When the next economic downturn eventually comes, will your bank be ready?
In this episode of The Purposeful Banker, PrecisionLender CEO Carl Ryden and 11:FS CEO David Brear discuss the strategies banks should employ to go beyond just weathering the storm, to actually prospering during tough times.
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Transcript:
Maria Abbe: Hi, and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the minds of today's best bankers. Today's podcast is a conversation between PrecisionLender CEO, Carl Ryden and David Brear, CEO of 11:FS, the London-based fin tech consultancy and digital bank builder. With a few guiding questions from our host, Jim Young, Carl and David talk about the R word, recession.
No, you won't get any economy predictions from the episode, but you will get some great ideas on how banks should prepare for a recession and how the best banks can actually turn tough times to their advantage. Enjoy.
Jim Young: David, thanks so much for coming on the show.
David Brear: Yeah, no problem. Thanks for having me.
Jim Young: All right. This is going to be one of those podcasts when Carl and a featured guest are on where it's just my job to get out of the way, but I will start things off with the first question. David, is it about being out in front of a recession, being able to predict when it's coming, or is it about, for banks, what you do once a recession hits?
David Brear: Tough question, right? Rock or a hard place to a certain degree, but I guess from my perspective, I think it's probably most, what do you do? I think the ability to predict precisely when those things are going to happen is, when is and where is lightning going to strike? I'd say mainly it's your ability to react to the situation and adapt to the circumstances that it's in. That really sort of feels like it's most important for big organizations to really sort of deal with those situations, I'd say.
Jim Young: Carl, do you have any thoughts on that? I mean, when you're talking to bankers, are you advising them on sort of whether they should try to be the fortune teller here or just be able to react quickly?
Carl Ryden: Jim, you know I have thoughts on things, all sorts of things. That's just the way it goes, but I mean I think ultimately what you're seeing right now in banks is, particularly in the US, and David can talk ... It's probably different in the UK, but in the US we've had a long economic run, positive rising tides lifting all boats.
Right now you're starting to have some banks really get a little bit squeamish. I think for us in the US, the inverted yield curve that occurred earlier this year, late last year, kind of spooked some folks because that's typically a precursor to a recession. There's a lot of argument that things are different this time, but also I think there's always this uncomfortableness, I think, when we have a long run of good things. Bankers, by their nature, are always like, "The other shoe's getting ready to drop. Something bad's getting ready to happen." Even the smallest little thing now calls those folks to retrench.
I think the key thing is not to overreact and kind of, as the old saying goes, don't fight the last war again right now, but ultimately I think it does make sense to be prudent and think about how you position yourself best for the downturn, if there is one, but still get to participate in the upside. I think you're seeing folks start giving that some real good thought. I talk about the rising tide lifting all boats. Another quote, I think it was actually Charlie Munger who said, "When the tide goes out, you find out who's swimming naked."
When things go bad ... Typically when things are going well, all the banks are getting better or they're about the same pace. When things start to go bad is really when they start to separate and you can make up ground on your competition. The things you do to prepare to take strategic advantage of that are really important, moving to lower cost origination channels, digitizing the bank, all these things that are ... You can actually make a positive case for doing them in good times, but actually if you look at them, "Okay, how do we do this, and how's it going to help us make up ground on our competition, make up ground on our other banks, better serve our customers?" Through that time, that's where you really build loyalty, where you really build a brand and really where you take share and lock it in from your competition.
I think we're seeing a lot of folks take a lot of proactive measures towards that. One of the things we'll touch on maybe later is one of my favorite folks ... I don't know if David, if you've ever read Nassim Taleb's book "Antifragile"? It's a great book. The idea is the opposite of fragile is not robust or impervious to change. Antifragile is the opposite, where when things get crazy, you actually get better because of the craziness. I think trying to think about how you build that antifragility into the bank is really helpful.
David Brear: Yeah, I can definitely see that. I think it's a difficult one, isn't it? Because on one hand, this isn't a zombie apocalypse we're trying to prepare for. It's not building a shelter under our houses and filling it full of cans of food. This is something that we've seen before.
