Chris Wasden makes a scathing commentary on the intransigent posture of banks as to innovation. He admonishes that unless banks keep up with the pace of innovation of a new entrant whose value proposition is several times of a higher-order magnitude than theirs, innovators can make dinosaurs of the banking industry.
Here is the transcript of the video
Emmanuel Daniel (ED): I’m pleased to be able to speak today with Chris Wasden, a professor of innovation at the Entrepreneurship and Strategy Department, University of Utah. This conversation is very important because we want to wrap our minds around what banks really know about innovation, how they should see this journey from where they are today, and where they need to go.
There’s this whole dimension of fintech that is threatening to disintermediate the banking industry. At the same time there’s this desire by the incumbent industry to wrap the innovations that are taking place today around what actually already exists in that regard. So the first question I have for you is: What do you think banks think about innovation? And what should it mean to financial services?
Chris Wasden (CW): Innovation is a very popular word, and if you look at Google trends on the use of the word “innovation” over time, you see this exponential curve because everyone wants to use it and associate it with their brand so that their brand comes out as innovative. The reality is, saying innovation doesn’t make you innovative, and banks are notoriously not innovative. So this is the fundamental problem: Is it crazy for a bank to be an innovator?
If we look at their track record, banks are really not innovators, and they’re afraid of innovation. But now consumers are saying, “Amazon can move an atom from their warehouse to my home in hours and a bank can’t clear an electron in two days? What gives? Why can’t I have the same experience in banking that I have in every other aspect of my life?”
Now, consumers vote, and so what happens is this consumer desire to have digital experiences in finance like they have in every aspect of their life then gets to the elected representatives, which then gets to regulators, and so we actually have this happy coincidence that regulators now are starting to drive innovation in banking faster than bankers want to accept it. And this is a great thing because again banks wouldn’t be innovating without this pressure.
Five years ago at Sibos the idea that fintech was going to disrupt and revolutionize banking was ridiculed as crazy. Two years ago fintech was actually violently opposed: this is crazy, we can’t allow this, we have got to have regulators step in, we have got to have some sort of brakes put on this. 23-year old kids who came from Silicon Valley or some other part of the world didn’t know anything about banking, who didn’t know that banking was a “serious business” and has to be done in “serious ways”, were dismissed as completely “not serious.” It’s interesting that this year fintech is accepted as conventional wisdom: Of course, we have to do all these things; of course we have to partner with these fintech companies; of course, we have to be more innovative.
This is the normal march of truth: that things are ridiculed, violently opposed, and then finally adopted as the accepted wisdom. So I think we’re at this point where everyone realizes that fintech is the truth. It is reality. It is the way the world’s got to go. But not because banks or financial services are leading in the innovation race; they’re actually lagging.
All that banks are saying is, let’s take an Amazon, Google, Twitter, or Apple experience and let’s put it in the context of financial services. All that banks are doing is copying.
Now some would argue maybe this isn’t innovation at all, because you’re just copying what other innovators have done. But my argument is anytime you take something new that creates value, and apply it in a new context, that’s innovation within that context and that’s fine. So I think that’s kind of where we’ve been, where we are, where we’re going in the reality of innovation.
ED: What banks need to see is all that innovation becoming a reality in their balance sheet. It’s one thing to say, yes, we need to do all these nice things, that’s where the customers are, but it’s a different thing to look at your own balance sheet and say, oh at the end of the day we’re a corporate bank, we’ve got five very important depositors, and the rest of them don’t matter. Or, we’ve got this huge loan book and we’ve got 10 very important corporate clients and the rest of the world doesn’t matter. So the reality of where they are and what they think they need to be, that’s still a bridge to be crossed. Therefore in this march to truth as you explain, what is the next phrase? Where is the connection?
