Why Banks Are Sleepwalking Into Extinction And What To Do About It


Earlier this week Michal Panowicz shared this stunning stat that demonstrates how much money banks are throwing away holding on to the past:

The top 25 global banks spend more on their branch network, than the top 25 global tech companies spend on R+D by 2:1.

To put a number to it, in ONE YEAR – $50Bn was spent by those 25 banks on branches alone.

Banks are spending a huge amount on “Technology” too -(just look at these headlines: Headline 1Headline 2  and Headline 3) . Not only are branches an albatross of cost, but the technology spend is enormous.  Banks are being disrupted by Fintech players who operate at orders of magnitude less technology cost, and require no branch network.

IDC Tech Spend


To compete banks have seen boom in technology costs, but this is not being off set by branch closures. Not even close.

Fools Gold: Digitising a Paper Process

When banks moved to computerise in the 1970s, having all of their core accounting come out of the branches seemed like a great way to reduce errors and remove cost. In fact, it was. It worked.

Naturally not all bank branches adopted computerisation at once. Banks kept account numbers and sort codes, so the branches (and other banks) that weren’t yet computerised could still talk to each other with cheques, cash and letters of credit. At the time this was the logical thing to do.

Layer on top of that the international nature of banking. Banks needed a way to move money around the world, and in the 1970s realised they needed to create standards to do so. Despite many new standards and updates, the core internal and external systems function much the same way as they did in the 1970s. Banks talk to their customers and each other in a digital representation of the paper world in the 1970s.

40 Years later, this technology is creaking at the seams, and forcing banks to keep their branch network alive.  High Street Bank technology is predicated on the existence of branches.

Worsening Service – Increasing Costs

By taking the decision making power out of the branch, but keeping backward compatibility with the paper banks now have the worst of both worlds. Banks still have the cost of paper processes and  now branches unable to give the type of community service and instant decision making they once could.

It would seem logical that banks are spending as much as they are on technology, recognising the need to get better at service and cut their own cost base to compete with Fintech and Tech companies (as well as each other).

So Where Does All of That Technology Spend Go?

Yet when you break out the £1Bn or so a Tier 1 bank claims to spend on technology more than 97% of this goes on keeping the lights on, or incremental product releases.

(Note: A lot of incremental products get called “Innovation” in banking – but keeping a mobile app running, or creating a new loyalty scheme is outside my definition of disruptive or R+D innovation.  I’m also not including “venture funds” inside of R+D.  I’m defining pure R+D as developing new products intended for launch in more than 24 months time)

When you look at pure R+D banks spend £970M to avoid having to replace core systems and £30M investing in their future in my estimation.

Now look at the amount of money the big tech players are spending on technology R+D, innovation and disrupting markets.

Somewhere between 5 to 20% of revenue. For Google with revenues of $15Bn in 2014, that’s $1.5Bn on pure R+D Innovation!

Now let’s look at the Big 4 UK Banks (and switch back to Sterling)

  • Lloyds 2014 revenue – £18.4Bn
  • Barclays 2014 revenue – £25.7Bn
  • HSBC 2014 revenue – £14.2Bn
  • RBS 2014 revenue – £15.2Bn

Average revenues of £18.3Bn – . If they were spending 5% of revenue on pure R+D that would be £918 Million, not £30 Million. To compete with a Google level of investment (at 10% of revenue), that would be £1.8Bn on innovation alone. Until banks:

  1. Close significantly more branches and
  2. Transform Culturally and Technologically
  3. Get Honest about the Definition of “Innovation”

they cannot compete in a fintech future. Top line will continue to erode and banks will cost cut “just enough” to make it to next week.

Banks are spending the right amount of money on the wrong things

Fintech could be the answer, but playing with Fintech whilst still trying to carry the burden of under performing branches and 1970s core technology is little more than PR. Innovation starts at the core and works out.

I imagine most banks would love to spend this amount on R+D but their budget is locked away for other things.

