This growing ecosystem of start-ups aims to siphon off banks' more profitable lines of business, especially the pools of lazy profits such as foreign exchange fees and card-not-present fees. That's why most traditional banks need to quicken their own digital reinvention if they want to hang onto their profit pools.
A quick look at the competition reveals that many small firms have succeeded by meeting previously unfilled financial needs. The social trading company eToro, for instance, fulfills investors' desire to see, follow and automatically copy the actions of their peers in real time. By breaking into the "members only" realm of Wall Street and financial brokerages, eToro has assembled 4 million registered users in more than 140 countries.
Lenda, meanwhile, aims to be the "TurboTax for mortgages" by providing a platform that allows borrowers to complete the home loan process completely online. Lenda has managed to shorten the refinancing process to 21 days, down from the average of 60 days in the U.S. mortgage industry, and is aiming to complete the process in just seven.
For banks, the salient questions are which businesses to invest in and how they can distinguish themselves from the competition. It's true that banks risk cannibalizing some part of their current business in an effort to keep up with fleet-footed startups, but better a bank cannibalize itself than allow other companies to take the lead.
Bankers who know they have to make digital investments over the coming years can succeed by taking a stringent, integrated approach to three areas in particular: funding, governance and talent management.
Funding: Think like a venture capitalist
The traditional banking mindset and metrics rejects digital initiatives for all sorts of reasons: they won't move the needle for a large business; they haven't been invented and built internally; they cannot satisfy longstanding capital expenditure hurdles.
But if a bank relies on net present value calculations and traditional business cases, most digital innovations will fail to receive sufficient funding, attention or support from employees.
Instead, bank executives should think and act more like venture capitalists, who tend to invest in a portfolio of options. They make many small investments instead of betting heavily on one or two. As the options mature, venture capitalists steadily increase the size of their investments. And they consider the bets that don't work out to be valuable experiments, not failures.
Governance: Run several innovation models at once
To build an innovation pipeline, banks can choose from a portfolio of models along a continuum of internal, grassroots development to external development, including acquisitions.
The venture arm of Spanish lender BBVA, for instance, makes strategic investments and acquisitions to add new offerings and capabilities faster than the bank could accomplish in-house. BBVA Compass's acquisition in 2014 of Simple, an online-banking platform, both expanded BBVA's U.S. presence and took hold of an innovative mobile money management offering.
BBVA operates Simple as a separate subsidiary, with the founding management team still in place. Incumbents can't easily replicate the entrepreneurial culture of an upstart. That logic also informs BBVA's open-platform initiative in which it interacts with external developers and potential partners to develop new product ideas and get help with product debugging. BBVA also sponsored a competition in which it awarded prizes for apps that tackled problems experienced by small businesses or that improved the organizational efficiency of BBVA's new headquarters in Madrid. As a side benefit, BBVA's big data team hired some of the winning developers.
Talent management: Banks are from Mars, start-ups are from Venus
Banks will not become financial Amazons or Googles overnight. But they can start to instil behaviours and norms that encourage innovation. They can encourage employees to spend 10% of their time developing "crazy" ideas, tolerate failure as opportunities to learn and hire people with new skills and experiences, from web designers to ethnographic researchers skilled in observing how customers behave.
Partnering with digital startups can also help banks inject fresh vision into their cultures. Capital One understands this imperative. It recently doubled down on mastering the digital customer experience by acquiring Adaptive Path, a San Francisco startup specializing in digital design and the user experience.
But for many banks, partnering with digital startups won't come naturally. Their cultures and ways of working differ greatly. Startups tend to move quickly and are willing to tear up what worked yesterday if they don't think it will work tomorrow.
So banks will need to learn how to create an environment that helps fledgling partners succeed rather than stifling them. This might be handled through an executive who keeps the rest of the bank at bay until the initiative is ready to scale up. Achieving this goal certainly requires banks to invest in capabilities around relationship management, business evaluation, and diligence and deal structuring.
Banks really have no choice but to act. If mortgage completion can be compressed to seven days, what happens to traditional bank revenues and profits when a start-up finds a way to reach two days — or two hours? Banks must reinvent themselves as strong digital entities or fade away as the customer base erodes.
Mike Baxter leads Bain & Company's financial services practice in the Americas. Richard Fleming is a partner in the practice and leads the firm's results delivery practice. Some of the companies named here are or have been clients; Bain's legal agreements with clients prevent it from identifying individual clients by name.