The following post is an interview with SVSG CTO and Financial Services Practice Manager Carter Smyth. Carter is an executive with over 25 years experience building technology teams to solve enterprise challenges in the financial services industry. He has extensive experience leading software development teams, business process reengineering, and global expansion projects. Carter joined SVSG in March 2017.

What challenges are you seeing banks and other financial institutions facing today?

It’s a time of great challenge and change in the financial services industry, but I also think it’s a time of great opportunity for the institutions who are forward thinking.  Banks have been weathering a “perfect storm” for almost a decade, digging themselves out of the 2008 financial crisis, while struggling to thrive in an era of more regulation, greater compliance burdens, higher capital requirements and less leverage, as well as record low interest rates in much of the world.

To go deeper on the business challenges, let’s review the core business of banking. I’m over-simplifying here, but the core business of banks is to lend out other people’s money that they’ve deposited for safekeeping, the principal source of this being the difference between the interest they receive from the loan and the interest they pay to depositors.  This “spread” between the interest rates, plus fees, less costs, is the majority of a bank’s profit.  Banks must hold a percentage of the deposits in cash, which is called the “reserve requirement” and is 10% in the USA but varies by country.  Banks must also hold a certain amount of assets based on their outstanding loans, called the “capital requirement”, to ensure banks do not take on excessive loans or excessively risky loans and become insolvent.  The capital requirements are increasing via an international accord for banks that governs capital adequacy and risk, called “Basel III”, which stemmed from the 2008 crisis.  This results in banks that are theoretically more solvent, but with less risk and making fewer loans it means less income.  When interest rates are lower, the interest rate spreads are typically lower, reducing income again.  And the regulatory and compliance overhead that’s been imposed greatly increases costs.  If you’ve noticed an increase in bank fees in the last few years, it’s an attempt to offset the lost income from these factors.

And while banks have been focused on recovering instead of innovating, technology has enabled a new class of Financial Technology (FinTech) challengers to emerge.   Challengers that will provide innovative and convenient services which could severely threaten traditional roles and revenue sources of banks.  Challengers who don’t have the regulatory burdens or high cost structures.  Challengers who don’t need to open branches in your neighborhood, because

77% of Americans now have globally connected super-computers in their pockets with fingerprint identity verification!

And with recent surveys indicating that half of millennials use mobile banking as their primary form of banking, this has the makings of another “perfect storm” – of disruption.

If large financial institutions are going to weather this technology shift, they will need to be open minded about what the role of a bank is, they should focus on creating the best customer experiences to insure retention and they should not be afraid of cannibalizing some of their existing business lines in the process. Creating the iPhone destroyed sales of the iPod, but if Apple had been afraid to cannibalize, the iPhone might never have existed. Banks need to embrace disruption, because disruption is coming whether they want it or not. The ones that can get ahead of this potential for disruption and figure out new ways to be relevant to customers are the ones that will succeed.

Where do you see opportunity for technology and FinTechs to disrupt today’s banks?

If a bank is taking deposits with one hand and loaning them out with the other hand,  they are essentially a middleman.  Certainly they are providing a safe haven for deposits and payment for use of your funds, while providing an “environment of trust” and perhaps some add-on services, but when you boil it down they are middlemen.

If there’s one thing we’ve learned in 25 years of the World Wide Web, it’s that the Internet eventually destroys middlemen.

The more financial information that a person or business is sharing with a larger community, the more financial offers are typically available outside of traditional banks. Some examples:  At the bottom end, we get all those credit card offers merely from the availability of your credit score.  You can buy a car with just your FICO score.

Amazon is now loaning money to merchants who sell products in their FBA (Fulfilled by Amazon) program.  Amazon already has access to all their sales data, sales patterns, they can predict their margins and much more.  This information allows them to assess risk with pin-point accuracy.  They loaned over a billion dollars last year and have served over 20,000 businesses since they started the program.  Amazon is a FinTech.

The FinTech company Square now offers loans to their point-of-sale and payments customers.  They can assess risk because of all the information that runs through their system.  They’ve loaned 1.5 billion to 130,000 customers.

In both of these cases they are supporting their “community” or ecosystem, which creates more revenue from transactions.

