Innovation Basics for Community Banks and Credit Unions

 “We must innovate!” Are you sick of hearing this yet? Are you focused on revenue growth, expense management and the increasing burden of regulatory compliance? If so, innovation may be the furthest thing from your mind.

And yet the plaintive refrain continues, and it has merit.

Why Innovate?

Not because everyone else is doing it, that’s for sure. Not because it makes us look cool.

But banks and CUs need to innovate, because otherwise the world is going to keep moving forward and leave us behind. Eventually so will our customers and members, whether consumers or businesses.

Customer and member expectations are changing – this is nothing new. You’ve probably implemented some mobile and online capabilities in the hope of keeping up. You may have established that you need a digital strategy, though perhaps it isn’t fully articulated yet.

But unless you are actively innovating (see below for what I mean by this), you are creating risks and missing opportunities. I’m talking about opportunities to increase revenue and reduce operating expense. Opportunities to better manage all kinds of risk – market, credit, operating, and regulatory.

What Exactly is this Innovation Thing?

If you Google this question, you’ll get lots of definitions. Probably the one I like as much as any is this straightforward one from Yale University:

Innovation can be defined as the process of implementing new ideas to create value for an organization. This may mean creating a new service, system, or process, or enhancing existing ones.

Key words: new, ideas, value.

So in innovating we’re doing something new. This results from some out of the box thinking (“ideas”) that will create value for the organization. Don’t you seek to do this all the time? Of course you do!

So having demystified this innovation thing, let’s talk about how we can become more intentional about it. When most people talk about innovation in banks and credit unions today, they have some specific ideas in mind. Things like digitization of the customer / member experience. Or they're thinking about automation of manual processes. Or leveraging all that data we don’t quite know how to use.

Often, when people talk about innovation, they’re talking about bringing in FinTech superstar startups. (Here we’re using FinTech in a broad sense – as enablers more than disruptors). They hope they will fix their problems, wow their customers and mollify their regulators.

This article is about this narrower kind of innovation because, well, that’s what everyone is saying to you that you ought to be doing.

By the way, community banks and credit unions have at times been among the best innovators, even in this more limited sense. Who were the early adopters for mobile banking, for example? But it is also easy to be left behind. Without an innovation strategy, in a rapidly changing world, this risk will become more and more acute.

In the rest of this article I want to address three important questions:

1. What are the barriers to innovation? And what are some best practices to address those barriers?
2. What are the key areas in which we should be looking to innovate?
3. What innovation model will work best?

Barriers to Effective Innovation

Innovation isn’t easy, no matter how you define it. It takes time, costs money, and requires attention from very busy people. And sometimes, we seem (like Alice with the Red Queen) to be running as fast as we can just to stay in the same spot. Here are a few things that stand in the way, and some general approaches to addressing them. I’m sure you’ll have other things in your list, and encourage your comments and input.

1. 
   Other priorities: the tyranny of the urgent. By its nature innovation is a strategic activity. When day-to-day pressures dominate, long-term strategies fall by the wayside.Solution: ensure that at least one senior leader has innovation as their highest priority. This should be the main activity on which their performance is measured.
2. 
   Ill-defined needs. We know we need to innovate. But we don't know what problems to start with. Solution: create a prioritized list of innovation opportunities. Each should have well-defined problem statement, desired outcomes, and measures for success.
3. 
   FinTech companies that don’t understand us. Technology vendors may have a good solution for our stated problem. But they know nothing about banking. They don't know how banks work. And they have no clue about risk management.Solution: set expectations early. Be patient, but be insistent that they learn. Or ask them to add a banking-knowledgeable member to their team. [Full disclosure: I have a vested interest here, since this is what BTC does.]
   
4. 
   Being sure a new idea will work. An idea may seem compelling, and yet there are so many unknowns. Will customers behave as we expect? Will we get the intended improvements? What if it can't handle product volumes? Solution: use tried and tested approaches for Proofs of Concept.  (A PoC demonstrates that we’ll get the intended results.) Plan for Pilot implementations. (Pilots are controlled and limited production implementations. These can be closely monitored with minimal impact from failure).
5. 
   Inability to integrate with our core banking system.We may have found a good, stable, functional solution. Now we have to ensure it will work with our existing core banking and mobile platforms. Core banking systems are typically closed, and heavily vendor controlled. Integration can be expensive or even impossible. Solution: get an early take on what a solution’s integration points will be. This may mean bringing in your System Integrator, or even your Core Banking or Mobile vendor, early in the process. Start negotiating early to limit losses if the price tag is going to be too high. In the longer term, start considering a core and online/mobile strategy that demands openness from your vendors. (There are moves in the direction of openness, and some emerging vendors focused on open platforms).
6. 
   Resolving problems after production: once we’ve overcome all the other barriers and implemented a solution, the challenges don’t stop. What happens if the solution goes down, or we find bugs? What if a regulation changes and we need to adjust the solution? What if the solution has introduced new fraud or data theft risks? Solution: ensure that your Third Party Risk Management strategy extends to all kinds of technology and service provider. Make sure that you have active vendor management in place. (Increasingly, your regulators require this anyway). This may be partly outsourced (though of course that introduces a new kind of third party risk). Carry out an operational risk assessment before production roll-out. Make sure you understand and manage risks resulting from this new solution.

