Can the banking system as we know it survive?
The traditional banking system is under threat. Not from its traditional competitors. Not even from startups. Not even from Amazon or Alibaba. But from itself.
We at The Strategy Group often use banking as an example of how innovation is threatening old business models. We ask ourselves, how can banks survive under the threat of fast moving, consumer-centric technology companies? Perhaps this isn’t the real question we should be asking ourselves. Perhaps the real question is, can these large, complex organisations continue to run with integrity and proper accountability, or will they fray at the edges and rot from the centre until they destroy themselves?
Here in Australia, Westpac shareholders were rocked several weeks ago when the regulators sued the bank over 23 million breaches of anti-money laundering laws, including some payments that enabled child exploitation in the Philippines. We have now grown accustomed to hearing stories of banks wildly violating regulation - from Wells Fargo’s Ghost accounts to Goldman Sachs helping raise billions of dollars (earning suspiciously high fees) that allowed Jho Low and then Malaysian prime minister Najib Razak to steal $4.5B (USD) from the Malaysian people.
Our hypothesis is that these organisations, with traditional management structures, very traditional board structures, massive employee numbers (Westpac has around 40,000), and archaic legacy computer systems, have become too complex to operate in a time of disruption and rapid change. They functioned well in more stable times, but to function now, banks must rethink their underlying business model and governance structure.
Most large banks are past what we call the Pivotal Factor. The Pivotal Factor is that point in which a well-functioning firm starts to fray at the edges and rot from within. It’s when complexity starts to impede mission - when a culture of “no” starts to institutionally kill the collective desire to put their “all” into their work, when back-to-back meetings drown leadership or when misaligned KPIs take the organisation down the wrong path. Every organisation has a Pivotal Factor and it will change given the resources at hand. We have seen small organisations reach their Pivotal Factor only to have it change once they hire a more capable board or CEO. Without major change, it’s very difficult for firms to reverse momentum past the Pivotal Factor. An organisation’s leadership must be able to identify this point, which is not easy to do, and they must turn the ship around, which again, is very difficult to do. This becomes much more difficult for large, complex organisations like traditional banks.
For these large banks, they have moved past their Pivotal Factor and this repeated unprincipled behaviour is a symptom. We don’t believe that the people that work at banks are evil people nor are they corrupt. In no way do we think that Brian Hartzer, the former CEO of Westpac who resigned over the anti-money laundering scandal, wanted to support a small group of paedophiles. We are sure he is horrified at the whole situation. The entire organisation has moved past the point where a leader can have proper oversight of operations. Is it really feasible, or conceivable for a CEO or board member to be able to have oversight over 40,000 people within a Kafkaesque governance structure? The answer is clearly no. It doesn’t matter how many audit reports or independent reviews take place. A leaky boat will always be found to have leaks.
Greed compounds the issue for banks because of exactly what they deal with every day: money. Australian commissioner Hayne pointed it out on the first page of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services “First, in almost every case, the conduct in issue was driven not only by the relevant entity’s pursuit of profit but also by individuals’ pursuit of gain, whether in the form of remuneration for the individual or profit for the individual’s business”. A history of misaligned KPIs and bonus structures have resulted in bankers focusing on short-term gains at the cost of the long-term benefits of their customers and society. It is no wonder that many Australians don’t trust their banks, and consumers are happily jumping into the arms of neobanks like Xinja, 86400, Volt Bank and Up.
So what can be done about it?
There is unfortunately no magic bullet and every bank must look internally to find its own answers. However, we maintain that there are several places for Australian banks to look.
Reduce size: If banks want to maintain their current governance and business model, they can choose to reduce size so that they become more manageable. They should then look to improve operations by plugging holes and other marginal improvements. This might work because regulators like to protect the industry, reducing competition for the sake of perceived safety. Marginal improvements in governance structures, systems and KPIs combined with a more manageable size could get the organisation to a point where it hasn’t passed its Pivotal Point.
Acquire or start a Neobank: Drop the baggage and start over with the core business. This is an opportunity to build new systems and processes from scratch and to scale this entity as the traditional business declines. A separate entity will be needed in order to allow the entity to flourish and to stop the corrosive culture from spreading into the new business. It will need to have a tech culture and not a banking culture. This is the approach that Bendigo and Adelaide Bank took with Neobank Up when they partnered with technology company Ferocia.
We are huge proponents of this approach, and we feel that it has the potential to reshape banking for the better by allowing banks to build digital, customer-centric products. In general, we have helped several large Australian companies launch and scale startups. We believe it allows for new vibrant cultures to breed improved governance structures.
Drop the unsuccessful entities: Banks should kill off or spinout non strategically aligned periphery products or divisions so they can stand on their own feet. This is another way to simplify the business model to help the bank focus on the governance of their core business. For too long, banks have added complexity to their operations by trying to cross sell mediocre products to their customers such as insurance or securities trading. Rather than unsuccessfully attempting to compete with successful entities providing excellent service and products, they should partner with these other businesses and look to share profits.
‘Culture eats strategy for breakfast’
Peter Drucker has been credited with saying ‘culture eats strategy for breakfast’. We couldn’t agree more. The heart of stepping over the Pivotal Factor is the unravelling of culture. The unwieldy entities that banks have become don’t allow a top-down proliferation of good culture. They have depended on governance and controls which are too fragile at such a large scale and during this time of growing complexity.
New answers need to be found. Without it, banks will lose market share to companies that offer better service and that are not repeatedly in the news for tripping over their own feet. It’s time to rethink the model and come to grips with the fact that the current model is under threat… from itself.
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