Digital banking: Lessons from the digital disrupters

Entrepreneur Lisa Gansky started Ofoto in 1999. It was the first digital and social online photography website at a time when the masses were still using film. It heralded the digital disruption that the photographic industry was about to witness. 

In 2001 incumbent Kodak bought Ofoto and Gansky moved over to run Kodak’s digital business. It was Kodak’s for the taking. Kodak owned all the rights for digital capture – all the intellectual property surrounding digital photography. 

Kodak had even created the first digital camera. As customers transferred from film to digital, Kodak was in prime position to shift its entire business and take advantage of the innovation.

In 2008 Ofoto (then rebranded to Kodak Gallery) had 60 million customers. Yet by 2012 it was bankrupt. Why?

According to Gansky, it was because Kodak could not make the switch from its old business model that focused on film, to a new model driven by digital.

“The firm made 80% margins on film. A new business model with a different ramping rate and nowhere near that profitability initially just couldn’t convince the senior executives to make the shift.” Rather, digital was considered a side-business.

“Those running the company thought the shift to digital would be slower, emerging markets would grow with film and that they had time to ramp down the film side of the business while the digital took over – but the shift happened almost overnight. One day film was there, the next it wasn’t and Kodak was too late,” says Gansky.

Kodak’s fate may have been determined by innovation in the photography sector, but it is an example being replicated across industries far and wide in the digital age. An example of large incumbents that ought to be the frontrunners, but instead cannot let go of their former profit-generating businesses and make way for emerging and more relevant business lines driven by technology or social interaction.

There are stark lessons here for the banking industry. As one consultant points out: “The boardrooms, executive conferences and meetings of the banking sector are looking less and less like their customer base. We see heads of business that are more focused on upcoming retirements filled with golf courses than mobile cash transfers via start-ups and use of the sharing economy. 

"And they’re not open. They come from an era of being aggressive or defensive in business. They don’t understand sharing or the social element the world now operates in, let alone digital technology. The innovation they are signing off on appears more like lip-service than actual hardcore embracing of technology. They are on a burning boat twiddling their thumbs.”

It’s a sweeping statement that many banks would argue is unfair. HSBC announced a $200 million investment in May in tech start-ups. In July, Santander announced a $100 million venture capital fund for financial technology suppliers. 

Barclays has its very own building, Escalator, to run an accelerator for so-called fintech start-ups over three months. Wells Fargo recently announced an accelerator programme. Citi Ventures scouts and seeds fintech start-ups. And just about every big bank seems to be supporting a bootcamp or fintech lab/hackathon.

But there’s a problem: the changes that have occurred within retail banking seem paltry compared with the overhauls in industries such as publishing or travel. Who doesn’t buy their books online, if buying physical books at all? Who doesn’t book their own flights and hotels using peer reviews or online platforms instead of going to a travel agent? 

Consumer behaviour has been transformed across sectors, yet US banks are still working with checks. In most countries cash transfers abroad cost vast amounts in commissions. Payments take days to clear and appear in accounts. Branches waste hours of valuable time with their doors closed. 

ATMs charge for withdrawals of a customer’s own cash – because as one head of a retail bank in the US explains: “Why should we pay for the real estate and let other bank customers use our branch for free?” There are at least five solutions to this problem that don’t involve making an individual pay $6 to take out cash.

Could the banking industry drown in a flood of relevant, cheaper, more efficient service and product providers unless someone at the helm of the large retail banks has the courage to make a noteworthy shift? 

“Virtual currency was a pariah, but not anymore. Bitcoin is now bigger than Western Union and catching up with PayPal,” points out Eddie George, founder and CEO of NewFinance, a global network for thousands of fintech start-ups and peers.

Banks need to wise up. So why aren’t they? And what could they learn from other industries?

Biggest excuse

The biggest excuse the banks will give is regulation, and to some extent they have a point. They are held back from innovation in part by regulatory or infrastructural hurdles. 

“Having checking accounts in the US is a burden on the banks. So is not having chipped cards. Banks don’t want checks anymore than we do because the cost of check-processing is significant. It is a problem of regulation and infrastructure,” says Bob Gach, co-founder of the FinTech Innovation Lab and a global managing director at Accenture.

Regulators haven’t helped to modernize financial sectors by keeping out new entrants. For example, Wal-Mart wasn’t allowed to start a bank in the US.