Key Innovation Areas

The best areas for innovation will depend upon several factors. What kind of institution are you? What are your strategic priorities? What are the biggest roadblocks to your strategic progress? Here are some areas in which innovation is actively transforming community banks and credit unions the world over. Notice that most of these do not need rocket science. But they are all things that customers want or that stand in the way of increased profitability and well-managed risk.

1. Simpler and more convenient access to more services. Perhaps the most obvious area. You have (most likely) basic services available online and via mobile apps. But in order to increase satisfaction and retention, you need the banking experience to be enjoyable and engaging. The more the customer does on your mobile apps especially, the more likely they are to stay with you and refer their friends.
2. Safer and more secure access to services. Closely aligned with the previous item is the need for customers, bankers and regulators to have confidence that money won’t be stolen through fraud, that identities will be protected, and that non-public personal data will not be compromised. This is the area of cyber-security, and many innovative approaches are being taken to address it.
3. 1. Provide critical insights into customer preferences and expectations. These will drive marketing campaigns. They will help customer service representatives and branch bankers to truly be able to cross-sell. They will allow you to anticipate problems and defuse difficult situations.
   2. Give better understanding of drivers of profitability at the product feature level.
   3. Optimize use of capital for regulatory and investment purposes.
   4. Provide for risk-driven customer due diligence and transaction monitoring. Examples would be fraud and AML predictive analysis.
   Making full use of your data. You collect data in a number of ways, but you know you’re not making best use of it. Some of the data is locked away in your core banking or online or mobile systems. But even they provide after-the-fact access to data that could be very valuable. Some technology providers provide very rich data. For example, mobile app vendors like Malauzaiprovide detailed click-level data on every aspect of every customer. Other vendors will sooner or later succumb to pressure to open up more. Europe is already requiring it, and other countries will follow suit including, eventually, the US. Having all this data is great, but the harder question is “how can we get meaningful and actionable insights from it?” Through advanced analytics, business intelligence and visualization tools is the obvious answer.  However, the real innovation will be in enabling these capabilities for non-technical bankers. What will all this data do for you? Here are a few examples:
4. Risk and Compliance. A huge area of concern, particularly in the area of regulatory compliance. Costs for compliance are growing consistently. With diminishing spreads, the criticality of effective credit risk management has grown. Senior bank and credit union executives face greater regulatory scrutiny. And they have to respond to constantly changing regulations. Cyber-risk management requires constant attention. This is where a subset of FinTech, called RegTech, comes into play. This is in addition to FinTech solutions specifically targeted at risk management.
5. Offering products that previously weren’t feasible. You know your limitations, and want to focus on your core customer segments. But even there you’ve not been able to fully compete with larger banks. For example, a community bank may have a growing small business customer base that buys from overseas. You can’t offer cross-currency payments, so your customer has to go “across the street” to a big bank. You lose revenue, and sometimes you lose customers. Or you want to be able to offer personal financial management tools to your members, but don’t have the capacity. This is an important aspect of FinTech-driven innovation. Through software-enabled partnerships, you can include a whole range of new products and services in your mobile apps without having to build the operational infrastructure to support them. For example Currency Cloudoffers a payment engine that integrates with your mobile app. This provides for FX to be handled by an international bank at wholesale rates (which offers you FX revenue). It then routes the payment through SWIFT or local clearing systems (giving you transaction revenue).  Other examples include such things as supply chain finance; payables and receivables management; investment advising; and corporate card management.

These are really just food for thought. You’ve probably been bombarded with ideas by cold-calling FinTech companies anyway. But remember the most important thing. You, not they, get to decide what is most important to you. Armed with these critical innovation priorities, let’s take a look at some approaches to innovation.

What Innovation Model Will Work Best for Us?

Well, of course that depends. It depends on your size, the kinds of innovation you need, the people you have, and the innovation budget you’re set aside. There are in fact several approaches that can be taken.

Any of the below approaches can be taken unilaterally by a bank or CU, or through regional trade associations. While this may erode some competitive potential, it does allow for cost-sharing, resource-sharing, and larger scale projects. If the problem to be solved is a wide-spread one, then it may be worth exploring to see if others in your industry are already addressing it.

