Banking in the Age of Innovation. Uh-Oh…

by Jack Milligan

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I believe there is a strand of conventional thinking (I hesitate to call it wisdom) that considers banking to be a highly regulated industry offering little opportunity to innovate. I would agree that JPMorgan Chase & Co. would be restricted from, say, buying Google because of prohibitions built into the Bank Holding Co. Act of 1956 that forbid banks from engaging in non-banking activities. (Of course, with a market capitalization of approximately $362 billion, Google would be more likely to acquire JPMorgan, whose market cap is a mere $243 billion.) The definition of what constitutes a “non-banking activity” has been stretched down through the years by subsequent federal legislation (banks are permitted to own securities firms and insurance companies, for example), but clearly a community bank would not be permitted to acquire a local car dealership because it wanted the inside track on offering auto loans to the dealership’s customers.

Building a Culture of Innovation

But there are still plenty of opportunities to experiment within banking’s permissible range of activities. Earlier this month my colleague at Bank Director magazine, managing editor Naomi Snyder, wrote about Wells Fargo & Co.’s Startup Accelerator program in which the big San Francisco-based bank makes investments of up to $500,000 in early stage technology companies that are developing ideas Wells Fargo might eventually want to incorporate into one of its own businesses. In addition to the funding, companies that have been accepted into the program are mentored by one of Wells Fargo’s many business units for six months. In effect, the business unit is a product development guinea pig. Wells also takes a small investment stake in the companies, although Bank Holding Company Act restrictions limit these to less than 5%.

In September of last year, I wrote about a program at Bank of New York Mellon Corp. where the bank also tries to encourage innovation, but in this case among its own workforce. In 2009, the company established a pilot program to review ideas submitted by its 10,000 employees. That first year the bank received over 1,000 ideas that generated about $165 million in pretax profit. The program has grown even larger since then – it now includes several elimination rounds with the finalists traveling to the company’s New York headquarters to make a five-minute pitch to a panel of judges. The winners receive both a cash award and the opportunity to leave their current jobs and join a company-run incubator where they get the chance to develop their idea to operational readiness. Since 2009, the program has generated over 13,000 innovation ideas.

Of course, Wells Fargo and Bank of New York Mellon are large organizations with enough resources to spend freely on this kind of activity. Or at least, that’s probably the excuse that many smaller institutions would use to explain why they don’t have the time or money to innovate. Except that they do, on an appropriate scale. I’ll point to one area that is exploding with innovation right now – mobile banking. The cellular phone could very well end up having an even greater impact on banking than the Internet did a couple of decades ago. In January 2014, the usage of all mobile devices exceeded personal computer usage over the Internet for the first time. Many financial technology companies are using smart phone apps to crowd into the payments space and peel off market share from traditional banks that have been slow to embrace the mobile revolution.

Can you guess which U.S. bank was the first to offer mobile phone picture bill pay? The answer is First Financial Bankshares Inc. in Abilene, Texas. With $5.8 billion in assets, First Financial is not exactly a small community bank – but it’s not $1.7 trillion asset Wells Fargo, either. At Bank Director’s recent Bank Board Growth & Innovation Conference in New Orleans, Dave DeFazio, a partner at the consulting firm StrategyCorps, gave a fascinating presentation on how banks can increase customer usage and build loyalty by including a wide range of popular consumer apps in their basic mobile banking offering. This struck me as a no-brainer because it doesn’t cost much and puts the bank at the front edge of the most important development in retail and small business banking over the last 20 years.

I wrote in my last blog – “Beware the Fintech Raptors” – about the emerging financial technology companies (hence the term fintech) that are beginning to challenge traditional banks in many of their core lending and payments markets. Innovation is to these companies what flight is to a raptor: It’s what they were born to do. Traditional banks need to pay attention to what these new fintech companies are up to and find ways of competing with them in the innovation arms race. There is still value in a bank charter, but that value could decline over time if traditional banks allow themselves to become the equivalent of an Internet dial-up service in this new Age of Innovation.