A first wave of innovation in the 1980s brought banking almost to its knees. A second is now waiting to be embraced – and the industry will have to make sacrifices, says Samuel Gerber, a writer and editor at finews.ch.
This feature by Samuel Gerber is the seventh contribution to our section finews.first. It is a forum for renowned authors specialized on economic and financial topics. The texts will be published both in German and English. The contributions appear in cooperation with Pictet, the Geneva-based private bank. The publishers of finews.ch are responsible for the selection. Previous contributions: Rudi Bogni, Adriano B. Lucatelli, Peter Kurer, Oliver Berger, Rolf Banz and Dieter Ruloff.
What passed as innovation in banking in the 1980s didn't much impress Switzerland's most powerful banker of his time: «The Harvard graduates are flooding Wall Street in numbers hitherto unknown to prove their elitist vocation as fast climbers. In doing so, they show commitment to professional ethics. Their only goal is to reach or surpass their personal million-dollar income target within months.»
This damning verdict by Robert Holzach, chairman of the Union Bank of Switzerland (UBS) proved prophetic. In 1987, he anticipated the general atmosphere at the industry 30 years later, after six stock market crashes and a financial crisis.
«The industry will never find a way back to the Swiss banking of its founding fathers.»
Based on the experience of 2008, the Harvard graduates' profit promises and risk models have been exposed as chimeras. Instead, bankers are emphasizing traditional values again. Notions such as customer advice, service, investment competence and performance are paraded by bank managers and PR-departments alike. But the industry will never find a way back to the Swiss banking of its founding fathers. On the contrary.
Banking may be focussing more on traditional values, but the next big wave of innovation is awaiting them. And it contains risks: for some, it may well end in disruption of business or even closure.
Today's sense of optimism is reminiscent of the times when banking talked about innovation for the first time. Generations of bankers had up to then served their customers armed with the same products and instruments. In the 70s, this was about to change radically.
Youssef Cassis, professor of economic history at the European University Institute in Florence, identified the three factors behind the change.
First of all, inflation was soaring and exchange rates had been left floating not long ago, creating a sudden need to hedge against the volatility of the markets.
«The technology allowed banks to make the new financial products available to the market.»
Second, and at least as importantly, visionary theories about the financial markets had been developed. They allowed the implementation of the strategies – and of course the calculation of derivative bets.
Last but not least, there was a powerful new instrument ready to help translate strategy and theory into practice: the computer.
The new technology allowed banks to make the numerous new financial products available to the market and to trade them. The industry embarked on a race for the best technology. «Innovation was at the heart of the role that international financial centers enjoyed in recent times,» Cassis concludes.
A young man from Eastern Germany was among those who understood that big things were taking shape. In his early years, he had yearned to become an engineer. But then, in the late 60s, he started working in the more lucrative banking business. His career since has been inseparable from the history of Swiss banking. He rose right to the very top, and has been in charge of both big banks of the country, UBS and Credit Suisse: Oswald J. Gruebel.
«Banking is heavily reliant on numbers and therefore by nature very open to the further development of computers,» the 72-year-old former banker said in an interview. «With the processing power it became possible for the first time to offer swaps and even much more complex financial products.»
«Selling became the focus of the customer relationship.»
Gruebel also makes mention of a fateful consequence of this development. The technological development took primarily place at the banks themselves and only in a second step was taken to the customers. Fateful, because selling became the focus of the customer relationship. Hardly anybody was interested in what the customer wanted. Once the bankers understood that they could earn more with bets on the financial market than with their clients, that was that for an exchange of equals.
«Customers became a sideshow,» Michael Lewis, the bestselling author of «The Big Short» accurately put it.
In Switzerland, where private banking had always played an important role, there was an additional twist in how the relationship between banker and customer changed. The untaxed money that had started flooding into the country since the 70s, had the power to alter the once close partnership into a marriage of convenience. The customers brought the money. The bank kept mum.
«Swiss banking has lost its honey pots.»
At the turn of the century, innovation hadn't only left the customer behind, but also the banker. The fall of Lehman Brothers in 2008 was an example of how the industry had failed to understand the risks or price of the instruments that had helped them achieve an affluence hitherto unknown.
The ensuing fall hurt, and doubly so in Switzerland: UBS and Credit Suisse had to retrench. And the foreign jurisdictions, which had seen their tax revenues drop because of the crisis, did all they could to fill their coffers again. Silently accepting black money definitely became a business model of the past.
«The pendulum is swinging back in favor of the customer. But simply returning to the old values won't be good enough.»
But which model will replace the old one? Swiss banking has lost its honey pots, in times of the automatic exchange of information and negative rates. It needs new ideas if it is to catch up again. Banking has to go into innovation gear again.
One to have understood the dilemma faster than others has ironically emerged from the epicenter of the failed first wave of innovation. Jan Schoch worked for both Goldman Sachs and Lehman Brothers and helped them sell financial products. He stuck to his business even after derivative had become a dirty word. He co-founded Leonteq and started selling his products through a state-of-the-art technological platform. He mixed technology and financial services before the word 'fintech' even existed.
Schoch, not yet 40 years of age, has since expanded to Asia and signed an agreement with Raiffeisen, which took a holding stake in his company.
«The financial services industry was a victim of its own success in the years leading to the financial crisis,» Schoch says. To escape from this role means finding a way back to the client. The pendulum is swinging back in favor of the customer. But simply returning to the old values won't be good enough.
It will take a lot of innovation to turn the tide. Banks have to outsource all that is not part of their core competence. «Specialization will start taking hold of the financial services industry in the coming years,» Schoch said in an interview. A goldmine for companies such as Leonteq.
The speed with which the next wave of technology is washing over the industry is so dramatic that banks need to consider sharing with the specialists their most valuable asset – the customers.
«The role of the bank as an intermediary is losing in importance.»
With digital channels widely available, companies outside the industry are technically capable of taking products directly to the customer. Clients today are able to conclude financial transactions with companions with the help of a smartphone-app. The role of the bank as an intermediary is losing in importance.
Even more so, if the newest technology in development turns out to be a success. Experts are pinning their hopes on the Blockchain technology. It enables secure and fast online transactions without the help of an intermediary – something that would fundamentally alter financial services as we know them.
Christina Kehl, co-founder of digital insurance-broker Knip in Switzerland, has a clear vision of the shape of things to come.
«Established financial service companies – banks and insurers alike – will have to focus on their core competences if they want to survive in the long run,» the entrepreneur said in an interview. One option would be to delegate the customer relations to fully digital operators, which will be able to do the job more cheaply and efficiently.
Of course, Kehl admits, there is a long way to go: «The fight for the customer has only just begun,» she says.
Eventually, banks will have to give in. The grand old man of Swiss banking, Oswald J. Gruebel, is fully aware of this: «Customers will tell banks to adjust,» he says, rather grudgingly. But true to style, he waves the dark clouds away with a joke: «Perhaps we'll stick an information for use leaflet to our financial products soon: can be deadly for your assets.»
Samuel Gerber is a writer and editor at finews.ch. He was in charge of the finance pages at Switzerland's «Handelszeitung» and also worked for Axel Springer Switzerland and at a number of regional newspapers. He studied business journalism at the ZHAW university in Winterthur as well as languages at the University of Bern. His essay was first published in «Handelszeitung» and the edited version is being published by finews.ch with the kind approval of the business paper.