The sort of financial services and the cycles that financial services go in by nature will go up and down as different sort of factors sort of play out. I think it's prudent to definitely sort of plan for an occasion where the economy is not growing at the speed that it would be in kind of a growth environment, but equally I think the things that banks would need to do to most efficiently prepare themselves for it, mostly from my mind are really about good, prudent business running, because things that actually are most scarce when it comes to the times of real depth of recession, in the same way as they are in war times with food or water, are really the things that people get really sort of obsessed about.
If you kind of look at the sort of prudent ways in which banks of all sizes really these days should be running, it's only a lack of focus on really restructuring from an OpEx perspective and actually running the operation incredibly efficiently that potentially could get in the way of them really surviving a downturn. I think it's an interesting one. I think there's almost the luxury of we're, what, 10 years into a 7-year cycle when it comes to the the likelihood of a recession? The idea of really sort of preparing for this imminent doom, if it's used as a good catalyst for people really getting together on delivering the types of things that really add value to consumers, but fundamentally really getting their back office in order for structuring, for cost efficiency and repeatability when it comes to processes, then, I mean, whatever excuse people use, that sounds like a pretty good one to me.
I think you're on to something there. Ultimately, a lot of the things that you're going to do to prepare for a downturn versus the things you're going to do to just ... They're good, hygienic things for the bank to do, period, right? No matter what situation, they're a lot of the same things. Ultimately what happens though is in the banking world, I always like to say this, kind of fear schedules their day a little bit. When you make a loan to somebody, the most you're ever going to get repaid is the loan and the interest to your promise, so your upside is capped. It's all about eliminating the downside. A lot of that exists within the bank.
In some ways, putting in place the digital service channels, putting in place the digital low cost customer acquisition, putting in place the methodologies around pricing and profitability and those things, and knowing where you're deploying capital, they're all good things to do. What happens is it's actually easier to get them done within the bank just from a motivation standpoint to say, "Hey, we're doing this to prepare for the downside." Reducing ... Fear of loss is actually a more powerful motivator within the bank than chasing upside in a lot of cases. A lot of times, like you said, I think a lot of things you do are the same.
Yeah, I think definitely the fear of loss, definitely in bigger organizations, because they have all of the customers, don't they? Actually the successes over the last 100 years to get them into the size of a Wells or a Bank of America or a Citi, actually the loss of that is much more of a driver than creating new capability or moving things forward. It is interesting what motivates different types of organization to do that. Obviously if you're a startup, you've got little to lose. Your motivation actually is taking advantage of the climate and evolving as the situation develops essentially.
Jim Young: When you're talking about fear ruling the day, and also David, you mentioned sort of that whole kind of storing up for the zombie apocalypse and that sort of thing, the idea of a recession, Carl, I think you mentioned, as an opportunity and not something to be endured and survived, not storing up everything for winter and just living off of that, but rather actually looking at it as, "This is a chance for us to move ahead in the market," how hard is it to convince bankers to think that way? For the ones that do, what's sort of the common traits you kind of ... How do you sort of know when you've run across a bank that is looking at it that way, as an opportunity rather than simply something to be endured?
David Brear: I think to Carl's point, actually convincing people to do anything other than what has got them to the success that they have today, is really, really difficult. To the point around using, do you use the carrot or do you use the stick, then different people in different levels of the organization need to feel different types of motivation to sort of really sort of face into these things. I think when it comes to, particularly as a recession, I think big banks, to Carl's point, will see this as the zombie apocalypse moment of actually making sure that they've got enough cans of food to weather the winter, as it were, but really I think it's ... You sort of point to any sort of model that kind of looks in this. Anybody who merely is looking to survive is probably not much of an existence in the first place.
I think the often misquoted points around evolution, that it isn't really the survival of the fittest, but it's those that are fundamentally most adaptable to change that actually survive. Really, I think that's the thing that when you look at the organizations who are really investing sensibly ahead of what is inevitably going to be a downturn, for me, it's those that are really looking at rationalizing of monolithic architectures. They're rationalizing of the change that we've kind of seen from the analog world to the digital world, and fundamentally what does that mean in terms of the structure of their organization and actually how they're set up? Because we haven't said fin tech yet, but really what fin tech has sort of shown big organizations is that the reality of their sort of world has changed so dramatically and what can now be done with 15 used to take 1500.
