I spent most of week-before last in Mexico City, speaking at the CL@B conference.   At one of the side events, a reception hosted by Getronics, one of our major partners, I had the chance to speak with James Gardner, who asked me if I intended to speak about anything "interesting or controversial."  Considering that this was my first speaking engagement since taking my new role on the world-wide team, I said that I hoped for an interesting talk, but controversial certainly wasn't on the agenda. 

"I see," he said.  "I opened my talk by telling them they'd all be out of business in 10 years."  ZOINKS!

Combine this with American Banker's 3 part series on the "end-game" for U.S. Banking, and the overall industry mood seems somewhat fatalistic, indeed.  What are the trends driving these radical predictions for the future of the industry, and what is technology's role in aiding (or resisting) them?

  • Disintermediation, the quintessential b-school dotcom buzzword, is alive and well.  Gardner's forecast of doom rests primarily on several classic disintermediation plays.  First, peer-to-peer lending schemes like Prosper and Zopa, which seek to match lenders with borrowers directly, while still allowing the lender to manage risk thru diversification.  Second, increased competition in core banking activities from unlikely sources, to wit, PayPal.  Over $8 billion US worth of payments were processed thru PayPal in Q1 2006, and the service boasts over 100 million user accounts.  Is this a possible threat to a bank's payment processing business?  Absolutely.

    Considering that the core function of a bank is to act as an intermediary between borrowers and lenders, the emergence of viable disintermediaries is a source of concern.  I think it remains to be seen whether these new disintermediaries are merely a threat or a clear and present danger, as these new institutions' ability to manage risk over the long term is still unknown.  Nonetheless, complacency would not be a good approach for the incumbents.
  • Commoditization.  Increasingly, innovations pioneered by one financial institution are quickly copied by all competitors.  Commoditization increases the threat of substitutes and eliminates the "imperfect imitability" of innovation-based inputs.  In the short run, the largest banks will benefit from this phenomena, as the truly scarce input becomes the scale at which they can make investments.  As Bank of America CEO Ken Lewis pointed out in a recent American Banker interview, "Look at what size allows you to do when you want to make an investment. We made a $675 million investment last year [in the global investment bank] and never asked for forbearance from analysts."  In addition to sheer scale, brand power leans in favor of the largest players.
  • Open Architecture.  Some large universal banks, offering a range of products and services, have come to the conclusion that they do not wish to organically provide all of these financial products.  Everything from major products like retirement accounts all the way down to gift cards at the teller counter can be offered thru "open architecture," another catch-phrase that essentially means acting as a distribution channel for other firms' financial products.

Taken together, commoditization and open architecture are causing the industry to re-think the horizontal and vertical integration decisions of the past several years, resulting in a slew of both M&A and divestiture activity.  Why not outsource a commodity line-of-business?  Why broaden our investment product portfolios thru open architecture?  What product or service do we provide better than anyone else?  Questions like these are sure to be debated as banks try to find the optimal mix of organic growth and open architecture offerings to maximize profits moving forward.

So where does technology fit?  In short, I think it all comes back to two things:  SOA and composite applications.

  • SOA is an absolute good.  The ability to integrate systems based upon open XML standards will allow big banks to tailor their value-chain more optimally.  One of the classic arguments in favor of vertical integration is the elimination of transaction costs, because it is simply too costly to contract and coordinate activities across firm boundaries.  However, service-oriented architectures hold the promise of greatly reducing the friction of crossing firm boundaries, especially in a areas like financial services where the transaction involves pure information (as opposed to physical transfer of "real world" boxes, steel coils, or hog bellies).

    Smaller institutions likewise benefit from SOA, as it enables them to build diverse product portfolios thru the use of open architecture.  In this regard, community banks can look small, providing the local expertise and personal touch of a small-town bank, but act big by providing an array of products and services that rivals their massive competitors.
  • Composite applications provide a user-friendly, integrated front-end that looks like one application but is actually talking to many back-end systems.  A composite app is "composed" of many autonomous pieces. Here, "autonomous" means "not sharing programmatic type information", but if that's too geeky for you, consider the benefits:  multiple application teams concurrently developing sub-pieces of the composite application, which can then be brought together in different combinations to meet different business needs.  For example, a teller may need to see a common customer module, a cash deposit module, and a bill-payment module.  A call center agent, however, may need the same customer module along with an escalation management module and sales module.  Because the composed pieces are loosely-coupled from one another and communicate across defined boundaries using XML messages, composite applications are like an SOA-based desktop application.

    The type of flexibility provided by composite applications is valuable to organizations of all sizes.  For large banks, the ability to allow geographically and organizationally dispersed development teams to create and deploy (and fix) their applications independently, without affecting other UI components is a huge benefit.  Citigroup's Citivision application (case study here) is a great example of this benefit in action. 

    For small banks that build their value chains thru open architecture, the desktop can become an unusable mess of internal and business partner systems--unless you build a composite application that smoothly integrates all of these applications into a single UI.