Sitting through EBCG’s “Phoenix 2016 FinTech Conference for CEE” in Prague, this correspondent found it hard not to sympathise with the consensus that traditional banking is in its death throes after he had to dash out for an appointment with his bank over why his mortgage is a third more expensive than a competitor’s, travel 45 minutes by tram and bus to the bank’s HQ in a dismal concrete cluster of grey modernist buildings across town, only to be told by the bank rep that she couldn’t possibly give out any information because he didn’t have his passport with him.
There’s certainly ample and growing evidence that banks around the world, not just in Central and Eastern Europe (CEE), are ill prepared for the “perfect shit storm that is about to hit us”, as one banker at the financial technology (fintech) conference confided to bne IntelliNews.
Yet it’s not as if the banks haven’t had time to prepare for the deluge of smart, innovative, flexible firms looking to eat away at their intermediary role in financial systems; it’s more than 20 years since Bill Gates predicted the demise of banking by noting that in the future we would need banking, just not the banks. But like many industries that spy on the horizon a disruptive wave approaching, for many years the banks have taken half-hearted steps to ameliorate the effects of it, only to realise that a wave gathers pace and height as it approaches the shore, leaving those defences looking woefully inadequate.
There is a growing sense of urgency within the industry now, as the banks – like the humans in Philip K. Dick’s novel from which we take our headline – re-examine exactly what it means to be a bank. The industry’s legion of critics say they need to come up with ways to restore the trust of consumers, defend themselves against the new competitors, and avoid commoditisation and becoming “the next dumb pipes” of the financial system, as one banker put it. In essence, to borrow a line from Philip K. Dick’s “Do Androids Dream of Electric Sheep”, the banks must decide whether to “Emigrate or degenerate! The choice is yours!”.
Abracadabra! business disappears
The speed with which the fintech wave is crashing through the industry is well illustrated by the news that the money market fund of the Chinese online marketplace Alibaba in just nine months reached over $100bn in size – something that took the giants of the industry, Vanguard and Fidelity, over 10 years to achieve. In the subsequent two years, the Yu'e Bao money market fund, which is offered by an independent finance company under the Alibaba umbrella, has now overtaken JP Morgan to become the world’s third biggest.
Huge investment across the globe is pouring into this new breed of companies that are moving into all segments of banking – retail, corporate, SME and investment. According to “Pulse of Fintech”, a quarterly report created by KPMG Enterprise and KPMG Fintech along with CB Insights, 2015 saw a total of $13.8bn of funding flow into fintech startups: $7.7bn of that went to US startups in 378 deals; $4.5bn of that went into Asian startups in 130 deals; and $1.5bn of that went into European startups in 125 deals.
In CEE, the region’s fintech startups are involved in the same range of activities as elsewhere, from peer-to-peer lending to international money transfers: they are exploiting inefficiencies in the banking system, competing directly with the banks, using existing banking infrastructure to compete on price, or creating new financial products that don’t yet exist.
Whether the banks in this relatively young banking market of CEE are better placed than elsewhere in the world to repel this onslaught, perhaps leapfrogging the developed world banks in the same way they leapfrogged the fixed line telcos by going straight into mobile telecom, is a matter of some debate.
Like elsewhere in the world, banks in the CEE region are already reeling from the effects of the perfect storm of a lack of public trust following the financial crisis, stricter capital requirements, a high degree of regulatory involvement, the ultra-low interest rate environment amidst a still fragile economy, and now a flood of new, nimble competitors. According to Raiffeisen Bank International, the CEE banks’ return on equity reached its lowest level in a decade in 2015, falling below 5%.
Amid this squeeze on profitability, the banks are having to spend big on revamping their businesses to stay relevant in a digital age of banking and social media.
In retail banking, the banks are at a particular disadvantage because their inefficiency stems in large part from the fact they have huge, complicated legacy IT systems, many of which originate from the 1980s, or even as far back as the 1970s, and simply weren’t built for the age of digital banking and social media. To change the core IT systems of a bank, to ‘re-platform’ it, is a project that would take three to five years and run into the billions of euros. The current financial pressures as well as the risk of something going wrong during that process make traditional banks wary of attempting this.