For me, the ones that you sort of see who are fundamentally changing how they do change and actually sort of changing the level of value that they believe that they need to actually offer to the customer, because in a changing world, those who add the most value to consumers I think are ones that most likelihood of sort of survival and thriving, if that makes sense.
Carl Ryden: Well, when I think about ... David mentioned about the 7 year cycle and we're 10 years into it, but it's interesting, where does the 7 year cycle come from? There's a lot of anthropological studies around this, around why is it seven years and those things. Why is that a thing? I think it turns out one of the jokes, but I think there's truth in it, is that seven years is about how long it takes an organization to forget where it was.
It may be that there's two things, the depth of the downturn in 2008 and 2009, it's harder to forget. We've been able to go longer because people are worried about it. I remember in 2006 when banks were ... There was a lot of crazy things I would see going on in banks and you go, "This can't last." Right now, at least, there is some worry and I think that's good.
I think the other thing that allowed it to extend a little bit longer is the the fin tech threat, because I think the fin tech threat has at least caused some large banks and other banks to invest in these things, as opposed to when times are good, you strip out as much as you can, boost your dividend, jack up your stock price, but don't invest in the fundamental technologies and fundamental capabilities that better position your bank. I think the fin tech guys have actually forced some level of investment in core operating issues of the bank and the core value propositions of the bank, which is probably set them up well, but I also think that, again, doing more of that, taking the time and the money that you're earning right now and using it to invest and position yourself better, where you can more efficiently create better customer experiences in the downturn, provides you a strategic advantage that is really going to allow you to gain share.
I think folks who ... I see a lot of banks and bankers, not a lot, a good number of folks even within large banks who think of it that way. I think helping them realize that and communicate that is really pretty powerful.
David Brear: I think that's a really interesting point around the ... Since 2008, the changes that we've seen haven't just been in those large organizations that were affected by it. We've seen such whole scale regulatory reform since 2008 that actually, fundamentally the environment, the ecosystem that is financial services now is a very, very different place. I think we've gone from people measuring once a year to the regulator playing such a close attention to big organizations and new organizations in the whole sort of landscape. It's forcing a different cycle this time. Definitely if you look from a UK lens perspective, the regulatory change here and the competition mandate that's actually been sort of brought through has really sort of brought about a very different level of stability, I'd say, within the ecosystem in its broadest sense.
Really that's, if I'm honest, I feel like that's just being felt in other geographies. A lot of the things that have happened now within HKMA over in Hong Kong or with MAS over in Singapore, and actually with places like the Fed in the US now, the changes, even the Department of Treasury for the US ... An event that I was at with the FCA last week, we're talking about actually the cycle now just being so dramatically different because of the amount of scrutiny that the entirety of the system was in. In a way, if you've ever been pulled over for speeding, you drive at the speed limit for the next six months, exactly at that limit type thing. Then it feels like the whole industry is probably acting in a very different way than they were pre-2008.
Carl Ryden: Capital levels right now for banks have never been higher. The characteristics, if there is a downturn, of this next downturn, have to be different than the last one just because structurally, not just from the regulatory oversight that's been put in place, the psychological piece of the speed limit, but there's now more cops, actually more police actually policing the road. They probably set the speed limit down to 45, down a little bit lower. You see banks incredibly well capitalized right now. Again, I do think you're going to see less just complete failures, but I think you're going to see there still is a lot of room to be gained.
Jim Young: We've talked a lot about this from a tech perspective. I wanted to shift a little bit to the front lines. An article that really spurred a lot of this conversation was from Bain called, Is Your Sales Organization Ready for the Next Recession? It cites some stats and argue for really preparing your sales team for that. It seems to me like I can see sort of that logic if you're thinking digital transformation and planning ahead, but what if my sales team is just ... It's keeping its head above water right now. It's not, for all we've talked about, a great economy. We know about margin compression, et cetera, and every banker we know tells us it's super competitive. If they're focused on the here and now and just trying to hit this quarter's numbers, how do you get them to focus on their sales approach, what it should look like for a future environment that may be around the corner or may not?
