Outsourced Bank R&D for Competitive Advantage

A Modern Fintech Plan for banks of all sizes

“The lifeblood of our business is that R&D spend . . . We have to continuously create new innovation that lets people do something they didn’t think they could do the day before.” Steve Ballmer — Microsoft

I never thought I would open a blog with a Steve Ballmer quote, but this just works:

Why open a banking innovation article with a quote from the previous head of Microsoft, a big tech company? Easy, what are bank CEOs claiming now?

ING Bank CEO Ralph Hamers has told The Banker that he wants ING to be seen as a tech company with a banking license.

Goldman Sachs’ Sanjeev Mehra said “Banking and technology are becoming indistinguishable,” all the way back in 2016. And Goldman’s CEO Lloyd Blankfein has long said GS is a technology company with a bank license.

“We are a technology company,” JPMC CFO Lake said, speaking at JPMorgan’s Investor Day in 2016.

I tried to find the myriad quotes from Apple, Amazon and Microsoft about how they hope to operate like a bank, I could not find even one. There does not appear to be a lot of bank qualities that technology leaders want to emulate. Including profitability or stock price as Ralph Hamers of ING says the superior price / earnings multiple of tech companies is one of the reasons he wants you to view ING Bank as a technology leader.

Is it valid for a bank to simply say “We are a tech company with a bank license.”? In fairness to the bankers making this claim, the number of “technologists” and programmers at any given bank today can sound impressive.

However, I think the language they use speaks volumes. I read JPMC’s Strategic Update of February 27,2018 given by their CFO, Marianne Lake. This tome is 110 pages (PowerPoint Deck) of great information about the bank. The deck lays out all the essentials of a very well run financial services organization;

“JPMC is customer centric” (of course)

“They are deeply integrated” (of course)

“JPMC Executes with discipline — capital, expense and controls” (said every bank, ever)

Add to these highlights an array of charts and graphs showing JPMC outperforms Citibank, Bank of America, Goldman Sachs, et. al. in every branch and financial ratio imaginable.

Banks address technology in language that sounds like me speaking Spanish. (non-native and non-fluent, but almost convincing) “Digital Everything” is a section of this amazing deep dive report on JPMC.

“Our customers demand digital capabilities” is a shocking text box on one slide.

Compare JPMC’s deep dive deck to Google’s (Alphabet) boring 10K filing from 2017 that has section headers such as:

· Access and technology for everyone

· Moonshots

· Machine Learning

“Throughout Alphabet, we are also using technology to try and solve big problems across many industries.”

“Google was a company built in the cloud and has been investing in infrastructure, security, data management, analytics, and AI from the very beginning.”

So no, saying you are a technology company with a bank license is not enough. But what is a bank to do as the world moves towards a tech first, digital native world?

R&D is my answer. I published this chart a while back and got some great comments on it, I think this shows the huge gap between saying Digital Everything and just being great at digital.

Banks are just not spending or prioritizing their tech budget in a way that allows them to be truly innovative. While Amazon, Google, Microsoft and other big tech companies spend double digit percent’s of their revenue on R&D, JMPC spends under 1%.

Banks need to continue to maintain and build on their current tech budgets, we can’t very well have the ATM network grind to a halt due to lack of maintenance. What is a bank to do with their tech budget being eaten by BAU projects and upgrades to dated technology? We all know that the amount of Cobol code in banks running on HP3000 platforms is shocking in this day and age of Cloud and AI. Working around this legacy infrastructure is the goal of working with Fintechs to deliver innovation.

VCs invested $31 billion in 2017 just into Fintech startups plus they invested billions more into InfoSec, Cloud and Data companies that banks can access quite easily. Cherry picking these companies that are nearly custom-made for banks and other legacy FI’s is a low-cost way to access the next generation of financial technology. Although working with Fintech startups is hardly risk free, it is manageable.

Most VCs use some variation of the following for evaluating investments:

1. People / Team

2. Market Size

3. Technology

4. Product Market Fit

5. USP — Unique Selling Proposition

Some VC investors will want to know how much “traction” the product has as a measure of Product-Market Fit. Every VC might have other criteria that their unique investment thesis requires too. The great news for banks is if they engage at the right time, the VCs will have assumed a lot of the risk in the Seed and A-round financing. If a bank engages with a Fintech after these 5 criteria are met the risk for them is greatly reduced.

Do banks need to set up a venture investment arm to engage with these Fintech darlings? No, not at all, as a matter of fact that can be a distraction as most Corporate Venture Capital (CVC) groups get a bit confused about balancing IRR (Internal Rate of Return) vs. Strategic Value.

CVC groups constantly try to balance how engaged to be with their own business units vs. the Fintech’s team. This balance of power can be avoided by simply engaging with Fintech startups to add value to the bank’s product roadmap.

My thesis is that banks can engage with Fintechs on a commercial basis for mutual benefit and deliver a better set of products and capabilities for their customers.

How?

Before following this guide on engaging Fintechs, I hope you will realize that your current methods of procurement, NDAs, engagement and approvals are too heavy handed for this task. Get senior executive buy-in to do things a bit different when engaging with Fintechs. Nimble processes that speed up the administration of this effort will go a long way to showing your Fintech partners that you are going to be a good partner.

1. Develop a Fintech strategy based on your bank’s technology needs using a lens of customer experience first. I call this Contextual Innovation ensuring not to just do tech for tech’s sake. Focus on real customer value.

2. Engage the Fintech ecosystem from VCs to influencers to universities (MIT and Stanford) and the folks that write about Fintech like Business Insider, CB Insights and others.

a. I would also recommend attending Money2020 as well as maybe Finovate.

b. Accelerators like 500 Startups, Plug & Play and others can be a value added source of Fintechs as well.

3. Based on the roadmap from #1, find a couple of Fintechs that can fill in a crucial capability that will show results and benefits within 12–18 months.

4. Do a POC with 1–2 Fintechs, nothing too hard and I would personally not include your IT team at this point. Be sure and have success criteria for the POC and try not to beat up the Fintech on pricing or compliance. Think of this from the startup’s point of view.

5. If the results of the POC meet the criteria or show promise, iterate the product and criteria for a Pilot program.

6. Now it gets harder, you need the Fintech to touch bank infrastructure and this will require your IT, Infosec and other compliance team members.

a. It is very important that the Pilot has a limited time basis, no more than 90 days.

b. This of course requires your internal partners to move at startup speed instead of bank speed.

c. I recommend setting up a bonus pool for successful Pilots that deliver value for all the team members involved. Make the lawyer that read the documents feel like he is invested in a startup’s success has surprising benefits to team morale.

7. Production is of course the hardest step in this journey. This will require more resources and a larger team.

a. Please keep these teams as small as possible. The reason Fintechs move quickly is they are small, focused teams. Pardon the military analogy but it is like you want to setup Seal Team Six, not the US Army.

b. Again, it will be worthwhile to have a bonus pool allowing internal team members to feel the excitement and reward of moving quickly.

R&D at a bank is not likely in the near future, but a well thought out and tightly executed process of moving from Fintech discovery to POC to Pilot to Production is doable.

Personally, I have seen these journeys from the Fintech side and the big bank side and can assure you the key is small, agile teams that are really excited about delivering innovation.

A final note, I am a big fan of JPMC and consider them to be one of the better run banks in the world, I only use them as the example because they put out such great investor reports.