schwab, Fidelity and Vanguard, all of which have created their own robo-advisor offerings.
An upsurge in M&A activity can be a sign of a maturing industry, and this appears to be the case in the fintech space; after several years of breakneck growth, the market for digital advisory services seems to be stabilizing. Lending support to the idea that the pace of expansion is declining, at least among business-to-consumer digital wealth management services, is this blog post from industry expert Michael Kitces, who reports that robo-advisor growth rates have dropped precipitously this year to approximately one-third of year earlier rates.
In an interview for this article, Kitces, publisher of the Nerd’s Eye View and co-founder of the XY Planning Network, advised that FIs looking to purchase or partner with a company in the fintech sector focus on aligning any such effort with their core strategy. He suggests they identify the core business model used by the partner or acquisition target and ask how the technology powering that model feeds into the FI’s business strategy: “Is it lead generation? Is it customer retention? Is it expanding wallet share? And will the technology realistically be adopted, by the right customers or prospects, to serve that goal?”
One obstacle banks looking to buy their way into the digital wealth management sector may face is that M&A activity in the industry has lessened the pool of potential acquisitions. Tomas Pueyo, vice president for growth at fintech firm SigFig.com, points out that while buying can allow FIs to accelerate their time to market in comparison with building technology of their own, so many digital wealth management companies have been acquired that those left are mainly newer entrants to the space. While some large FIs have built their own fintech systems, the vast majority don’t, he says, “because they are much less productive than startups at creating new technology and don’t have as strong a culture of user experience.”
Mike Kane, co-founder and master sensei (a Japanese martial arts term that means teacher or instructor) at digital wealth management firm Hedgeable, expressed similar sentiment in regards to the difficulty banks face when competing with startups from a technology standpoint. Along these lines, Kane outlined some of Hedgeable’s latest feature introductions, including “core-satellite investing, bitcoin investing, venture investing, a customer rewards platform, account aggregation, and increased artificial intelligence with many more things in the pipeline.”
The difficulty of competing with nimble startups and the paucity of attractive acquisition targets leaves partnering as the preferred option for banks interested in entering the market, according to both Pueyo and Kane. “The great thing about partnering is that it dramatically reduces cost and time to market,” says Pueyo. “It’s a way to pool R&D for banks with very little cost and risk.” Kane also sees branding benefits accruing to banks which work with innovative technology firms in the sector: “Young people trust tech firms over banks, so it is in the best interest of old firms to partner with young tech firms for product in all parts of fintech,” he said.
SigFig has partnered with a variety of companies throughout its existence, beginning with AOL, Yahoo, and CNN for their portfolio trackers, and more recently with FIs including UBS, the largest private wealth management company in the world. Hedgeable also has made use of the partnership model in building its business. Kane reported that over 50 firms, including both U.S. and international FIs, have signed up for access to the firm’s free API. Hedgeable offers its partners revenue sharing opportunities to go along with the benefit of saving money they would otherwise spend developing their own platform.
Amresh Jain of Strategic Mergers Group, who advises clients looking to do deals in the sector, sees digital wealth management solutions only gaining in importance as new technologies make it easier and more efficient to process and allocate investment portfolios: “The first phase of digital wealth management was focused on the ability of robo-advisors to automate the investment process. The next phase, in my opinion, will see human advisors increasingly integrating their efforts with digital wealth management solutions to provide an enhanced client experience.”
The charts look dire indeed. Economic growth as measured by gross domestic product has been anemic. Net interest margins, a main profitability figure for banks, have been under increasing pressure, with only a slight uptick in the fourth quarter of 2015 from a median of 3.08 percent to 3.13 percent. Loan yields also are down. Compliance and regulatory expenses are going up, according to Steven Hovde, chairman and chief executive officer at investment bank Hovde Group, and a presenter at Bank Director’s Growing the Bank conference in Dallas yesterday.
“Fintech and banks are going to end up marrying up,” he warned the crowd. “It’s the only way you are both going to survive. If you think you can do it on your own, you are sadly, sadly mistaken.”
Not long after that, the doors to the ballroom opened and about 140 bank executives and board members were invited to snack on breakfast burritos, as well as mingle with each other and nearly 100 executives from technology companies along with various leaders from professional service firms.
