AI will hurt banking without a ground-up approach

Injured Piggy Bank WIth Crutches

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The last twelve months have seen AI fever reach new peaks. Every technology giant we could name have got a huge AI story to tell. Starting with IBM Watson, Google Allo, Facebook AI Research, Amazon Echo have all had major traction. This is also reflected in investments being made into the AI industry. Industry leaders magazine predict 2017 would be the year of AI investments. It is predicted that about $37 Billion would be invested into AI by 2025. There have been similar “This time it is different” stories on AI for almost 50 year. Well, I believe it is definitely different this time, mainly because AI was preceded by the Big Data revolution this time. I believe it is different for firms and industries with access to quality data to leverage for AI. I believe that the technology firms mentioned above have got their data right. And I believe banks are a joke when it comes to quality data. AI will hurt banks without quality data.


Internal legacy tech challenges and data quality problems aside, new regulation in the form of PSD2 is going to have massive impact on a bank’s strategy to customer facing AI use cases. With PSD2, customers will be more in control of their transaction data. Third party providers (TPP) will now have access to customers’ transaction data, in the process becoming an abstraction layer between banks and customers. So, unless banks completely rethink their customer interfacing model, nimble players who can create clever AI applications on customer’s financial information, will make banks just a utility provider, hence hurting their margins.

Banks have two challenges to resolve at the same time, internal data quality issues to make AI work for operational intelligence, and external data ownership issues to make AI work for dealing with customers.race_for_ai_new_1-featured.png

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Data is the 21st Century Oil

There have been some success stories with Fintech firms doing AI and there are new ones emerging every day. The world is moving to a place where there will be an AI app (and an app store) for most activities. When we were evaluating IBM Watson at PwC, one phrase the IBM team used was “Watson going to school”. This effectively meant training IBM Watson on a particular topic. Let’s assume IBM Watson had to be trained in MIFID 2 regulations, it involved loading the regulation text into Watson and then an SME spending a few weeks with Watson asking questions on MIFID 2. The SME would then provide feedback on Watson’s answers, and Watson would use this data to provide better answers next time. This needed to be done until Watson became an expert in MIFID 2 before the capability could be launched commercially. We also learnt from the exercise, how understanding legal/regulatory language was different from natural language. That exercise showed how critical data, data structures and the taxonomy of data was for AI applications to work. On that note, news is that IBM just acquired a Promontory Financial Group to help improve Watson capabilities for banks’ back office functions.

'And then Dmitri noticed something that would have a profound effect on the human/robot wars.'

Regulations for data have failed?

Most successful AI platforms have access to high quality data, and in huge volumes. They also get to see regular transactions across different streams of data that they can then learn from. This is the case with Fintech firms that use AI at the heart of their proposition. What about our dear banks? Banks do have data, but the quality, integrity and accuracy of data stored digitally is generally appalling. A few years ago BCBS 239 emerged as a regulation focused on fixing data in banks, however compliance to that is mostly being treated as a check box exercise costing the banks millions. The point being, banks are years away from processes and infrastructure that provides quality data. If AI is introduced into this landscape, it would be more detrimental to existing processes, as there would be more hands involved in confirming results suggested by AI, and the costs of using AI would outweigh its benefits. Is there hope?

Banks need to get back to the drawing board to make the most of AI. Here is a simple approach I can think of,

  1. Banks need to have a function to deliver Intelligence capability.
  2. This function needs its own budgets and operating model.
  3. Very similar to data governance models, the Intelligence organisation needs to be federated across the firm.
  4. This federated model needs to cover parts of the bank that benefits most from AI, but also where data and processes are more matured
  5. Implementation of AI in these parts of the bank could spark viral uptakes across the firm
  6. There needs to be standardised ways for AI applications within banks to interface with each other. Without this, there will be AI applications developed across the bank for every single process and there wouldn’t be any integration possible. This is where governance will help.

Well, in order for the above to work, data still needs to be of good quality. Top down models are not always lean in their approach. However, it is possible to achieve a top down model that can be lean, if the priorities are based on benefit realization rather than empire building to get to an MD promotion.

Now, what about external challenges?

