​FinTech and Blockchain: Are banks dead?

Banking and financial services are under threat from a combination of technology innovations, a difficult economic environment, and changing consumer expectations.

During a recent CXOTALK conversation with banking technology leader, Oliver Bussmann, we explored the dynamics underlying these challenges to financial services. Oliver was Group CIO for UBS, the largest private bank in the world with $1.74 trillion under management. At UBS, he was known as the firm's "blockchain guru."

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My conversation with Oliver explores issues such as the challenges posed by FinTech startups, why blockchain matters, the CIO role, and advice to startups that want to work with established financial services companies.

A summary video of that conversation is embedded above; you can read a transcript of the short video below. You can also watch the entire 45-minute episode.

Why blockchain matters

Michael Krigsman: Now, some of the technologies you mentioned, but we all hear about blockchain. And, of course, that's not the only technology that's changing banking and financial services. But, tell us about blockchain, for those of us who don't know, just give us a very brief introduction. What is blockchain, and why is it so important?

Oliver Bussmann: Yeah, for me, it's a great experience in discovering the blockchain technology in an early stage. Remember, Michael, we've been through the mobile enterprise maybe 6-7 years ago, that consumer advisors in the mobile space came up, and then at that time, SAP realized that it would have a significant play in the enterprise too. So you learn over time to discover those megatrends and see in an early-stage the potential, and then put the best team on that: a small team to explore, to understand, and then become a leader in those trends. I can say that from my time at SAP, very successful, and mobile advisors tapped the early stages, and also applications.

And then also here, let me share the story that happened to me also, that I discovered, or we discovered that blockchain is simply ignored, because we got it pushed by an entrepreneur in Switzerland that [...] is saying we can do FX trading, foreign exchange trading online, settle everything in real time. And usually, if you do stock trading, it takes at least 2-3 days to first settle, the exchange of cash and security takes time, and this immediately bold statement that we can do this in a few seconds, everything is settled, the cost of doing business would be low, plus the real-time execution would reduce operational risk, risk capital would come down, and we said, "Hmm, that's hard to believe."

And then we discovered that you know, that the underlying technology of Bitcoin, the blockchain, is the key driver, because it's so normal for most of the banks, and still with Bitcoin with the reputation to even discover that, and to discuss that. And then we discover that the blockchain technology, based on Bitcoin, at the end is a major simplification of our business.

And let me explain a comparison: today, if you do a trade, it goes to different parties. You sell something, they have the buyer, there are different banks in place, stock exchange, clearinghouses, I would say between at least almost ten parties involved, and they have to reconcile the investment business. They have to exchange messages, raise my cash, raise my security the right way; they have to reconcile; it's a major effort to do that. And, blockchain at the end, in a very simple way, you store information over the internet that both parties can point to. It's almost a reference, a database reference that you can point to. And there is a mechanism in that if you do a transaction, it's first of all locked, it's recorded, you cannot manipulate that. Plus, there is a software at the end, making sure that this transaction only is unique, verifies it. So you don't need a third party to verify your transaction, but the software is doing that.

So that business logic is part of that ledger, and at the end, the whole messaging goes away, you have a direct impact, a third party is not necessary anymore, and so complexity goes away.

The low speed of doing business is going away, plus the accessibility of blockchain and Bitcoin is public ledger at the end, it makes it easier to access that information from anywhere because it isn't stored anymore behind firewalls, it's accessible for the different marketplace, and there's encryption in place to make sure only the relevant parties have access. So it's a game-changer from my perspective, and game changer not only for the financial services industry, for insurance, for trade finance, you see this also for the internet of things.

You have a lot of information, send some information, and what do you do? There must be certain events to happen, and there should be like a smart contract that you can act on that. It's like, you have sensors in your fridge and your fridge is empty, what do you do then? And, there should be a clear definition if those kind of events are happening and triggered, then you buy something online immediately, right? So that technology, this is why certain high-tech firms like IBM, for example, and other firms see this combination from dedicated business to make it happen.