The tech companies have something many banks lack: innovative products and simple, customer-friendly digital solutions for a changing world. Meanwhile, the banks have some things many of the tech companies lack: actual customers and a more stable funding base.
In a sign of increasing acceptance of the transformative power of technology for the banking industry, the conference drew a crowd hoping to learn ways to grow their banks. The vendors were selling everything from data analytics to simplified mortgage platforms and a core system that gives a star rating to customers based on their profitability to the bank.
An executive who spoke at the conference—Eric Jones at core processor Fiserv—said his company has a two-way alert system where customers can take action digitally to respond to alerts by moving money between a savings and a checking account when they get a low-balance notice. Another vendor, Blend, automates the mortgage lending process complete with an application you can fill out on a mobile phone.
Even a representative from Lending Club, the marketplace lender, showed up hoping to lure in some business, although he declined to talk about the company’s recent woes, including internal controls troubles and the abrupt departure of founder and Chief Executive Officer Renaud Laplanche. (Lending Club partners with banks by selling loans to them generated through its online platform, or marketing consumer loans to the bank’s own customers, particularly if the bank doesn’t want to bother with consumer lending.)
Tom Ashenbrener, a director at First Federal Savings Bank of Twin Falls, Idaho, a $575 million asset bank, said his bank was a fairly conservative lender, but looking to grow nonetheless. He wouldn’t rule out the idea of his bank working with online lenders to grow loans. “There are partnerships that could allow us to stretch,’’ he said. “One of the ways we’re going to be prepared is by transforming ourselves.”
Joe Bartolotta, an executive vice president at Eastern Bank, spoke at the conference and had a more urgent tone. He mentioned the destructive impact the start-ups Uber and Lyft have had on the taxi business. “If the taxi business was ripe for disruption, where is banking?’’ he asked.
“You don’t invest to stay where you are. You invest to go where you want to be in the future,” says Chris Nichols, chief strategy officer of CenterState Banks Inc., a $4.9 billion asset bank headquartered in Davenport, Fl. The term is everywhere–innovation. But what does it mean relative to banks? In an industry burdened with compliance and regulatory pressures, it is rare for bank leadership to have the bandwidth to also think creatively. And when it comes to financial technology, many bankers feel that they don’t really understand this new world they are trying to enter. Nichols was the keynote speaker at a recent conference put on by the law firm Bryan Cave–Crossroads: Banking and Fintech Conference. The following is an edited conversation between Nichols and FinXTech Head of Innovation Kelsey Weaver.
When it comes to innovation, who at the bank is or should be responsible? Nichols: Everyone should be responsible for innovation. Anyone can lead the charge. Every banker needs to understand the basics of how a bank works–credit, deposit gathering, compliance, finance—and the same is true for innovation. Everyone within the bank should be on the lookout for how to improve a process and how to incorporate new technology. The mistake that many banks make is leaving innovation to their IT group. Technology and process improvement is democratized at CenterState so any business leader can spearhead an effort with the support of IT, compliance, management and other line staff.
What area of fintech do you think has had the most profound impact for your bank? Nichols: Figuring out how to add value to our customer’s lives and figuring out how to become more efficient in delivering our services are two areas that all banks need to have a relentless focus on. As a metric, we want to become part of our customer’s lives once per day and want to cut our efficiency below 40 percent over time. Neither effort will be easy, but it is getting easier over time with new processes and technology.
What advice would you give to other bankers when it comes to innovation? Nichols: Be intentional. Proactively develop a culture of innovation so experimentation is the norm and failure is just part of the process. Next, commit to improving a process. Start with creating a vision, incorporate that into an action plan, approve a budget and hold someone accountable for execution. Improving your loan process is an excellent place to start in order to deliver credit faster and cheaper. Next to cutting branch delivery costs, loan processing is the second largest functional cost for a bank. Operational leverage in these two areas is easy to obtain and can make a huge difference on the bottom line in addition to the lives of a bank’s customers.
What advice would you give to fintech companies looking to work with banks? Nichols: It is no wonder banks have a hard time working with fintech companies. There is a disconnect on both counts. Banks need to understand the urgency and mindset of the entrepreneur while fintech need to understand the compliance and reputational risk that the bank has to be responsible for.