PSD2 could be a great opportunity for banks, and of course a huge challenge too. Let’s focus on the opportunity first. Say a customer banks with Barclays for his salaried account, has a mortgage from Halifax, and a credit card from HSBC. If Barclays was willing to be an Account Information Service Provider (AISP), it can effectively source the customer’s transaction (with their permission) from Halifax and HSBC and could offer Personal Finance Management (PFM) services. Imagine having access to transaction data across all products that your customers have. Barclays with access to mortgage transactions from Halifax could create a credit product for the customer for home renovation. While this is just one example, PSD2 could create new revenues streams for banks if they were willing to target other points in the payments value chain. That is a whole topic for discussion by itself though.

AISP in action

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While this sounds good from the banks’ perspective, the more likely outcome would be Fintech firms, and possibly tech giants (Google, IBM, Microsoft, Amazon) making clever use of customer transaction data as they are light years ahead of banks in their AI capabilities. While we have already discussed Tink in DailyFintech, Qapital and more recently Klarna are also jumping on the PSD2 bandwagon.

How can AI-Fintech firms chip into the story above? Well, they don’t have much to lose (unlike banks). AI firms focused on banking use cases, should focus on small problems and solve them really well. And the AI industry focused on Banking will need to identify the importance of standardisation of interfaces for data interactions across banking applications. While this exercise will be made easier for customer facing use cases (thanks to the PSD2 wave), operational AI internal to banks will be a much harder nut to crack. If achieved, it will allow for multiple processes and activities within banks to be replaced by AI in one go. I wouldn’t be surprised if banks, warmed up by Blockchain revolution, form consortiums to drive AI revolution. And if this happens, I believe AI penetration within banks could be faster and deeper than Blockchain managed.

Arunkumar Krishnakumar is a Fintech thought-leader and an investor. 

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RobinHood Freemium could enable a lot of new Low Cost Active Alpha services

The equities broker model has been slammed by two waves of change:

  • End of fixed commissions. This happened decades ago and simply opened the market up to competition.
  • Internet. This is what enabled the human broker to be replaced by servers and led to e-brokerage firms such as eTrade, Charles Schwab and many others.

Which brings us to RobinHood

RobinHood offers zero cost equities brokerage and plans to upsell to premium services later – a classic Freemium strategy. They recently raised a $13m Series A and claim traction among Millenials (who have less to invest and therefore scrutinize the current fee of about $10 per trade more carefully).

For a service that is close to zero cost on a per unit basis and falling further every day thanks to Moore’s Law, a Freemium strategy makes sense.

The question is about the upsell. If RobinHood creates their own value added premium services they will end up competing directly with the bigger e-brokerage firms. However, if they simply offer an API to anybody who creates value added services they will create an ecosystem that is far more powerful than what any single firm can create. These kinds of Low Cost Active Alpha services are complex, so it is smarter to let other entrepreneurs create them. These entrepreneurs will be quite happy paying RobinHood for customer access. This could be a classic network effects game that unbundles services and creates a stack. It is the same dynamic we are seeing in the lending marketplace business.

Today, RobinHood appeals to Millenials with less to invest. When we get another Bear Market, wealthier older investors will also scrutinize the per trade cost. At first a Bear Market will reduce trading costs as we get the usual “death of equities” stories. That will hurt the traditional e-brokerage firms but RobinHood can afford to sit it out. Trading volume will eventually return.  There is always money to be made by active traders. All they need is volatility, the actual direction matters less. Active traders care about the per trade costs. RobinHood could be one of those businesses that take off in a Bear Market.

Nutmeg: cute name but those living off AUM fees won’t love it

When fixed brokerage rates got decimated by the double whammy of deregulation and digitization, banks and brokers sought refuge in Assets Under Management (AUM) fees. You can understand why, it is a lovely repeat business, with great revenue visibility and low churn. So it is no surprise that lots of digital disrupters are following Jeff Bezos line about:

 “Your fat margin is my opportunity”

Nutmeg caught my eye for three reasons:

  1. They recently did a Series B and for all the talk of a Series A Crunch, it is at Series B that you have to show serious traction. I am not privy to what traction Nutmeg has, but having done a Series B means they probably do have a lot of traction.
  1. I was seeing lot of billboard ads around London for Nutmeg. I tend to be skeptical about advertising to build a brand (maintaining a brand is different). However, in this case the revenue should be sticky and they are up against household names, so advertising makes sense.
  1. I love nutmeg; I put it on my oatmeal and French toast. That does pose a branding challenge when you Google Nutmeg; unless you add some qualifier like financial or money, you end up on cooking sites.

