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Jim Young and Carl Ryden discuss the increasingly popular term "ecosystem" and how having one benefits your bank. You'll learn why you need one, how to manage implementing one within your bank, and navigating through inevitable friction points.
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Financial Ecosystems: The Next Horizon for US Banks
Podcast Transcript
Jim Young: 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. I'm your host, Jim Young, Director of Communications at PrecisionLender. I'm joined today PrecisionLender CEO, Carl Ryden.
Today, we're going to talk about the concept of the banking ecosystem, what it is, why lots of people are talking about it, but also why at PrecisionLender we have a different variant of it, of that concept.
Carl, this concept isn't new, the ecosystem, we wrote a chapter about this very same thing in Earn It, put out a white paper about it as well, but recently, McKinsey and Microsoft put out their own white papers about the topic, which we will link to in the show notes. Those are two big industry heavy hitters. Why do you think they're now jumping on the ecosystem bandwagon as well?
Carl Ryden: Well, I think there's ... folks are bankers out on the podcast, so they ... a lot of them are, so the simple answer is follow the money. Right now, we're at a unique point in the history of banking over the last 20 years, I would say. Eight or 10 years prior to the downturn, many banks were in the boom years, finding ways to go and grow and go and grow and win more deals. Not really investing in technology. A lot of the technology innovations that we ... are driving all this didn't exist back then. Cloud-based services, software as a service, those things that are ... have fundamentally changed.
Then the downturn happened, they don't invest for almost 10 years because their hair's on fire. This is a quote from The Smartest Guys In The Room, the book about Enron that I enjoyed. They said, "At the end, it was like our hair was on fire ... every day we came to work, our hair was on fire and all we had to put it out with was a hammer." They go for eight years where rates are low, they're cutting costs, those things. Now, you're starting to get some relief on the horizon, the economy's picking up, the rates have risen. I think what most banks are seeing is there really is a ... You've got this 20 year period where you've invested almost nothing.
Right now, you'll see almost every bank that is in the process of ... that is in it to win it, in it for the long term, is taking that new wave of profits from rising rates and investing in rebuilding the ... what I call the brain of the bank, rebuilding their overall value chain of how they deliver things. Now you see lots of talk around the ecosystems and the ecosystems folks are putting together. You see Microsoft, you see McKinsey, BCG ... There's all sorts of articles around these sorts of things about how to think about it. I think you can see that coming to fruition now.
Jim Young: You've mentioned the phrase, "Brain of the bank," and around here, that's what we use a lot more often than banking ecosystem. Are those different names for the same thing? Or is there a difference in the two?
Carl Ryden: I think they're different slices, different viewpoints of the same thing or similar things. We actually made the brain of the bank ... we actually started with a larger concept called the commercial bank value chain. We break that value chain into two main pieces, the brain of the bank, and the heart of the bank. The heart being the core system, general ledger, transaction processing, transaction management piece, which is really not the metaphorical heart, metaphysical heart like the heart and soul. It is the physical heart, it pumps the blood, keeps you alive, you got to have it. It is largely, in terms of the value chain of the bank, probably one of the most commodity things that you do, processing transactions.
What we call the brain of the bank is really the mechanism through which you make better decisions and drive better outcome and drive better conversations with your customers, which is your CRM system, pricing profitability, origination workflow, and the portfolio management, is what we call that ... the brain of the bank. I think you're seeing a shift of in the past, folks would ... the core system, the general ledger was the tail that wagged the dog. It was what everything was bound to, these legacy type technology and legacy systems. Now you're staring to see, through the use of Cloud-based services, SAAS-based solutions, open APIs for moving stuff around, you're starting to see folks plug in and build a ... rebuild the brain of the bank.
The ecosystem concept now, the ecosystem, a lot of times when folks talk about it with that slice, they think of it from the standpoint of the set of tools and technologies and the list of things to do. Kind of the three Ts, tools, technologies, and to-dos, that you got to put together. If you only focus on those, sometimes you can buy a bunch of tools and a bunch of technologies and check off a bunch of to-dos, but you haven't fundamentally transformed the value chain of how you create valuable interactions with your customers and how you ... to quote the name of the book, how you earn it, how you earn a better return. We like to look at the slice in terms of the value chain, in particular the piece of it which we call the brain of the bank. How do we drive better conversations, better discussions, and better value for our clients, for the bank's clients?
Jim Young: Yeah, that's a good point, that you can get so caught up in checking off all those boxes that you lose sight of what you're trying to check those boxes off for, what the outcome you're trying to get out of that ecosystem that you're building. Reading both the McKinsey and Microsoft pieces, and this is honestly a thread that runs through a lot of the content out there about banking transformation, still feels like a great deal of the talk is about the customer experience and meeting the customer needs in terms of the retail banking customer. Why do you think that is? Does it matter? I mean, could you basically apply the same principles they're talking about with the retail customer and just change out the word and put commercial in there, and would it be the same thing?
