Paper & Blocks

[Originally published in November 2019].

“What is the point of finance?”

This question was asked to me by a curious seven-year-old after I had told him what I do for a living.

I paused for a second, almost disturbed that I didn’t have an automatic answer…

At its roots, finance is about the allocation of assets and liabilities over space and time within the bounds of risk and uncertainty. The financial system facilitates commerce and economic activity. “Facilitates” is the key word in that sentence. Finance is the economy’s circulatory system. Hence, it is a means to an end, not an end in itself.

That fact is hard to remember sometimes when financial services often seem so concrete: towers that house financial institutions span the skylines of most urban centres, the constant flicker of numbers across a ticker tape at stock exchanges represent the market determined values of the world’s largest companies, we purchase financial products and mutual funds off of the shelves of institutions like they are cans of soup at a supermarket, even the dollars in our bank accounts (which can be touched, if in paper form) can all seem so tangible.

Yet, whether you are a person, a company, a government, or some other type of enterprise, the financial system exists to facilitate your activity, to help you reach your economic ambitions or broader objectives. But, if you are in the financial services industry—more specifically, the retail financial services industry—it is easy to forget this, exactly like I did when responding to my curious little friend.

Missing the forest for the trees

This point is worth remembering—that finance is there to facilitate economic endeavours, not be an endeavour in itself—because I think in forgetting it, we sometimes lose our way. A classic case of missing the forest for the trees.

Over the decades, retail financial services has become very product focused. Bank accounts, mutual funds, life insurance, etc. Each is treated as if it were something that is assembled in a factory, packaged up in wrapping, and shipped off to a consumer to consume. But financial products are not necessarily “consumed”. We do not use or exhaust the depreciable life of a bank account because that function cannot exist. The only reason we move assets from place-to-place, or from time-to-time, is to reach some sort of life-related goal.

Moving assets (eg. making a payment) to purchase a new Tesla is not enjoyable because we are making a payment. It is enjoyable because we are getting a new car, a new way to get from point A to point B, a feeling of freedom, and maybe a new way to communicate something about ourselves to the rest of the world. Moving assets over time (eg. taking out a loan to purchase the car) only shifts the timeframe over which we can accomplish these goals, enabling us to reach our objectives more immediately, or at a later date.

To run through a few more examples:

A mutual fund also does not exist as a product in the traditional sense. It exists to move our accumulated capital from the present day to some day in the future, hopefully growing it by leaps and bounds along the way at an appropriate or minimized level of risk. Funds also exist to provide wider access to this function via the operating efficiency of a unitized structure. Doing so extends the ability to take some of the value that we’ve earned or accrued today through the way we make a living and move it to another time (perhaps retirement) where we’ll need it more.

Risk-based products, like insurance, are particularly interesting on this front. They exist to smooth out life’s volatility and provide customers with intangibles like the peace-of-mind knowing your family will not be left with a financial burden if something were to happen to you (life insurance), or that you will not have to choose between Rover’s vet bills and paying next month’s rent should your furry friend’s sock eating habit catch up with them (pet insurance).

I know these are all gross simplifications, but as an industry, often times it feels like the general conversation and the strategic initiatives that I see in my day-to-day have become increasingly disconnected from those endpoints. We discuss product development, client segmentation, and who we can sell more to, without first asking the question of “why” we are doing so and what function it serves for the client in the first place.

The recipe for an analyst

Before we move on, a quick detour about where this is coming from.

By day, my job is to conduct research and consult on strategy in the retail financial services industry. I am a facilitator of the facilitators. Talk about being two steps removed from the action! But in doing so, I am lucky to be able to collect a variety of viewpoints from industry participants in all areas of the value chain and across multiple financial services verticals. From some of the largest global financial institutions to some of the most narrowly focused start-ups. From executives, founders, strategists, product managers, analysts, financial advisors, and regulators. The conversations are wide ranging and thorough. We promise confidentiality, and in return, ask for candor. The result is a hodgepodge of sometimes conflicting opinions, thoughts and ideas about what the future of financial services holds.

By night, when I’m not spending time with my lovely wife and rambunctious wheaten terrier or trying to stay active to fend off the spectre of my thirties, I am a recreational reader and occasionally emerge from my house to dabble in some networking.

My reading habit mostly derives from a decision to move an hour-long train ride away from the office. That ride, however, has provided me with the gift of two uninterrupted hour-long periods of reading and reflection each day. Yes, every cloud has a silver lining! Most of the topics I consume are non-fiction: a blend of business, economics, psychology, and anthropology, delivered through memoires, narratives, anthologies, and even the occasional textbook.