But pointing the finger at regulators is a little convenient for the banks, which will be quick enough in trying to exercise influence to stall innovation until they catch up. “In the UK 85% of the business is in the hands of four banks, so it is certainly a skewed industry,” says George. And the phrase “regulatory costs” is thrown around a little too easily when it comes to explaining banking fees or lack of investment.

But time is ticking. “You have an amazing experience on Amazon that is tailored to you, allows you to see reviews, select your price point and then make your order seamlessly, and you wonder why on earth that isn’t happening in finance. The financial services industry is going to have to match the expectations set by other sectors. People no longer see financial services and products as differing to other services and products,” says George.

If regulators choose to embrace new entrants, then any banks that are unprepared could be faced with an exodus of customers. “Because, let’s face it,” says one consultant, “we all are hoping for a better alternative to the bank we currently use, but at the moment we’re having trouble finding one. Brand loyalty to banks died in 2008.”

The same, increasingly, applies to corporates. Economies need more and faster capital. “Bank inefficiencies are actually costing governments money,” says Samarth Shekhar, co-founder of FinTech Forum DACH. “The UK is pushing new financial services entrants as it knows it needs its SMEs to start thriving and the banks aren’t funding them.” 

In August, the UK government announced a new agency – Innovate Finance – to focus on new entrants to the financial services sector.

It’s also not smart from a regulatory standpoint to block innovation. Says George: “Entrepreneurs will simply find another way to be efficient with their money. No one is going to pay money to transfer money abroad via a bank when through TransferWise or PayPal it’s incredibly cheap and fast. And if countries don’t embrace these new payment models then regions like the Isle of Man that do will win a lot of business.”

There’s another problem: banks are large, complex institutions. Can they be expected to innovate and regenerate at the same pace as smaller companies that have new technology in their DNA?

“This isn’t like the consumer-goods industry,” says Gach. “The large transaction volumes involved coupled with the reality of money as the ‘product’ requires industrialized technology and platforms across systems, and it needs to be incredibly robust before it starts. The fiduciary responsibility is much bigger for these large institutions than it is for a consumer-goods company, so you can’t just get going, hope it works out and grow with your business.”

One banker says it will cost close to $1 billion for a well-known Wall Street firm to overhaul its legacy systems and modernise.

That’s not to mention labour issues. Says Shekhar: “The banks need to work out: how am I going to redeploy all the people in my branches? Or how am I going to lay them off in a kindly manner? It’s not easy to say: ‘Let’s kill those people’s careers and move onto the new model’ though.”

It is the same with the thousands of financial advisors employed by banks. The relevance of financial advisors is diminishing. Platforms such as the US's FutureAdvisor, which provides automated online advice, and the UK's Nutmeg, which provides online wealth management, have already emerged and they wipe out the need for a middle man. UBS Americas, Bank of America Merrill Lynch, Wells Fargo and Morgan Stanley employ some 50,000 advisors in the US alone.

And the final, and probably most likely reason for the lack of change is simply what every industry encounters among its incumbents when change is in the air: paralysis.

Paul Campbell is disrupting the music industry through his firm Amazing Media, and he says it is the same across every sector: “If you are running a long-established business, sitting on the top floor of a huge building earning a massive salary, it’s impossible to set fire to that building. 

"You can’t implement radical change. Instead you get into defensive mode, trying to preserve what you have. But that doesn’t work when fundamental change, especially technology-driven change, is happening around you. This is what we are seeing across all industries.”

Unused value is waste

Gansky, who authored the book ‘The mesh – why the future of business is sharing’, divides the changes into two parts: the first is the pragmatic shift from a world organized around ownership to one organized around access; the second is the principle that unused value is waste.

“Access trumps ownership today,” she says. “People don’t need to own a store if they only want to use it for several hours a day. Instead they will share a store, or have a pop-up store. Others are taking on landshares to grow food. It’s happening in business where entrepreneurs are coming together to share across the supply chain, and it makes much more sense economically.”

The result is that firms are being set up at a much lower cost. She says Ofoto required $60 million to start up in 1999, and when she priced what it would cost to set it up in 2007 it was a mere $2.5 million.

The significance of this is clear for the financial industry. If you asked a bank CEO how they would design a bank today, it is unlikely the answer would be to have 1,000 branches. And it is also likely there would be some sharing across the chain with firms like PayPal, TransferWise and perhaps a crowd-lender as partners. 

