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A recent piece Wall Street Journal piece - and a subsequent analysis piece by Ron Shevlin of Cornerstone Advisors - highlighted the large gap between enterprise banks and regional/community banks when it comes to spending on tech.
It's hardly surprising the big banks spend more in terms of total dollars, but they're also dedicating a larger percentage of their budget to tech investment.
Why is that, and what does it mean for the banking industry? That was the focus of this week's podcast.
Jim Young: Hi and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics in the minds of today's best bankers. I'm your host, Jim Young, Director of Communications at PrecisionLender, and I'm joined again by Dallas Wells, our EVP for international operations. Today, we're gonna talk about the growing technology spending gap between enterprise banks and regional slash community commercial banks.
The genesis of this discussion comes from a piece written by Ron Shevlin at Cornerstone Advisors. Well, Ron and our CEO Carl Ryden will occasionally engage in a friendly disagreement on social media. There's a lot of stuff that Cornerstone puts out that matches how we view the commercial banking world. The piece that Ron wrote is called The Cultural Differences between Mega Banks and Smaller FIs, IT Spend. We'll have a link to this piece in our show notes, as well as a few other related pieces.
But first let's clarify. Obviously, Dallas, big banks have bigger budgets, but the numbers that caught my eye were tech spend as a percentage of overall budget. Were you surprised that that number was higher for big banks?
Dallas Wells: Yeah. I thought it was a shocking difference. The way I looked at it, they have numbers in there for tech spend as a percentage of total assets. That's a really easy way for us to common-size this. And I think in general what we find even in talking about pricing all the time is that bankers, and especially small banks, sometimes get caught up in the percentages, and as we say here sometimes, you can't eat percentages. Those don't keep the lights on. You have to sometimes convert those back to dollar to see what you're really talking about. I just plugged in a couple of smaller bank sizes with those percentages, just so we could, as we start this conversation, just get that as context.
They list a couple of the big banks, JP Morgan and Citi. Those are not outliers. I think those are indicative of most banks of that size that we are running into. They're spending about 50 basis points of their asset size on tech spending. The smaller banks, according to Cornerstone, are spending 22 basis points, so less than half.
Again though we're talking about, well that's 28 basis points. Does that really matter? Well if you're a $500 million bank, that means you're spending about $1.1 million. If you spent percentage wise what the big guys are spending, that would be $2.5 million. So $1.4 million every year of extra spend that could go to technology. Think of all the projects that have come to your community bank and you've said no to for budget reasons. How many of those would fit in with an extra million four per year?
That's for a $500 million bank. That's pretty small. If we go a $1 billion bank, you're spending 2.2 million. It should be five. So, that's $2.8 million of extra spend. Then finally a $10 billion bank. Add a zero to that. You're spending 22 million. It should be 50 - I say "should" - to match what the big banks are doing.
So, that's a $28 million gap there. That's what your customers are starting to see. I was shocked that it was that big. I knew the big banks were, they always allocate a little more budget for this kind of stuff and treat it almost as R and D, but that is a shocking difference.
Jim Young: Ron notes that part of the reason for this is that big banks, and this is not surprising, are investing in tech that's not even on the radar of smaller banks. Blockchain type AI sort of stuff. That's why I'm curious though, if you're a smaller bank, do you just shrug that off and say, "Yeah, that's not our area. It's okay that we're not involved in this area." Or do you look at that and you start ringing some alarm bells and saying, "Gosh, these guys are pouring money into an area that we haven't even addressed."
Dallas Wells: Yeah, I think that's a fair question because if you just go with the premise that big banks spend more on tech, what they're doing, and what they have the ability to do is to take some gambles. They can put significant amounts of money into a blockchain project and then just kill it if it doesn't work. They can swing and miss on some. That's the budget that smaller banks do not set aside. They do not have money for testing things.
I think for the most part, that's okay. They don't have to do as many experiments as the big banks do, but, and we've talked about this on this podcast before, most of them call themselves fast followers, so in their mind they're saying, "We'll let the big banks play with it and kick it around and fall on their face in a few of them. When we see the ones that work, we'll jump in."