CW: All right, so regarding the pressure that’s creating pain for the banks, that starts from the consumer perspective, the consumer desire, which in turn drives the activities of the bank customers—the corporates and commercial customers—and then that pressure on the customers puts pressure on the banks. Banks couldn’t care less about consumers whom they charge $15 for a wire transfer that they only pay $.50 to complete. Swift is not the cost in the system, Swift is almost free in the system. The cost is what the banks are charging the consumer for a bloated legacy infrastructure that’s not needed anymore.
And banks are not going to eliminate that bloated legacy infrastructure unless there is some pressure on the system. That pressure comes from the fintechs, and increasingly from their own customers who are saying, “Look I need to have more rapid, transparent, cost-effective, and efficient processing of payments and I want to have it instantaneously. I want to have it ubiquitously.” This means that a customer only needs to have a cell phone number or an email account and they can transfer money. And that’s where we start to see pressure.
Concurrent with that though, if you look what’s going on in the United Kingdom and the United States with the Fed; when you look at what Australia’s doing with real-time payments, you’re starting to see regulators step in and say, “No, we’re going to impose the pressure too.” So there’s a bit of a pincher movement now where banks are getting pressure from their customers because those customers are getting pressure from consumers; and then banks additionally get pressure from regulators who are getting pressure from consumers through the ballot box. Those two things are forcing banks now to innovate.
ED: Two things in what you have described struck me. One is the reason banks charge $15 for a $.50 transaction is because salaries within banks are ridiculous. Bankers are probably the highest paid in any country outside of lawyers and brain surgeons, and completely out of whack with the skills required. Banks are bloated also in terms of number of employees. Banks take on staff that they don’t need.
What would a typical bank organizational structure look like when it’s an innovative business?
CW: Let’s compare and contrast the issuance of consumer credit first. For a traditional bank to issue consumer credit, it gathers hundreds of data points about the customer over the course of perhaps a week, and then takes another week or two to make a credit decision before finally giving the credit. That’s a very cost-ineffective way to do it because there’s many people involved in collecting the paper, photocopying the paper, creating digital versions of the paper, forwarding it on, decision making, etc.
How does a fintech company make that same decision? They gather 20,000 data points about you, the customer, mostly from public sources. They get access to your cell phones. They can actually see who you’re texting, at what time of the day, who you’re calling, what sort of apps you use. They gather 20,000 data points in a matter of seconds and they make a credit decision in a matter of seconds. We’re not talking about variations on the same theme. They’re radically different: where one process takes weeks and involves dozens of people, one process takes seconds and includes almost nobody. It’s completely automated. Banks are never going to adopt an innovative way to allocate credit, to make payments, to do anything by making their current system more efficient. They have to blow up their current system.
Now, when you say that to banks, they’ll say, we can’t blow up the current system, the current system has to have five lines of reliability, it’s got to follow these certain established protocols and whatnot. But the reality is there is no way they will be able take down a system that takes weeks to make a decision and gathers a couple of data points—which by the way are not as accurate in predicting credit outcomes as gathering 20,000 data points that a fintech company does. Banks have to run a parallel system, but they have to keep the current system running as they build the new system. Yet the new system will not be built by modifying the current system, since the new system will have almost no human labor costs in it. It will be automated.
ED: And as they try to make that journey to building a new system, what they find is a bloated employee base made up of very ordinary people who look for very defined processes. And the reason the banks can’t give up their traditional credit scoring model, for example, is because (i) it seems to work, (ii) they seem to understand it, and (iii) everybody uses it.
Given the automated, multiple data point infrastructure you’re talking about where employers can check on staff and potential employees by looking at their Facebook accounts rather than their references (which probably doesn’t tell you anything anyway), given that the culture of looking at what is out there in social media is only just starting, where have you seen an industry that has made that switch, and what are the triggers that help them make that switch?
CW: We live in a market economy. The only thing that changes people’s behavior is failure and pain, and tension within the system. And if there’s no tension in the system between the current state and the future state nobody changes. It’s just the way we’re wired, it’s the way we are. And so any industry that’s made this sort of change is because they have harnessed that tension in such a way that they drive creativity and innovation to come up with the new model. I think probably the best industry to look at is the telco industry and the handset manufactures.