When it comes to networking, conferences and after-work events are a great place to learn, but I have found one-on-ones to be a particularly astute way to get to know someone on a human-level, and indirectly, get to know their thoughts, opinions and unique perspectives on the topics at hand.

The mosaic

Across the two endeavours—the personal and the professional—a lot of ground gets covered, which is true for any engaged analyst or strategist. All of that work contributes to a pool of assorted frameworks, knowledge, and intellectual property (a mosaic, if you will) that synergize to become the algorithm through which an analyst processes information and the lens through which they see the world.

A mosaic is an appealing operating framework for an analyst of any type. Each and every person is a constantly evolving mosaic, built upon one’s own education, experiences and other gems of knowledge picked up along the way. Similar to how a fixed-income or equity analyst leverages mosaic theory—the collection of a variety of different micro inputs to arrive at a macro opinion about the value of a security—the hope is that every piece of information contributes to a greater whole, where you are taking an assortment of trees to eventually assemble a forest.

To be an effective analyst you also need to know what you don’t know. It almost feels counterproductive to try to build an information advantage in the information age, so I’ve grown fond of seeking new frameworks or ways to think about the world, rather than just cramming knowledge into my brain about specific topics. It’s the old adage of learning how to think, rather than what to think.

The mosaic I’ve constructed over the past decade was aimed squarely at understanding the future of the financial services industry and what lies ahead for myself, my family, and our clients. The challenge of being an analyst, however, is that you have little agency over your ideas. You are not the ultimate executor. It is usually someone else taking the handoff and running with the ball. Sometimes they run it downfield, but often times, they can be run off-course, be taken out-of-bounds, or be shutdown completely.

Sometimes, you cannot even see how the play turns out. For an analyst, this means there is an incomplete feedback loop, which makes learning from your mistakes harder than it would be otherwise. It also means that something you have ownership over is given away to someone else (yes, for money – cue the small violins), but let’s just say I can certainly empathize with a songwriter who spends countless hours crafting lyrics and verses, only to have someone else sing the tune.  

Regardless of my career choice-related grievances, one way I hope to contribute to moving finance forward at the present time is to participate in the industry conversation: to get ideas out to whoever wants to take the handoff and run with them. More importantly though, to get feedback, to get input, to learn, and to continue building the mosaic.

On that front, there have been a few recent observations flowing from my day-to-day which I think require more comprehensive discussions by minds greater than mine. Many of these center around the overused but ill-defined term: “fintech”.

Let’s talk about fintech

What is fintech?

Sometimes it is a revolt.

Sometimes it is an evolution.

Often times, it is a new idea that has yet to find its fit in the established financial system.

At its core though, fintech is really a broader discussion about advancing the financial services industry and pushing forward change. While technology is the often-cited enabler, enhancer, or disruptor, the roots of most fintech start-ups I’ve come across stem from an idea that returns to the basic functions of the retail financial services industry: facilitate and improve the lives of customers. Sometimes the motive is cost-related, other times it is about democratization or improving the client experience, and many times, it is about simply delivering more value to the end client.

Technology is typically one of the main enablers of change in the fintech movement, but equally important is the freedom that comes from starting a business from scratch, and the ability to build it from the ground-up with a modern tech stack and hopefully even more modern reasons for being. Consequently, technology is but one of many considerations fintech start-ups are leveraging in formulating their strategic plans—and usually, it is secondary to client-driven and/or economic motives.

So what do a revolt, an evolution and a new idea all have in common? They all represent the solution to perceived problems or issues that currently exist in the established financial services industry or for the customers it serves.

Financial services industry challenges… there are many

Ask ten people what the biggest challenge facing the financial services industry is… and you will likely get eleven answers. Yet, in making a feeble attempt to simplify the situation, many challenges facing the industry ultimately seem to stem from a couple of things: dealing with change and/or a failure to remember finance’s core function (which I hope has been well defined by now). But since we can likely all accept change as a constant, there is no point in fighting it and every reason to try to take adequate steps to figure out a way for it to work in our favor. When it comes to dealing with change:

The current system does not scale: We’ve constructed a massive financial system that tends to have economic models built around serving the few, while underserving the masses. It’s a classic application of the 80/20 rule, but in many cases in the financial services industry, it is much more extreme. That’s fine. It’s a sunk cost. The system also had to evolve this way because in the pre-internet era, finance did not scale as well it could today. The issue I want to highlight is in how things have evolved since. While the rest of the world has moved into a digital age, most of finance has stood still. So while the industry is still doing a good job of serving the high net worth, the large institutional investors, etc., it is also trying to service the everyday consumer with business models, communication channels and solutions to problems that are inherently “high net worth”. Financial advice fees are tied to AUM (which does not scale for those who have little to no AUM). Checking accounts are tied to brick-and-mortar branches (which does not scale for those who operate primarily in the digital realm). Insurance contracts are tied to static underwriting models (which does not scale for those who are good risks but need specific coverage). In anchoring systems to the past, we sacrifice the ability to scale the future.

