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Thursday, November 15, 2018

Today's Profits Mask the Undercurrents of Forthcoming Chaos

By Mark P. Dangelo
August 22, 2017

Topics:
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(Mark P. Dangelo is president of MPD Organizations LLC, featuring books, industry reports and articles. He is a strategic management consultant, outsourcing advisor and analytics specialist with extensive process, technology and financial results and is a frequent contributor to MBA Insights. He can be reached at mark@mpdangelo.com or at 440/725-9402.)

Mark DangeloWith the summer months in winding down and as we prepare for a busy fall season within our organizations, we sometimes in a passing thought wonder by the end of our business careers, how many professional books have we read and more importantly internalized? What made the two or three we can probably remember--if we can even remember their titles--memorable as compared to the others?

Were the principled messages thought provoking, controversial, focused on going to war, required for a project or concentrated on redesigning parts of the enterprise? Did they speak about technology, personnel, regulations or availability of data? Were the ones we remember just the last ones in the queue? In the end, did all the reading, work and results or their message really boil down to, "We tried?"

As financial institutions have become more, not less, systemically important to the domestic economic expansion, they also face fewer traditional competitors (see Federal Deposit Insurance Corp. institution levels), are viewed with excessive societal distain, continue to commit transgressions for profitability and are perceived as stifling innovation due to cultures which are dedicated to greed. In general, their popularity is less than desirable for a consumer or homeowner who has increasingly more choices (e.g., mobility), requires integration with their lifestyles, and who has little forgiveness for those institutions who are secretive about their financial security and privacy.

It is easy to forget in times of profitability, boom and bust cycles don't always have a storybook ending--things may be good now, but wait for the cycle change. That the latest bestseller may not hold THE answer to what consumers are thinking and how they are speaking with their financial product and service purchases. And, when we stop asking hard questions, when we stop embracing more than non-adaptable incremental changes, and when we stop fearing that "banking is necessary, banks are not," we arrive at a point of inflection that bodes ill for tomorrow's health of our financial institutions.

Comprehensive Control of the Channel is Past
It is in the face of these questions and the perception of pervasive bad actors within financial institutions, which effectively reduces the barriers to entry for startups and crossover firms (e.g., Fintech, retail giants, white-labeled solutions) to create beachheads in an industry long dominated by conservative leaders. Combine the challenges within the industry, and even what transpiring (and needs to happen) within once valued secondary markets for mortgage securities, traditional financial institutions are starting to concentrate and segment into two distinct operating models--utility and customer facing.

The former, the utility model, is represented by extensive regulation and high-levels of capital investment--much like an electrical utility generating power and the lines used for its distribution to homes. In this model, and its new iteration labeled BaaS (Banking-as-a-Service) or BaaP (Banking-as-a-Platform), is made possible by not just mobile technology and vast partnerships with consumer apps, but also due to standards and Application Program Interface (estimated at more than 15,000 and counting). The utility model also provides the scale needed by startups, while satisfying a consumption versus build deployment demand.

The idea of building a "killer app" provided the genesis for financial institutions to partner with consumer-facing financial solutions and social media providers. Post-Great Recession, financial institutions were directed to concentrate on regulations, leverage ratios and put forth living wills to meet public and private demands for safeness and soundness across the financial services supply chain. The result was a bifurcation and a relinquishment of market segments to those better able to provide consumer and retail services, as compared to high-capital build demands of middle and back-office solutions.

The markets are splitting and it is very likely that in just three to five years, the fork in the road that created the events of today will branch themselves into additional forks. These new splits will diverge to a niche play or merge back into a common model depending upon the speed by which financial institutions accept the revolutionary environment in which they are competing.

As shown in the conceptual graphic below, especially in our current era of populism, the four Vs (volume, veracity, variety and velocity) have brought many financial institutions to a critical inflection point which is problematic moving into the future--beyond demographic boundaries which many products and services are designed to satisfy.

DangeloChart1

Combine these events with a highly divisional and rapidly changing political messages, and the familiarity by which financial institutions held captive, their consumers will dissipate as their ability to quickly change institutions becomes turnkey and in the power of the account holder--not the provider.

Stating an axiom, banking is the cornerstone of capitalism--without credit our societies would stifle and fail, without electronic global settlements the mere idea of competing globally at today's pace of economic development wouldn't be possible. Even communism came to understand that leverage and payments can make or break a social-economic structure.

I believe that the day of paper currencies is long past. I believe that T+0 is not a goal, it could be done much sooner but doing this would significantly decrease profits within major institutions. I firmly believe that credit cards, most brick and mortar branches and traditional loan processes will vanish in the next decade replaced by their digital equivalents for a mobile society not focused on brand but value add. I even firmly believe the idea of offshore outsourcing's relevancy has passed for a multitude of business, security and privacy reasons.

Heresy to be sure, but the indicators are clearly moving from yellow to red. And, if financial institutions get there way and peel back burdensome regulations, commoditization of their products and services, along with extensive disintermediation of their markets will be a byproduct of removing the very shackles they desired. For as markets become less regulated, barriers for non-traditional entrants are lessened and impacts more severe when it comes to those believing in tradition ways.

