If you don’t drive your business, you will be driven out of business” (B.C. Forbes)

Dear Reader,

In this sixth  edition of Dialogue, emphasis is on innovation in the Financial Services industry.  Since the financial crisis, banks have deleveraged their balance sheet and in some cases had to off-load businesses to deal with the consequences of the crisis. They are gradually complying with the tsunami of new regulations, not only in terms of more European oversight but also in terms of additional capital and new liquidity requirements. As a result, profit levels have dropped to levels where acquisition of additional capital is becoming a big challenge unless going forward profit levels  can be restored to levels needed to be able to access the capital markets. As Jamie Dimon, CEO and Chairman of JPMorgan said among other things in his letter to the shareholders: ”While the banking system is safer than ever before, it does not mean that there are no challenges ahead and that these new regulations have not created new risks”. He even warned that the next crisis (and it will come, he claimed) will not be caused by the banks. He said that because of these too rigid rules: the next crisis might even be more severe with even greater volatility impact on the markets than experienced so far. While it is crucial that the efficiency and effectiveness and even more importantly the undesired effects of these regulations be assessed and if needed corrected, it should also be acknowledged that banks have still major strategic work ahead of them particularly in assessing the business model they need to face the new challenges.

The CEPS Banking Business Model Monitor 2014 has classified banks in the following clusters: investment banks, wholesale banks, focused retail banks and diversified retail banks. Contrasting the banking data pre-crisis and data post-crisis, the Monitor shows that 90% of the banks have not changed their business model. However in the group of banks having received public capital support, two/third have changed their business model to the greatest benefit of the cluster of focused retail banks. But that is of course because these banks were forced by the authorities to restructure their business and refocus on their domestic market. Choosing a sustainable competitive business model goes of course beyond the four clusters mentioned above. Besides the type of bank you want to be, it is at least as important to identify which corporate and/or retail customer segment you want to serve, which services/products you want to offer to your chosen client segment. It is particularly in the latter where banks still have a lot of work ahead of them. Banks are increasingly realising that innovation from within the bank is not likely to lead to greater competitiveness. The banks’ traditional risk management processes and project governance structures were designed when their services needed to be automated or made more real-time but are totally ineffective for innovation killing even whatever great idea that may have surfaced internally before it could become a service.

In the meantime consumer behaviour has changed and the world is becoming digital. The banks as a result are facing increased competition not only from “Fintech” start-up’s focusing on a variety of financial technology services such as payments, lending, personal finance, equity finance and so forth but also from digital giants such as Google, Apple, Facebook who enter the financial services market by focusing on some components of the financial service chain leveraging the insights they have in their enormous client base without risking to be subject to regulations banks have to comply with. The article of Bjorn Cumps “Why does Goliath partner with David?” segments this new financial services landscape and discusses how banks may have opportunities to partner and to collaborate with these new competitors.  

Venture Capital investment in FinTech companies has exploded the last few years reaching $12 Billion worldwide showing the degree of opportunities for innovation in the financial services industry. Most innovation so far has occurred in mobile payments and cash transfers. The interview with Joachim Goyvaerts discussing PayPal’s view on payments, gives insights on how a start-up could take advantage of new regulation with the objective to foster a seamless European market as if it is a domestic market, of new technologies and of consumer behaviour changes.  It is also interesting how PayPal to become successful had to become a trusted partner for its consumers. Something banks are often claiming is one of their distinct competitive advantages. The interview with Heidi Rakels discussing Guardsquare  the world’s leading provider of optimization and obfuscation software is a great example of a successful software development strategy by using the experience of users to continuously upgrade a product to achieve a stable, robust and reliable product. This article touches upon one of the reasons cited in Bjorn’s article why banks have so far not been successful in innovation. The mismatch in skill set and the need for an innovative entrepreneurial culture in banks something which is almost contrary to the financial services industry  DNA.

Banks now realise that to take advantage of the innovation wave, they will have to look externally. We see innovation centres being set up in banks with the mission to better understand and learn from the external world,  assess to what extent they should partner or collaborate with interesting initiatives outside and even in some cases are prepared to invest in FinTech venture capital funds. As Johan Kestens states in the article “A Bankers’ View on FinTech”, the focus of banks on the FinTech market should not be what they are doing to the bank but what the bank wants to do with them. Whatever the bank does with them, it should be relevant for the bank’s clients. Indeed banks can learn from the healthcare business. While the healthcare has traditionally been successful in innovating from within, sole reliance on that source of innovation is not sufficient anymore. Given the high degree of investment in research, the time it takes to bring research to a final product and the difficulty to predict success, the healthcare sector realised that they had to take advantage of external innovation. Now they are very open to use whatever relevant mean to take advantage of these opportunities through acquisitions, partnerships and collaboration or even simply use their market knowledge to help these companies to develop their products. A fundamental motivation behind all of that is to better understand the external market. 

It is good to see that banks are taking initiatives to better assess what is relevant for them. The question however that can be asked is whether banks are doing enough upfront to question their business model. You see banks sometimes partnering with several initiatives in the same domain with the prime reason to maximise their chances to catch the successful wave. Some banks spend time and money in following-up and investing in start-up’s but at least from the outside not always with a clear purpose in mind. It is of course important to develop a better understanding of how these FinTech companies and digital giants can influence the banks’ business. However to maximise chances of success for a bank, it is of prime importance to redefine first their business model with a focus which client segments and services can give them a sustainable long term competitive advantage taking into account not only their own strengths but also the new business environment. This is not a small challenge given that many banks had to retract to their domestic market while consumers have become even more international and cross-border. Clarity on their business model going forward will put banks in a much better position to make the right choices. Insurance companies will have to face sooner or later (but rather sooner) similar external threats and opportunities as the banks do now and should also learn from other sectors how to readjust to a rapidly changing world.

We would appreciate receiving feedback and views.  We plan to have the next Dialogue edition to focus even more on the business models of the banks and insurance companies, and if you want to make a contribution, please let us know. In case you have new ideas for other topics you may find interesting, your suggestions are also always welcome.  

Ignace Combes
Chairman Centre for Financial Services (Vlerick Business School)

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