But spending less than half, you're not doing that. You're not following fast. You're doing the bare minimum that you absolutely have to. You're putting a shiny new cover on your mobile app, and the same thing on internet banking, and calling it good. You're digitally transformed. I think what you'll find, we see what under the hood what these big banks are working on. It ain't just a shiny interface anymore. These are big transformational changes that are gonna make a real difference to the customers.
Jim Young: I go a lot of times with the, maybe it's because my favorite baseball team, the Atlanta Braves, is a small to medium market team, at least according to spend. They can't afford to miss on the big free agent in the way that a Yankees or a Cubs or a Red Sox can, but at the same time, you can't sit there and just say, "We're turning a profit. That's it," because you've got to invest in your team's infrastructure, scouting, etc., etc., or risk falling farther and farther behind into eventually just being completely irrelevant. Anyways.
Dallas Wells: Yeah, and I think the point there is that blockchain stuff is, it has proven use cases, but we haven't seen really viable commercial use cases inside of a bank yet. Those things may be around the corner. Let the big banks invest in that stuff. But the AI, that's here. That's going to be a part of your business, and the longer you ignore it, the more you fall behind. The important thing to remember there is a lot of the stuff that's changing, a lot of the what I talked about, the under the hood transformations, it's data based. It's who has the best data. This is the contest that's been going on with Google and Amazon for a decade plus already. They give things away to get data because they know that the data is the path to win.
The same thing is slowly happening in financial services where the big banks that are putting these projects in place, they're getting their data cleaned up. They're putting it in data warehouses where they can use it and shift it between departments. They're getting rid of the silos. You can't just flip a switch and turn that on. You can't be a fast follower with that and expect to have something up in a quarter. It takes time. It takes infrastructure. So, that's not experimental stuff. That is putting things in place that are gonna show quick dividends and it's gonna be hard to catch up to.
Jim Young: Yeah, absolutely. And yes, I probably did make that analogy just as a way to reference that my Atlanta Braves are in first place right now.
Dallas Wells: I'll let you get that one in. That's fair.
Jim Young: Thanks. As a Cardinals fan, this is maybe not that big of a deal to you, but for me, it's pretty big.
Dallas Wells: Yeah, I'd rather not talk baseball at the moment. We are languishing in third place in the Central Division and I've already been hearing it from the resident Cubs' fans. So, we'll move on.
Jim Young: It raises the other question though of essentially can smaller banks have a, hey what can you do? Bigger banks can experiment. They can gamble on these sort of things. They've got mountains of money to pull from and we don't have that. In other words, A, it's harder for us. Then Ron references another person who's a podcast favorite of ours, Chris Skinner, and some arguments Skinner had in a recent blog post. Skinner, if you're not familiar with him, does not pull punches. Here are a couple of quotes that he had that I think, you know it's not hard. You don't have to read between the lines. These are right on the lines here.
"If you don't think you can change a teeny weeny bank, then what the hell are you doing? Massive banks are changing and they've got 1000 times the challenges you have."
Then the other quote:
"Most small financial firms I've met are ultimately constrained by the negative thinking of their CEO. This is because many small financial firms are led by a CEO who was anointed ages ago. They got the job. They've been there for years. They're not really a CEO, to be honest, but just a caretaker for the next guy."
Wow. Dallas, take each one of these quotes separately here. Do smaller banks ... They have some, I think we agree, they have some legit reasons for not being able to completely mimic what big banks are doing on the tech front, but is Chris Skinner throwing out some appropriate tough love here?
Dallas Wells: There's some truth in what he's saying. I love that Chris just says it. So many people that talk about the banking industry, they're selling to the banking industry, and so they have to be cautious about how they critique things, and Chris just says it. So, full credit there. It makes his stuff enjoyable to read. I think it's good conversation starters. So, he can start the conversation, do the hard work. The rest of us will just jump in. That said, I think he has a fair criticism with the what the heck are you doing there. The big banks have 1000x challenges. They have way more challenges than you have.