Carl Ryden: I think it's a similar thing. I think folks tend to focus on the retail side in a lot of the mainstream media and a lot of the focus on the retail side. One, just because the count's higher, the number of ... in the surface area, of people it touches, is much higher. The second thing is it's easier for folks to grok. I mean, because they ... almost everybody has a retail bank account, checking account, savings account, whatever it is. Commercial is a much narrower scope, but a much higher value scope in terms of the operating income to the bank. I think there just tends to be a focus around retial stuff because you see these retail and consumer technologies in the Cloud. A lot of the stuff that first came in was marketing automation and other things that easily transfer over onto the retail side. All of that, in terms of redesigning the customer's journey through the bank, is every bit as true for retail as it is for commercial.
I think it's actually probably more valuable in commercial because you can actually ... it's less of a commodity experience by its nature. There are things in the commercial banking value chain that are fundamentally difficult by their nature. There are some things banks make difficult because of dysfunction in their process and legacy systems, whatever. Were seeing folks change that out and eliminate those things, but actually doing things that are difficult, underwriting a commercial real-estate load, underwriting a commercial construction loan, doing things that are difficult and doing them well is really the source to sustainable value, but you want to cut out everything that's not difficult. I think on the retail side, a lot of it is focused on the aesthetics, the things that bankers in the back of the bank tend to dismiss a lot. [inaudible 00:07:53] it's just eye candy. Some of it is, but a lot of that is much more of a commodity type business. Mortgages and car loans and those things.
Jim Young: You touched a bit on this next one when you were talking about why people are talking about the ecosystem, I think. The McKinsey piece says that basically, we're at an inflection point with this. It's not just everybody's talking about it, but now we're at the point where more and more and more people are going to start doing it, to the point where if you're a bank and you're not thinking along these terms and you're not acting along these terms, you're now going to be the laggard and this sort of thing, and not the fast follower. Do you agree? Is the inflection simply a matter of the economy and the fact that the banks are flush with cash now?
Carl Ryden: Yeah. I think it is. I think it's ... You've heard me say this before. In some ways, bankers ... In the south, you can say anything about anybody as longs as you say, "Bless their heart," so bankers, bless their heart, fear scheduled their day a lot because when you're a bank and you loan people money, the most you're every going to make is the interest rate you're paid plus the principal you gave them. You will never make more than that, you can only make less. It really is a fear of loss that permeates everything they do. I would say bankers quickly moved from the fear of being first and being wrong to the fear of being last and being right.
I think what you're seeing now is some banks, some big banks, and some other folks, somewhat through prodding of non-bank lenders and prodding of consumer retail stuff, you're seeing there's ... some banks move and when some banks move, I think particularly in the commercial side, your risk isn't being so much displaced by the third party. They'll nip at the edges, the non-bank lenders. If you see another capable bank competitor move, that's the threat. I think you're seeing folks start to act. There is an inflection point and that inflection point, I would say, moves from the fear of being first and being wrong to all of a sudden the fear of being last and being right. I think that's what we're seeing right now.
Jim Young: In terms of moving, the McKinsey piece also says that outside the US, in particular Europe, is moving a lot faster on this than the United States. Is that a cultural thinking thing or what do you think is behind that?
Carl Ryden: Oh, there's probably some ... Whenever you talk about Europe and the US, there's ... Yes, culture matters. There's a cultural difference. Having lived there, I can tell you yeah. Also, I think there is some regulatory background to this and probably the regulatory exists as a artifact of the culture and their attitudes towards banks and those things. Concentration among banks, there's a huge thing. There are some truly innovative banks, I think, particularly in the Nordic banks, in northern Europe, who are doing some interesting things. That spreads across Europe really fast and folks start to say, to their elected officials and to the regulators, "Why [inaudible 00:11:12] our bank ... why doesn't our bank do this thing?" I think one of the regulatory things that are really affecting that is ... I think it's PSD2. I always get the acronym wrong, but it's the regulation requiring banks to open up all their consumer data via APIs to other parties.
I think that's driving a lot of the discussion that you no longer have the walled garden where once you're in here ... once you're in our bank, we have all your data and everything even though we may not do everything we should do with it. It's going to open up for innovation for folks to take your data, layer on intelligence, blend it with other data, and actually, truly fulfill the promise of helping you manage you're financial life to a better place. That's probably prat of the marketing materials of tons of tons of banks. They do a good job of doing it on a one to one personal basis, but being able to do it at scale is what you're seeing. I think the opening up of the bank's data in Europe through the API is going to drive all sorts of innovation. The banks there know it, and so they're trying to get ahead of it.
Jim Young: Got you. Is the goal there, then, to have that ecosystem to build that as much as possible within your bank so you don't have to go outside to complete your ecosystem?