Innovation in banking is near impossible…

Because of two sins in HOW banks operate

  1. Everything is Based Locked in Paper
  2. Risk Is Managed With Tick Box Processes

Paper is Killing The Banking Industry

Stupid things happen when transactions live in paper. Stupid things charging the wrong fee to a customer because what was inputted to the charging system wasn’t the same as what was on the paper. Or when the market moves against the banks (like in 2008) banks scramble around looking for the piece of paper losing billions with each passing minute.

Perhaps the worst example is account opening.  To do this the bank has to find the paper that proves you are who you say you are. Most people and companies are incorporated in paper somewhere (either with a Government or Companies House equivalent). Giving a bank account or performing a very large transaction requires finding all of these pieces of paper, translating them and then understanding all of the rules written in paper. Translation errors, ambiguity in international law and having to rely on a network of other banks to have performed their own due diligence makes this a near impossible task for banks.

This stuff is NOT EASY, because banking is complex and relies on paper as the golden source of truth.  Paper + complexity of transaction = errors

Tick Box Approach to Risk Management is Killing Bank Profitability

The way a bank reacts to incredibly difficult regulatory and legal requirements is by creating a tick box process inside a spreadsheet. The way a bank meets its regulatory requirements is by creating a committee who “sign off” against a high risk transaction (either with email or paper) by checking that all the tick boxes were ticked.

If all the tick boxes are not ticked? Fill in another tick box, logging which tick box wasn’t ticked and get an email from someone senior
saying it’s ok to to go ahead, because the tick box about not ticking the box was ticked. This is the same process that has been followed for decades, yet the fines keep coming. Those regulatory fine numbers are far bigger than the innovation investment figures.

There is a real need to change HOW banks address their problems.

The vendors and the consultants all fall for this group think. When the supplier selling you digital solutions replicates your tick box
process, and the consultant recommends a new tick box process, the whole thing becomes a case study in the death grip of paper.

Surely – There are digital solutions to…

  1. Create a Digital Core (remove paper in operations)
  2. Create Digitally Savvy Control Functions (replace tick boxes with data, dashboards and decisions)

The Digital Core

There are three main options when looking at really rebuilding the internal technology stack (as David Brear points out)

  1. Stick with what you’ve got but update it
  2. Go for the latest version of SAP / some other vendor name here – and create incremental improvement
  3. Go for something much newer that may not even be on a Gartner magic quadrant

Option #3 is always the hardest to take. To make your core accounting and payments engine run on something you may have never heard of is a scary thought. Yet this is the key, if you ever want to grow the topline again as a banking CEO, compete with Fintech players and delight customers with digital. This is the best option. Chris Skinner has some great thoughts on What is a Digital Bank?

The Digitally Controlled Bank

The earlier example of onboarding a new customer demonstrates how banks being locked in paper really holds them back. If I look at your passport and a utility bill, maybe even your credit score, how much do I really know about you? You’re a real person and you’ve bought some credit products at some point in history. I’d argue that is far less than a branch manager in the 1950s knew about you. Yet this is how a bank is going to decide if it give you a mortgage. Because they’re locked into processes they built in the 1970s, predicated on paper.

What if instead we learned the real lessons of Big Data? Get past the marketing hype and the change here is cultural. Don’t believe the
paper, believe the data. How many people bought a coffee at the same place, at the same time as you this morning? Then paid for a new tube pass in the same place, at the same time as you did? And tweeted from the same location as you, with the same account at the same time?

With three data points I can be pretty sure you are who you say you are. The burden for those inside the bank is to prove this to their
internal compliance teams and to regulators, that it’s inside existing policy, regulation and legislation. It can be done, but the tick boxes
processes make it near impossible.

Regulation Makes This Hard but Not Impossible

The reason why it’s so hard to build a real competitor to banks is that managing regulation requires experience and cost. Trying to go around regulation when dealing with people’s money or their house is quite different to disrupting taxi services or retail shopping (e.g Uber vs Bitcoin).

Some regulatory regimes are purposefully not tough on new sectors to allow them to grow and self regulate to a degree. Ultimately there comes a point when building something new you have to interact with the regulator. Having the people with the experience to engage strategically with regulators, as well as come up with creative / automated regulation solutions is the key gap in fintech and banking.

