As they labor to adapt to the digital age, banks and credit unions wonder whether all the investment and angst required to bring innovation to life will be justified by financial results. Does it actually pay to be on the leading edge? Or is the digital movement so hyped that the fast followers and even the “wait and see” pack could wind up doing just as well as those who step out ahead of the crowd?
Research by Accenture finds that being a pioneer is paying off, in two ways.
First, for those institutions that are truly “all in” on technology, which the firm calls “digital focused” players, efforts have started producing definite financial gains over those who are less committed, which the firm calls “digital active,” as well as over “the rest.”
“The gap between the ‘best’ and the ‘rest’ is beginning to widen in a manner that should be worrying for those still struggling with digital transformation.”
— Accenture report on digital leadership
Second, Accenture’s international study finds that digital focused institutions around the world are being rewarded for their efforts by the financial markets.
“We now see that digital leadership does indeed drive superior economic performance — and that the gap between the ‘best’ and the ‘rest’ is beginning to widen in a manner that should be worrying for those still struggling with digital transformation,” the firm states in its report, “Caterpillars, Butterflies, and Unicorns: Does Digital Leadership in Banking Really Matter?”
Accenture’s colorful analogy is that some institutions are still in the cocoon, yet to metamorphosize into butterflies — successful digital creatures. Others are out of the cocoon, but remain caterpillars that are “still heads down, munching through a diminishing pile of leaves.”
The premise of the report is that time is running out for those that would stay ahead of the pack and be relevant with a compensating return. Building on its analogy, Accenture suggests that merely being an “upgraded caterpillar” won’t cut it now.
“Being a fast follower or just dipping your toe in the water is not an effective strategy anymore,” says Paula O’Reilly, Managing Director in the Accenture Financial Services practice. “Now you have to decide what you want to be when you grow up.”
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What Impresses Wall Street and Other Investors
“Bank investors appear to share our view that the future prospects of banking industry incumbents have deteriorated, and that disruption is going to limit their ability to consistently create profitable growth,” the report states. The firm’s analysis of valuation trends indicates that investors are less impressed by traditional banking operations conducted in age-old ways. Accenture stresses that spending on technology to “run the bank” must be balanced against tech spending to “change the bank” in order to evolve at a competitive rate that will be effective and also visible to the markets.
Digital leaders have made it clear to the markets that they are changing their approaches to banking. Accenture capsulizes the different paths taken, continuing its butterfly analogy:
“Some, such as Bank of America, Royal Bank of Canada, and Lloyds Banking Group, focused on digitally-enabling their core business, while others, like BBVA, also adopted a venture capitalist-like mindset, taking minority stakes in a portfolio of businesses and making a series of acquisitions in search of the right conditions to accelerate the chrysalis phase of their digital transformation. Others, like ING and DBS, have focused on an inside-out cultural transformation, based on the logic that thinking and acting like a butterfly is a necessary precursor to creating new market initiatives.”
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Are You Really the Digital Leader You Think You Are?
Innovation efforts can come with a lot of trappings. In some circles, for example, having an innovation lab, or even several of them, would seem to be living proof of intentions and commitment.
“Unless you have a plan for how those innovative ideas are going to be implemented, they’re not going to get you very far.”— Paula O’Reilly, Accenture
Yet having a lab or a team doesn’t guarantee that innovation ever gets out to the public. The report makes it clear that sometimes the conflict between mainstream bankers and the “cool kids” in the lab will prevent much innovation from being anything beyond a shiny toy that never gets implemented.
Accenture’s analysis of 161 large banks in 21 countries worldwide broke the group into:
- Digital-focused, those that appear fully committed to digital transformation — 12%.
- Digital-active, those in digital transformation but which lack coherence in their efforts, who haven’t told the markets a compelling story about their intentions — 38%.
- “The rest,” those that have made little progress and which may still be mulling over the entire matter— 50%.
(The “unicorns” of the report’s title, incidentally, stand apart from these groups. Citing examples like China’s Ant Financial, the report points out that these companies were digitally born. This puts them even beyond the digital-focused status.)
