Innovation, like digital transformation, is a concept that everyone agrees is important, but only a relative handful of financial institutions have actually mastered it.
Unfortunately, many more think they’ve mastered it.
“Over the last year and a half with Covid, many financial institutions who digitized existing processes think they’ve ‘taken the hill already’,” says JP Nicols, Co-Founder of FinTech Forge and the Alloy Labs Alliance. “They say, ‘Yep, we did innovation. We can check that off’.”
Nicols and his Co-Founder, Jason Henrichs, spoke on the Banking Transformed podcast, moderated by Jim Marous, Co-Publisher of The Financial Brand and CEO of the Digital Banking Report. They covered in detail about what is required to be innovative in banking.
As banking expands and diversifies, it is more critical than ever for institutions to drive innovation and to differentiate themselves, Marous observes. That requires an openness to change, a high degree of engagement from all levels of management and staff, and the use of data, applied analytics, new technologies, and skillsets that many banks and credit unions lack.
As it says on the FinTech Forge website, balancing the pressure of innovating in a highly regulated environment while responding to the rapid changes in the fintech landscape is hard, but it’s not impossible.
Henrichs, an engineer and investor worked for PerkStreet Financial, one of the earliest neobanks, as well as for nonbank consumer lender First Marblehead before joining up with Nicols to launch Fintech Forge in 2015. Nicols has worked for several banks including U.S. Bank for many years during a period of rapid growth.
FinTech Forge works with financial institutions to create innovation internally and through partnerships and investments. Alloy Labs Alliance, formed in 2018 with 12 founding members, is essentially a shared innovation lab for institutions that don’t have the resources of a megabank. It currently has almost 60 members. One of its sub-groups recently introduced the “Chuck” P2P service.
Innovation Key No. 1: Action Not Strategy
The problem with many banks and credit unions is that they treat innovation like a core system conversion, says Henrichs. In a core conversion, you can predict pretty accurately what you’ll be doing on Tuesday of week 32.
That doesn’t work with innovation, he says, where typically “you’re not going to be sure what that future state is going to look like.”
“You become innovative by starting to act innovative, not by thinking about it.”
— Jason Henrichs, FinTech Forge
“If you spend too much time trying to think through the plan and what the end state is, you’re either not doing something that’s interesting because it’s highly predictable or you’re creating a plan that you stick rigidly to and ignore all of the learnings you could have along the way,” Henrichs maintains.
“Lao Tzu has a great quote that relates to this,” Henrichs observes: ‘The journey of a thousand miles begins with a single footstep.’ Meaning, you become innovative by starting to act innovatively, not by thinking, “Oh, we need to change our culture and then we can actually go innovate’.”
Innovation Key No. 2: The Difference Between Learning and Failure
The most innovative organizations have both top-down and bottom-up innovation, Nicols points out. “You need the top to give permission to try things that management doesn’t know what the result is going to look like. It takes courage and leadership to be able to say, ‘We’re going to explore here’.”
This is rare, however. “It’s seldom you hear a bank CEO talking about all the mistakes they made along the way to the corner office,” Henrichs observes. That behavior trickles down through the organization. So part of the change needed to create innovation is to distinguish between learning and failure, says Henrichs.
“Banks tell us that they’re a ‘fast follower,’ to which we often respond, ‘Well, you’re half right. There’s nothing fast about what you’re doing, but you’re definitely a follower’.”
— JP Nicols, FinTech Forge
The management of one of the Alloy Labs Alliance members, New York City-based Quontic Bank, has a phrase that Nicols and Henrichs both like a lot: the bank emphasizes “Progress not perfection.” It encapsulates the concept of trying things and learning from them.
Innovation from the bottom up is also important because those are the people who are close to the customer, the product, and to the problems that the product is supposed to solve.
“There are times where Six Sigma makes sense,” Nicols states, referring to the widely used process-improvement methodology. “You want your network uptime, your audit committee and your loan book to be highly accurate. But innovation is about what we like to call ‘One Sigma’ thinking. Applying that, management might say: ‘There’s a 60% chance this is going to work as expected. Let’s go ahead and try it’.”
“It’s difficult to do that,” Nicols states, “but that’s what banking leaders have to be willing to do.”
Innovation Key No. 3: Focus on the ‘Edge of Money’
Banks and credit unions are used to being at the center of money, Henrichs observes — deposits coming in, payments going out, loans being made. But for customers, those products are all a means to an end; where money meets their life and their broader goals.
“People don’t wake up in the morning and say, ‘I need a new mortgage’,” says Henrichs. “No, it’s ‘I’m having a baby;’ ‘I’m moving to a new town,; ‘I’m buying my first house;’ ‘I’m retiring and buying a second house.’ That mortgage means something broader.”
That’s just the first step, however. Financial institutions need to look beyond their traditional product lineup and traditional roles. Henrichs and Nicols refer to this as focusing on “the edge of money.”
The problem with most strategic plans in banking is they're neither strategic nor plans. They're a collection of tasks that usually are driven by a competitive checklist.
FinTech Forge runs a Concept Lab, the goal of which is to accelerate the adoption of new technologies and services that aren’t necessarily related to banking. As an example, Henrichs says “two of our banks have partnered with a startup called Carefull out of New York City. What Carefull does is help adult children plan and manage the healthcare expense for their aging parents.”
For these two banks, partnering with Carefull was a big step into the unknown, says Henrichs. “They said, ‘We don’t do things like this.’ But guess what? Community institutions have a lot of older customers.”
That’s how to reinvent banking,” Henrichs maintains: “Go deeper into customers’ lives and meet what their needs are.”
Innovation Key No. 4: Look for Ways to Differentiate
“When you think about our industry,” Nicols states, “every bank looks pretty much the same as every other bank — they all sell 95% of the same products and services backed by 95% of the same policies and procedures.” Figuring out how to expand that 5% difference into maybe a 15% difference is crucial. “That’s the ‘edge of money’ that Jason was talking about. I think that’s really what the future of banking looks like.”
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“The banks that are winning are efficient — because you still have to defend and extend your core business,” Nicols states, “but at the same time they are looking to create options for the future — things like the partnership with Carefull.” In essence what this means is that the winners are not just replumbing banking, but reinventing banking.
“Instead of waiting for the market to define your future for you, get out there and try some things — test and learn — and figure out what works.”
Banks and credit unions will still rely on loans and deposits, of course, but more institutions will become focused on different customer subsets and different markets and niches. “The institutions winning today are already doing that,” Nicols believes. “Those that don’t do that will just be a part of the continued consolidation that we’re seeing.”