In a system of complexity, inertia reins supreme: It is a problem at a very human level. If we do what has been successful in the past, it will likely be successful in the future, so why change? This assertion probably holds true in a static environment, which is why it is perhaps not so true today where volatility rules. North American equity markets keep hitting new highs while bond markets continue to do the same as interest rates remain stubbornly close to zero at both ends of the yield curve. National economies participate more and more in a global (instead of local) marketplace, despite what trade wars loom on the horizon. And the political climate… well let’s not go there. All this complexity translates into the interest rates, expected market returns, and the availability of capital which distills down into the financial products that retail investors use every day. When faced with complexity, uncertainty, or faraway/long-term outcomes, the overwhelming nature of the situation creates complacency, keeping the status quo as the norm even when more suitable or beneficial products and services emerge. In embracing inertia, we sacrifice the ability to get the most helpful products to a place where they can add the most value to peoples’ lives.

Many people are well meaning, but are aimed at the wrong target: When it comes to the boardrooms, I see a heated focus on what competitors are doing, but tend to hear much less discussion about what the customer is doing or what the customer needs above and beyond what the current product/service delivers. Unfortunately, sameness isn’t a strategy, it’s a recipe for mediocrity and avoiding change. Those who are executing on improving the lives of their customers are generally less concerned with their competition than those who are fighting for the last basis point of market share.In prioritizing market share and returns over the needs of the user, we sacrifice the connection with the end customer necessary to understand and help solve their problems.

Building on this final point: sometimes the human element is forgotten altogether. The industry’s ultimate end customer is the everyday consumer and that consumer currently has a truckload of real and pressing problems.

Personal finance: it is not easy for anyone

Maintaining a list of the financial challenges facing consumers on a day-to-day basis becomes a Sisyphean form of punishment for anyone attempting to take on the task. Each person has their own individual personal financial issues, most of which likely change over time. The best we can do is come up with some broad categories, which as an industry, of course, we often do. A list of five common examples follows:

• financial security
• access to financial products and advice
• managing the complexity of financial decisions
• allocating capital to optimize risk and reward
• maintaining healthy spending/financial habits

But, are today’s products and services adequate to tackle these issues for the entire population? In some cases, yes, but in other cases, no. Either way, there is certainly room for improvement, which is typically an intention that gets dropped into most product development discussions I’ve witnessed. That is fantastic! Sometimes, though, those good intentions can often get masked by having ideas anchored to the product shelf as it exists today which can lead to incrementalism.

For leaps and bounds to occur, a broader perspective can be helpful. Sometimes, that broader perspective can start with the common framework of looking at products as either vitamin or a painkiller. The framework is simply a well-known way of thinking about the world and whether your product/service is solving a customer’s problem (painkiller) or is simply a nice to have (vitamin). In the vitamin’s case, convincing customers to use or switch to your product can be tough to do. It can require a big marketing budget, habit-forming product development savvy, or simply a compelling service that is 10x better than what is available in the market today. In my experience, a large majority of fintech start-ups today fall into the ‘vitamin’ category. Thoughtfully constructed vitamins grow over time, but typically at a slower-than-preferred pace.

In the painkiller’s case, however, the product is usually found by the customer seeking a solution. The marketing budget can be lower, the switching costs can be lower, the solution becomes more important than the product itself. When I speak with vitamin sellers, I can usually detect a good amount of painkiller-envy in their faces.

Solving for financial painkillers

If the goal of fintech is to make a big impact on the financial lives of its customers and distribute that solution to a wide number of individuals, then it is going to require at least some ‘painkiller-esque’ characteristics.

At the industry-level, then, what are those consumer pains that appear to be most prevalent in the marketplace? In industry discussion circles, I often hear that high costs or a shoddy digital experience are top-of-the list pains for clients of long-standing providers of financial services. For some, perhaps they are. But when was the last time you switched your core checking account provider because their online banking service was missing a few features or because it charges a $9.95 monthly account fee versus the market rate of $4.95? Painful, yes. Worth going through all of the administrative work and behavioural headaches that have to be overcome to switch to a new bank, no.

So if an improved digital interface and lower cost products are only incremental improvements, what are some of the other pain points that provide an opportunity for innovation? Taking each of the five examples again, a different frame can be used to ‘define’ the pain relieved by financial ‘painkillers’.