Carl Ryden: I don't think that's the winning solution. Just because of the ability for a bank to recruit and build the talent base necessary to maintain that pace of innovation. Now, I think you need to find the things that are ... When I talked about find the things that are hard, that you do well, and that only you do well, and invest there. Everything else, ask yourself, "Is this thing something that a third party can innovate faster, and can learn faster because they work with 100 banks?" That's something where you kind of get through the ecosystem. I think that's just another general trend that is moving its way into banking, it's happened everywhere, in Cloud-based solutions, in SAAS-based solutions, across the board you're seeing ...
Salesforce.com can build a CRM system and innovate faster at building a CRM system than we could have ... We do software for a living, we're quite good at it, but we could never build a CRM system as capable as that one or keep up with the pace of innovation that they keep up with, so we just get to buy it and use it and piggyback on that and focus on what is core to us, which is making software for banks when pricing loans. You got to figure out what your core is, find the hard things that you do well that no one else does well, focus your efforts there. Then make sure it connects to these other systems and stands on the shoulders of giants in that regard.
Jim Young: Yeah, that kind of fits into what ... In previous podcasts we talked about a piece that Chris Skinner wrote, and basically saying that banks should avoid trying to do 100 things average, basically. Providing a bunch of services that are not really ... that are pretty mediocre. Let's get back here a little bit to the ... I want to finish up talking about that conceptual value of the ecosystem. Is some of it really, honestly on a pretty mundane level? I.e., I don't have to ... if I've got a good ecosystem, I don't have to login to multiple time to different accounts and different solutions?
Carl Ryden: I don't think that's the single sign on type experience. In the early days of this, I think it'll make a huge ... It's a huge friction point. If you can eliminate the friction point, it gives you ... you'll get out of the starting blocks sooner and can have some ... build an early base of folks. You create value by removing friction. I think those sorts of removals of friction become more a cost of entry. It becomes table stakes very, very quickly. Then you truly have to differentiate and provide more valuable service than that. I don't think you can build a long-term sustainable position through that. It's a must-have early on, and finding ways to remove friction, I think, again, gets you down the road sooner and gives you a headstart where you can build a base of customers faster, but long-term ... And I go back to ... You've seen this play out before.
In the early days of the internet and online, solving that walled garden was AOL. It was a lot of folks who used AOL. That's where you would go, keyword AOL. You don't see that anymore. You start to see those things move out and open up a lot more where the federated login, whether it's through Google or Yahoo or Facebook or whatever, those things on the consumer side now have displaced the need for that walled garden. You would see folks move from AOL, you saw another walled garden strategy with Yahoo and again, huge benefits early on, in terms of removing that friction, but it can be arbitraged away later and negated, and then you compete on value.
Jim Young: How much of that value is ... and we talked about friction points here ... but how much of that value is, once you've built this thing out, is in improvements in efficiency versus the augmented intelligence aspect of the ecosystem? Are banks there at that ladder point?
Carl Ryden: I think that's coming. I've been involved in technology for a long, long time now. Maybe 30 years or something. You've seen quite a few patterns. What I'm seeing with making use of intelligence, making use of customer behavioral data, the right kind of data, the right way, to generate more valuable, and customized, and personal experiences for consumer, not just retail, but commercial and across the board, and even augmented human experiences to where you make your people seem smarter and more capable. I've never seen anything happen as fast as that is happening right now. I think the efficiency thing is ... there's a great book that was written by Peter Drucker, which was on ... The Effective Manger, which was, I think, required reading at Amazon.
It's a book written in 1962. One of the things they trade off is what's the difference between effectiveness and efficiency? Efficiency is doing things right, the most efficient way. Effectiveness is doing the right things. Those two things is what you have to balance. What happens, what I, a lot of times, see with banks and with companies, and Peter Drucker talks about it in his book, the focus on efficiency is, "How do I do things right and do things cheaper and more efficient and more cost effective?" At some point, you start trading off effectiveness for that, and it leaves a wide swath of ground open to your competition.
I think efficiency can't get you all there, but you can only ... You have a certain amount of fixed cost, and it's a one over X relationship, and so as you start making it more and more efficient, you kind of asymptotically approach the floor, in terms of creating value, in terms of creating more valuable experiences to folks that they will pay for, that they've ... There's no ceiling on that, and that's where effectiveness comes in. I think there definitely has to be a balance, and getting them right. Being efficient leaves room to find ways to be more effective, but efficiency in itself is a race to erase the bottom.
Jim Young: All right. Well, as you can probably tell, Carl could talk about this topic for a long time. I could listen to him talk about it for a long time. We're going to call a wrap on today's podcast for that. That'll do it. Thanks for listening. If you'd like to learn more, visit our research page at explore.precisionlender.com. If you like what you been hearing, make sure to subscribe to the feed in iTunes, SoundCloud, Google Play, or Stitcher. We love to get ratings and feedback on any of those platforms. Thanks for listening. Until next time, this has been Jim Young with Carl Ryden, and you've been listening to The Purposeful Banker.
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