Partnering up is the new conventional wisdom. Banks can do very well when they bring their strengths to the table to be joined to the strengths of a fintech player or other specialist, the thinking goes. Many companies, wise to the trend, have started to talk the partnership line. And of course “we’re your partner in this” is an old standard when selling almost any ongoing business relationship.
But once you get past trendy usage, what is your relationship, really? Is it a true partnership? Or is it simply a vendor relationship with the wrong label?
What makes this important is that the bank going into an arrangement with its eyes open and with strategic thinking may make different decisions—even choose a different company—depending on how the relationship is characterized. Choosing partnership or vendor relationship has implications in who should be involved in decisionmaking; in risk management; in regulatory involvement; and more.
During the recent National Conference for Community Bankers of the American Bankers Association, Cornerstone Advisors Director of Research Ron Shevlin spoke about fintech and community banking. “Fintech” and “partnership” had been all over the program and Banking Exchange met with Shevlin and his associate Sam Kilmer, senior director at the consulting firm. The goal was to probe the differences between partnership and vendor management.
Words have meanings
During his presentation, Shevlin said one thing that drives fintech people crazy about working with banks is that the relationship gets turned over to the bank’s procurement function. He summarized a common fintech experience this way: “Banks’ procurement departments treat us like mini IBMs and harass us with requests that could destroy us—if we let them.”
In the interview, Shevlin began by saying that he had no monopoly on minting definitions. However, to him, “the word ‘partnership’ implies shared risk and shared reward. But the way that both fintech companies and banks are approaching it is more as a client-vendor relationship.”
Continuing, Shevlin explained that perhaps some fintech providers “are deceiving themselves into thinking, ‘This is really a partnership, so I should not have to be held to service provisions, response times, and other such commitments. This relationship is experimentation and not production-level institutionalization’.”
Interestingly, Shevlin said, he’d attended a session that had “partnership” in its title where the two speakers made it clear that they saw their role as technology service providers. One characterized his firm’s relationships as partnerships. Shevlin took issue.
“If you are a provider, you are selling services, and that makes you a vendor,” Shevlin observed. He noted that the executive said that his firm only made money when a bank put volume through his company’s system. To Shevlin, that’s a vendor relationship. If nothing goes into the system, the bank bears no cost and the vendor receives no revenue.
“What is a partnership?” said Shevlin. Without a working definition, “we are dancing around the elephant on the table.” To put a rhetorical stake in the ground, he said, he relies on the shared risk, shared reward model. To this he added: “Revenues and costs are variable, and that implies an upside and downside to both parties.”
Would you make them a loan?
Taking “partnership” as a true shared risk-shared reward arrangement, we explored the concept further with Shevlin and Kilmer.
Kilmer picked up on the point Shevlin made regarding procurement.
Today’s fintech community reminds Kilmer of the web and mobile community when it was a brand-new factor in financial services.
Bankers would want to work with a particular company that had fresh and exciting ideas. Exercising due diligence, the bank’s CFO would research the proposed provider’s finances.
“And the bank would find the company was losing money hand over fist,” said Kilmer. “They would complain that the strategic vendor they wanted to help them build their future couldn’t qualify for a commercial loan from the same bank.”
Yet those thin financials didn’t imply failure, said Kilmer.
“They were pouring all their profit back into R&D,” he explained. “And that was what helped make their interface the one the banks wanted to use—because they had 50 people working on it.”
“Entering into such a partnership with a firm like that, you have a higher tolerance for risk than if you were dealing with a Jack Henry, Fiserv, or FIS, right?” said Kilmer. “Yet if the bank treats all providers identically, running them through the same hamburger grinder in Procurement, it will drive fintech people crazy. It would be like treating startup companies and mature companies the same in your commercial lending department.”
Shevlin pointed out that Procurement “doesn’t negotiate partnerships. They negotiate contracts. And they are good at it. They can negotiate performance provisions down to the last detail.”
“The reality is that most fintech providers are relatively new firms that don’t have the staff, processes, and capabilities in place to deliver true technology services yet,” he explained. “They are something different.”
In his presentation, Shevlin made the point that a key strength that banks bring to the table is that they have learned to satisfy customers.
“It’s easy to be innovative when you don’t have to take care of any customers,” Shevlin said of fintech firms. “They can have a culture of innovation because they don’t have to have a culture of customer service.”
Handling partnerships differs from get-go
Shevlin described what he sees as the appropriate difference in approach inside a bank in this way:
“If you are on a bank’s executive team and want to enter a vendor relationship, then you get the functional people involved. You get Procurement involved. You get Legal involved.
“However, if what you want is a partnership, you get the board involved. Partnerships are a board-level discussion. That’s not a job for Procurement, nor, necessarily, the functional executive running an operational business function.
Why this demarcation? Shevlin explained that partnerships are strategic—that’s a board matter. In addition, partnerships involve some risk, and that goes to risk appetite, also a board concern.
Shevlin acknowledged that the normal pace of board deliberations does not synch well with the pace of change, especially in today’s climate. Hence, boards should be discussing their attitudes towards partnerships before any opportunity presents itself.