I don’t think there’s another industry in the world that innovates as rapidly as that. Look at the innovation and the radical transformation that smartphones have made. The iPhone is not even 10 years old. Okay, we’re on version seven of the iPhone and it’s not even 10 years old. So these companies have a pace of innovation, which is every 12 months, they come out with the next new thing and everyone has to keep up.
Now we saw just a few years ago two companies that had over 50% market share in this market, RIM and Nokia, basically go bankrupt. Nokia was bought by Microsoft before it went bankrupt and then within 12 months, Microsoft completely wrote off the entire investment in the company. RIM is still struggling and just announced they’re going to have android phones because their current system does not work. So you look at that industry, and everything that has been going on with regard to smartphone innovation, new platforms, operating systems, etc., these were completely foreseeable, it wasn’t as though they came out of nowhere. But these companies had legacy infrastructure and were unable and unwilling to make any of the changes necessary. The chief operating officer of RIM in fact ridiculed the Apple phone as being completely ridiculous: “You don’t need any of its capabilities ’cause after all an RIM phone had apps, an RIM phone would give you access to the Internet.”
But did you ever use those apps? Did you ever access the Internet on an RIM phone? It was an awful experience. But again they lived in this fantasy land that they did everything that needed to be done and no one needed innovation beyond what they were doing. And within just a couple of years they were dead.
Banking is a highly regulated industry. Regulators have let banks like Lehman go down, but they claim they’ll never do that again. But what is happening is as these fintech entrants come in, they’re not trying to compete with banks in these highly inefficient legacy systems per se. They’re cherry picking and identifying the most profitable businesses that banks are doing a terrible job at. We’re going to do FX. We’re going to do some of these money transfers across borders. We’re going to go after that stuff and take that away, and by the way, we can do this at a 90% lower cost than the banks can do it. Let’s see them try to compete.
ED: Right, and it is a 90% lower cost. How many bank innovation labs have you visited and what’s your general sense of where it’s all going, the things that banks try to bring in-house?
CW: I’ve visited several. The challenges with these innovation labs are several. One, the life cycle of innovation. The first thing that has to be done is discover an opportunity to innovate—solve a problem with an innovation. Two, incubation. After you discover, you have to incubate or remove technical risk. To do this you build a prototype, test the prototype, do a pilot.
The problem is that incubation should end with some sort of commercial launch in the first business model for that innovation. Banks are not good at that. They don’t want to launch something that’s going to fail. And the reality is almost every single first business model of every innovation fails! Google’s first business model failed. It wasn’t a paid search. It was a traditional business model of licensing software on a license and maintenance program, and all the portals at the time turned them down, and so they went to paid search because their first business model failed.
Three, acceleration. Acceleration is all about iterating successive business models to figure out which one is the best business model. After you do that, you move into scaling.
Now there’s a chasm between discovery and scaling, and banks cannot cross that chasm. They can’t go from discovery to incubation, to acceleration then scaling. What most of the innovation labs are doing are what we might consider incubation—they’re building and testing prototypes.
Banks may be doing a small pilot, generally not very commercially oriented, but they’re not bringing anything to scaling. They’re not really bringing them to market. I think that’s the biggest problem and it’s because banks are so risk-averse. They’re so afraid of failure. But you’ve got to fail to be able to learn! If you don’t fail, you don’t learn, and you don’t iterate, and you don’t improve.
ED: If I can just ask you, you know, categories of innovation and which ones are more likely to revolutionize financial services as we know them today, which would they be? Data analytics, biometrics, payments, or what America is talking about, robotizing the advisory business? The latter to me sounds a bit farfetched. It’s probably three or four iterations away before it actually makes sense but, you know, somebody is going to invest in that sooner or later. How would you categorize the major innovation classes and which ones are further ahead than others?