Carl Ryden: Well, I think you also have to ... The sales team, particular on the commercial side, that's where you really have a sales team. A lot of folks today are offering digital banking and those things, but it's also true there, I think, but the sales team generally has a great deal of momentum. They're out winning deals and winning the deals they can win. A lot of times those deals ... The sales team at a bank is, a commercial sales team, is compensated solely on volume, right? They win as much as they can win. They grow. It's interesting because in the street, I think Wall Street in the US in particular amplifies this, but I think it's true also around the world, what they care about is loan growth in them until they don't care about loan growth in them and all they care about is loan loss, reserves and capital, right?
That's kind of the shift of focus every 7 or 10 years or something. I think what you need to think about is when your sales team builds that momentum of winning, winning, winning, and loan growth, and for them it's easy to do longer term deals for riskier credits and you get more of them, but what do you do ... How do you set them up to make sure that they're saying no to the right deals? How do you make sure you're not piling on the particular types of deals that would be sensitive to a recession and cause the capital and loan loss reserves, because what happens is what freezes out a bank is asset quality issues, right? When the loan loss reserves and the capital stuff start taking over, all investment falls zero, and the banks that can continue to invest and continue to grow and better serve their customers are the ones that take share. Coach your RMs and your sales folks and align them around, "Let's make sure we're winning the right deals, make sure we're saying no to the right deals."
Then when you do that, I think you start building some amount of discipline in there and maybe even start thinking about things more than just volume. Think about the risk you're putting on the balance sheet and how you're positioning the balance sheet for what might be a potential downturn. That doesn't mean shut down things or raise credit standards across the board or any of those kind of blunt force instruments, but it really means kind of tilting the table towards the ones where you can have really responsible and profitable growth that's going to allow you to continue to invest. I think that's the key thing is continuing to invest on behalf of your customers to make their experience better and the thing you have to protect.
David Brear: I completely agree with that. I think it's one of those ones where, to your point really, salespeople will pretty much do whatever they are incentivized to do. I think the last recession probably showed us that if people are incentivized badly then bad things happen quite quickly. I think the other trait of good salespeople are they will understand what it is the needs of the people of that they're actually sort of dealing with. In order to sort of continue those cycles, then the people who understand their clients best, and whether that's through data or whether it's through the relationship that they can create with them, have a much greater potential of kind of navigating any sort of downturn.
I'd say that maybe something that organizations could look to do of to try and mitigate those changes, because I think anytime there's a sort of stutter step from an economy perspective, the sales force and the sort of mentality of the people within that organization are usually the slowest thing to kind of react to the new world, but when it comes to the types of things that people are making decisions on, then I mean, this plays so beautifully into the digital world for me because the more things become automated, standardized and actually even things like risk modeling, being an able to be sort of managed and controlled centrally, then actually your ability to dial up and dial down risk from an acceptance criteria perspective, or even down to the types of business that you really want to sort of underwrite, become a lot simpler, that it's not down to just frontline salespeople making decisions about sales, that actually what we're doing is we're supporting people with technology to make the most informed, most accurate decisions.
At that point really, the delivery mechanism for them could be a human, could be an app, or could be anything you want it to be, but ultimately that means consistency in the decision making for organizations, which arguably is another weapon for removing any of that uncertainty or a disproportionate level of appetite for risk in some people as opposed to others. Definitely that's what we've seen with some players over in Europe is really how that standardized modeling, even if it's delivered by a human, can really sort of lead to a much more consistent and much better sense of change when those gears start shifting.
Carl Ryden: One lesson to add on that, I think you're much more likely to be working on behalf of your customer and their success as opposed to against it. If as a bank you think there's some chance we're heading to a downturn, there's actually a really good chance that what a lot of your small business customers, and even medium sized business customers, might not need right now is increased leverage and more loans, right? What they might need is other things. You actually think on their behalf a little bit and actually start solving their problems. I think, the dream world for me is where we had the intelligence and the tools within the bank to then arm our relationship managers to have those conversations and our salespeople to have those conversations with their customers, and actually set their customers up for the downturn. If you set your customers up to survive and do well on the downturn, you set the bank up to succeed in the downturn as well.
Sometimes the momentum of the sales team of more loans, more loans, loan growth's important, actually encourages your sales team to do things that are not necessarily to the benefit of their customers and the bank's customers. Ultimately that's not a good recipe for success for anyone.
