Embracing the F-word

That’s “F” as in fintech, shorthand for the emerging array of digital financial services, technologies and startup companies racing to hand the banking sector its “Uber” moment. The banks? They’re running just as hard to prevent it
By Jonathan Woods

Transformation: Jeff Marshall, head of Scotiabank’s new Digital Factory, is leading that company’s charge into mobile and digital banking

Somewhere in an office in downtown Toronto, standing beside a ping-pong table, young engineers and software developers in jeans arrange multicoloured sticky notes on whiteboards outlining the next steps in the refinement of a digital mortgage application service. You would be forgiven for mistaking the scene as being that from within a tech startup. Instead, it’s taking place in the heart of a 184-year-old banking institution.

Welcome to Scotiabank’s Digital Factory. Launched last fall, and slated to move from its current temporary digs into a new, freestanding 70,000-square-foot space at the end of summer, the Digital Factory’s mission is to become nothing less than “the undisputed innovator in mobile and digital banking.” When construction is completed, the Digital Factory’s new space will be home to 350 developers, user experience designers, engineers and data scientists tasked with creating digital solutions for the bank’s 23 million customers. Even now, its teams have already started tackling frictions in mortgage applications, day-to-day banking, small business loans and credit cards. Despite the leisurely feel, an urgency underlies the operation’s existence. The Digital Factory was created, according to its head, Jeff Marshall, a former vice-president of marketing with retail and technology expertise, when bank management recognized “that for us to be competitive, we would need to materially invest in technology, and in particular, around a digital transformation of the bank.”

This massive effort is just one part of a serious tech mobilization taking place not just at Scotiabank (TSX:BNS), but inside every one of Canada’s major banks and financial services companies. In the past two or three years, there has been an explosion of activity as all these institutions seize on the need to devise new strategies, ramp up their technical competence and create digital products and services.

For decades, technology has been the main underpinning of banking operations, but largely that’s been in the back rooms and under the hood. However, as pretty much everyone who hasn’t been lost in the woods or on an extended, off-the-grid isolation retreat in recent years knows, the changes taking place now across the economy are all about the front end—the way people and businesses shop, the tools and platforms they use to interact digitally, their desire to personalize, customize and self-direct their consumption of products and services, and the inclination to do more and more of this on the move, from their smartphones and other mobile devices.

In the process, digital “disruption” has suddenly become the most overused term in business. Overused but not overhyped, however. And while the financial sector is not yet suffering the shock and upheaval seen in other areas, the agents of this would-be disruption are out there—in the form of existing technology giants and a drove of newer startups called “fintechs.”

Recognizing these trends and the threat that fintechs pose to their profit centres, boards and senior management at the banks are aggressively working to innovate internally in order to either fend off the up-starts, acquire them or become partners. Are there “Uber” moments out there waiting to happen? Perhaps. “Legacy systems, bureaucratic tendencies and entrenched biases” are the banks’ biggest vulnerabilities, says one 2015 report. But Robert Sedran, managing director at CIBC Capital Markets, which produced that report, also stresses that the banks “are on top of it. They are working on making sure that they’re delivering innovation to their customers,” he says. “So they’re not relaxed, but at the same time, they realize that they have structural advantages that position them so that if they’re smart about this, they can actually grow their businesses.”

MAKE NO MISTAKE, THE CREATION of something like Scotiabank’s Digital Factory isn’t just about the products and services it might produce. It also sends a message to the market, to competitors and to would-be employees. That bank’s recent pledge to invest $3 million over 10 years to create a digital banking lab at Ivey Business School at the University of Western Ontario works in a similar vein. Not surprisingly, all of its major competitors are touting comparable, high-profile initiatives. Royal Bank (TSX:RY), for example, recently launched an “innovation lab” in Silicon Valley to work with startups. The facility complements existing labs in Toronto, Luxembourg, New York and Orlando. In April, meanwhile, Bank of Montreal (TSX:BMO) announced a partnership with Ryerson University’s existing business incubator for startups, DMZ, to create something called “The Next Big Idea in Fintech.” Toronto-Dominion (TSX:TD), for its part, has opened a lab in Waterloo, Ont., in that city’s Communitech innovation centre, to work with startups. And CIBC (TSX:CM) planted its digital flag at the MaRS Discovery District in Toronto, with a goal of creating a corporate innovation hub to explore financial technology opportunities.