Any areas like this where there is a vehicle to share information, an opportunity to reduce “friction” in the flow of money, plus available excess capital, it has the potential to erode business from traditional banks, thus being a “disruptor”.

This reduction of financial “friction” by using technology and innovative processes is a vast area of potential disruption.  Before the 2008 crisis, banks were streamlining the mortgage process and it became easier to get a mortgage; perhaps too easy.  After the crisis the regulatory and compliance burdens, along with tighter loan requirements, introduced a lot more friction into the system, making mortgages much more difficult and tedious to obtain.  An example FinTech startup that is reducing friction in the mortgage space is StreamLoan. They are making the loan process simpler, efficient and digital, reducing paper based components almost entirely.  Anywhere you can reduce friction, you’re going to have an opportunity. And not just in banking, but in all sorts of financial services, investment management, trading, insurance and other areas.

Syndicated loans are another target for wider adoption and disruption I believe.  This involves a group of banks or investors participating in a loan to spread the risk.  Syndicated loans are typically large and many inefficiencies remain, as most transactions are still conducted by phone calls, emails and spreadsheets.  Technology and alternative approaches can greatly reduce these costs, making syndicated loans a potentially worthwhile lending approach for smaller businesses as well, especially in communities that understand each other’s businesses and risks.  This is already happening in Islamic Syndicated Finance, which has restrictions on methods of charging interest.

Communities that have asymmetric but symbiotic cash flows and relationships can utilize technology to support each other’s cash flow needs, bypassing the traditional bank, using technology and new approaches to make them efficient.  Farming, suppliers and manufacturers, merchants and distributors, to name a few.  There are farm banks and merchant banks that already support these functions somewhat, but they are all ripe for new approaches and efficiencies.

Other examples include direct payments, settlements, escrow, and multilateral netting will likely change dramatically over the next decade.

In many of these examples I’ve emphasized the community or ecosystem characteristic.  That’s because the Internet has fostered the development of like-minded, symbiotic and often global communities like never before in human history.  Community used to mean local but the Internet can make a community global in scope.   Likewise, banks used to be a local community organization.  You knew the banker, the bank was invested in your success; you both had “skin in the game”.  With bank mergers creating national and global footprints, that barely exists now.  Banks now rely on rigid metrics and processes to determine loan approvals, which too often results in small businesses being poorly served or “community” requirements not being well understood.  There are true benefits to community banking, with some inefficiencies.  I believe technology can foster a return to more community banking in certain business and consumer “communities”, in the modern global definition, realizing the benefits without the inefficiencies.  Traditional banks could provide tremendous value here if they choose to.  They already have so much data that could give them an advantage.

Speaking of data, traditional banks have vast stores of data that are rarely used for analytics and customer value-add, at the customer level, industry level and macro level.  Why doesn’t your bank predict your monthly cash flow and send gentle reminders about funding accounts and due dates?  Why can’t your bank analyze your accounts and suggest higher interest bearing vehicles when you have too much in your no-interest checking account, with overdraft protection to pull it back if needed?  Why won’t your bank suggest paying off your car loan when you have plenty to cover it in savings, showing what you’ll save?   All these could easily increase goodwill and customer satisfaction, but would risk losing bank revenue.  If banks want to retain customers in the new FinTech era, they will need to foster these improved customer experiences.

It would be unfair for us to talk about a disruption of the financial industries without mentioning blockchain. How will blockchain affect the finance world?

Blockchain technology, I believe, will be a disruptive force in the financial industry. The entire banking system functions on trust – and quickly grinds to a halt when that trust is questioned.  Going back to the bank being a trustworthy middleman, if blockchain can create and distribute the unalterable record and proof of transaction, blockchain is effectively “baking in” and distributing trust into the system.  So, the blockchain system could essentially become the middleman in many situations.  The bank would play a reduced role – or no role.

An obvious example today is escrow, wherein a third party holds your money while you’re attempting a major transaction.  If blockchain systems can provide the trust and automation of transfer if criteria are met, then the escrow agent only needs to resolve exceptions, greatly reducing their role.

I’m really interested in the opportunities for blockchain that ensures trust is maintained in the system itself and not wholly by a bank or single entity.  Other examples include direct to party payments, syndicated finance, cash flow management and multilateral netting (an ecosystem of suppliers, manufacturers and distributors, for example, who instead of paying invoices individually, add up all debits and credits that come in and make a “netted” single payment every month to each other).