Financial security: High debt loads, low levels of retirement savings, a lack of a sufficient ‘rainy day’ fund. Each of these challenges come along with stress, anxiety and an aptitude for pushing the problem further down the road because no obvious (or willingly employed) solution exists. To quote a recent comment from one of my colleagues: “More than 70 per cent of those retiring over the next decade have less than $100,000 in financial wealth”. You don’t have to read Piketty’s 700-page tome on inequality to know that the challenges for this group of individuals certainly differs from those who have built up a more sizable nest egg. Regardless of the cause of the predicament (which could be from circumstance, financial decision-making, etc.), stress plus anxiety can be the result.  

Access: There is nothing more painful then FOMO (that’s the fear of missing out, for all you non-Millennials out there). When a service or opportunity is available to some and not others, that can cause distress. Sometimes it’s for a valid reason, like the inability to have hedge funds distribute products in $10 increments to your everyday investor who is likely ill-equipped to assess the risks they’d be taking in the first place. But other times, the barrier is nothing more than structural or technological, like the ability to access financial advice as a Millennial or take out an unsecured line-of-credit with a thin or non-existent credit file.

Dealing with complexity: Finance is complicated. There’s no question about it. There are also large information asymmetries that exist between those who are well-versed in the topic and those that are not. Financial advisors are one way to alleviate that complexity by outsourcing it to someone else. But when it comes to financial advice, in many countries, it is arguably those who need it most (those who are indebted, just starting to accumulate assets, or have low levels of financial literacy) who are least able to access it because of the manner in which financial advice is compensated (typically a fee based on the level of client assets under administration). A lack of advice can leave people to deal with the complexity themselves resulting variety of feelings, among them are overwhelm and exhaustion.

Allocating amongst risk and reward: Yes, the high net worth also have financial challenges. Stress and anxiety can also result from trying to grow financial wealth and allocate capital amongst the endless options that exist in the markets. Optimizing risk and reward is a fundamental pillar of the financial system. After all, diversification is the only free lunch. But ensuring these benefits are adequately distributed, and more importantly, adequately communicated to those that receive them is a central challenge. A failure on that front can lead to the common stress and anxiety that also results from other types of financial decision-making.

Maintaining healthy spending/financial habits: My wife and I have another couple we hang out with named the Joneses. They are a couple that got married and then went on a year-long honeymoon around the world for us to all observe from the peephole that is Instagram. They are indeed, very hard to keep up with! Keeping up with the Joneses typically results in a trade off: feelings FOMO or inadequacy are a trade-off with spending money to keep up to alleviate that pain. The problem is, this can encourage emotion-driven and sometimes poor financial decision-making, leading to more (you guessed it), stress and anxiety.

This list could go on. It is by no means comprehensive. But, if you’ve noticed from the above, these pain points boil down to their roots which are emotional, social and/or psychological.

Pain is a horrible thing. But it is also how we grow. It let’s us know that something is wrong and that we have to seek a solution, and hence, what pushes us toward painkillers despite our hesitance to take our vitamins. There are businesses to be built and money to be made around ridding the world of these pains. Many fintech firms and founders I know are well on the path to doing so.

Yet, analysis or strategy executed at the product level will often miss these underlying motives. Simply providing a lower-cost or digital version of the financial services functions that exist today might not be competitively sufficient progress. Clayton Christensen perhaps frames this best in his book Competing Against Luck while explaining that consumers pull products and services into their lives to get a specific job done:

A job has an inherent complexity to it: it not only has functional dimensions, but it has social and emotional dimensions, too. In many innovations, the focus is often entirely on the functional or practical need. But in reality, consumers’ social and emotional needs can far outweigh any functional desires. Think of how you would hire childcare. Yes, the functional dimensions of that job are important—will the solution safely take care of your children in a location and manner that works well in your life—but the social and emotional dimensions probably weigh more heavily on your choice. “Who will I trust with my children?”

Analysis at the product-level can lead us to focus on the outcomes and symptoms (ie. high debt loads, inadequate retirement savings, etc.) instead of the underlying problems or casual mechanism that can influence a customer to use a product in the first place.

A quick recap

The industry’s function is to facilitate.

Many of those the industry is facilitating are having financial challenges.

Numerous fintech start-ups have emerged to tackle these challenges, but have yet to attain widespread distribution.

And for the established financial services giants, there are certain structural, economic and psychological barriers holding back change.

So what are the solutions?

From experience, it is hard to come up with a solution before the problem is well-defined. For the few that stumble upon this post, I’m hoping the above frames some of the challenges that the industry and its customers face in a slightly new light. Importantly, however, these are the observations of one person with all the inherent biases and shortcomings that come along with one person’s opinion.

