Change is a constant, the saying goes. But perhaps not so when it comes to financial services. For institutions such as banks and other firms of size and scope, names (and deposits) have been built on careful aversion to risk amid asset accumulation.
That may have to shift a bit in a world where technology is changing how we do business and transact across the globe.
In an interview with PYMNTs after a webinar by the pair titled, “Financial Services Innovation — The Risk of New vs. Nothing,” John Epperson, principal at Crowe Horwath LLP, and Jason Henrichs, managing director at FinTech Forge, discussed the challenges and rewards of embracing change, even as firms are mindful of what works.
Data show that when it comes to innovation, more than half of respondents at the webinar said they were in the midst of initial or elementary stages of technology deployments.
Said Henrichs, “I’m a little surprised by how many people actually said they were” this far along, and “we kind of questioned how many people are raising their hands because they don’t want to be the kid in the classroom who would say they are not actually making moves already.”
“This is a really hard shift,” he said of financial services, “from the front lines of tellers to the back office to the presidents and CEO and boards of these banks and financial institutions.”
The fact remains that the industry at large, he continued, “has a zero-fault tolerance,” and when processes and technologies are built around that mindset, innovation is challenged simply because there is “no way to do something new and succeed at it 100 percent of the time,” especially when using technology to solve problems.
Added Crowe Horwath’s Epperson, “It’s just hard” to embrace innovation in a culture “that perceives a five percent loss on anything as catastrophic.”
Within financial services, there’s an analogue to the technological evolution that brought us the mainframe, then the desktop and more recently the mobile device.
Henrichs noted that the analogue has been where “banking exists in branches, and you go in and deposit your check and take out cash … Then it became, “Oh, I can do more things online, and I can actually upload my own ACH services,” and where it ultimately ends up is the overarching question: “What is a bank?”
FIs as a Means and Not an End
The key issue that many in the industry forget, Henrichs says, is that “we are a means, and not an end.” People are less focused on needing a bank itself than they are with the concepts of needing, for example, somewhere to store money and somewhere they can get money to buy a house.
Banks are not headed toward extinction, he said, but some of the services are branching away from being the purview of a bank. Referring to those services, Epperson says the perspective outside the industry has been that financial services as a whole has focused on the user-facing products and services and on headlines generated by apps and the way payments are done.
But, fundamentally, he continued, there is an archaic quality to the back office within the traditional financial institution. Mainframes still underpin operations, he said, and digitalization of processes could help those offices be nimbler.
Other firms have been entering financial services, Epperson says, and they have been at ease with digital technologies and able to compete with speed and agility. “I think one of the fundamental challenges in the traditional brick-and-mortar space is a focus and an energy on replacing and updating back-office technology.” Expanding on that, Henrichs says that some of his own firm’s banking clients said that “it’s not fair … if [FinTech firms] met the same compliance and regulatory standards that we did, they wouldn’t be able to" innovate in the way that they do.
There is some truth to that, but the reality is that a lot of these innovators … take a fresh sheet of paper and they say, “Wait a second. Just because this is the way we have always done it, is that the way we have to do it going forward? What if we start working backwards, not from the solution we have but from the problem we are trying to solve?”
It is all too easy to sidestep the back-office functions, Henrichs says, in favor of the sexiness inherent in developing a new app. Though the excitement may be on developing nifty features geared toward millennials, he said, it may be in fact more rewarding to focus on “know your customer” (KYC) and why it is a challenge to get payments to move a bit more quickly.
“There are some fundamental infrastructure-level things” that are holding the industry back, he says.
Though there need not be a specific order to change and innovation, some parts of a firm’s structure and makeup, Epperson says, may have urgency over others, and “I, personally, would put culture first.” Financial services companies “have lived in a mentality and a process” that doesn’t understand innovation, and “as we adapt a broadening ecosystem with a lot of different players” refocus is important. Turning to compliance, he says, “Regardless of the statutory requirements, compliance is good business” and can help foster healthy cultures within an organization, all while keeping risk and risk controls in mind.
