The Great Divergence: Banks and Technology
By Rob Cossins on the 25th November 2020Artificial Intelligence
Across the global economy, industries are being disrupted by technology at a dizzying pace. Sometimes changed, sometimes replaced entirely by new entrants. The largest 10 companies globally are unrecognisable compared with just a decade ago. Let me put forward a prediction for financial services: there will be a Great Divergence in market capitalisation, as Banks able to implement new technology accelerate away from the group and gain market share.
Bank spending on technology ranges anywhere from 17% to 30% of operating costs. On average, this is higher than technology-led companies such as Alphabet (19%) and Amazon (13%). The numbers involved are large — in 2019, JP Morgan spent over $10bn on technology alone. This is an oft-cited number, but doesn’t quite cover the whole picture. So why the difference? Every year, Banks invest billions in maintaining legacy systems, core infrastructure, network upgrades, support and other traditional spending. This is before they can even begin to think about investing in new, transformational technology.
Strategic technology decisions in large, regulated organisations are difficult. Structure, legacy and even the location of technology staff all conspire to slow innovation, adding layers of cost. Often this is grounded in good rationale. After all, we expect large regulated financial institutions to be responsible with the money of both corporates and individuals. But given these proportionally large technology budgets, can more be done?
The Banks that leverage technology correctly across their business units will reduce costs faster, lowering their cost/income ratios and increasing market capitalisation. But it’s not just about costs. Imagine a world where a corporate has a choice: Bank One can provide new capital instantly, while Bank Two takes months, pricing is similar. Which Bank will get the business? It’s clear that speed will win in this case. After all, there is only so much you can achieve with process change and restructuring. Some Banks realise this, which is why market leaders are training staff, from front office to back office, in coding languages. Technology is becoming part of the organisational DNA of these Banks.
Banks have competed on talent for years, but now they are also competing on technology. Radical thinkers and innovation-enthusiasts will generate out-sized returns for their organisations, while improving client experience. Those that embrace cutting edge technology will see increased revenue, reduced costs and lower losses from defaults. This will result in winners and losers, as the winners accelerate away from the pack, creating strong market positions. We think every Bank has the opportunity to innovate and grow into one of the world’s largest companies, while unlocking growth for their clients.
But what about new entrants, and why is finance any different?
In other industries, new entrants are creating significant market value. In the automotive industry, the market capitalisation of Tesla, Inc. (TSLA) is surging as the share price rockets. There is a long (and growing) list of global competitors that Tesla is now larger than. Putting all debate about stock market bubbles aside, there is clearly value being created from new disruptive technology.
There is a single reason why we believe finance is different — balance sheets. This is the capital to lend money, over long periods. Balance sheets are difficult to build, tough to manage and highly regulated. This creates a natural tension in the scope of what new entrants are able to achieve. Even Revolut, one of the fastest-growing new entrants in Europe, does not have a UK balance sheet and it cannot lend here. There are notable startup exceptions at the beginning of their lending journeys, but it won’t be long before we see the impact of the pandemic causing defaults across lending books.
Balance sheets also need to be large enough to cover a wide range of company sizes. The larger the corporate, the larger the underwriting requirements. Big capital is required to originate, underwrite and distribute the coming wave of private equity transactions and corporate activity. But just having a balance sheet is not sufficient to defend an existing position — Banks that can combine their balance sheets with market-leading technology will experience the kind of growth and market share typical of new entrants.
Particularly during a pandemic, Banks play a critical role in ensuring liquidity reaches every part of the economy that needs it. Despite the wave of exciting FinTech firms, established Banks still make up the vast majority of loans extended in the UK and globally. Using the current environment to make difficult, long term decisions on technology will generate benefits for years to come.
At Scribe, we’re taking a research-led approach to artificial intelligence, bringing cutting edge technology into the industry, accelerating lending and investment decisions. We see the huge potential of this technology and are working alongside Banks to deliver real, tangible AI-driven solutions.