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Banks Failing Innovation Test, Claims New Report

You don’t have to spend a long reading up on the financial services industry to come across the notion that banks are burdened by an innovation problem. Recent years have been replete with studies suggesting banks must adapt to the digital revolution or die – with one of the most common prescriptions being collaboration with the FinTech start-ups leading the disruption.

On the other hand, there is also no shortage of stories about the growing levels of investment banks are making into start-ups, tech incubators, and innovations such as blockchain technology, and every major bank can now point to initiatives that seem to indicate their understanding of the need for change.

Weighing up the arguments put forth by both incumbent institutions and FinTechs, the balanced conclusion might be that banks need to innovate more, but that they are well aware of the problem and actively addressing it.

If that’s what you think, suggests a newly-published paper by The Disruption House, then think again.

Working with a series of 38 different criteria, The Disruption House’s research is unique because it doesn’t rank financial institutions based on current profitability, but rather on their likely capability to innovate in the future. Their methodology outperformed other leading indices when analyzing company success on the stock market over a three-year period.

The report itself is titled “Why Banks are Failing the Innovation Test and How they Could do Better,” and the results—some of which are highlighted below—are fascinating. It’s also worth noting that The Disruption House says the question of which financial institutions have the highest innovation capability is “probably one of the most important to ask for the future of the western economy.”

The Most Potentially Innovative Bank Isn’t a Bank
Reminding readers that their methods judge whether an organization is adaptive or “sitting around waiting to be disrupted,” The Disruption House lists Alibaba, the Chinese e-commerce platform, as the leading financial institution by “innovation capability.” Alibaba recently acquired a banking license, and the report suggests their number one spot is thanks, to a large extent, on the cultural climate in which they operate: “Financial institutions in Asia are typically emerging from a world of e-commerce or the web, which means they have a close relationship with the real economy. By creating high levels of integration they are redefining the modus operandi of commercial banks.” China’s Tencent and venture-backed start-up Ripple also made the top 10, resulting in a considerable presence for “technology companies who are not really banks.”

DHB_Top 10

The Most Strategically Important Banks Have Less Innovation Capability
Focusing in on banks in the West, the report pulls no punches, stating: “Western banks believe their biggest problem is cost reduction and/or start-up disruption. They have yet to understand the imperatives of business process change and are fixated on the idea of digitization without understanding the new role of business platforms. As a result, they are creating problems for themselves by believing that ‘digital’ is somehow a solution-set.”

Backing up that claim, the paper points out that the top 10 global systematically important banks (G-SIBs) lag the index of all companies for innovation capability by 23%, and lag other banks by 10%. Financial institutions in general, says the report, have an innovation capability that is 10-15% lower than other companies worldwide. These scores imply banks fell short in many of The Disruption House’s criteria, which include things like the “The externalisation of innovation to third parties.”

DHB_Capability indicators

Bank Leaders “Do Not Grasp the Modern Economy”
Interestingly, the report notes that “the capacity for banks to make strong strategic moves in the market is high, but is not being deployed. The main reason for this is leadership.” In fact, this issue of leadership within banks is singled out as the one which needs to be most urgently addressed. The paper goes as far as to say “Leaders do not grasp the modern economy and need to take a lead on technology-driven innovation and to communicate a narrative that spells out the future of banking.” Elsewhere, prescribed solutions for this lack of leadership center on the need for new blood: “To develop new operating models there is an urgent need for banks to host an inter-generational dialogue at the leadership level. The changes they need to make require continuity over a 10-year period, and younger generation executives are closer to the coal face and perhaps quicker to grasp what changes need to be made…”

Partial Praise
Three G-SIBs did manage to claim a spot in The Disruption House’s top 10, namely CitiGroup, BBVA, and BNY Mellon. Moreover, there is a glimmer of light in the claim that “banks have improved their innovation capabilities over the course of 2015 but not significantly so.” Overall though, the report is defined more by statements like this: “There are serious deficits in innovation capability at many leading banks…” Or this: “Banks have a strong background in platform technology that they are not adapting to modern needs.” And finally: “When compared to non-financial firms’ innovation capability, banks lag significantly.”

Ultimately, then, The Disruption House’s report could be thought of as a warning shot that flies a little closer to the target than much of today’s commentary urging unity between banks and FinTechs. Its recommendations to overhaul leadership and corporate culture cut a little deeper, extend a little further, and perhaps demand more introspection from those shaping the future of financial institutions. It remains to be seen if such predictions of what lies ahead will have any significant impact on banks’ strategy in the here and now.

If you’d like to see more of The Disruption House’s findings, the full report can be downloaded from their website.

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