The AUM business is a three-layer stack:

  • Top of the stack.This is where most of the digital disrupters play. At the high end, this is called Wealth Management; this is where Private Banks and Multi-Family Offices operate. The middle market is all about investing employee pension funds and other tax-advantaged savings plans (such as 401K plans in America and ISA in UK).
  • Middle of the stack: passive-but-specialist ETF index funds. This is the enabler for the layer above. You could not do this with Mutual Funds. You can buy and sell ETFs as easily as a stock and they do “tax loss harvesting”. The fact that you can assemble a portfolio at low cost using ETFs is the enabler. This is like MS Windows enabling Office. The risk – as with all stacks – is that a big player at this layer (such as Vanguard or Blackrock) could move into the layer above; there are already some signs that this is happening.
  • Bottom of the stack. Custodians. This is also an enabler for innovation. The overriding lesson from the Madoff scandal was “don’t trust anybody who is self-custodizing”. The reason is simple; they can simply lie about what the assets are worth. A new brand – whether it is Nutmeg or Wealthfront – can simply say “the assets are stored at Big Global Custodian X, we never have access to them”. That helps build trust, which is the critical thing when it comes to money.

There are many “winner-takes-all” markets where network effects rule; all marketplaces tend in this direction. The AUM business is not one of them. Today there are thousands of companies operating at the top of the stack. This will probably also be true in the digital-first world. There will eventually be consolidation and that will benefit all the startup founders and investors in this space.

One company that looks like the “Gorilla” (in Crossing The Chasm speak) is Wealthfront. They grew to $1 billion in AUM in about 2 years. That shows how wide open this market is. There is room for Nutmeg to do the same, even within the “small” UK market.

“Bits don’t stop at borders, but money has to show its passport”.

Wealthfront is in America, Nutmeg is in the UK. With a few minutes on Google you can find “national alternatives” in just about every country. The mix of regulation and consumer risk aversion when it comes to money favors a well-funded local player.

Eventually, many of these national players may be acquired by a big global AUM player. That could Wealthfront. Or it could be Schwab. To put that $1 billion from Wealthfront into perspective, Schwab has $2.3 trillion in AUM. Yes that is t for trillion. Or to normalize that it is $2,300 billion. You cannot buy Wealthfront or Nutmeg stock today, but you can buy Schwab stock. Vanguard and Blackckrock are a bit bigger (around $3 tn and $5tn respectively)

Yodlee IPO $YDLE the picks and shovels of Fintech

Yodlee is one of four in my Fintech IPO watch list and the first to actually go public.

The much bigger Lending Club IPO is next on the calendar.

However Yodlee is first out of the gate.

Here are the key facts:

  • Consumers don’t know Yodlee, but developers and entrepreneurs and Bankers are quite familiar with Yodlee. This is a white label service. That is why I describe this as the “picks and shovels” of Fintech. You use Yodlee to retrieve data from multiple banks for applications such as Personal Financial Management (PFM).
  • Founded in 1999, by mostly ex Microsoft guys, so the white label platform play makes sense. This was before social media and mobile made it so cheap to reach consumers directly and the biggest tech successes such as Microsoft had been platforms, so a white label strategy made sense.
  • Revenue in 2013 was $70.2m, 21% increase on 2012, small loss of $1.2m. Not massive growth but enough to hit profitability pretty soon.
  • Built into their customer’s processes so revenue visibility is good. Partnered with Y Combinator so they get a mix of high potential startups with steady bank customers.
  • 14% of revenue from Bank of America which is also a shareholder.
  • Headline says, “soared 45%”, but then it dropped back to 12% up on the day. Sounds like a reasonable start. This week will show what Mr. Market’s verdict is on Yodlee.

I have no idea yet whether Yodlee is a good or bad valuation, I will be digging into that later.

After Apple payments we will need Mint even more, but you can only get it in USA

On a visit to the UK people told me that they wanted to use Mint but it was not available.

This is yet another story of:

“bits don’t stop at borders, but money has to show its passport”

Various alternatives are popping up. They will do well after the Apple payments becomes mainstream, as it probably will.

Like many people, I spend too much money on iTunes because it is friction free. Spending cash makes you stop and think, so you spend less. Swiping your phone is easy, so you spend more. That is great for merchants and Apple, but lousy for your personal finances.

A personal finance app that is mobile first and that acts as a warning along lines of “this swipe could harm your financial health” could do very well.