Ernest Hemingway was known for his stories about a lost generation, bullfighting, and big game hunting, but one does not generally associate Hemingway with ideas of innovation and disruption. Yet, in his 1926 novel The Sun Also Rises, Hemingway creates an apt metaphor for the nature of innovative and disruptive change. When a character in the novel is asked “How did you go bankrupt?” he replies, “Two ways, gradually, and then suddenly”. How better to describe the process by which innovation and disruption can creep up on an industry or an organization, resulting in a sudden shift in the landscape.
Leading financial services firms are facing unprecedented pressures, from technologically savvy customers, from hard-pressed regulators to Washington DC politicians of all political spectrums, and from aggressive new market entrants. This wave of financial services innovation and disruption possesses serious potential to unsettle perhaps the most traditional and central industry in our economy. The American financial system is what Hamilton built. Today, longstanding incumbents – major banks, insurance companies, asset management firms – are under competitive siege.
In the context of this backdrop of change and convulsion, I recently participated in a day-long program, organized by The Economist, which focused on the challenges, as well as the opportunities, posed by innovation and disruption in the financial services industry. The program, “Finance Disrupted: Fin Tech Comes of Age”, highlighted the forces that are gradually reshaping the financial services industry today. How will the financial services industry, as we know it, evolve? What impact will change customer’ behavior, and generational shifts have on how financial services are delivered? How will regulatory demands and expectations limit or accelerate innovation and disruption? Who will emerge as the leaders in the industry over the next decade?
FinTech Threatens
The Economist program brought together more than 200 policymakers, senior business leaders, entrepreneurs, and leading thinkers, to share perspectives and debate issues arising out of technological and business innovation and its impact on incumbent financial institutions. The subtheme of the program was the emergence of Fin Tech firms as a potential threat to large financial incumbents, such as the “Big Four” retail banks – Citi, JP Morgan, Bank of America, and Wells Fargo. Representing the perspectives of the Fin Tech sector were executives including PayPal President and CEO Dan Schulman, Square CFO Sarah Friar, Lending Club CEO Scott Sanborn, and Kabbage Co-Founder Kathryn Petralia.
Fin Tech innovators shared their vision built upon an ambition to address unserved or under-served consumer markets, which have been characterized as the un-banked or under-banked, for which credit has not been readily available. According to the FDIC's 2013 National Survey of Unbanked and Underbanked Households, as many as 46% of Americans are unable to obtain credit on favorable terms from traditional banks and financial services providers. Lending Club, which claims to be the largest provider of personal loans in the market today, operates on the customer value proposition that “you could be paying less for credit”. Square is presenting a payment alternative by taking “principled risk". The emerging wave of Fin Tech firms aspires to make credit more accessible on better terms, improve the process by which payments are made, and to remake the financial services industry to be more inclusive.
Tech Giants Loom
There has been a flurry of ongoing speculation in recent months about the ambitions of the “Big Four” tech giants – Amazon, Apple, Facebook, and Google. Earlier this year, there had been media reports that Amazon was preparing to acquire Capital One Bank, itself an innovator in financial services. With market caps that dwarf those of the major banks, vast customer platforms, and gradual entrance into payments processing, what is preventing the tech giants from going all-in on providing full banking and financial services? This was the subject of a closing debate at the Economist program, on the topic of whether Fin Tech startups or the Tech Giants, posed the greatest threat to incumbent banks and financial services leaders.
In his recent book, The Four: The Hidden DNA of Amazon, Apple, Facebook, and Google, Scott Galloway, a Professor at NYU’s Stern School of Business, chronicles the ascendancy of “the Four Horsemen” – Amazon, Apple, Facebook, and Google, noting their rise in market capitalization by $1.3 trillion from 2013 to 2017, a sum equal to the GDP of Russia. The Economist panelists echoed the potential threat posed by the tech giants, due to their financial power, as well as their market position as trusted brands with established platforms that can offer an “interface, data, and trust advantage” to their constituencies. It was noted that 40% of the customers of the tech giants have stated that they want to have the ability to do their banking through these platforms.