Attacks Poised to Begin
Disintermediation caused by established and upcoming enterprises is no longer just about Fintech--it's created by cross-purpose enterprises spread across hundreds of industries. These "upstarts" know what apps consumers use and their behaviors large and small in their daily lives. They know how to mine information and share it securely with other organizations. They know how to tap into layered, orchestrated delivery models to create action-oriented profiles for trustworthiness of qualified lending. They know how to get between all the white spaces and find what it is that financial consumers are not just doing, but thinking. These are things that financial institutions never had to do, as they determined what consumers did and made their behaviors align with product or service limitations.

That was then. Financial institutions were built on paper, forms and green screens. They forced the customer to give them duplicate information, even though it exists elsewhere within the same institution or across partnered products. "Give me information, provide me the result," turned into dogmatic processes backed up by burdensome regulations. The shift has been rapid as banking has moved to the enterprises having it "their way" and shifted to consumers who want it "their way."

To cut to the chase of what is likely to transpire (using the four Vs above), we can see in the table below that disintermediation will have broad impacts across the enterprise. It should be noted, disintermediation is just one of four pillars that is being attacked--the other three include commoditization (discussed very briefly below), regulatory compliance and digitization (more than traditionally simple, complex and layered models).

DangeloChart2

Cycles are Shortened--Permanently
Commoditization is the 800-pound gorilla that most financial institution leadership loses sight of when they concentrate on margins, profits and market share. The most important question financial institutions can ask is, "Are we asking the right questions?"

For example, should institutions hold onto data, thereby depriving competitors of any value from their customers? Or maybe the better question is, what data should they hold onto to ensure they have a broker or "bookie" financial supply chain role guaranteeing them of fees and profits regardless if the consumer makes or has money? Or will a more egalitarian culture promote profitability and growth by making the institution value-added and thus the preferred partner for existing and new financial institution enterprises? What this says for financial institutions is that depending upon strategy and capabilities, some of the approaches will be moot without substantial transition and or revolution within front, middle and back office infrastructures built over decades.

Financial institutions, and the cultures they painstaking created, always thought they were a one stop channel and once they had you--they had you. That's how the whole idea of house holding and cross selling and all that other slogans came to be. "If we can lock them in, we can sell them more products," came to the board rooms and shaped for years how profits were sought after and booked. The same thing with fee based incomes could be said. These encompassed key strategies for financial institutions, and they have been for basically three decades.

If banks try to put up fences to contain a consumer, that's going to drive existing and future customers away. Financial institutions must be able to determine, "What markets do we want to be in based upon our brand, our solution sets, our delivery capabilities and our skill sets?" If we don't have the capabilities and we don't necessarily want to be in this market, then our delivery and branding models should reflect that. If we want to be competitive, then what will it take to excel recognizing the cross-industry models gaining success with behavioral adjusting buyers?

Often, financial institutions are chasing and spending money on things that they're not good at or never will be good at unless they invest heavily. That is where you begin to look at products and services within the banking world that a lot of these Fintech folks are going to offer. These "challengers" are going to come in and say to you, "We'll give you this as a white labeled or black box service. We'll find various partners, we're beginning assemble these things based on best in class or best in breed."

That's really the choice of bankers. Are they going to try to dig in, hold on, put up regulations, deal with lobbyists and go to their politicians and say, "Pass legislation to keep these people out." Well, what's going to happen is if we go into that protectionist kind of mode, regional or national, the rest of the world isn't thinking that way. We may defend the initial onslaught, but we will not survive.

To the completely disconnected financial institution, existing barriers to entry are not a perfect inhibitor to competition when it comes to protecting markets and the consumers. These new competitors will find a way to compete with banks regardless of the inhibitors--regulators, licensing, consumer groups, politicians--as they see financial opportunity with commoditization of many products and services within the financial institutions. What can banks do to protect themselves?

While the idea and challenges of commoditization could span volumes for financial institutions, the table below points to but a few of the priorities that should be spread across dashboards to avoid the commoditization of your solution sets and provide a path to new solution sets. Banking, lending and regulations are poised for a large upheaval before the end of the decade. If we don't start turning our conservative cultures very soon, the only way to stop commoditization will be more nasty barriers to entry in the form of regulations to keep the upstarts out. We lose by inaction and we definitely lose with more regulation.

DangeloChart3

In the haste of rush to be "like(d)," there are competitors, places and extraordinary unforeseen risks, within a globally interconnected financial system (and there are many, stacked layer upon layer). We can only bring our concerns and recommendations to the varied leaders and leadership teams--but what will happen in the absence of action?

In an era of populism, it seems like every bit of assistance or advice is focused on slogans and divisions. What financial institutions need are capabilities that allow them to execute against an innovatively relevant business model that is both adoptable and adaptable. Incremental improvements become a step back or stop-gap measure.

So, for all those business books we have read, I wonder, how many really made a lasting impact? How many will you remember in the face of high-stress adversity coming from all channels? What happens if as has been said, "Banking is necessary, banks are not"?

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA Insights welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at msorohan@mba.org; or Michael Tucker, editorial manager, at mtucker@mba.org.)

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