When it comes to major strategic decisions on services, products, deals and partnerships, of more potential immediate significance are changes afoot in the ranks of senior management and, in some cases, on the banks’ boards. If you want to win the fintech wars, the thinking goes, you need to have proven, tech-savvy leadership in place, either in existing roles or new senior positions. RBC threw down the gauntlet in this regard in 2014 when it named Bruce Ross, previously general manager of global technology services for North America at IBM, as its group head of technology and operations. Likewise, in 2014, Scotiabank hired Michael Zerbs, previously IBM’s vice-president of risk analytics (and former president and chief operating officer at Algorithmics before that). Zerbs was named co-head of information technology for enterprise technology in 2015.

About the same time, Manulife Financial Corp. (TSX:MFC) signaled its seriousness about fintech when it created the new role of chief innovation officer and named Tim Ramza, the company’s former vice-president of wealth management strategy and business development to fill it. On the board side, meanwhile, the most notable upgrade thus far has been the addition of Scott Bonham to Scotiabank’s board in January. Bonham comes with a large Silicon Valley rolodex as co-founder of GGV Capital, a successful venture capital firm with a focus on consumer Internet, mobile computing and enterprise software, and portfolio companies such as Airbnb, Square and Alibaba.

IF THESE MOVES DON’T CONVINCE you that the banks are taking the fintech phenomenon seriously, consider the results of a recent PwC survey of global banking CEOs. It found that more than 80% of respondents said they consider fintechs a competitive threat. At TD’s last annual meeting, CEO Bharat Masrani told shareholders that with the rise of fintechs, “the emergence of a new class of competitors is now a reality.”

Why such worry? Fintechs identify pain points in financial services and solve them through mobile technologies and digital business models. Operating without the enormous infrastructure, technical debt or regulatory hindrances of the large financial institutions, fintechs are bringing to market cheaper, faster and more customer-centric financial services that are particularly appealing to the highly connected millennial generation.

“The interaction that customers expect with the banks is no longer defined by the banks,” says Gabriel Woo, RBC's vice-president of innovation

Fintech offerings already cover the range of financial services including payments, lending, financial management, crypto-currency and cybersecurity. Beyond those attributes, however, there is another important detail. In relation to the banks, fintechs actually fall into two categories: collaborators and competitors.

In the former bucket is the collection of companies working with incumbent financial institutions to provide services and technologies that either empower the banks to deliver their services faster, cheaper and more securely, or work through the banks as a channel to market. Vancouver’s Trulioo is one such company, providing financial services providers with secure access to reliable global data sources to instantly verify identities online around the world through a single API (application program interface) integration. Zafin, also based in Vancouver, is another example. It has developed a relationship banking platform that uses advanced analytics to tailor banking products and services, track conditional offers and optimize pricing and product mix for each customer. In tech marketing lingo, it enables banks to be less product-centric and more customer-centric.

In the category of competitors, you’ll find startups that are attacking almost every offering the banks have. Robo-advisers like Wealthsimple, Wealthbar and Nestwealth offer digital wealth management services that replace human financial planners with automated, online portfolio management and advice. One of their key selling points is fees well below those of traditional providers. Then there are marketplace lenders such as Grow, Borrowell and FundThrough. These companies seek to carve out market share by simplifying and expediting business and personal lending through technology.

As noted earlier, if there’s been one innovation above all that has contributed to the rise of fintechs it is the ubiquity of the smartphone. That device’s role as the focal point of planning, connection and activity has transformed consumer expectations in every domain, including financial services.