Being the most highly capitalized firms in the world today doesn’t necessarily equate with becoming successfully operating banks however. As one panelist suggested, why would the tech giants want to jeopardize their dominant position across many industries, when the big banks do not pose any threat to them? Wouldn’t the tech giants face many potential barriers to direct entry into the financial services marketplace? For example, a high regulatory barrier presents obstacles and a potential roadblock for tech giants seeking entry into financial services. Among these regulatory obstacles are 50,000 pages of regulatory requirements, including the Patriot Act, CRA, EFT, as well as bank holding company limits.
While many customers express a yearning for an Amazon/Google-like financial service customer experience, observers note that the large tech firms are already in financial services, providing payment and other financial services without the potential handcuffs of becoming banks. There was a frequent refrain. Why should the tech giants go any further when they are not likely to relish the financial hit that comes with becoming low market cap banks? As one panelist remarked, “who in their right mind would want to get into banking or financial services today”.
Ultimately, it was argued, that the large tech firms lack the required expertise in the intricacies of banking and financial services. These are firms that, by their actions, have shown themselves to be highly averse to regulation. The recent news about Facebook confirms this point of regulatory aversion. Wouldn’t the tech giants face the potential of strong anti-trust backlash if they entered banking? It is the view of many in the industry that the tech giants just don’t need the headaches, and simply don’t have the stomach to enter banking.
Incumbents Innovate
While leading banks and financial services firms face the threat of competitors in an industry that is rapidly becoming a battleground between traditional incumbents and fast-moving innovators, the incumbents do not intend to stand still. Drivers of the changing financial services marketplace include behavioral changes, technological changes, and a proliferation of data. Clients want and demand innovation. In response, incumbent banks are appointing executives who can make them innovative and entrepreneurial, and join in re-architecting financial services approaches. These innovation executives are striving to make large banks innovative and entrepreneurial. Citi Chief Innovation Officer Vanessa Colella pointed out that when new entrants come into the marketplace everyone benefits, noting “the whole frontier moves” for both innovators and incumbents.
And while innovation can represent a challenge for a 200-year-old firm like Citi, it should be remembered that firms like Citi, Bank of America, JP Morgan, and Wells Fargo were born out of innovation and continue to innovate in selected areas each and every day. A great example is Charles Schwab. Schwab President and CEO Walt Bettinger shared his perspectives on innovation in an interview on the “Future of Finance” at the Economist program. Bettinger noted that “successful firms disrupt themselves”, making the case that Charles Schwab is still disrupting the financial services brokerage market, a generation after its founding in 1971.
Bettinger believes that today’s customers expect a “no trade-offs world”. He noted the difficulty in building a trust-based brand, where trust is developed based on actions, not what you say. Bettinger is skeptical when it comes to speculation about the entry into financial services of tech firms like Amazon or Google, echoing the observation that the tech giants operate in lightly regulated industries in contrast to large banks and asset management firms which operate in highly regulated industries. Do these firms really want to invite the Federal Reserve and other regulators in their door? Noting that at the end of the day, any financial services firm must be in the business of giving consumers better outcomes, Bettinger concluded that “you need to have courage and will” to disrupt yourself, or to accomplish anything.
Lessons Learned
Perhaps the last word on the subject goes to curmudgeonly 86-year old regulatory legend Arthur Levitt, who was the longest-serving chairman of the Securities and Exchange Commission, holding that position from 1993-2001. Levitt appeared on the opening panel of the program, but his comments seemed to resonate long after the day was done. Going against the grain, Levitt summed up the Fin Tech entrants, dismissively remarking that “Fin Tech entrepreneurs march to their own rules”. The incumbents, he noted by way of contrast, provide assurance, safety, and security. Levitt continued, warning that “aggressiveness is the backwash of innovation”. Ouch. Levitt further cautioned against the Silicon Valley “fail fast” paradigm in a highly-regulated industry like financial services where safety is an imperative. We saw that playbook and its result on Wall Street in 2008-2009. Levitt concluded ruefully, “regulators have never kept up with business development”. How true. Buckle up.
Randy Bean is an industry thought-leader and author, and CEO of NewVantage Partners, a strategic advisory and management consulting firm which he founded in 2001. He is a contributor to Forbes, Harvard Business Review, MIT Sloan Management Review, and The Wall Street Journal. You can follow him at @RandyBeanNVP.