Solving for painkillers can help to develop products or services that are positive for client outcomes while also being compelling enough to get them onboard. But it is really only step one.

On where thing in the financial services industry go from here, of course, I have my own thoughts, but this is where I want to leave this conversation open to interpretation (or maybe save some fodder for another post). I do not feel that my experience gives me a right to be prescriptive on this front, mostly because I believe finding any solutions at all will likely result from taking a path-dependent trial-and-error approach which cannot be foreseen in the first place. But, there are a few observations and principles which I think can be helpful in moving forward.

• Build for the long-term, not the short-term: Patience seems to be the most underappreciated virtue for someone operating in the fintech realm. While technology moves fast, finance [typically] moves slowly. Consumers [typically] take time in evaluating their options and changing their providers. ‘Typically’ is inserted here to make the point that there are times when finance moves quickly. These are rare occasions, however, like the global financial crisis of 2008, when the spell of inertia is broken and people and companies are forced to react. In most other cases, fintech is a marathon, not a sprint. Even bitcoin is over a decade old…
• Avoid anchoring the future in the past: Technology provides an opportunity, not just to replicate analog services in a digital form factor, but to create brand new ways of delivering value. It is the quickest path to differentiation.
• Open tends to out innovate closed: What is the business case for open banking? Right now, there is not much of one. But give a bunch of developers an access point to raw material, a usable interface, and the economic incentives to try new things, and wonderful results can emerge. Unfortunately, they just cannot be anticipated ahead of time. There are countless other examples of open ecosystems out-innovating closed systems. We should all be thankful that Apple decided to open the App Store to third parties and not try to develop everything themselves. Openness is something to be embraced and celebrated, not battled and dismissed.
• Find incentive alignment across stakeholder groups: Growing with your customer, not at their expense, should be a more obvious operating principle than it is. The same alignment advice applies to employees, partners and any other stakeholder that touches the industry. If everyone is incentivized to move in the same direction, it becomes much easier to steer the ship.
• Collaboration > competition: Similar to the global crisis we face in dealing with climate change, we are going to have trouble solving a global problem (that has a ‘tragedy of the commons’ coating) with national solutions. Instead, it is about seeing ourselves as global citizens, and only then, can we make progress through collaboration instead of confrontation. Financial services is very similar, where siloed operations are preventing new initiatives from moving forward. Collaboration, whether between internal silos or between companies and competitors, will ultimately be helpful in pushing the industry toward progress.
• Don’t villainize firms for making money: Start ups tend to nag incumbents because their fees are too high. Competitors compete in price wars in what ultimately results in a win for the consumer. Growth has continued to be prioritized ahead of profitability, something that has never been more evident than in the ongoing WeWork IPO saga. Making money almost seems to be villainized in today’s fintech climate, where the customer stakeholder group gains at the expense of the shareholder group. Ultimately, this great for customers and competition, bringing the most efficient solution to the forefront. But making money is not a villainous activity. It is how existing businesses can afford to allocate capital to new projects and keep moving forward. In fact, to make an obvious point more obvious, making money is the basis of capitalism and much of the economic progress we’ve made, period. Without a business model, finance has no way to move forward. That business model just has to find the right balance between its stakeholder groups (consumers, employees, owners). It has to be transparent, well understood and well communicated. It has to be sustainable.
• Tell the story: Money, like other social constructs, exists as a story and is only as valuable as the value others assign to it. All assets, in fact, are like this. That is why you can build the best product in the world, optimized in every way, but without others believing the story behind the value, it will fall short. Which leads to an obvious point: communication—and story telling in particular—is a significantly underrated skill in every company, particularly those in finance. Tell the story. Explain how the product will solve problems and better lives. Craft the narrative, don’t let it be crafted for you.
• Enjoy: There could be many more millionaires in the world if everyone saved every penny they ever earned and never had any fun along the way. But what kind of life is that? That’s also true for many financial services clients that the industry serves every day. If finance’s function is to facilitate, then that includes helping people enjoy the fruits of their labor. We can’t forget to smell the roses along the way!

Finance is about people

That last point is probably the most important: there has to be a reason and motivation for people to pursue their fintech aspirations beyond the obvious monetary potential. That is where the human element, the core function of the industry, comes into play. Finance has a lot of changes to make to amplify the good it brings to the world. Fintech pushes financial services in that direction.

In addition, there is something I wanted to wait to point out: over the past 5,000 words dedicated to discussing fintech, there has been little mention of technology itself. That’s because fintech is largely about a shift in mindset. It is about change. It is about doing financial services better. It is about people.