Banking is Necessary. Banks are not.

So said Bill Gates in 1994 predicting that technology would transform even this stodgy sector protected by regulation and incumbency. However globally banks have proven to be extraordinarily resilient institutions that have weathered many crises, nationalization, regulatory backlash, fraud and poor management and so Bill’s prescient quote has been forgotten until the recent frenzy over “fintech” startups. The question now is whether they will be able to out maneuver the latest threat to their existence.

A combination of technological advances, the pervasiveness of smartphones and venture capital backed entrepreneurs is finally beginning to threaten opaque, multilayered and transaction cost laden financial systems. In theory, depositors and borrowers will get more direct, more immediate and cheaper access to each other cutting into the margins of the banks that are today in the middle. Just one digital settlement technology call Blockchain is estimated to save lenders more than $20 billion/year in costs. The big risk for traditional banks is not erosion of margins but customers fleeing from them leaving them irrelevant and stranded with costly legacy infrastructure.

In India the dynamics are even more interesting. The existence of foundational building blocks like Aadhaar and eKYC, financial inclusion programs like Jan Dhan Yojana, and tech savvy entrepreneurs like Nandan Nilekaniwho are determined to use technology and innovation to bring about inclusion and eliminate corruption may cause India to once again leapfrog the rest of the world to pole position. This poses a huge risk to India’s banking system which is still dominated by public sector banks.

Even the best private sector banks in the world are struggling with this disruption. This is because banks are designed to be conservative and risk averse with cultures that are unsuited to rapid change and unable to attract the best technological talent. In India the challenge is profoundly greater because our public sector banks are facing an existential crisis of weak balance sheets and huge non performing assets and are hamstrung by the limitations of government ownership. Their only shield which is regulation is also coming down as the RBI is permitting the entry of new competitors. The risk for our public sector banks is that they become sitting ducks as new competitors nibble away at their best customers and most lucrative part of their business leaving them with a declining and low margin portfolio. This could severely cripple the government’s priority sector lending ability and the nation’s development.

However banks should not be underestimated. Banks’ greatest strength is their customer franchise and hardwon reputation for trustworthiness and stability. Banks also have considerable expertise in regulatory compliance and risk management. Finally, banks have capital. They have the capacity to invest and the staying power to weather intense competition.

It turns out that fintech startups and banks have exactly complimentary strengths. These new breed of companies are entrepreneurial, nimble and can attract the smartest minds but they have a voracious appetite for capital as they grow, they have yet to build strong brands based on trust, and they lack a sophisticated understanding of regulatory compliance and risk management. Therefore the most promising future scenario is partnerships and coopetition between the new disruptors and incumbent banks.

There are two broad responses to the new threat of disruption in the industry today. One response is to shut ones eyes and hope the threat goes away or at least materializes on some one else’s watch. The second is to blindly mimic what the startups are doing; witness the number of banks who are offering mobile wallets, mobile apps, building concept digital branches and so on. The latter are necessary learning experiments but far from sufficient. What might be more successful is a more disciplined three-pronged approach. First, use technology to radically simplify the customer experience. Think Uber or Amazon and use them as benchmarks for simplicity. Second, get teams to work on radically simplifying and speeding up internal processes. Think about a 95% reduction in the time to approve a loan or open a new account. When it comes to new business models, it is hard to predict what or who will succeed and the best approach might be corporate venturing rather than in-house innovation where banks get into strategic partnerships sometimes cemented by equity investments in promising startups thereby creating valuable options for the future.

It is famously said that culture trumps strategy and this is never more true than in the conservative world of banking. So executing such strategies, while conceptually simple, pose a severe cultural challenge Banks will have to find a creative way to create an organizationally distinct unit that has the ability to bring in outside talent where essential, free from the constraints of the procurement process and which has the mindset and ability to partner with startups. For this strong personal leadership from the CEO and unambiguous support from the Board becomes imperative. It is crucial that RBI and the Finance Ministry support the creation of such ambidextrous structures by at least a few of the largest public sector banks.

The disruption posed by financial technologies is like a tidal wave. We overestimate the speed of change in the short term but we radically underestimate the magnitude of their impact in the long term. Banks have a rapidly narrowing window of opportunity to position themselves to ride the wave. 

Ravi Venkatesan is the Chairman of the Bank of Baroda and former Chairman of Microsoft India. This was first published as an opinion piece in the Economic Times