“What we all realize now is that the interaction that customers expect with the banks is no longer defined by the banks, but by all other aspects of customers’ digital lives,” says Gabriel Woo, vice-president of innovation at RBC. “With the advent of mobile technologies and smartphones, and the ability to do many more things using digital technologies, clients’ expectations are now shaped by things like e-commerce—how they’re able to buy stuff; through social networks— how they’re able to interact with their friends; through information portals and news portals—how they’re able to stay informed and get news. Those are obviously just individual examples, but they have shaped how customers expect to interact with parts of their lives and service providers.” Customers have come to expect personalized, targeted offers combined with speed, convenience and automation.

Another factor in the emergence of fintechs is increased trust in digital services. Canadians are accustomed to dealing with money online, with more than half reporting the Internet as their primary banking channel. Ironically, it was the banks themselves that fostered this trust, being among the first in the world to introduce Internet services like online banking and e-mail money transfers.

Jim Orlando, managing director, Omers Ventures: latest fund targets fintech opportunities

Venture capitalists have of course noticed these developments and are feeding their growth by pouring ever more money into fintech startups. Some $19 billion was invested globally last year, an enormous rise over the $1.8 billion invested in the space just five years ago. In Canada, several high-profile fintech investments have been made in the past year including Power Financial’s $10-million investment in Wealthsimple and a $20-million Series B round for Bench, a Vancouver-based company bent on automating bookkeeping. Last year, Omers Ventures closed its $260-million Fund II with co-investors BMO Financial Group and Cisco Investments to target, in part, fintech opportunities.

ONE PLACE YOU WON’T YET SEE much evidence of the fintech threat is in the banks’ market share. According to a report from Citigroup, just 1% of North American consumer banking revenue has shifted to new digital models so far. Even so, the authors warn, that could change quickly. In that same report, they estimate digital competitors could own as much as 10% of North American consumer banking revenue by 2020, rising to 17% by 2023. Ominously, they also note that almost half of global bank profits come from personal and small- and medium-enterprise banking, a domain into which almost three-quarters of fintech capital is being deployed.

Citi analysts say banking’s “Uber” moment will occur with “the shift to mobile distribution being the main channel of interaction between customers and the bank.” This channel and the customer expectations that accompany it are exactly what the fintechs are apt at satisfying, and the consequences for banks falling behind may be dire.

How and when this moment will manifest is anyone’s guess. As Citi’s global head of digital strategy has said regarding disruption in consumer banking: “We’re not even at the end of the beginning.” Citi’s digital strategy team examined disruption in other industries, noting that an average of 44% of market share moved from physical to digital models over a 10-year period. In that span, the share slowly shifts at less than 2% per year until “an inflection point around year four, when traditional share declines rapidly accelerates to >6% per year.” If other industries that have gone through digital revolutions are any indication, then the banks can expect the same inflection point and rush to digital in financial services.

Compounding the pressure on bank management is the situation Canadian financial institutions find themselves in at the moment, manoeuvring through a low-growth environment comprised of a depressed energy sector, an unemployment rate around 7% and a maxed-out household debt burden. As CIBC’s CEO Victor Dodig said in April this year: “These headwinds make our need to transform the way we operate as a bank even more urgent.”

But in the short term, at least, such macroeconomic factors will weigh much more significantly on bank profits and share prices than either fintechs or even the investments the banks are making in technology to keep up. While all five of Canada’s banks announced restructuring charges in the past year and a half related to digital technology, for example, the total combined hit was a modest (as banks go) $1.2 billion. CIBC World Market’s Sedran says he expects such charges will be an ongoing event as banks address “legacy systems and processes.”

WITH THE PROSPECT OF AN “UBER” moment out there, banks are working to retain their customers by stepping up their own digital channels before new, agile competitors have a chance to steal them away.