So what I'm saying is, it is like the internet 20 years ago, a game-changer that has a major impact on the financial service industry, and I also believe in government, healthcare, supply chain management. Every time you have multiple projects involved and they need to be synchronized; that is the way going forward.

Michael Krigsman: Are there examples of banks or other large organizations that are using blockchain in a meaningful way today? Or is it too early yet?

Oliver Bussmann: No, I think you see the first use cases coming up. Use cases like in general, the FinTech area, the payment area; it's a target section because of payment, the business is profitable, there's a lot of profitability, there's a need to simplify that from a user access perspective.

And the uses that I think will come through in all their stages is the cross-border payment. It's complicated because you have to go through a lot of central banks to do those cross-border business for retail and institutional finance, it takes time, and it's on average roughly you pay $25 for each additional transaction. And parts like Ripple, for example, other ledger providers, they will simplify that, and there's a collection of six banks already working on that. They are using the technology for their cross-border business within the bank. The next step is they build a network to exchange those transactions, and the infrastructure will be simplified for that, speed is different, and then also the cost to market because the projection is that a transaction that will cost today $25 will come down to less than a dollar.

Michael Krigsman: Wow. Amazing.

Oliver Bussmann: That's exactly what is a major change that will drive that, because if you're an institution or corporation doing international business, and you sit on stage with your corresponding bank and say, "You know, I'm paying $25 on average, domestically I'm paying less than a dollar," that is a clear amount to bring it down below that. But then, you understand the revenue is coming down, the banks that are able in moving earlier and adopting it will have a change to get more market share. So if you're not part of the train, it could hurt you significantly.

Disruption in financial services

Michael Krigsman: And, what are the changes that are taking place in financial services right now?

Oliver Bussmann: Yeah, it's multiple dimensions that the financial institute has to cope with right now. It's after the financial crisis of 2008-2009, the amount of regulation is significant, I would say.

To protect consumers after 2008-2009, a lot of new regulations in all jurisdictions, put a lot of effort into controls, risk management, compliance, to avoid any misconduct in the future. And, to give you data points, today, usually large players invest between 50% and 60% of their IT investment change [in] the bank just to stay in line with the regulatory requirements. That is significantly higher over the last 3-4 years and a lot of the potential investments that you need for new services, new products to implement, improve certain customer services, that is now absorbed by the regulatory requirements. And, there is also then a push for certain software. If you run a global business, you have to stay in line with local requirements, regulatory requirements. So the regulation is a piece which will stay, I don't see that amount of investment requirements will come down.

The second is consumer behaviors. Everybody has different preferences now to access information, making decisions. There's definite patterns, the generation that is now becoming highly networked, they don't go to the front anymore, they want to talk to their financial advisor over the phone or video, they want to have automated information. The decision-making process is different. So, the consumer preference, how they like to be served in the middle of a big change.

The third dimension is new technology. We are going to another major change even bigger than the first one, 2000-2002. There's significant venture capital and resources coming into the whole innovation, the startup community. You know, I saw at UBS a few years ago, the VC spending was at that time $3 billion US dollars. That number is from 2013 up to 2015 up to $20 billion. And the projection for this year is going to be up maybe to $24-25 billion. And so that should be enough time, and if you compare that with the internet investments 20 years ago, there was $500 million in 1995 spent on innovation in the Internet-related companies. You see the amount of resources and capital coming into the environment.

And then, from a macroeconomic perspective, there is significant pressure on banks, especially European banks, because there are limited growth opportunities. If you cannot go because interest rates are low, and the transaction volume is also because in the market of uncertainty, is low. So, there's a revenue pressure, the pressure even on the cost side is going up significantly. Cost side meaning your cost-income ratio is under pressure compared to US banks. US banks are at 55% of your cost vs. revenue; most European banks are at over 70%. So there is significant pressure on those banks to be very careful to reduce your operating expenses, which also has an impact on potential investments going forward. So it is a constrained and stressed environment, and the new technology is even triggering, from my perspective, even bigger, significant change.

This excerpt is part of episode 202 of CXOTALK, a video show that offers in-depth conversations with people shaping technology and the world. Check out the list of upcoming episodes.