For example, we work with very large banks. They will have terminology that they use for calculating profitability returns. We in our tolls shorten it to just call it ROE. It's really a risk adjusted return number, and there's all kinds of stuff that goes behind that. But to make it clean and easy and because we're aiming at a target, we just call it ROE. Some of our larger clients will say, "We can't call it that. We have to call it BA3R2 and the two has to be like a squared." We're like, "What the heck are you talking about? That doesn't make any sense." They're like, "Look, we have had 1000 meetings with 20 people in each meeting to come to agreements on how this stuff works. You're right. It doesn't matter. It's silly. We should just use your way. It's quicker and cleaner, but that means I have to have another 1000 meetings and negotiate this all over again, and it's not worth the effort. Just call it what we call it, and let's tackle the hard problems and leave the easy ones."
Big banks have to make decisions like that about everything. If you want to change the cover on your TPS reports, it is really, really hard because it's so ingrained across thousands of people and there's a dozen different departments that all have to get their fingers in it. Whereas a small bank, the management team can just come in and say, "It's different. We're calling it ROE now. The printout looks like this. Done. I'll tell the 12 people it effects in person." So, he's right that it is a much bigger challenge. Now yes, they have bigger dollars to throw at it. They have specialists. They have project teams, but it's a whole different animal. And really at a small bank what we've found is if you have a person there who just has the gumption and they're high enough on the food chain to have the authority, a single person can push through these kind of changes. You don't see that at the big banks. So, I think that one's a fair challenge.
Jim Young: Then you, kind of getting into the next part though. He identifies the culprit here as that single person being essentially 180 degrees opposite of what you would need at a smaller bank. Do you think that's fair?
Dallas Wells: That's fair at a lot of banks. Of course, that's not a blanket statement that you can make, but we have come across our share of, I think he's exactly right. They're caretaker CEOs. They were handed a healthy profitable business and they feel like their job is to hand off a healthy profitable business. The easy way to do that when you have such a short term view, which is, I think what he's referring to is most of these CEOs, if you just look at the demographics, they're gonna be around for what, five years? They don't have a long time to hang around, so why rock the boat? Why make this really hard? Why make it where I have to put in 75 hour weeks to get this thing done and I've got to pull my hair out when I can do the simpler thing, which is let's cut some expenses. Let's sell a branch. Let's get skinny. The profits will stay the same, or maybe even go slightly up and to the right, and I hand this thing off and go play golf.
There's more of that than there should be. Now, there are plenty of banks. The one that pops to mind that you hear a ton about in the banking world is we need more CEOs like Jill Castilla, down at Edmond, Oklahoma. That is just sheer force of will and personality. She has reshaped that bank and made it a regional powerhouse. And they are going to be for the next decade plus because she's not cutting expenses. She's doing the hard work. Yes, there was some clean up and some of that at the beginning, but now big investments in technology and brand and people, that's the kind of CEO that's going to take a mediocre bank that's just plodding along, and transform it into a real winner for years to come. That's the difference and I think that's what Chris is talking about.
Jim Young: Yeah, and I will say too, as a little bit of a defense here. The back story with Jill's bank is that they were in dire need of change, so it's easier to be a change agent when everyone agrees you can't caretake. If you're a CEO and you've got a board that is telling you, "I want you to continue to churn out the same" ... They're not always, even though you talk about the power they have at a smaller bank. They're still not 100% independent actors here. If they've got a board that doesn't want to look beyond the next five years, then that can be constraining for them as well.
Dallas Wells: Yeah, I think that's a real challenge. I think that's the uphill battle that community banks face is that if you're a $500 million bank using the numbers I outlined, and you go to the board and you say, "Hey, out of last year's profits, hand me another million four," and I'm not 100% clear on where or when the return shows up. I just am pretty sure that it will. What this takes is, unfortunately, this is not a banking thing. This is a business cycle thing and an evolution of a business thing. This is somebody comes in and steals your lunch and starts taking customers from you. For a while it was Fintech painted as the boogieman. Somebody new, some new tech player was gonna come in and steal your customers.