There are signs that this strategy will work to a degree. Take the example of mobile peer-to-peer (P2P) money transfer providers, a class of competitors whose apps allow users to split a dinner bill, cab fare or any other payment by requesting and sending money amongst themselves. One P2P app popular with millennials in the United States is Venmo, which is owned by PayPal. In the first quarter of 2016, US$3.2 billion was transferred through the platform. However, Canadian banks have already developed convenient digital payment methods similar to those offered by Venmo and other P2P providers. “On my TD app I can send money to you via e-mail transfer,” says Jim Orlando, managing director at Omers Ventures. “So it’s going to be much harder for Venmo to really make inroads here in Canada because of the fact that this capability exists on the bank apps themselves.”

On the flip side, in areas where fintechs get the jump on the banks and come to market with digital services that are cheaper or more convenient than what the banks provide, the banks have other ways to play catch-up. Citi’s analysts, for example, point out that “business models that are based on a lower cost-to-serve may be easier to replicate by incumbents.” And if beating them at the own game doesn’t work, the incumbents could always buy the fintech intruders.

A third option, as noted earlier, are partnerships. According to RBC’s Woo, this strategy recognizes “that there’s just no way that we would have a monopoly on smart people or on good ideas.”

Sean O’Connor knows what that looks like. O’Connor is vice-president of partnerships at Grow, a Vancouver-based online marketplace lender that uses data science and automation technology to meet the changing customer expectations in Canadian financial services. Grow raised $10.2 million in 2015, only 10 months after launch. Having recently inked a partnership with Conexus, Saskatchewan’s largest credit union, to enable the province’s residents to apply for loans from their phone, tablet, or computer and receive funds the next day, it has been living up to its name.

Kevin Sandhu, CEO of Grow: partnering “inevitable”

For all the success some fintechs are having, one rarely hears bellicose assertions from founders that they intend to “Uber” the banks. Quite the opposite, in fact. When asked what he sees as the likely way forward for fintechs and incumbents, Grow’s CEO Kevin Sandhu says: “Partnering is really the inevitable route.”

TD’s Masrani also endorsed this scenario: “To describe [the current situation] as an ‘epic battle’ between the incumbents and insurgents would overlook a fundamental truth: companies—on either side—are focused on building an even better customer experience. And so you’ll find companies working side-by-side just as much as competing head-to-head.”

In its 2016 Canadian banks report, PwC recommends that banks take a hard look at their internal talent and innovation, and where they don’t measure up to fintechs, to “look to partner or collaborate with fintech disruptors—even engaging in a “cooperation strategy,” where competitors cooperate for mutual benefits—to rapidly create new products and ideas to build new capabilities at the speed the market demands.”

CIBC’s partnership with Payfirma is an example of just that. Michael Gokturk, CEO of the mobile payments solution developer that provides its services to the bank’s business clients, says, “We’re very good at payment technology. The bank is very good at their core business and the credibility factor. By partnering together, the bank wins because they’re offering their customers the latest payments tech. We win because we get access to their customers.”

Other banks have been active in partnerships as well. TD partnered with U.S.-based Moven to develop MySpend, an app that al- lows customers to track expenditures and manage their budgets. RBC has partnered with Toronto-based Bionym to test its wearable product Nymi, a wristband that authenticates user identities through their heartbeats. And after Scotiabank participated in a mammoth, US$135-million Series E round for U.S.-based Kabbage, an online lender that uses data available online and sophisticated analytics to judge credit worthiness for small business loans, the two are now working together to offer small business loans to bank customers.

Looking ahead, the one certainty is that there is no room for complacency. When assessing what happened to companies in music sales, video rentals, travel booking and other sectors that have undergone significant digital disruption, Citi’s analysts said: “In each of these cases, incumbents either transformed or became marginalized.” And finally, Yair Weisblum, consulting partner in financial services strategy and operations at PwC in Toronto, adds this cautionary note. “The disruptors might not all survive, but the disruption will stay.”

Photography: Jeff Kirk (slider, top); RBC; Omers Ventures; Paul Joseph (bottom)

Note: This version of the article contains corrections from the version printed and originally posted amending information about Michael Zerbs’ hiring and tenure at Scotiabank.

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