“The strategic planning process should identify and define that the bank has a business to protect, or an opportunity to explore,” said Shevlin, “and that the board sees a partnership as the most effective way to do so.”
Management may well bring this to the board, but it is the board’s job to push back, to prod. “You can’t take a year to approve a partnership, so you have to have been through these check points in advance,” said Shevlin.
Kilmer said that a consequence of the pace of change is that boards increasingly revisit strategy quarterly. This process is more a review, but comes sooner than the next annual session.
Say “no” to board tech maven
As a side note, Shevlin raised a trend that would seem smart, but which he believes can hurt a board that wants to keep its bank up to date: the appointment of a “tech director.”
This is a board member selected because he has a technology background.
Often, said Shevlin, someone will point out that the board has no member with tech expertise. “So they get some guy with some sort of tech background. Then all of the tech decisions wind up being deferred to that board member. And that’s not good.”
The CEO may not feel qualified to make tech decisions, said Shevlin, but the tech background a recruited director brings may have nothing to do with banking.
Similarly, Shevlin resists the idea of a board-level technology committee. Boards are supposed to oversee management, and if the bank forms a board tech group because management lacks tech ability, “then the committee is overseeing nothing— because there’s no capability there.”
Shevlin said that some decisions need not be brought to the board. Some relationships aren’t really partnerships nor vendor relationships. What’s left? A “distribution channel.”
“That’s not a board-level decision,” said Shevlin. “Management decides, ‘We have funds that need to be deployed. So we’re going to buy some loans, say, through Lending Club’.”
Kilmer pointed out that some tech decisions come down to a build or buy point, and the dollars involved rise to a board-level concern. Or because it’s a strategic decision.
Building takes money, and regulators tend to look askance at community banks building their own applications because everything is under their own roof, said Kilmer. There is no outside team or community to fall back on. Buying may not just mean buying a service, but buying another bank that has licked a strategic issue and come onto the market at the time a potential acquiror wants to gain that ability, that talent.
Some relationships occupy a twilight zone, Kilmer admitted. He said that Cornerstone has a client bank that negotiated a honey of a deal with its main technology vendor. First, it negotiated a stipulated price and got it. But added to this, he said, was its negotiation for the right to obtain new releases of the provider’s software first—becoming a pilot site for the vendor and recipient of new, cool stuff.
“They are some kind of uber-client,” said Kilmer. The bank’s side of the bargain is that it serves as the vendor’s demonstration site, where prospects can see the product in action.
“This is interesting,” said Kilmer, “because in an arrangement like that you are not a builder, but you’re closer to building than just buying off the shelf.”
Big question: Picking the right vendor for tomorrow
Go to any banking or fintech conference today, consult any of several databases and you realize that the tools and services available to revamp financial services in a bank are growing exponentially.
Shevlin says that a key challenge for banks will be balancing a vendor’s current strong lineup of products with the need to have a vendor whose products will evolve or be replaced to meet tomorrow’s needs.
“We’ll have new channels, new technologies, new whatevers coming down the pike,” said Shevlin. “So what a bank needs in five years may be very different from what it needs now. Do you go with the vendor who shows up at your door with the right solution for 2017? Or do you go with the vendor who might not fit your needs as well in 2017, but who appears to have better technological development capabilities?”
Elaborating, Shevlin said, “some fintech vendors are better positioned for future development than others. They are more flexible, more innovative, more on the cutting edge than others.”
What concerns Shevlin is that “many banks are not framing their choice in those terms.”
The way business is done is changing, and both consultants see the need for banks to bear that in mind when selecting the firms they will work with. How well will the offerings of a traditional bank technology company mesh with chatbots and other artificial intelligence, for example, compared to those of a young fintech firm?
Kilmer said that much of technology in banking traditionally dealt with servicing, handling business after it has been acquired. Nowadays, the entire customer relationship is being touched by tech.
“The revenue creation process is becoming just as engineered as the servicing process,” said Kilmer. Consumer behavior and banks’ response to it have become intertwined, and have a feedback effect on each other.
What banks bring to the table
Yet Shevlin sees strength for banks going forward, if they use it.
“Banks bring an established base of customers to the table, whether we are talking retail or business, that a fintech company wants access to,” said Shevlin. Fintech companies require a distribution channel and audience—banks have that, and can use the additional revenue brought by a fintech partner.
Shevlin added that two basics about the banking business can be forgotten by banks because they are in it, yet they represent advantages.
One is deposits. Access to those is very important to some fintech players, and banks have that franchise.
The other is a banking basic: credit underwriting.
“Banks have underwriting competencies,” said Shevlin. “They have that from years of experience, learning what works and what doesn’t. Fintech providers still need that. They seem to think that they can build it all with alternative data methods, but there is still a capability that banks bring to the table that a fintech partner could potentially leverage.”
Shevlin added, regarding marketplace lending’s ease of use: “If you’ve got money, and a nice process, it’s easy to lend to the folks who aren’t creditworthy and who aren’t going to pay you back.”
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