Re-Examining the ‘Culture of No’
All too often, Epperson and Henrichs say, there is a “culture of no” in an organization, especially within risk management. Illustrating the concept, Epperson says, “the way we treat risk is the way we kill a mosquito. We torch the entire earth.” Part of that overkill can stem from the nature of the tools at hand, but fundamental changes come, he says, with looking at “how do you reward behavior? How do you reward some failures, and how do you penalize certain behaviors that are not in context with risk and compliance?”
In other words, risk and compliance can become strategic, when today it is the “office of no” because it is the last check mark on a new initiative. Risk and compliance officers, Epperson says, should have a seat at the corporate table when it comes to strategy and multi-year plans governing where firms are headed. Risk and compliance personnel can also be a boon in the marriage between people and services, he continued. “They can innovate the compliance risk out of products,” he says, instead of being the last stop in the process.
The “’no’ mindset” that is also the hallmark of risk and compliance, Henrichs says, is one that can also be catastrophic, as firms are ultimately “completely blindsided” by something they cannot see (such as, perhaps, a game-changing technology or consumer behavior). Thus firms should also be scrutinized on how they respond and react when new challenges arise and what can be done differently.
“The idea is rewarding the learning,” said Henrichs,“ as opposed to rewarding the complete avoidance” of risk. Epperson says that one way to look at innovation in risk is through “a flow of funds perspective” which is marked by certain regulatory requirements and corporate responsibilities in a payments ecosystem. “If you are structuring a deal with 10 different parties,” he said, “what types of risk and compliance activities are the responsibilities of these parties?”
Technology is important for sharing data, Epperson says, but a seasoned risk and compliance analyst at the table when structuring the deal can help thoroughly vet the overall efforts tied to compliance and oversight and the returns on investment therein.
Regardless of the corporate department, Henrichs says the most immediate challenge facing any firm interested in adaptation is removing friction. Part of that friction is front-office based, but a lot of it, he says, is also back-ended. Many of the traditional financial institutions, said Henrichs, have been doing something right, as “they have been around for a really long time.” They also enjoy stability and trust.
The world, however, is evolving quickly for individuals and companies. For workers, the expectation is that interacting with [business] technology is going to be an experience that is a lot like interacting with an iPhone. That spells friction for the scores of people in the back office, spread across any number of risk functions. Against this backdrop, Epperson says, many firms have endeavored to layer apps on top of mainframes, working with and driving the concepts of artificial intelligence and machine learning, which can help operating efficiencies and margins.
Henrichs says the path toward that automation comes as officers look at fraud and KYC, and in tackling those two areas may decide they are also “going to hit AML.” These are areas that are rich with data, he added, but the means by which that data is collected demands greater focus.
Among key challenges to innovation as discovered by the webinar? Epperson said 45 percent of the audience said that it was risk and compliance, and legal, that hold back companies from innovation. “That’s surprising,” he said, “because I would have expected even more. The conversations that I have had,” he said, “have always been pointing fingers at risk and compliance.” But in defending the compliance department, Henrichs stated that mindsets that slow innovation “start at the top of the house. A lot of what we see is the CEO smacks the table and says, “We need to be more innovative,” and then turns around to risk and compliance and says, “Make sure we do not take on any more risk.” Those two conversations are taking place [apart] from each other and … are bound to fail”and are full of tension.
There can be a “lowercase ‘I’ in innovation,” Henrichs said, noting that gradual rollouts of new products and processes – and especially in-depth testing of those rollouts — can yield dividends. Financial firms, in the end, need to delve into the minds of their customers, discovering how they think about their problems and how they talk about their problems.
“Some of the banks have competitive advantage,” Henrichs said, “because they have data” and can start to examine it. He noted that the code that you begin writing in machine learning is not actually the algorithm you end up with.” In the end, he said, companies must adopt “a Darwinistic approach to innovation.”
“New ideas,” he said, “must be released into the wild to see which ones survive.”