Jim Young: Final question here. David, I'll turn it to you on this one. The last part of the Bain article is sort of going through its listing of how to get your organization ready for the recession. It says as the title, "Start small, fail fast." From a tech perspective, you nod your head, "Well, of course. That's the way these things work." That's all well and good, but does that really apply to a bank, and particularly a large, global bank? We're talking about the whole turning a luxury liner or turning an aircraft carrier. Is it possible for them, when it comes to this sort of stuff, to start small and fail fast?
David Brear: I'm not sure banks really understand what small or fast really is. That's sort of the problem really in that statement. When people sort of say fail fast in most big bank organizations, then big programs are, 3-400 million and they're 3-4 years long. The idea of failing at anything that they do is potentially hundreds of millions of dollars sort of down the toilet when it comes to failure. I think the other thing to kind of point to there is that if you go and talk to the FCA or the Fed about what failure is, then actually it's a very different sort of connotation than actually what the banks or the financial services institutions themselves consider failure.
For me, if this really sort of gets to the crux of the problem and the change that we're really sort of seeing in the environment right now is in sort of a digitized world where everything is kind of a proxy of what has gone before it, where you're seeing paper-based capability just being digitized into websites and mobile apps, then with that it has sort of been brought the cadence of everything costing a lot of money and taking a lot of time. In the new world of a truly agile organization where your ability to decide to do something, do it and have it in the market is weeks, not years, then actually your ability to do something and be wrong and change it is a fully expected and tolerance that you sort of come to live with.
I honestly think the difficulty is really getting the banks into the mindset where actually they don't place big bets. It's a move away from, "We're going to put all of our money into some sort of machine learning AI thing that solves everything and fights off the inevitable zombie apocalypse or whatever," and actually moving to a point where they get that sort of real sense, I think, of emotional intelligence to know that they're not always going to be right. With that ability to do smaller things and continually test and learn, I think the biggest proving point for me on this is the amount of organizations that start a program and then midway through the program realize that actually the world has changed and the thing that they're doing is no longer relevant.
I've seen this so many times with so many organizations spending billions of dollars to get there. It's a real weird thing. We say the biggest risk to your project is getting to the end and nobody caring. The more people can isolate things and do them at a very cost effective manner and a very quick way to actually put them in the hands of people and actually understand whether they care or not, that really encapsulates the digital worlds that we're kind of moving to. Test and learn in a startup sense is just a natural habit that you do. In a big organization, it's just an alien concept.
Carl Ryden: The start small, fail fast, the thing that I hate is the fail fast. All these kind of memes or mantras that get out there that embrace failure and all ... That's stupid. Failure is a means, not an end. It should be start small, learn fast. You tolerate failure to optimize the rate of learning. I think David touched on this in his things about ... He didn't say test and fail. He said test and learn, right? The goal isn't failure. The goal is learning and maximizing your rate of learning to minimize the chance that you get to the end and nobody cares, right?
You tolerate failure. You want to manage it so that if you need to have small failures, to optimize the rate of learning you do, but I see a lot of folks go, "Well, we need to embrace failure." Well, that's just a dumb strategy. I'm like, why would you embrace failure?
Failure sucks. Failure is tolerated because it's necessary for learning. Then my goal is to learn as fast as possible and learn as much as possible about the needs of the customer and how do I best serve them. If you say, "I'm going to optimize ... " Failure is a means, not an end. One of the things that gets confused here is people embrace the means and forget the end. The end is learning.
David Brear: Yeah, I completely agree with that. I think if you look in other walks of life, actually in a sports context, you don't make every shot you take, but if you don't learn from that in terms of the technique that you do for these things, or where on the court you take a shot or when it's better to pass than it is to shoot, then all of these things are learning opportunities to move forwards, but at the end of the game, you're still looking to win.
Actually, if the failure is so catastrophic, then actually it risks the chance of the organization to actually succeed or not. It is neither small and it is neither fast at that stage.
Jim Young: Okay. Well, I think that's a good point. I know you two could continue going on talking about these topics for a long time, but I think this is probably a good spot for us to wrap up this show. David, thanks so much for coming on.
David Brear: No problem at all. Thanks for having me on.
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