There are many people that equate blockchain with just alternative currencies like BitCoin, but it’s much more than that. It has tremendous potential but there is much to sort out still.  The banks could get ahead of the curve by funding tech incubators to work out these issues through smaller, motivated startups, then integrate the best ideas into new and existing platforms.  They should be empowering and rewarding their internal people to master the new technologies.  To be fair, some banks are doing that now.

The truth is that even though all this technology is nipping at the heels of traditional banks, there’s still plenty of opportunity for them if they can execute.  If there is some innovative new blockchain based solution by a financial powerhouse like Bank of America, JP Morgan, ING or BBVA, you’re going to trust it far more than you are some startup, aren’t you?  You presume that they’ve invested the time and effort to do it right.  And if they make a mistake, you know they have the resources to make it right.

At the end of the day, it’s still money we’re talking about, and most people are careful and conservative about their money.  They want to deal with a firm they trust with a proven track record.  This is where traditional banks have a big advantage.  In building systems, the worst place you can make a mistake is in systems dealing with health and safety, but number two is money.  Banks know this – and those that can alter their visions to the new realities and execute accordingly will do just fine.

How will PSD2 affect US financial services?

PSD2 is a European Union directive that stands for Payment Services Directive 2.  The PSD2 essentially mandates that banks from the European Union provide a free method for outside payment service providers and account information service providers to access accounts at EU Banks. That means payment service providers like Paypal and Venmo, or account aggregators like Mint will have easier, more extensive and free access to banking information for their customers.

Today the US is arguably ahead of continental Europe in FinTech developments through mostly organic growth.  Although most of continental Europe shares a single currency, only about 3% of individuals have accounts outside of the country that they live in.

The PSD2 is intended to create a more fluid and dynamic banking environment in Europe and to simplify the process of banking across the European Union.  

The net result of PSD2 will be a cross-pollination of ideas between the US and EU, and when PSD2 is implemented, Europe could easily be ahead of the US in FinTech within a few years.  

I’m excited about the idea of standard API’s that can be accessed across banks, which the PSD2 will spawn, though it’s far from certain how “standard” the APIs will be.  If a single bank can create a compelling API platform that causes other banks to adopt it, we’ll see some fundamental changes in European banking that are impossible to predict, but could greatly influence US direction.  Even if the APIs across banks are divergent and not standard, PSD2 should still greatly lower the barriers to entry for FinTech startups in Europe, resulting in lower barriers than the US.

Interestingly, the retail bank that had the highest JD Power satisfaction rating in the California survey this year is the subsidiary of Spanish bank BBVA, who is considered one of the best prepared European banks for PSD2.  

What made you decide to join SVSG and take lead of its Financial Services Practice?

I had an exciting career as a senior manager at some of the biggest financial firms like JP Morgan & Bank of America.  In the last few years I’ve been helping former colleagues from these firms startup hedge funds and investment management firms as a consulting Chief Information Officer.  We call ourselves “big bank refugees” because we love the business but grew weary of the management headaches of endless mergers.  Working with these smaller firms has been tremendously rewarding, but last year I realized I missed the thrill of solving the big enterprise challenges at those large institutions.  The thrill of building and leading teams to create innovative technology solutions in investment banking, capital markets, global compliance and tackling other challenges, it’s tremendously rewarding to me.  I decided I’d start a consulting collective with CTOs that shared similar passions with diverse talents to solve these tough enterprise challenges.  But right away I met this fantastic group at SVSG that was already doing this, with tremendously talented CTOs, engineers and designers, who wanted someone to build their Financial Services practice.  From my perspective it was an ideal match.

What competitive advantage do you gain partnering up with SVSG vs. launching your own practice?

When it comes to solving tough problems, I’m a big believer in mixing up teams to gain diverse insights from individuals with a variety of talents, backgrounds and perspectives. And when you’re combining the competencies of 20 extremely talented CTO’s who have experience across many industries, there is a lot of mixing up to do. Having such a diverse and deep team of innovators on call at all times is extremely powerful.  And that’s what we have here at SVSG.  I’m extremely pleased to have this breadth of talent at my disposal and am excited about the future.