CW: There’s a debate right now on block chain, whether the best place to apply it first is in payments or in contracting areas, and a lot of the focus has been on payments. Block chain is actually interesting because of the impact is has on distributed ledgers and things like that. So there’s a debate because payments is where the volumes are, it’s the big market. But the reality of almost every single innovation that I’m aware of is that they never directly enter the big market they’re going to eventually conquer. This is part of the message of Clayton Christensen with his innovator’s dilemma. Almost every innovation comes in through a small niche market that is currently being poorly served and has huge pain points and huge gaps in inefficiency. The innovation gets traction there, it improves there, and then eventually it makes it to the mass market. Innovation doesn’t start with the mass market.
A lot of people believe that payments is actually not the best first place for a block chain system to start to really take over payments. The best place is contracting. Why? Because you’ve got huge inefficiencies there with lawyers and other administrative people creating new contracts all the time and going through a very efficient process. Why can’t we turn contracts into API’s? Why can’t we turn contracts into block chains? Why can’t we eliminate 90% of all of the costs—labor costs—of contracting through these technologies and there it will actually get massive adoption because the waste is so great. And then we can turn our attention to processing payments and things like that afterward.
So what we’ve got to figure out is where do we start because the pain points are so acute that people are going to run to this solution since it eliminates tremendous amounts of waste.
ED: At the same time, even if it’s just talk about these as concepts, as technology is there, some of these developments are profound, like block chain with its marvelous algorithms that will literally carry so much information so quickly and distribute it and make it available all the time. That in itself, is an accomplishment that many bankers don’t appreciate, and we need something of that magnitude to simplify and make something readily available in banking.
Regarding contracting, trade documentation is still “trade documented”, or documented credit as it is called. When you buy or float a bond in almost every country in the world, it is still done by solicitors. In that regard, give me a sense of the different places on the table at the moment—block chain, bigger analytics, biometrics, any other elements?
CW: When we talk about digital innovation, we tend to bundle them into the four technologies: social, mobile, analytic, and cloud (SMAC). We don’t really view analytics as separate entities. When you look at a credit decision being made by a fintech company that collects 20,000 data points, they’re collecting 20,000 data points mostly from a mobile device. They’re doing analytics on 20,000 data points to come up with new insights. All the information resides in the cloud and oftentimes it’s data gathered through social means. So they’re actually doing all four of those things to apply it to credit.
The same can be applied not just to consumer credit but to small business, medium-size business, corporate business credit, etc. For example, Amazon sells 800 digital cameras on their website and another 10,000 digital cameras that other people sell. So Amazon has become a platform for commerce and as such now gathers tons of information about millions of companies and millions of consumers about what they buy and how they buy it. So when you get access to Amazon’s data, all of a sudden you can now make better credit decisions through that social medium.
So if we take every single aspect of finance and look at SMAC, we can see how we could apply it in credit, payments, essentially how we take those four digital technologies and apply them in every use case in the industry.
ED: As to picking winners and losers, are we picking winners and losers flippantly and not conceptualizing what we need to be looking at? When you look at the models, there’s an overemphasis on China because of its size. But when you look at what actually happens on the ground, China may be the world’s largest market but it is a closed market and the population is a captive audience. I have this feeling that we actually leap from one falsehood to the next when we talk about the “next big thing.” So in a closed market where bank rates are actually determined, a non-vendor can enter into that market and get a rate that’s 4% more than what banks offer. That’s a no brainer. It’s not the technology that makes the moms and pops invest, it’s the fact that you get 4% more.
CW: Yes, I think there’s a couple of things we need to look at. For example, my wife and I were walking through Singapore and she was amazed at how clean the subway stations are. We have lived in New York for 16 years and the subway stations there are dirty, messy, they’re not air conditioned. They smell bad. But the point that I made to my wife is that the subway systems in New York City are a hundred years old and a hundred years ago, they were state of the art. So you’ve got this infrastructure, this legacy that now is a hundred years old. But to rip that out is so prohibitive, costly, and if you look at the incremental gain of having a Singapore or a Beijing subway system in New York City versus what it has today, the incremental value is not that great.
