For the last five to ten years, innovations in Financial Services industry have been accelerating. However, the innovations were not triggered by traditional banks but new market entrants: Fintech start-ups aiming to improve customer experience in some specific product or service area, challengers from other industries, like retailers aiming to leverage their existing processes to improve delivery of financial services or big-tech companies aiming to complement and improve their existing business and related customer experience. Finally, there are also fully digital challenger banks aiming to simplify banking and make it more customer-centric. Thus, disruptive innovations have dominated the industry while traditional players have not been able to respond with sustaining innovations – at least not until recently. In order to keeping up with the challengers, incumbent banks must change their mind-set and attitude towards risk-taking. Adopting decision-making processes familiar from Venture Capitalists along the new agile ways of working will ensure the pace of innovations and also sufficient risk mitigation.
Why banks are challenged in the first place?
A digital tsunami has avalanched over industries transforming the ways how we consume products and services. That has set consumers’ expectations regarding customer experience on a new level. For long, traditional banks were not able to respond to the new requirements set by their customers, leaving the door open for new players to enter the market.
Also, in some markets banks were – and still are – doing extremely well. For example, in Scandinavia banks and other financial institutions are in a good shape, and opportunity to steal a piece of oversized profits naturally attracts disruptors. A good example is Klarna, who has announced that they are aiming to cut the prices in half related to payments and in that way steadily grow their market share. And looking at Klarna today, it seems that they haven’t totally failed.
On the other hand, in the markets where banks are not doing that well and are perhaps still suffering from the previous financial crisis, customers may have lost their trust on many traditional players. An example of this is UK, which is currently the most active market of new digital challenger banks.
Hence, there are several avenues for disruptive innovations to challenge the status quo of Financial Services industry. In Europe this is also boosted by regulative initiatives like PSD2 and MiFID II aiming to increase transparency, competition and innovation in the financial services’ markets.
Banks have left several doors open for new innovative challengers to enter the market
Why has it taken so long from banks to react?
Bankers are not reluctant to innovations. In fact, about 15 years ago bankers were really innovative in introducing new financial instruments like mortgage backed securities (MBSs) and collateralized debt obligations (CDOs). The aim was to mitigate credit risks by dividing and distributing the risks between several parties. The problem was that the instruments became extremely complex, making it eventually really difficult to understand the underlying overall risk levels. At the same time bankers, especially in the US, were innovating new distribution channels relying on independent sales organizations and sometimes even individual persons as the mortgage brokers boosting the asset base of the new securitized instruments. These innovations were key factors leading eventually to the financial crisis in 2008.
Due to the nature of financial services (dealing with money) and especially the learnings from the financial crisis, traditional bankers tend to be highly risk-aversive. And high risk-averseness usually doesn’t go well hand in hand with innovations. Risk-averse managers typically demand a large amount of evidence before being able to make decisions, which leads to delayed actions and a risk of falling behind the progress in fast-moving disruptive environments. In addition, traditional banks are large and highly hierarchical organizations with high levels of politics and internal focus potentially hindering further the rapid decision making required to drive innovations successfully forward. This kind of cultural legacy and “old-school behavior” may perhaps be the biggest hurdle for traditional banks to drive innovations required to respond to the disruption.
How to catch up then?
In order to make bankers innovative again banks can investigate learnings from other industries. One key element of successful innovations is customer-centricity. The mistake related to pre-crisis innovations was that bankers created even more complicated products on top of already originally complicated financial services. Modern innovations tend to move to an opposite direction: simplifying financial services making them more understandable and easier to consume. Innovations are aiming to solve the real problems a bank’s customers have and finding ways how to monetize the value created for the customers. Innovations do not limit only on products and services but cover also new business models and new ways to create value for the bank.
When innovating in an uncertain environment under disruption the banks need to adopt new agile ways of working. The key problem related to high risk-averseness is the delayed start due to the high demand of information prior to the first go-decision. One key principle of agile ways of working for managers and leaders is to admit that there are numerous uncertainties which cannot be known in the early stage of innovations but need to be learned along the way as work goes on.
In fact, an innovation funnel and aligned funding is the best way to mitigate risks related to investments in innovations: Instead of high up-front investments based on vague analyses trying to model out all potential outcomes and scenarios under high uncertainty, the investment decisions are spread along the different phases of the innovation life-cycle replicating the models which venture capitalists typically apply.
Exhibit: Example of funding criteria in different stages for internal innovation ventures
Catching up innovative forerunners, banks – like any other companies – need to adopt a new type of leadership. Banks need leaders who are prepared to take risks and are brave enough to make decisions that enable innovations on a continuous basis. The leader must be adaptive and have the stomach for failures. The leaders must also be able to stand lower level of control and empower teams to innovate autonomously and let the teams decide what’s best for them in terms of how they work in order to achieve mutual goals. This is even more emphasized when Banking and Financial Services are moving more and more towards ecosystems where innovations, business logic and value creation is based on collaboration between multiple ecosystem partners.
Aligning autonomous innovation teams with strategy requires strong leaders with great ability to show the direction. However, successful innovations require also new skills from banks’ entire personnel. Driving innovations on team level requires strong ownership and entrepreneurial attitude within the teams. The teams must have sufficient multi-disciplinary skills and each team member must have responsibility and commitment to achieve common business goals. In banks with traditionally complex and hierarchical organizations this may require a major shift in mindsets of the entire personnel.
Successful business needs innovations and success in innovations requires both new leadership philosophy and new ways of working. Success requires guts to take risks and tolerate failures
Can risk management be turned to a competitive advantage?
Traditional banks have been challenged by innovative new entrants. But banks are fighting back and currently going through a massive transformation into modern companies of the digital age. Innovations are needed in order to establish a differentiated offering in the markets and to outperform competition. That’s why strengthening the link between strategy and business operations is a vital component of sustainable competitive advantage as it enables building a culture conductive to innovation.
Successful business needs innovations and success in innovations requires both new leadership philosophy and new ways of working. Leadership must be based on visionary guidance and trust. The ways of working with innovations must be based on agility and strong ownership. Success requires guts to take risks and tolerate failures.
Due to the fact that Banking and Financial Services is dealing with money, risks related to fraud, misuse, counterparties and asset value volatility will always be present and must not be neglected. Traditional banks master risk management, but banks must be cautious to not let risk-averseness hinder their innovativeness. Harnessing new agile ways of working to manage risks related to innovations, and leveraging banks’ traditionally strong knowledge on industry risks may provide banks with a key competitive advantage to outperform the challengers.
Sources of inspiration
- Linda Holbeche (2015), The Agile Organization: How to Build an Engaged, Innovative and Resilient Business.
- Eric Ries (2011), The Lean Startup.
- Max Knuts (2017), Measuring the progress of internal corporate ventures within a corporate accelerator: Developing a measurement system
- Numerous discussions with industry experts and clients
This is the first part of our blog series on innovations in large corporations. To read our introduction to this blog series, click here. In the next blog post of this series we’ll shed some light on how you can innovate your innovation portfolio. Stay tuned for our next post!
Author
Jani Ristimäki, Manager, BearingPoint Digital & Strategy