The “Do Nothing” Approach

One approach that could be taken, and is de facto being taken by some organizations, is to wait for innovation to come to you. You will receive countless cold calls. Some may be relevant, and one or two may be a good solution for you. If this works, it is more by luck than judgment. Occasionally the right partner will call. They will help you to define a real problem or opportunity. And they will help you to understand how their solution will integrate into your environment. But this is rare. Most FinTech companies don’t have the knowledge to be able to do this. And chances are slim indeed that those who do are addressing your particular priorities.

Appoint an Innovation Leader

This will be an essential component of your innovation strategy (see barrier number 1 above), whether or not you also take one of the approaches that follow. What isn’t so clear is who it should be. Is it automatically the Chief Information Officer? Not necessarily unless your CIO is particularly business-savvy, and able to think in terms of balance sheet impact, capital utilization and so on. Should it be your Chief Marketing Officer (or equivalent)? Or perhaps your biggest challenges are regulatory in nature, and you consider the Chief Risk Officer. The answer to all of these may well be a resounding no. The biggest problem is that innovation would be only a portion of any of these executives’ jobs, and you have not addressed barrier number 1 above.

The innovation leader should be a senior executive, ideally reporting directly to the CEO or President. Their primary responsibility is innovation. Top-level sponsorship and support are absolutely critical to success. This allows you to select someone who understands both banking and technology. They will be expected to know how to forge effective partnerships. And they will be able to lead multi-functional part-time teams to drive results from innovation efforts.

Matchmakers

Finding the right partnerships can be very difficult. You have an idea of what you’re looking for, but finding which of the thousands of potential partnerships will be the best fit for you is very difficult. Even with a dedicated innovation leader and perhaps a small team, the search process is a long and arduous one. One answer to this is to join a service that acts as your FinTech scout. They bring together financial services companies and vetted FinTech companies. An example is global FinTech matchmaker Matchi.biz, which is headquartered in Hong Kong, and has a presence in the UK, India, Europe, and North America.

Another form of matchmaker is an organizer of innovation get-togethers, tours or events. In all these case banks and FinTech companies are brought together. For example, the Silicon Valley Innovation Center will facilitate tailor-made meetings with selected FinTech companies.  They will choose companies likely to address problems faced by a particular bank. They will also help with the process of moving forward with particular FinTech companies, e.g. by leading a Proof of Concept.

Innovation Challenges

An increasingly used approach is to invite the FinTech community to offer competing solutions to a specific problem. FinTech providers will have the opportunity to present and demonstrate their solutions. Consultants may be retained for a short time to facilitate the innovation challenge. They will pose relevant questions, and offer expert opinions to the bank on the viability of each contender. This is quite analogous to the Shark Tank style of investment contests..

There are some keys to success for an innovation challenge:

• The business problem should be well-defined, bounded, and clearly articulated
• The business problem should not be so broad that no one company can solve it. It also should be so narrow that no company is likely to have addressed it.
• Specific expectations should be articulated prior to the challenge. These will include integration, regulatory compliance, company sustainability and ongoing support.
• The challenge should be widely advertised in the FinTech community through social media and key online sites. Consultants employed to run the challenge will have networks and channels that will help to drive this.
• Clear plans for what to do with the winner(s) should be mapped out in advance. Will you want to conduct a Proof of Concept? Who will pay for this, and using what resources? If this is successful, how will the implementation project be managed? And so on.

Hackathons

In a different twist, larger banks in particular conduct “hackathons”. The idea is similar to innovation challenges. But the assumption is that a solution to the defined business problem will require some custom development. Participants will build on their own platform, tools and expertise to create a prototype solution to your unique problem.

This seems likely to provide a specifically tailored solution that is unique to your company. But it has some disadvantages. There is a greater need to prove the solution, since by definition yours would be the first production implementation. It also raises questions around ongoing support as the FinTech company continues to develop core products.

Accelerators, Incubators and Sandboxes

Larger banks may create an environment in which FinTech companies can develop solutions. This is done with input, mentoring and advice from bankers. The environment may give them controlled interfaces to bank systems, which helps with integration. The bank may also provide access to investment funds. This is expensive and beyond the reach of most community banks and credit unions, and so is not treated further here.

However, one approach that might be taken is partial sponsorship of a broader incubator, such as the Boston-based FinTech Sandbox.

Conclusion

No matter the size of the bank or credit union, several things apply:

1. Innovation is not optional.
2. There are effective and ineffective ways to innovate. Successful innovation requires the right resources, investment and leadership.
3. Innovation is rarely possible in a vacuum. It will be accomplished through carefully selected partnerships.

If you have been passive in your approach to FinTech-driven innovation, I strongly encourage you to take the next step. Community Bank and Credit Union leaders are welcome to contact me to discuss further.

Graham, a 30 year banking veteran, runs BankTech Consulting. He is an expert in commercial banking, and provides strategic insight and internal business cases to banks. He works as a fractional Customer Success Executive to Fintech firms, facilitating their partnership with banks.