Mihkel Vitsur: «Banks Are Not Synonymous With Innovation»

With banking itself not very innovative by nature, modernization is being relegated to fintech. If banks are to remain relevant, they will need to reform by proxy, Mihkel Vitsur writes in an article for finews.first.

This article is published on finews.first, a forum for authors specialized in economic and financial topics.

Banks are structured, regulated and have stern foundations that have been framed over hundreds of years. Innovation, on the other hand, invokes feelings of disruption, risk and instability. The further innovation moves away from «established», the more uncomfortable the territory becomes. Banks cannot be «uncomfortable», as this brings along unnecessary risk.

On the other hand, the lack of innovation makes it challenging to keep up with the market's needs. Technology and businesses are progressing. With the development of digital financial services soaring, be it the crypto world or p2p payments, there is a need for the traditional banking sector to keep up.

«The main hurdle lies within the concept of innovation»

Business needs are also changing. New types of businesses, e.g. influencers, e-commerce, cryptocurrency or affiliate marketers, are becoming more dominant in global commerce. Traditional banks find it challenging to understand these organizations and lack the offerings those organizations need.

With banking itself not being innovative by nature, the modernization is being forwarded to smaller firms taking on the «banking-innovation-is-the-future» mindset and setting up fintech companies, ultimately offering banking services to these new sectors. If this is to continue and if banks are to remain relevant, they will need to reform by proxy. How should Banks navigate the innovation landscape?

The main hurdle lies within the concept of innovation. When thinking of innovation, one's mind automatically veers towards the thought of risky innovation, like disruptive or even more perilous, radical innovation.

«Radical innovation a high probability of failure»

Disruptive innovation involves applying the latest technologies and processes within an existing business. Disruptors typically take an under-serviced segment of the client pool, and by leveraging new technology, service them more effectively. Robo-advisory is a good example here.

Radical innovation (the riskiest type) brings about the possibility of immense change and a high probability of failure. A daunting task that, at its core, needs a culture that is not part of what banks traditionally stand for. Bitcoin and Blockchain are examples of radical innovation. But innovation does not need to be radical or disruptive. Change or improvement can also come from a more thought-out, incremental approach, which is less risky.

Incremental innovation improves an existing marketplace with new and tested technology. Risks can be efficiently managed whilst also removing the negative connotations that innovation invokes. This way, there can be a gradual yet steady shift towards modern banking whilst keeping stakeholders comfortable and consumers satisfied.

«How should banks approach disruptive or radical innovation?»

A simple, highly influential example of incremental innovation is Credit Suisse's initiative on client onboarding. In 2017, the bank provided customers with the option to initiate a relationship with the bank through a completely digital onboarding process, known as online relationship onboarding, eliminating the need to visit the bank to open an account physically.

Whilst this is not a new technology and used widely throughout the financial services sector, seeing a larger bank take the leap is proof that it is possible to innovate incrementally. But how should banks approach disruptive or radical innovation?

In his article «Banks and Innovation – A Pair of Opposites», finews.ch editor-in-chief Peter Hody proposes that it is essential to have differentiated risk management within a bank. «Without any risk, there won't be anybody around to generate innovation, and without a risk tolerance, new ideas will never be tested for their usefulness».

«Credit Suisse cannot afford to fail in the same way as for example, Revolut »

It is exceptionally valid, but what good is setting up differentiated risk management if you cannot out-innovate the big techs (Googles, Facebooks) or other on investment steroids operating fintechs?

Tech firms are celebrated for taking risks and failing fast. Failures are seen as necessary risks toward an ultimate goal for progress. Credit Suisse cannot afford to fail in the same way as for example, Revolut – in front of their external and internal stakeholders. Different metrics judge an established bank and a fintech.

Tech firms usually see a unique problem and start to solve it from scratch, in many cases without jeopardizing their existing business. Banks, in many cases, are innovating because of the regulator or to catch up with an external threat. In case Facebook's Libra Project fails, it would have a minor effect on its advertisement revenues. In case a bank's innovation fails, it would mean an unhappy regulator and investors - in a good case scenario.

«Bankers are motivated differently»

Tech firms pay good salaries, and as upsides, they offer stakes in the company, which value can grow exponentially. Bankers are motivated differently. They get annual bonuses based on the profitability of their individual goals. Here's the problem: A tech firm is pushing the idea that if we all work together on a vision and the company succeeds, we all do well.

Meanwhile, a bank requires sign-off on a project from twenty different department heads. That process is not conducive to progress, mainly when somebody from the Geneva office is more conservative and kills a project because he is afraid that it would affect his bonus. Some banks will succeed in taking big leaps, but most should ally with innovators and not try to become radical banks.

«One breaks new ground, the other earns, later adopts or acquires the innovations»

Banks have an extraordinary number of products and services, a large and existing client base, trusted brands and a fortress balance sheet. Fintechs have skin in the game, founders, investors who are happy to subsidize a bent reality and are looking for solid foundational partners to prove their business cases.

Banks providing innovative companies controlled access to their financial infrastructure can help fintechs develop their use-cases and succeed or fail fast. In a worst-case scenario, banks gain new paying customers; in a best-case scenario, a new business vertical. Banks should see costs associated with supporting these innovators as an investment into staying relevant in the entire value chain.

Being relevant also reduces the banks' fear of innovators as they are inherently linked through the process of innovation. One breaks new ground, the other earns, later adopts or acquires the innovations that have been market and consumer approved in some cases. It is important to note that Finma encourages innovation and is also fully aware that banks, particularly the system-relevant ones, need to minimize risks.

«Banks simply need to be a little more aggressive here»

With Finma’s support and security for innovative businesses, the industry can shift the banking sector to where it needs to cater to the modern audience. Finma’s strategic goals for 2021 to 2024 including, that innovation will remain a core element for the authority to apply existing rules to innovative business models and products by taking a pragmatic and forward-looking approach.

With the regulator's vital support and transparency, innovators are allowed to test new grounds. What fintechs and banks know is that they need to move faster and bolder on how they attack new markets. Sometimes new markets look too small or appear not to be critical – until they are. Banks simply need to be a little more aggressive here.

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