“The problem for banks is the high cost of customer acquisition and uncertain long-term return,” says Pawel Turczynowicz, the founder of Ybanking, a Polish fintech firm that is not actually a bank, but a platform that connects users to achieve better pricing terms from the banks. Turczynowicz calculates that even in Poland, which has a strong and profitable banking sector, the customer acquisition cost for a profitable customer is around PLN2,000 (€450), so with the average annual return being PLN700-800, it takes a bank three to four years to make back its investment in acquiring that customer.
Some see this as less of a problem in CEE, because the banks in this region are, to some extent, much more modern than their Western European counterparts, having only been established in the last two decades. “Polish banks are much more adaptable because it’s only 25 years old the modern banking system in Poland,” says Jedrjez Iwaszkiewicz of D-Raft, a Warsaw-based technology accelerator for finance modelled on the UK’s Level 39, which looks to bring start-ups together with existing corporations. “Bankers here know how innovation works and what it offers… so we have really innovative banks.”
That’s maybe so, though the banks in CEE are still, like banks everywhere, conservative institutions wedded to making money in the traditional way, with very strong fiefdoms and deliberately engineered fierce competition between various departments. “If you try to touch or disrupt core systems, they will find a way to block you. They have revenues, they have targets to meet – it’s a key problem and why innovation is so hard in the big banks,” says Gorkem Cokcetin, innovation-idea development manager at Turkish bank YapiKredi.
Mario Brkic, head of Erste Group’s subsidiary BeeOne, tells an instructive story of how he was told in 2012 when the autonomous innovation lab was first formed that his team could do anything they like except fiddle with core banking services; “no interfering with the big important stuff”. When his team began secretly doing just that, they were found out and told to stop, so they just renamed the project “George” and carried on with what they were doing, which was ultimately vindicated when top management saw the prototype and approved it.
Brkic, who admits he once promised himself he would never become a banker, is an evangelist for the idea that it is possible, with strict autonomy and independence, for an innovation lab belonging to a larger banking institution to be successful. “Hell on earth for me would be to work at the innovation department of a bank – they have a feeling they need to participate but a lot of them are just set up as a puppet department,” he says.
Certainly, other European banks realise the necessity of cutting its innovation lab free; BNP Paribas, for example, eventually moved its innovation lab, an entirely separate company, to San Francisco. L'Atelier BNP Paribas’ CEO, Louis Treussard, is, like many who work at innovation labs that are independent but still owned by banks, a believer in the vision that the future of banking will lie with traditional banks partnering up with fintech startups, where each brings their own special abilities to the table.
“What might a bank do for a fintech startup?” Treussard asks rhetorically. “Three things, basically. Firstly, volume. When you manage money on behalf of tens of millions of customers worldwide – both companies and ordinary people – over many years you build up the kind of know-how for which there is no substitute. Secondly, public trust. Major banks earn trust by virtue of the sheer size of their operations, which tends to promote their brand and boost their reputation. Whatever financial startups do, they still need to build sufficient trust so that corporates or private investors will entrust their money to them. Thirdly, the ability to meet regulatory requirements, which are continually being tightened with the aim of protecting savers and the economy as a whole.”
Leaving aside the issue of people’s trust – “no, they don’t trust us at all any more,” a Bank Austria executive sighs – the regulatory aspect is one that other bankers agree is an area where banks still hold an edge over fintech startups. “I don’t want to be rude to startups, but there’s a bit of naivety out there,” says Aaron Whitehead, the Vienna-based head of business development at Western Union International Bank. “I appreciate what they are doing on the user side, that inspires us, but to go in and replicate this cross-border engine we have is going to be really tough. We spend about 4% of our revenues on compliance.”
That cuts little ice with many in the fintech world. For a start, while banks are subject to exemplary and growing scrutiny, their new competitors are either under- or even non-regulated. This is often because their very nature means they operate in a different way to banks and, as one fintech executive says, they operate in the “grey zone”, with regulators keeping tabs on them but often no more than that.