It’s the same thing with the banking system. The US or the west has banking systems that are not a hundred years old, they’re hundreds of years old in terms of infrastructure and basic function of the bank. There is no desire in China to recreate western banking in China. China wants to leap frog and come up with a more efficient delivery system for financial services, and it’s going to be on the back of technology.
Now let’s compare and contrast India with China. In India, the number one search engine is Google, the number one social media platform is Facebook, and the number one micro blogging site is Twitter. If you go to China, the number one search engine is not Google, the number one social media is not Facebook. What you have is local—Alibaba, Baidu, WeChat. They’re the ones that dominate. Because of that, you also have them becoming the technology platforms for distributing other services, including financial services. So when you pull up your WeChat app, you’ve got your credit card there. You can do peer-to-peer payments. You can order a cab and pay for it. You can pay for other sorts of things, as well as do your social media communication. So it becomes a platform that people are using a dozen or more times a day for transactions and for other activities that they’re doing.
With Alibaba, it has the platform for commerce—just like Amazon in many other countries—and so as that platform for commerce, it is also the platform for credit. Because they have these platforms that are connected, let’s put this in the context, right, platform players in technology have hundreds of millions of customers.
Take Amazon, Facebook, Apple, and look at JPMorgan with 25 million, which of these digital companies are digital from birth? They didn’t start analog and become digital. They’re native digitals! They have platforms that are multiples larger than the largest financial service company. They have data that’s exponentially greater than these banks have. They have a model of innovation that is same-day or same-week innovation, not a year-long innovation program. And they also are in an environment where people are more accepting of rapid change in innovation and some failures with tech innovation, which we are not accepting in other parts of the world. So the reason we focus on China so much is that China has huge pain points to create financial inclusion.
India does too, but China has local innovators who have created massive platforms that are the vehicle for delivering financial inclusion and unfortunately, Google’s doing hardly anything in finance. Amazon is now. Twitter’s not doing anything in finance and so India’s hobbled by US technology that’s not very innovative when it comes to finance. So who are the innovators if you look at who’s getting the new banking licenses in India. It’s Vodafone. It’s Indian tech companies. It’s not the big tech companies because they’re stuck with, unfortunately, US big tech companies that are not innovating finance.
ED: What you say is very interesting except that in China the way in which some of these innovators are coming into the market—and maybe we shouldn’t fault them for it—is somewhat through the back door. Alibaba got its banking license despite the rules being against that. In fact, I talked to the regulators at a personal level and even among regulators they scratched their head and said: “How did that happen?” And I get questions like, “How do we structure a license for a payments only bank?” And there are different models to do that. So there is no second AliPay in China right now…
CW: Well, there’s no second Amazon in the United States either. So part of this is Metcalfe’s laws of network effect. And part of it has to do with just good business strategy. As Amazon says, I’m not going to compete with every sort of online retailer, I’m going to provide them the rails to be online retailers at the lowest cost possible because they’re going to benefit from my economies of scale. And so what we see with Alibaba is network economics at play, which we see in all digital technologies.
So I don’t think so much about whether it can or can’t be done by somebody else, for when you have an installed base of hundreds of millions of customers it’s difficult for a number to just come in unless their value proposition is so much better than yours. That’s why we saw RIM and Nokia, which are digital companies, fail, because they didn’t keep up with the pace of innovation of a new entrant whose value proposition was several times of a higher-order magnitude than theirs.
ED: This is a very interesting and important conversation. To capture the essence and help banks build their own road maps, what is the kind of mental road map that you have and milestones that you like to see finance to go through, the same way telcos went through their own evolution from state-owned infrastructures to what they are today.
CW: But what are they today? Telcos are dumb pipes. Telcos tried to get in the app business, they failed. They tried to control the handset business, they failed. So telcos—I’m thankful they provide dumb pipes because without dumb pipes we couldn’t connect—at the end of the day telcos tried to be more innovate. They’ve had innovation groups. They had their own incubators. They had their foundries, as AT&T got its digital foundries and whatnot, but when they tried to get into banking, complete disaster. They had this consortium effort.
