‘Friend or foe’: What banks have learned from working with fintech

Three years ago fintech startups thought they were coming to eat banks’ lunch, but today the two are frenemies that acknowledge each side needs the other to stay in business.

Silicon Valley gave Wall Street a brief ego trip by bringing new technologies like blockchain and machine learning that could “revolutionize” the banks. But even though banks are more open to cross-sector collaboration, they still maintain that they understand the business of finance better than anyone.

“The narrative has changed but it does creep back every once in a while,” said Mary Harman, a payments strategy executive at Bank of America, at the Swift Business Forum in New York Wednesday. “We whipsaw on whether fintech is friend or foe… we’re distracted by legacy issues and regulatory compliance issues.”

Now that banks are catching up on the technology side, they’re learning that technology isn’t the problem to be solved, commercialization is. “We don’t innovate for the sake of innovation” has become their mantra as they’ve learned they can’t get swept away by the mere idea of innovation, they’ve gotta stay focused the business.

Here are three things the industry has learned from that process.

When not to innovate
Sometimes banks have to trade agility for standardization, sometimes it goes the other way around.

Banks can innovate fastest if they do so alone, but if they don’t have clients or customers to actually transact with, the innovation becomes pointless. That’s why involving a network of other industry players is so crucial — but getting many different entities to agree on many different things is bound to slow down all organizations involved.

“[Consensus] becomes the interest of the individual versus the greater good, and how we manage that drags the process along. It takes time and effort to get through legacy,” said Michael Bellacosa, global head of payments and treasury services at BNY Mellon.

Plus, it’s usually more important for institutions to keep the lights on and bump innovation down on the list of priorities.

“There are a lot of legacy services that make organizations a lot of money,” said Sean Rodriguez, faster payments lead at the Federal Reserve Bank of Chicago. “They’re well known, well run and profitable. If you look at them and say you’re gonna change all that, you have to think: how fast do I really want to do that?”

Approach startups as vendors, not partners
It takes long enough to bring a handful of banks to consensus. Technology startups in financial services now exist to speed up various processes, but adding in more participants can be distracting too. Banks need to focus on providing a business solution to a client or customer, and not on the hierarchy of relationships as institutions try to maintain the status quo.

“‘Is fintech a threat to banking’ is a very narrow part of a much wider discussion,” said Mark McNulty, global clearing and financial institution payments head at Citi. “Sometimes there’s way too much focus on the threat. This is just about partnership opportunities, about leveraging a vendor.”

By approaching startups as vendors instead of “partners,” one financial firm could even find a partner in another. For example, Citi recently launched a partnership with Nasdaq, that links the bank’s business payments services to Nasdaq’s blockchain platform — all made possible by Nasdaq’s use of blockchain startup Chain’s distributed ledger technology.

“This is an opportunity where fintech being deployed in another realm of the industry for settling another type of transaction still needs payments first,” McNulty said.

Don’t be a know-it-all
Financial organizations have to break themselves out of the silos they’re so used to working in, in order to evolve and become more nimble, which is essential in an environment where the technology underpinning the business develops so quickly.

For BNY Mellon, that kind of thinking began in its innovation centers, where it has been able to take its business development, operations and technology employees, put them together with third parties and push client problems to see what it could solve.

“When you’re embedded in the same things everyday, you don’t think of it the same way and usually don’t get that fresh outside look that allows you to be a little bit more nimble,” said Bellacosa. “I get very different perspectives and you can usually get to a solution you never would’ve thought you’d get if you didn’t attack it that way.”

Although, bankers have to be wary of catching “bright shiny object syndrome.”

“It has been a problem for a while across our industry,” said Citi’s McNulty. “It takes a lot of discipline to really focus on problems as opposed to technology.”

Big in Japan: How blockchain startup Ripple plans to disrupt Swift

Blockchain startup Ripple has now cornered a third of Japanese banks and is set to reach half of them later this year, but the first mover among providers of distributed ledger technology has been much quieter in the U.S.

Ripple has been so successful with its payment projects that this year it’s pushing to shift focus to its network. The company was a first mover in the blockchain space and has been relatively quiet and productive compared to its “vendor” peers like Hyperledger or R3 CEV. More recently, however, it has been anything but shy about going head-to-head with Swift, the current hub at the center of the global banking – which makes it hard to ignore how few U.S. bank partners Ripple has.

“[Ripple] is looking to bring some of the big boys to the network but as you can imagine, those are some of the biggest beneficiaries of the inefficiencies of correspondent banking,” said Javier Paz, a senior analyst at research firm Aite Groupe.

Ripple’s Patrick Griffin, senior vice president of business development, said the company has developed the first blockchain network with rules and commercial standard legal agreements. Its biggest obstacle now is in growing its sales team quickly enough that it can keep up with its innovation team, Griffin said. The company now has 150 employees.