Banks are used to going to the regulator and saying “this tick box process is how we’ve solved the problem”, regulators are used to hearing banks say “this is our tick box process”. The cycle repeats. Yet at the most senior levels, there is a disappointment on both sides of the lack of innovation here. There’s a chasm between people who write the rules and those who then enforce / follow the rules.

Fintech companies and challengers that are successful are good at approaching regulators and saying “this is how we meet your rules” often with a low cost, digital approach. It can be done. Banks can do it too.

Digital Isn’t Easy

A word on paper. There is an argument that if we relied purely on digital, the meltdown in 2008 would have continued without a check or balance. Sometimes slow technology is useful. There are also plenty of examples where spending money alone doesn’t deliver digital transformation.

A strong team that can deliver in banking requires experience in the tech sector and experience with financial regulators. There aren’t many with that skill set but I look at a company like Circle Internet Financial as a start-up disruptor who have built exactly that team. For the amount of Exec salary on offer, it must be possible for banks to create the environment for these people to succeed!

Perhaps the key here – is to *start* by changing HOW things are done.

Key Questions and Suggestions for Bank Execs

  • Is your business run in paper?
  • Do your compliance teams get digital?
  • Do your legal teams get digital?
  • Do your security teams get digital?
  • How are risks recorded?
  • How are programmes delivered?
  • How are cost decisions made?
  • Can you change the how?
  • How are you protecting innovation from tick boxes?
  • How do you then commercialise that innovation without tick boxes?
  • Does your culture rely on sign off from execs to get anything done?
  • How can you empower change with data and automation helping compliance?

Delivering change the same way you delivered change before is both a paradox and ironic. Much like everything in banking. I’ve seen far too many “Agile delivery programmes” become waterfall with monthly release cycles.

Actions To Take to Transform Banks to be R+D Capable

  • Study how technology companies deliver and create those small pockets of excellence.
  • Make sure the entire top team gets how paper is killing the company
  • Make sure they’re doing the same with their team
  • Get very close to the top 150 programmes by spend in the group and understand and change the how

When it comes to core system transformation – make sure once the “how” is fixed and digital, that the core digital transformation is the top of the agenda. Consider this. Newer bitcoin companies creating “bank like” products can run technology infrastructure to support Millions of customers for $130,000. For a bank to deliver a new product / UI, successful or not is often in the region of $30M to $100M successful or not.

Down to those same two reasons

  1. Being locked in paper (Paper at the core)
  2. Tick Box Risk processes (Not trusting data)

Banks are sitting on a gold mine of opportunity. They can give their customers the gift of advice, help and support to meet their ambitions, but to do this they must get out of their own way!

What are your thoughts? Do you work in a bank, around a bank or a fintech company and see it differently?

Think The Blockchain is Interesting But Bitcoin Isn’t? Think Again

Whilst the “Blockchain is interesting” narrative has merit, it created a dismissive approach to Bitcoin that misses a trick.  If you don’t want to miss that trick, read on.

Banks have gotten into this “Blockchain” thing like it’s the new snake oil,  a conversation about “Blockchain” will open any door and liberate a little budget.  As this Dilbert remix excellently sums up

dilbert chain

This isn’t the first post to explore “Bitcoin bad, Blockchain good”, but there are some things I felt still needed to be said. There is an excellent post by Richard Brown (which I recommend reading as pre-text to this) and another by Chris Skinner. Both make the point that saying “Blockchain not Bitcoin” is dangerous.

The subject has become too binary, either you believe Bitcoin will eat the world, or it is incompatible with current banking regulation and practices.

It may be helpful to understand why the banks instinctively warm to the Bitcoin bad narrative. There are three main misconceptions and one thing I agree with fuelling this:

  1. The Misconception: It’s easier to launder money with Bitcoin
  2. The Misconception: Bitcoin is not secure
  3. The Misconception: Bitcoin would not be profitable for banks
  • The Interesting Truth: There are valid, exciting and profitable use cases for the technology outside of Bitcoin’s architecture

I’ll tackle the misconceptions later in this post, but first it’s worth a quick refresher on what’s interesting about Bitcoin.