I can’t tell you how many times a fintech company just wants to connect to our core system or have us send over “sample customer information” as if these are simple tasks. Fintech companies need to understand that these types of requests are huge undertakings and don’t happen lightly. Vendor compliance for a start-up alone is daunting let alone entering into a beta test. At Centerstate Bank, like most banks, our customer is our most valuable asset and we are fiercely protective of both their data and their experience.
Further, we run into many fintech companies that just have not thought through their business model. We get pitched many models that just cannot work from a pricing or customer care standpoint. We will never let another fintech company aggregate our customer base or our brand value.
What other banks in your opinion are doing things right when it comes to innovation? Nichols: We stand in awe of many banks that excel in different areas. USAA, C1 Bank, Commercial Bank of California, Citizens of Edmonds, Triumph Bank, Live Oak, Texas Bank & Trust, Austin Capital are just some of the many banks that make equal or greater progress around being innovative. We follow and learn from a great many banks.
Filmed during Bank Director’s annual FinTech Day in New York City at the Nasdaq MarketSite, Kai Schmitz of International Finance Corporation, reviews why traditional banks need to join the digital financial services economy rather than stay on the sidelines.
The traditional community banking model, while still viable, is being challenged because of economic, competitive, technological and regulatory forces—many of which are beyond the control of any individual community bank. The largest banks have used their massive size, product set, and more recently, technology, to make dramatic gains in market share at the expense of community banks. I believe that progressive community banks should be considering new ways of doing business, especially in regards to their lending strategies.
Community banks do many things far better than their larger competitors, while enjoying a degree of trust and resiliency that the megabanks may never achieve. But those big banks boast something the community banks, standing alone, cannot match: the scale to operate the lending platforms which are now necessary in most lines of business—including commercial & industrial (C&I) lending. Many American businesses now require loan amounts of $50 million or more, a loan size that typically defines the low end of the “middle market.” Those loans required by middle market borrowers, companies providing goods and services serving a wide range of industries, far exceed the individual lending capacity of the typical community bank. The teams required to source, screen, underwrite and manage these larger loans are typically out of reach for a community bank.
To date, those megabank advantages have clearly outweighed the strengths of community banking in C&I lending. Without the ability to deliver many of the commercial loans that middle market businesses require, community banks are stuck in a quandary in which they often have to turn away customers with successful, growing businesses. The numbers are clear: In 1990, community banks with under $10 billion in assets accounted for over one-third of C&I loans held on the balance sheets of banks. By the end of 2014, community banks’ share of the C&I market has dropped to just over 15 percent of the market. The continuation of this trend will likely limit the profitability and growth of community banks as well as their ability to positively affect their communities in other lines of business. Equally important, it also subjects those banks to less diversified loan portfolios and the risk associated with loan concentrations, particularly in commercial real estate.
While each community bank may individually struggle to match the scale of the mega-banks, it is important to keep in mind that the biggest banks are saddled with their own challenges such as bureaucracy, legacy systems, resistance to change, customer fatigue and burdensome regulatory oversight.
Community banks, but for their individual lack of scale, ought to be well positioned to capitalize on these opportunities and to outcompete the megabanks. The innovation required for community banks to break this logjam—to free them to focus on their strengths—is here, and its essence is this: community banks no longer need to stand alone.
They can prosper by working together, particularly in gaining access to middle market lending. Community banks do have the scale enjoyed by the biggest banks, they just don’t have it on their own. Together, community banks hold $2.3 trillion in assets—13 percent of the assets held by US banks, and just shy of the assets of JPMorgan Chase & Co., the largest US bank. The question is how to leverage that scale while preserving the individuality, proximity to the customer and legendary service that contribute to their unique value.
Community banks should consider joining together in alliances or cooperatives in order to gain access to C&I loans, including diversified sectors such as manufacturing, healthcare, technology, and business services. In addition to using such partnerships to successfully source these loans on a national basis, other benefits such as diversification (size, geography, and industry type), access to larger customers, and combined expertise in underwriting and loan management can be achieved. One such cooperative, BancAlliance, consists of over 200 community bank members and has sourced over $2 billion in such loans.
Through partnerships such as these, community banks can succeed in delivering loans to job-creating middle market businesses throughout our country at a reasonable cost to each community bank, while adding to their net interest margin and diversifying their balance sheet.