Bill Gates once said: "The world needs banking but it doesn't need banks."
As fintechs take over the banking scene, banks' approach to innovation will determine whether they flourish or struggle to survive.
Let us travel back in time. It's 2010 and the banking sector is just recovering from the financial crisis. The top ten banks are in Europe and the United States. Revolut does not exist, nor do Monzo, Starling, or any of the other neo-banks.
It sounds like a different world. Today, six of the biggest banks are based in Asia and fintech startups have filled up the market, becoming real competitors to traditional banks. By using innovative technology and automation, fintechs are not only providing financial services to their customers, but also user-friendly interfaces and transparency. To keep up, banks have no choice but to undergo a digital transformation and innovate.
Although many banks are investing in IT, Big Data, and skilled workforce, the technological edge of fintechs is undeniable. On the other hand, fintechs struggle to secure profits that would justify their high valuations. The speed at which incumbents adopt new technologies is often not high enough, and most major changes in the market are due to digital disruption by fintechs.
Why do traditional banks find it so difficult to innovate? What are the obstacles and constraints preventing banks from catching up with fintechs? Let us take a look at the top seven barriers to banking innovation – and what can be done to overcome them.
1. Inertia trap
Some banking executives are extremely cautious when it comes to "innovation" or "technology deployment," even when it involves low-hanging technological fruit.
This resistance to change may stem from a lack of a business model that would support innovative ideas. There is no willingness to challenge business metrics that are still based on the old revenue streams. To change them, banks would have to move multiple pieces and perform complex tasks across many departments. Such operations would most likely impact revenues and performance. So, when institutional goals seem unclear, executives have no motivation to change – and remain trapped in inertia.
2. Hierarchical organizational structure
The problem of inertia is closely related to the hierarchical structure of most banks. This means that any innovative idea has to go through several levels of approval, and the hierarchy hinders creativity, agility and flexibility.
In organizations with flatter structures, ideas are more likely to see the light of day. Communication is faster and more actionable, and collaborative brainstorming is welcome, leading to more ideas.
To be more agile, banks must either centralize control and responsibility in one location or spread it across multiple locations. Both solutions are possible today because geography is virtually irrelevant, most customers do their banking online, and information can be accessed by any employee regardless of location. These trends mean that banks no longer need a rigid structure in which information and responsibility are housed in departmental silos.
3. Lack of an innovation culture
Innovation requires a culture of short failure cycles and improvement iterations that must be learned and accepted. These methods contradict the typical long-term planning in banks. Banks lack reliable data that would help them make assumptions about future innovations and are reluctant to test and experiment.
To overcome this roadblock, banks would need to adopt a "startup mentality," i.e., "fail fast and fail often," and accept that innovations do not always make money. This is especially difficult in large, revenue-driven organizations, but there are ways to overcome this challenge.
One is to work with external vendors – such as Netguru's agile tech teams – who can design a product to prototype and test. For example, Netguru helped Germany’s Solarisbank expand its API services and develop a debit card processing platform.
There are other examples. A recent one is Deutsche Bank, which has made significant changes, including closing its presence in 10 countries, cutting its investment banking clients in half, and upgrading its outdated technology. To achieve this, Deutsche Bank has committed €12bn and invited Amazon, Google, and Microsoft to bid for the bank's tech overhaul.
Read more: Why does innovation fail?
4. Lack of talent and skills
The hierarchical structures, outdated culture, and unwillingness to innovate not only made it difficult for banks to develop new functions quickly, but also to attract the right talent. The development and maintenance of current complex systems was mostly outsourced. Recruiting skilled engineers and IT specialists was a major challenge. Reengineering current systems is costly and time-consuming and requires skilled professionals who are already scarce in the market.
If banks are not willing to aggressively court top technology talent, they can outsource a product team as needed.
About 50 years ago, traditional banks led the revolution – they were the first to use computer networks, phone services, and the internal web. Today, there are still banks that rely on IBM mainframes from the 1960s.
It's no news that technology has evolved tremendously in the last 10 years and that banks have had difficulty integrating new features. However, the problem is bigger than technology itself and relates to what we have said before – lack of innovation culture, scarcity of IT talent, and inertia. Many banks don’t appeal to the needs of Millennials and Generation Z. It's not just about having modern IT systems, it's about bridging the gap between banks and their customers, who want mobile solutions, a seamless experience, and a "wow" effect.
The crisis of 2007-2009 brought remarkable changes in the regulation of the banking sector. Failure to comply with regulations results in millions of dollars in fines – and reputational damage.
These compliance efforts mean that banks are devoting their resources to meeting regulatory requirements – not to driving innovation. All too often, however, regulation is used as an excuse to stifle innovation and fall back on the status quo. Instead of seeing regulations as obstacles, banks could see them as assets. After all, regulations are there to protect customers and get products to market safely.
Last but not least, banks often see each other as competitors, not partners with whom they could join forces, share knowledge, and exchange experience.
"We should stop pretending that we can protect ourselves by trying to outdo each other by funding startups, and instead develop or venture into new initiatives together," said Anneli Bartholdy, Strategic Partner at Nordea, in an interview with Netguru.
Moreover, the upcoming battle will likely involve more participants than just banks and fintechs. BigTech players like Google, Amazon, Facebook, and Apple are vying for the role of banks – and they have a chance to succeed.
Financial institutions are under pressure to evolve and provide a more user-friendly, digital experience.
Many are struggling with these challenges, as change cannot be introduced overnight. Rather, banks must invest time and resources to overcome the obstacles. Most importantly, they must change their mindset and free themselves from archaic business models and organizational structures.
Digital transformation of banks would definitely benefit their customers, who would get more efficient service, user-friendly interfaces, and other benefits of modern technology.
In order to keep up with neo-banks and fintechs, the incumbents need to restructure and move towards a customer-centric model. If they are unable to compete with neobanks, they can form partnerships with fintechs – and if they fail to do either, they could be acquired by them.