Bitcoin’s Got Talent

Perhaps the reason there are so many misconceptions because so few people understand Bitcoin. It has a number of unique properties that banks are seeing as a threat, rather than an opportunity.  Think about the problem of Cash for banks…

Cash Got Problems (yo)

When you have money in your bank account, it’s not actually yours legally. The bank owe’s it to you (as ever there’s an excellent Richard Brown post that goes into more detail on this). They’re using that money on the stock market to make a profit.

The more you use debit and credit cards, the more profitable you are. If you draw out your entire wage as cash every month you’re one of the least profitable customers.

Paper cash is expensive. There are an army of vans moving cash around the country, from supermarkets to vaults and back again.  A logistical nightmare that adds a ton of cost compared to digital money.

Paper cash is also risky, it’s near impossible to trace because it exists physically and carries its value as it moves. Do you know where the cash in your wallet came from or who had it last? What about before then? If you ran a drug cartel, it would be very helpful to have a network of chicken shops to take all of that cash and get it into the banking system.  In developed markets cash is slowly being displaced (not nearly as fast as you might think!)

cash is king

But in developing economies it’s a different story

Cash Can Reach Where Banks Can’t

220 Million Agricultural Workers are paid in cash. If you live on a remote farm, or are urban poor, there’s a good chance you’re not profitable as a current account customer. You wouldn’t put enough money in the account per month to make the cost of giving you an account make sense for the bank.  Banks have to maintain branches, servers, data centres… all of that cost makes you expensive unless you’re giving them a significant amount of money per month to profit from.

If you get paid in cash, you’re trapped in a cycle of cash.

Recent years have seen the emergence of mobile airtime being used in place of cash… this helps, but only solves part of the problem. You’re still getting paid in cash and you still can’t save or borrow. You’re still not financially included.

Bitcoin As Digital Cash

When I send you money from my bank account to yours, my bank owes me less, your bank owe’s you more.  I haven’t paid you, my bank paid your bank.

This isn’t a possibility for under 18s or billions of unprofitable potential customers. This is where Bitcoin has huge potential. As a digital token that holds value, it can transact as cash. When I send you a Bitcoin, you receive it, not your bank.

Can a Bank Make Bitcoins Make Sense?

Regulation aside (for a moment), the mechanics for a bank to accept Bitcoins instead of cash would be relatively trivial. They’d just need an exchange capability. As soon as the “Bitcoin cash” is collected, it wouldn’t have to be physically moved anywhere.  If you look at it purely as a cash replacement, it actually makes sense.

Sure Bitcoin is a bearer asset (your bank can’t use it on the stock market – yet), but it reaches where the bank can’t.  It’s also got another trick up its sleeve…

Bitcoin is Permissionless

Permissionless innovation was a phrased coined to explain how the internet changed the telecom industry and created opportunity. Before the internet, all of your communications had to be compatible with the telecoms operator you used. The internet created a new set of rules. In a different way, Apple did this with the “App Store”. Inviting the world in to build whatever they like with a set of lego bricks.

Bitcoin similarly is an open set of lego bricks, that will always work no matter who you are. This property does not apply to the bank use
cases of what they call “Blockchain”.

A closed distributed ledger system has many advantages over today’s technology, but it’s not permissionless. It will therefore, never reach the types of customers truly permissionless innovations can.

To use Bitcoin you needn’t go to a branch and provide a birth certificate (which is quite difficult if your nearest branch is 5 hours away and you don’t have a birth certificate!) A mobile network operator tomorrow could decide that their airtime will be tradable for Bitcoins on a Bitcoin exchange.

It would then simply require someone to wrap these two things into a proposition for remittances (like say BitPesa) to make it really easy for Ex-Pats to send money home to their family to be received as airtime.


