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 1, Headline 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.
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:
- Close significantly more branches and
- Transform Culturally and Technologically
- 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
- Everything is Based Locked in Paper
- 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…
- Create a Digital Core (remove paper in operations)
- 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)
- Stick with what you’ve got but update it
- Go for the latest version of SAP / some other vendor name here – and create incremental improvement
- 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
- Being locked in paper (Paper at the core)
- 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?