There might be some open sourcing for software development. The costs would be far lower – which means new competitors can enter the financial industry more cheaply than ever and be more efficient. 

“Banks are tied to this idea of ownership and relying on just themselves. They need to open up, create a platform and start collaborating,” says Gansky.

The second meaningful impact of this move to access over ownership is that banks are no longer needed for consumer capital. “We are so much more connected that it is easier to raise capital now, especially as we need to raise less,” says Gansky. 

That has been nurtured by the rise of crowdfunding and lending platforms and investor groups such as AngelList. These avenues of raising money are also much faster and more targeted and have personal appeal.

“In the event of a natural disaster like our recent Napa earthquake it would be easier to raise money via a platform like neighbor.ly than waiting for a muni bond to launch,” says Gansky.

The mantra that unused value is waste is the driver behind the booming sharing economy. If you have skills and time, share them and be paid for it via TaskRabbit. If you have a spare bedroom, rent it out and make money on Airbnb or via Tripping. If you have a car, don’t let it sit there unused, offer someone a lift on Lyft, or BlaBlaCar, or Uber.

In the financial industry businesses such as Second Market have taken shares in firms that are yet to go public and created a trading platform to unlock their value. There are also some banks that use their branches for community programmes after hours to unlock value, such as Umpqua Bank on the west coast of the US. 

“We’re reaching a point where you can look at a closed bank branch on a Sunday and think – what a waste… what is my bank doing?” says Gansky.

It is the social element and connectivity of the world that is transforming every industry, enabled by digital technology. Banks are last to the party. “The main difference between new and old finance is the social dimension that now exists,” says George. 

“People get together and can share information and talk about their financial experiences and how they addressing it, and are very willing to switch to new services once they see other are.”

Successful disruption

It’s a hurdle that banks, for now, just can’t bring themselves to jump over. To many in the new tech generation, banking appears to be a business designed to keep your finances under lock and key and use the funds for its own profits. Yet many of the companies now successfully disrupting established industries began out of the need for something other than profit. 

For example, Amazing Media works through individuals who want to support musicians. Navigation app Waze works through people contributing to their maps and therefore improving the welfare of fellow drivers as well as their own.

Banks often like to talk about putting their clients first, but they are unlikely to take that to the level of disrupters such as Waze.

“When you look around the various industries and look at the firms having a huge impact, they are leading with community first, providing social good, and then working out what they can do to generate fair and transparent returns,” says Julie Mossler, a spokesperson at Waze, which Google bought for more than $1 billion last year. 

“Letting community be the driver of your business seems to be the emerging force behind disruption across industries.”

At Khan Academy, the online tutorial tool that has delivered 458 million lessons online for free, it is a deep desire to help others receive an education that drives the organization.

TripAdvisor, with 280 million monthly unique visitors to its site, is driven by the motivation to give people you don’t know and will never meet an insight into how to better spend the little vacation time they have.

TripAdvisor’s crowdsourcing of customer opinions might not seem like a good strategy for a banking industry that remains the subject of so much opprobrium from the general public, but there’s no getting away from the power of such sites for any industry.

As Stephen Kaufer, CEO and founder of TripAdvisor, says: “Whenever there are products and services and a considerable amount of choices, consumers want to know if they are making the best decision. Online reviews are a powerful tool illuminating the good, the bad and the ugly of these options to help consumer choose wisely.”

None of the above four firms were created out of the desire for profit – they all were created to fill a gap, for free, to serve others, and out of that they found a means to remain sustainable.

Such a strategy is anathema to most industries, especially banking. But it’s the mindset that is just as important as the motivation. As one consultant says: “There are very smart people working in the technology businesses of banks who are doomed to fail because the first question they are asked by their superiors is: ‘Will this make us money?’ and the second question they are asked is: ‘How can we make this make us more money?’”

The game is not entirely lost for the banks, but they need to move now. “It’s not an option,” says Gansky. “They need to stop hedging their bets with a little innovation lab on the side. There is a huge opportunity for a bank CEO to come out and say what we already all know: ‘We have waste, hidden fees, we are antiquated, and we have all this leftover from decades of a system with obscure practices’ – and then make a very bold move rather than just talking about it. 

"Focus on delighting customers, entrepreneurs and local communities. That would take some courage.” 

See how four digital companies have reinvented areas such as travel, music and education.