As an industry, telcos came together and created “ISIS”, and then when the Islamic State of Iraq and Syria emerged in the Middle East, they had to change it to Softcard. Then what happened to it? It was sold to Google. So telcos have tried to be innovative, but their every single effort has failed in every single industry. They’re not innovative companies. They’re dumb pipes. When you look at the banking industry I think the question we have ask ourselves, are banks merely going to follow the path of telcos and become dumb pipes?
ED: And if it is, and if that’s the conclusion we come to, should a good CEO of a good bank who is thinking 10, 12, 30 years ahead, say to himself, “You know what, this is where we’re heading, in the general direction of dumb pipes—playing the game instead of reinventing; pretending we can take on a proprietary approach everybody else becomes dependent on in payments, in wealth management”? Or should the CEO say, “Let’s collaborate openly”? Is there a wise way to build the bank of the future this way?
CW: One option is, banks could follow an Amazon model, which is a combination of dumb pipes, and banks provide the basic plumbing for millions of online commerce organizations around the world, but they also provide their own store. But could banks actually provide the dumb pipes for millions of different types of transactions; have their own branded experience, which is a great experience; and then leverage that with their customers they’re providing the dumb pipes to?
A second option is just follow the telco model, where, rather than waste all that money and time just say: We’re here to enable these types of transactions. You can use our rails to do it and you can put the front end on. You can own the customer. We’re not worried about owning the customer, and you can also own the back end and different parts, but we provide all of the back end infrastructure for it. That would be a much more efficient model.
I think that the challenge for all of these is, first, the ego in the banking industry. We see something as simple as KYC, where banks do not want to collaborate, come up with a single standard, and put it in the form of an API and share it with everybody. Everyone thinks they can create a proprietary infrastructure, documentation management, and all the risk management systems and whatnot, when there’s really no value in almost all of these proprietary infrastructure projects. Yet banks persist in doing them.
I mentioned this to some bankers the other day and they said: “Oh we’re getting away from that. We’re doing less and less of it.” But you talk to people in the bowels of the organization, you don’t see that big of a change. There is this tradition of collaboration for infrastructures. The best example is the frustration that I see with Swift, which has tremendous capabilities they would love to unleash in banking and finance, and the payments industry, but there is resistance on the part of banks because the banks don’t want to move that fast. The banks don’t want to be that innovative. The banks don’t want to give up that revenue. They don’t want to take away that part where they pay Swift $.50 and charge me $15, they don’t want to collapse that down to a dollar, because of the implications it has to the rest of their organization.
So I think that the ego and the fact that banks use a common infrastructure to justify their current business model is the biggest problem.
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In concluding the interview, Wasden again reached back into the past for a nostalgic comment on the erstwhile pillar of nostalgic memories, Kodak.
“You know what really failed with Kodak?” he asked. “Kodak invented all of the foundational digital technology. They forecasted how many years they had left before digital completely destroyed their business model. So they had foresight, they weren’t ignorant. It wasn’t as though it blindsided them and they had no idea digital was happening. They invented it. They forecasted it. They had plans around it.
“What was their no. 1 problem? Their objective with digital was to harass digital to support their core business. And they believed their core business was not sharing memories. Their core business was selling paper. And because that was their core business, all aspects of digital were used to harass the current technology, the new technology for their current business model. So when no one wanted to share paper anymore they went out of business.
“For banks, what business are they really in? People don’t want to buy FX. They don’t want to buy payments. They don’t want to buy—they want to buy a thing. They want their family to be happy.
“Alibaba, GooglePay, SamsungPay, ApplePay, even Google is getting into finance. So banks need to rethink what business they’re in, and quite frankly if you look at what these new digital companies are saying to customers, they’re saying, “You know what, payments are just part of this process that you as a consumer could care less about. I’m going to give you payments for free. In fact, I may give you payments for negative cost because of what you TRULY want.
“And that’s the real disruption and banks don’t get it.”
