Financial innovation has become a buzzword in the financial services industry, with connotations both good and bad. And, in spite of an unending stream of coverage, for many aspects of innovation today, it is still early days.
What does it mean to innovate? And how do banks and nonbanks do it? Can banks and fintech companies work together to make financial transactions more secure and more convenient for customers? To what degree will the regulators tolerate banking innovation?
In a whitepaper released last March—Supporting Responsible Innovation In The Federal Banking System: An OCC Perspective—the OCC made clear its support for “responsible innovation.”
The agency defined this as “the use of new or improved financial products, services, and processes to meet the evolving needs of consumers, businesses, and communities in a manner that is consistent with sound risk management and is aligned with the bank’s overall business strategy.”
This week OCC held a Forum On Supporting Responsible Innovation In The Federal Banking System. In one of the forum sessions, representatives from national banks, federal savings associations, and fintech firms participated in a panel to discuss how they are incorporating responsible innovation into their strategic plans and adopting appropriate risk management and governance processes.
Tapping into the cycle
Shea Wallon, managing director of a tech firm focused on blockchain technology, which underpins digital currencies like bitcoin, discussed how his firm, R3 Cev, is working with a group of 55 banks to find applications of the technology to banking.
Wallon handles strategic investments and partnerships for R3 Cev. He said his company is working with these banks to build a blockchain-based distributed ledger.
“Ultimately we want to help build a community around it and move towards adopting technologies from which the whole community can benefit,” Wallon said. R3 Cev and the banks it works with plan to share their research across the industry to promote and accelerate the technology.
Dana Deasy, managing director and global chief information officer, JPMorgan Chase, said technology advances have been “going on forever,” but today the advances are coming rapidly.
“Remember when the ATM was created?” Deasy said. “Everybody thought that was the greatest technology ever. Remember check image processing? This is a cycle.”
“The fintech companies are expediting the cycle,” said Nitin Mhatre, executive vice-president, consumer finance at Webster Bank. Banks have always had an interest in using technology to improve their delivery of services and products to businesses and consumers, he said, saving customers time, providing access to their money, and generally making it easy to bank with them.
Mhatre said Webster Bank views innovation as an opportunity to partner and learn. He believes banking and fintech “will converge into a solution that helps consumers and businesses in a positive way.”
Portrait of partnership
In many quarters that convergence is expected to take the form of partnerships. One player who has gone this way, Circle Internet Financial, was represented on the panel.
John Beccia, Circle’s general counsel and chief compliance officer, said his consumer payments company relies on a banking partner.
He explained that Circle works with 6,000 depository institutions, but that very few would be willing to work with fintechs directly because they believe the benefits don’t outweigh the risks.
“A lot of fintechs are early-stage companies that don't generate a lot of revenue,” Beccia said. “For banks and their regulators to be comfortable working with them, they must be able to show they have strong risk management.”
Circle overcomes banks’ reluctance by being well capitalized and having almost a third of its staff dedicated to risk and compliance. Circle received the first bitlicense issued by New York State.
Both banks and fintech companies have built-in strengths. The panelists agreed that banks have strong customer bases, trust, and a stable source of funding. They’re regulated and have weathered economic cycles. Fintech companies, on the other hand, are not regulated, or less regulated, so they can be nimbler. In addition, they also are more likely to attract talented young staff drawn to tech companies. As newer companies, they don’t have legacy systems. They can build compliance systems from the ground up that are more efficient than those of large banks.
Deasy believes the relationship between banks and fintechs has become symbiotic. Banks like the way fintechs take friction out of the system, saying they view the business through the customers’ eyes. He said JPMorgan Chase works with many young fintech companies.
“Last year, we touched 300 startup companies,” said Deasy. “We brought 100 of those in to pilot them. 50 became customers or we became a customer of theirs. We will do that again this year.”
Strategies for success
Success in financial services can be measured by a number of key performance indicators—acquisitions, retention, revenue, and valuation. However, the “key measure of success is whether you solved the problem and achieved the goal,” said Beccia. He noted that creating payments that are faster, more secure, and easier to move is a big achievement.
Failures are inevitable when you are experimenting, said Circle’s Beccia.
“Look at how many times it took the Wright brothers to get the plane off the ground,” Beccia said. He urged banks to take a careful, responsible approach.
“But even if you have failures at these institutions and these technology firms, you are pushing the ball forward,” Beccia added.
Barriers to successful innovation
Despite the many opportunities in innovation, there are risks and barriers to entry. Regulatory clarity and licensing process requirements are barriers in the U.S., said Beccia.
Licensing is easier in the U.K where the “process is simple and quick,” Beccia explained. This allows Circle to sell products and services to consumers throughout Europe. In the U.S., state licensing is a two-year process that requires significant capital, time and resources.
[Editor’s note: Subsequent to the session, the U.K. voted to leave the European Union. In the long-term that may affect the “passportability,” the term for the ability to offer such services throughout the E.U. Time and politics will tell.]
Security, if not a barrier, is an overarching concern, said Deasy of JP Morgan Chase. Daily attempts to compromise banks’ systems impact banks’ ability to move efficiently. Banks must invest time and talent to ensure the safety of their customers’ information and assets.
The billion dollar question
When will the new technologies like blockchain become commercially viable? When will they have the bandwidth to process the level of transactions necessary to support a financial system?
“That’s the billion dollar question. I don't think anybody really knows the answer to that,” said R3 Cev’s Shea Wallon, noting that some companies offer a product using blockchain technology, but the product is focused in certain areas. For instance, Nasdaq’s Linq platform, released in December 2015, enables private securities issuance documented with blockchain technology.
“From R3's perspective, we are looking to have some pilots with our members in 2016, taking real data feeds, and testing out the ROI potential to see if the technology can deliver.” He added that the industry is not likely to see benefits of the technology for three to five years.
The other panelists agreed.
“Things may seem like they are moving fast, but we are in the very early days,” said Beccia of Circle.
Deasy said, “Blockchain is getting a lot of press, but we can’t lose sight of the other amazing technologies being developed and already in use such as machine learning and robotics.”
Other coverage of sessions at the OCC forum:
• Fintech, “regtech,” and coping with tech: OCC forum examines the big picture of disruption
• Better serving beleaguered consumers: OCC forum session explores helping consumers via fintech
• OCC builds on innovation overtures: Looks like it’s still “beginning of the beginning”
• 10 takeaways from the conference: Banker-attendee Chris Nichols of CenterState Bank distills the day's proceedings into a think and do list.
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