The evaluation was based on several factors. Accenture combed through earnings transcripts, news releases, and published investment plans to determine how “all in” an institution was in digital innovation.
“We were looking for banks that were both talking the talk and putting their money where their narrative was, either through internal investments or by making acquisitions or forming partnerships in the digital space,” the report states
The study team also looked at what analysts and others have had to say about each of the institutions, whether the banks had won awards for innovation, and how they ranked in industry ratings for mobile apps and other services. Finally, subjective judgments were made based on Accenture’s own client work.
This revealed that while many institutions believe they are “all in” on digital innovation, not all make the grade in the eyes of outsiders. Accenture’s Paula O’Reilly notes that a small portion of those who consider themselves “all in” don’t walk the walk.
“Innovation isn’t just something where you snap your fingers and say, ‘OK, we’re innovative now’,” says O’Reilly. “It’s a journey around how you bring your workforce into valuing innovation, understanding what innovation means, and in a lot of respects rewarding innovation and the implementation of new ideas and ways of working. It’s more than ‘I stood up an innovation lab’.”
“All in” connotes implementation of innovation much more than it does development of innovation, according to O’Reilly. “If you have the cool kids off in the corner, that’s great, and they can think about great things over there,” she explains. “But unless you have a plan on how that innovation is going to be implemented it’s not going to get you very far.”
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How the Markets Favor Digital Leaders
Investors seem to get this, Accenture found, because digital maturity appears to correlate with better bank valuations.
“Overall, digital-focused banks are the only group with a price-to-book ratio about 1X and the gap to the rest of the industry is widening,” Accenture’s team determined.
The study looked at the performance of such banks, to see if they were “floating on a cloud of digital hype.”
That wasn’t the case, as digital maturity and increased profitability go hand in hand. While both digital focused and digital active banks are increasing returns, Accenture states, returns for “the rest” look to remain below 2011 levels for a while to come, despite generally positive macroeconomic conditions.
The final aspect of the analysis boils down to this — the focus on digital is driving improvement in the organizations overall.
“They are achieving their improved profitability through higher operating leverage that squeezes more profitability out of every dollar of assets,” the report explains. Beyond this, the study found that these institutions are typically more efficient than average. And this impacts both the asset and liability sides of the institutions. In a sense, the market is rewarding classical spread banking, according to the study, where digital investment is driving greater efficiency, rather than fee-based banking.
“For digital butterflies, the balance sheet is the principal source of income growth,” the study says. (The study contains an extensive series of charts demonstrating its financial arguments in detail.)
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Could a Recession Slam the Brakes on Digital Leaders?
While the issue was not part of the survey, a natural question for O’Reilly was the impact of a recession on the progress of innovation in banking.
“That been lurking in my brain as well,” says O’Reilly. She notes that the “fortress balance sheet” concept espoused by Chase CEO and Chairman Jamie Dimon has encouraged similar thinking among some digital leaders.
“Banks like that are prepared for a recession and they are going to be able to continue to invest in digital innovation because they have the luxury to do so. They’ve already done the cost cutting they need to do, and that will enable them to focus more on what they can do that’s going to help on the side of revenue growth.”
O’Reilly suggests that history is on her side, harking back to the Great Recession.
In some ways that period is considered when fintechs found their opportunity to move into banking. Many institutions were preoccupied with portfolio cleanup, regulatory restrictions on activities, and dealing with the Dodd-Frank Act and other laws and regulations that followed the financial crisis.
But not all traditional institutions were as burdened in this way.
“In the last go-round there were banks that were in a good position and they were able to leapfrog others who had so much cleanup to do,” explains O’Reilly. “Banks that are well-positioned for a recession now will have an opportunity to accelerate too.”
Finally, she points out that under current circumstances, regulatory barriers grow flimsier, and fintechs and big tech companies keep finding workarounds.
“As regulation continues to evolve, the types of protection banks have had is going to evaporate,” says O’Reilly. “The time has come when institutions’ leaders will have to make a decision regarding what type of bank they want to be. And then go forward.”