The World's Banks Risk Becoming ‘Dumb Pipes’
(Bloomberg Opinion) -- The most recent earnings season showed no slowdown in spending by banks on new technology. The reality is that much of this investment will not show up as superior profits, but rather as waste unless banks undertake a fundamental change in their approach to implementing new technology.
Most banks have the wrong strategy, the wrong structure and usually too much legacy baggage to develop new technology that would benefit their businesses. As a result, many are making the same mistakes as the major telecommunications providers almost a generation ago in that they risk becoming “dumb pipes,” where huge sums of money are spent on core infrastructure, but the real gains are likely to be made by more nimble entrants.
Some of this is not the fault of the incumbents, as the vast amount of regulation in the finance sector means it is hard to develop and implement a distinct strategy. Many major banks appear to have given up, offering little in the way of distinctive customer strategies, and generally competing on scale and forever trying to drive down costs. The focus on cost reduction is also leading to an exodus of talent.
From here the problems multiply. Despite statements like that from former Goldman Sachs Group Inc. Chief Executive Officer Lloyd Blankfein that “we are a technology firm,” the harsh reality is that most traditional financial firms are not actually very good at technology. Banks may spend vast amounts of money on “technology” and be competent in the actual engineering of – usually legacy – complex IT systems, but this is a very different thing to developing and successfully implementing genuinely new technologies. According to a study by consulting firm McKinsey & Co., 70% of digital transformation projects fail.
To really benefit from the implementation of new technologies such as artificial intelligence, traditional finance firms need to pursue a “digital first” strategy. But what does this mean? This is a complex subject and varies in different markets. For retail customers this can mean engaging with their banks through their smart devices to make the experience simple, intuitive and possibly even enjoyable. For institutional customers this can go beyond the bulk routing of orders but help with ESG reporting, investment analysis or complex hedging to match their specific needs.
There are various key themes behind this such as seamless interoperability between systems and platforms, enhanced customer experience and the ability to deliver customization all while doing it at low cost. Essential to this is the collection of data which must be rich enough so it can be used to drive more automation and customization. For example, past purchasing patterns or corporate earnings reports and statements can be analyzed and blended with other data to aid the development of value-added services.
This is hard for a highly regulated and rigid entity such as a bank. Operational structures are difficult to re-engineer. Corporate cultures tend to be resistant to change. Skill in sales or lending are not the same ones needed to run a digital centric firm. Australia’s Commonwealth Bank was still using magnetic tape to store key customer data as late as 2016. The data in these ancient systems is not particularly “rich” and requires significant wrangling to integrate into something useful. This is even more problematic when the bank is a product of numerous mergers and different legacy standards need to be navigated. All adding to time, cost and a reduction in value.
This makes recruiting the limited number of good technologists very hard. It’s not easy convincing them to work in the highly rigid structure of a traditional financial services firm, where the corporate culture is often hierarchical, cost focused and extremely cautious. Then there’s the need for talented generalists who know enough about finance, risk, data and tech to oversee and implement projects. These people are even rarer and often not appropriately empowered.
Given these challenges how have the traditional finance firms responded? Many have resorted to buying into so-called FinTechs in the hopes they can be bolted onto existing operations. But the grafting on of outside technology, almost as an afterthought, combined with the need to fundamentally alter operations to maximize the acquisition means many such deals are destined to fail.
Then there is the problem of what technologies or niches to back? Blockchain has been around for some time but still struggles to justify its existence. To a traditional banker the whole decentralized finance, or DeFi, space looks like a regulatory accident waiting to happen. What I suspect will happen is that many of these acquisitions will be written off, the acquired staff will leave and banks will continue seeing increasing competition in higher margin areas.
The alternative is to almost start over. In essence, build a new core banking platform inside the organization and then migrate the bank onto it. A good example is Lloyds Banking Group Plc’s partnership with Thought Machine. But this strategy still only addresses issues with core infrastructure and the final integration carries its own issues.
A key issue often overlooked is that banks are not particularly valued or liked by their customers and financial products are fast becoming unbundled. Younger generations often use aggregators, like Plaid. This means banks are getting an increasingly limited picture of their customers as the richest data accumulates elsewhere.
Hence, I suspect the biggest danger to banks is likely to come from some of the Big Tech firms. These companies do have the skills and scale in technology, and often have a much deeper relationship with their customers. They also have a real need to grow into new areas to justify their stock prices. We are beginning to see the first stirrings of this with Facebook Pay and Twitter Tips. More will follow.
For many banks, a fundamental rethink is required now before it’s too late.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ben Ashby is a Partner at Good Governance Capital. He was previously a Managing Director at JPMorgan Chase & Co.’s Chief Investment Office & Treasury.
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