“Banks are regulated to take deposits and to protect those depositors and hold a lot regulatory capital to do so. Because we connect our lenders with borrowers directly without using our balance sheet, we don’t have to have that regulatory capital so the process is more efficient,” says Giles Andrews, co-founder of peer-to-peer lender Zopa.
Others see the banks attempting to use the regulation that they complain about so vociferously as a means to preserve their markets. “Much in the way that big oil has tried to retain its grip over the energy markets through strategic regulation and tax ploys, banks will try to do the same – the bankers you heard the other day know this well,” says Sean Patterson, marketing and PR director of Worldcore, the Prague-based internet financial services provider.
“The thing is,” he adds, “is that the work that Western Union has been doing is no more seminal to the future of finance than AT&T’s Picturephone of 1969 was seminal to Steve Jobs’ Apple iPhone of 2007. The banks may be fine with being the backbone, but the growth areas of the future are undoubtedly in providing that better ‘user side’ experience that was mentioned.”
Some banks in the region seem to have accepted this. Jiri Manas of Ceska Sporitelna, the Czech subsidiary of Erste Bank, says the banks need to acknowledge that they simply don’t have the same level of interaction with their customers that the “sharks” of Amazon, Facebook and Google that are circling their business have, nor have the innovation to produce the types of products that people want. “Those guys, if they plug any service into this distribution channel with their customers whom they interact with on average three hours a day, they can delete one industry,” says Manas.
For this reason, Ceska Sporitelna last year took the unprecedented step of launching “Gustav”, the first open-source internet banking platform based on application programming interface (API) technology, which means the bank’s customers can create their own applications for their banking services. Ceska Sporitelna says it is now working with 20-plus external customers and 250 outside developers using API technology. “It is hard for people in banks to understand why we are doing this,” Manas admits.
Outside of retail and corporate banking, one area where banks might still hold an advantage in the region is private banking where, according to insiders, clients tend not to want online accounts or deal with passwords. However, even here any advantage is likely to be eroded as the ‘digital natives’ (those born or brought up during the age of digital technology) replace as private banking customers the older ‘digital immigrants’.
Crucial for private banking is security, where the fintech startups are at the cutting edge. “I think the strides that have been made in security in recent years has been fantastic. Because it’s an industry that deals with money, it’s susceptible to a lot of attacks, so I think anything we do has to have a security component,” says Patterson, whose company Worldcore has introduced voiceprint ID technology.
Certainly in CEE there’s no shortage of fintech startups willing to take advantage of these types of openings in the banking market. The region is awash with skilful, innovative and relatively cheap programmers and developers ready to take on the local banks and create fintech products designed specifically for the CEE market. “We think of Poland as a sun spot for innovation – big market, big corporations, a good access point for the CEE region and still quite cheap. CEE and Poland in particular is good place to start up fintech companies,” says Iwaszkiewicz of D-Raft.
Blazej Czachowski of Paymento, a Polish company that focuses on e-commerce transaction solutions, admits that luring qualified Polish programmers is getting harder, but there is always next-door Ukraine, whose IT sector is one of the strongest parts of the economy because of a plethora of talented programmers, to tap for more.
Having such a strong industry will be crucial for the CEE region as the banks start to shed jobs en masse – a process that everyone in the industry believes is inevitable. Even aside from banks losing business to the new fintech startups, within the banks themselves the advances in artificial intelligence will allow them to establish new business models, reduce risk and expense, and increase productivity, while automating a huge number of white-collar jobs.
A recent report from US giant Citigroup, titled “Digital Disruption”, predicts that the continued growth of fintech startups will mean 30%, or 1.7mn jobs, of bank staff at US and European banks will go by 2025. For example, UniCredit Group, the largest bank in the CEE region, said in May it would cut a further 2,000 jobs at its Bank Austria subsidiary, following the 18,200 jobs it would cut in a radical restructuring announced in November.
So perhaps Bill Gates’s prediction of over 20 years ago will be half right: we might still need banks in the future, just probably not the bankers.