Bitcoin As a Customer Acquisition Opportunity

Perhaps then Bitcoin is the technology equivalent to the student account. A loss leading outreach programme to win a new generation of customers because they’ll be valuable over their lifetime.  This might actually be feasible if local regulation allowed it.

Because the Bitcoin blockchain (ledger) is so very transparent,
you could actually watch Bitcoin wallet behaviour and use that to build risk models.

In other words, you’d be able to identify customers who may be low risk for a savings or loan product.

Granted, there’s a number of sizeable challenges before that could be possible, like consumer acceptance or the regulatory acceptance.

To make any of this a possibility will require a little imagination, a lot of opportunism and overcoming some key misconceptions…

Overcoming Misconceptions

Won’t People Launder Money With Bitcoin?

The recent Silk Road arrests suggest the FBI found it relatively trivial to collect evidence and arrest those involved. The issue is the network itself doesn’t require an identity. In itself, not having an identity to transact digitally is incompatible with existing regulation.

Yet if you see Bitcoin as cash-like, that doesn’t compute. I don’t need to identify myself to hold a small amount of cash. I just need to identify myself to put it in the bank. Which is why we’re seeing regulation focus on wallets and exchanges.

I think this is where regulators need some imagination, or to resist to the urge to look at new technology as if it is something existing
regulation can work with. It’s a hybrid of digital money and cash. So a risk based approach would say the regulation too should be a hybrid.

Regulation focussing more on what CAN be done with the technology, rather than what CANNOT be done will lead to the most innovation.

Is Bitcoin not Secure?

Mt Gox isn’t a Bitcoin problem, it’s a Mt Gox problem. The metaphor would be, if everyone in the room gave their cash to say – Chris Skinner – and Chris left the wallet outside in the street. That isn’t the fault of the bank, it’s the fault of Chris (or in Mt Gox in this case). Actually, Bitcoin has never been hacked. That is a remarkable achievement for a public utility and open source software.

Something that can’t be said for the very expensive Payment Card Industry (PCI) with all its regulation, pain and cost, we still see things like the TARGET hack.

Each day we build a higher wall and each day the attackers get closer. With Bitcoin there are no walls. The funds are so distributed it’s harder to find points to attack

If it’s Cash Surely It’s Not Profitable?

Because it’s digital cash, because it’s permissionless and because it’s transparent I think there are opportunities there. Those opportunities require imagination. They’re not based on the same business model the banks are comfortable with or used to.

If the banks have the imagination to see an internet like world of people who could be potential customers of savings or loan products.  Bitcoin could be very profitable as a customer acquisition tool.

The Alternatives to Bitcoin

The points above don’t suggest that what Ripple, Eris or Ethereum are doing is wrong. If anything some of these new entrants may have a better short term impact on traditional finance than Bitcoin does as regulators struggle to get their head around Bitcoin. There are huge potential cost savings and opportunities with distributed ledgers and smart contracts that don’t require Bitcoin.

However, just because a narrative is comfortable and fits your world view doesn’t mean it’s right. If the Telco’s had said “We like the
internet technology, but think it should be closed for just Telcos to use” – people would rightly think it’s crazy talk. Technologies that
treat value as a liability (an IOU), will never be able to displace cash in the same way Bitcoin does.

I don’t see why this argument has to be binary. Either you’re for Bitcoin or against it, it seems.  I’m for Bitcoin AND for it’s alternatives.  They’re both interesting.  Arguably the alternatives more so to traditional banks in the short term.

Prediction Time

We’re going to see banks adopt some permissioned distributed ledgers in the coming years and it will be largely invisible to the end customer.  Most of the action will be in those large contract movements between banks.  Banks will see major benefit from doing so, and doing so aggressively.

During that time we’ll also see non traditional wallet players and remittance companies gradually warm to the open / simplicity of Bitcoin (and / or it’s competitors / upgrades). For this long tail of airtime users and cash users having something that is interoperable and global will be a huge advantage.

The question then is how will PayPal react? Or Alibaba?

The Opportunity Cost for banks of not at least considering Bitcoin could be huge.

Simon Taylor – Making Innovation Work