Although it’s clear cross-border payments is due for an overhaul, it’s not so clear that Swift is. Banks and fintech companies embrace collaboration and partnership and the idea that the latter will come eat financial incumbents’ lunch is now a thing of the past. Most of those banks belong to both the Hyperledger project, of which Swift is a board member, and the Swift network itself.

In cross-border transactions, there are generally multiple stops a payment makes before it goes from the payer to the receiver. If, for example, someone in India wanted to send $1,500 to someone in the U.S., that person would probably visit a local bank perhaps unable to make that transfer, so that bank would send the payment to another Indian bank that could. The payment then goes to a U.S. bank which sends it to the recipient’s local bank, where the customer would finally pick it up. Each stop along that payment’s way eats up time and money in exchange and holding fees.

Swift’s biggest problem is that of “nostro accounts,” basically correspondent bank accounts – and that’s where Ripple can provide real value to the system, said Tim Coates, managing consultant at Synechron. Swift announced it is running a blockchain proof of concept with Hyperledger technology this January – months and in some cases a year after most of its U.S. members began running their blockchain PoCs. Damien Vanderveken, head of R&D at SWIFTLab, said it’s looking to see if blockchain technology can minimize or eliminate the friction brought by nostro accounts, but did not comment further on the project.

“The nostro problem is a big part of Ripple’s value proposition,” Coates said. “If we can do realtime settlements then we don’t need a whole store of nostro accounts. If not, then we always need a buffer of funds in each account and that buffer is just locked away. We shouldn’t have to put a lot of money away so we can exchange money between banks.”

Swift effectively is looking for ways to allow banks to use existing pipelines of connectivity, like Swift’s messenger, that don’t necessarily rely on nostro accounts but use other types of messaging, said Javier Paz, a senior analyst at research firm Aite Group. Effectively, Swift would be willing to disrupt itself to keep away competition like Ripple.

“Ripple’s success has been in cross-border currencies first in the peer-to-peer space and simple remittance and transfer across the globe,” said Ramesh Siromani, a partner in the financial institutions practice of A.T. Kearney, a global strategy and management consulting firm. “But to gain more volume attraction and network growth would require signing up more banks across the globe and in business-to-business payments where volumes are bigger.”

WTF is SWIFT?

What is SWIFT?

An acronym for Society for Worldwide Interbank Financial Telecommunication, SWIFT was launched in 1977 in Brussels to help establish practices for financial institutions. Specifically dealing with standardizing fund transfers between banks, SWIFT has become a multinational banking community communicating in the same language.

What does SWIFT do?

A few things, but they’re most known for providing a network that allows financial institutions to “communicate”. But we’re not talking about text messages or Christmas cards. Financial messaging deals with fund transfers, with each message calling on another bank to either send or receive funds. SWIFT also creates software that allows banks to send messages over their network. Companies don’t need to use SWIFT-developed programs to use the network, and can use their own or third party-developed software to send messages over the SWIFT network.

It’s important to note that SWIFT doesn’t hold any financial information themselves. The firm only provides a way to send financial messages and transfer funds between financial institutions.

How big is SWIFT?

Pretty big. SWIFT claims to have over 11 thousand financial institutions in its network. Over 6 billion FIN messages were sent in 2015, with a single day high of 27.5 million messages.

So Swift is foolproof, right?

Ummm…well, not so much. SWIFT has been hacked a bunch of times in 2016 alone. In February, the Bangladesh central bank was hacked, resulting in an $81 million theft. In May, $12 million got taken from an Ecuadorian bank. In June, a Ukrainian bank lost $10 million to a hack.

SWIFT has started responding to critiques on its security breaches, and just announced the release of a Daily Validation Report that helps banks stay on top of potential frauds.

Why is SWIFT important?

SWIFT is an influential cooperative that people don’t fully understand, which adds to its allure. It’s been around for a long time and is pretty well entrenched into international banking systems. For example, when Iran was hit with economic sanctions, the country’s banks were kicked out of SWIFT.

At the same time, SWIFT has been heavily criticized with susceptibility to hacks and security breaches. Blockchain enthusiasts also feel that SWIFT’s days are numbered, and that distributed ledgers will soon replace financial messaging. Even though that remains unlikely in the short term due to how deep its roots are in the banking world, SWIFT has been investing in blockchain innovation through its subsidiary, Innotribe.

5 trends we’re watching this week

5 trends in finance this week

[alert type=yellow ]Every week at Tradestreaming, we’re tracking and analyzing the top trends impacting the finance industry. The following is a list of important things going on we think are worth paying attention to. For more in depth trendfollowing, subscribe to Tradestreaming’s newsletter .[/alert]

  1. More banks sign up for SWIFT nascent payment tech initiative (PYMNTS)
  2. DTCC wants to coordinate industry activity on distributed ledger tech (Finextra)
  3. Why bank fintech accelerators are destined to die (American Banker)
  4. Is VC the right money for fintech? (TechCrunch)
  5. What Bank of America’s race to cardless ATMs says about the future of banking (Tradestreaming)