I think what banks are starting to realize is fintech will pick at the margins. They'll take some stuff, but the real threat is a competing bank who uses that same technology, who embraces it, changes that customer experience, and they have the infrastructure of a real, bonafide bank. They're the ones that are gonna come steal your customers. Then if you're a CEO and you're not just handling this healthy profitable business, but one that, gosh I've got two years of declines and this quarter looks even worse, that's the wake up call. That's what it takes. It takes a special CEO to see that coming and be brave enough to push before that time comes. But look at bank performance. You're seeing a divergence. You're seeing some go up and to the right and some go down. That divergence, those banks have a decision to make. Are we in this for the future? Do we invest and do what it takes to become the next generation of profitable bank, or do we just pack it up and go home?
And a lot of them are saying the latter. That's okay. That's a viable option is to just sell it. It's the in-between. The longer you wait, the less you can sell it for, the more harm you do to your shareholders. That's the decision point that CEOs are facing today. And I don't envy them. It's a tough one.
Jim Young: Yeah, absolutely. Let's talk a little bit about that decision point. Ron Shevlin suggests that the path forward here is for the smaller banks to zig a little bit when the bigger banks are zagging, and to focus on redesigning products and services instead of things like efficiencies and cost cutting. Is that the advice you would give?
Dallas Wells: Yeah, I think Ron is right on with this. Which is that a lot of that investment the larger banks are making is about efficiency. I don't think there's any secret that they're saying, "Hey, if we can make a piece of software carry that data from point A to point Z, all those people that are keying it from B on down the line in between, those people can go home. So, a lot of that investment is about efficiency. Community banks can't win that game. You can't out-Walmart Walmart. You can't do that on the scale that Citibank can do that. What you can do, though is you can have a really great understanding of your customer. Use data, use your people, use the relationships you have and build these very customer centric products and services. Invest in that.
Early in my banking career, I had a CEO had a good gut feel for this. I brought in a system that I wanted to buy, which was pretty common. I always wanted to buy new stuff. So, I brought it into him. I did my little pitch. He said, "Hey, it looks great, but we've done five things this year and all of them are internal. Bring me something that the customer can touch and feel." He wanted something with some direct contact. I think that's the bad habit the banks have gotten into, is everything's internal. Everything's about efficiency. Those things are important. I'm not saying you shouldn't do them, but things that the customer can directly feel, if you have limited dollars, start there. The rest of the stuff you'll get to after you have happy customers.
The part that's important though is that sort of what I started with. You can't just put a shiny cover on something and call that good. That's not customer centric. It's the operational things where when a customer comes in, when a customer picks up the phone and calls, when a customer logs in, they see consistent reliable information and they can do what they need to do from whatever channel they want to. That takes real investment in infrastructure, but it is for the customer. It's not to get rid of employees. It is to make things better for the customer. That's Ron's point and I think he's dead on with that.
Jim Young: Yeah, and it is doable on a smaller scale.
Dallas Wells: Absolutely.
Jim Young: All right. That'll do it for this week's show. A reminder, if you want to listen to more podcasts or check out more of our content, you can visit our resource page at PrecisionLender.com, or you can just head over to our homepage to learn more about the company behind the content. Finally if you like what you've been hearing, make sure to subscribe to the feed in iTunes, Sound Cloud, Google Play or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this has been Jim Young for Dallas Wells. You've been listening to The Purposeful Banker.
What's Next ...
To learn more about why this is a critical juncture for tech investment, check out "Four Reasons Why Now Is the Time to Modernize Your Commercial Bank Technology."
About the Author
Jim Young, Director of Communications at PrecisionLender, is an award-winning writer with experience in a range of positions in media and marketing, from reporter to website editor to content marketer. Throughout his career has focused on the story – how to find it, how to understand it, and how best to share it with others. At PrecisionLender he manages the many ways in which the company shares its philosophy on banking and the power of relationships Jim graduated Phi Beta Kappa from Duke University and holds a masters degree in journalism from Columbia University.More Content by Jim Young