The new imperative for value creation in financial services: how banks can profit by rethinking their purpose
by Maria Shopova, Consultant at S&G Technology Services
How banks create value currently and why this approach no longer works
Over the past decade, the banking industry has faced numerous challenges starting with the collapse of the mortgage backed securities and their derivatives during the 2007-2008 financial crisis, decrease in interest rates coupled with increased scrutiny over virtually all activities undertaken by the industry as well as the diminished public trust resulting in a major attempt to utilise technology in order to bypass the influence banks have over the daily lives of the public.
Against this backdrop, the value creation process in banking has changed incrementally – ever since banks started popping up on the map, their role was to serve as a mediator between individuals who have money and those who need access to money. Naturally, this is a simplified representation of the main operating model of banks to illustrate the point that although times have changed dramatically and the range of products and services that banks offer has become more diverse and sophisticated, banks still rely on deposit and lending activities as a main source of revenue generation (MX Technologies Inc, 2020).
In parallel with the emergence of powerful new technologies in recent years, we have also observed the rise of a new breed of consumers who are vocal and deeply disdainful of capitalism and the inability of corporations to recognize that the health and stability of the global economic system is closely tied to the health of the planet. From this perspective, banks are in a precarious position – they should either rise up to the sentiment and fulfill their role as an essential player in solving some of the most pressing challenges our society faces or risk being made obsolete by new entrants on the market (McKinsey&Company,2019). The number of consumers willing to invest in areas such as clean energy, affordable housing or sustainable agriculture and at the same time are prepared to accept lower returns on their investment for the sake of making conscious and ethical choices, has grown constantly in the last decade, a report conducted by the World Bank reveals (2021). This trend, coupled with the projections about the value of global business opportunities in social and environmental markets (market size at USD 715 billion currently) shows that there is untapped market with significant potential and that hard-nosed financial institutions might actually be leaving business at the table (the GIIN, 2020).
How banks should create value - the concept of shared value and how financial institutions can profit by rethinking their purpose
This notion could serve as an opportunity for banks to create shared value. Shared value is a term coined by Professor Michael E. Porter – one of the most prominent researchers in the fields of management science and competitive strategy. It represents the idea that a business can foster “operating practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions in the communities in which it operates” (The Shared Value Initiative, 2022). Shared value is cultivated on numerous levels across the company structure and business model and in the context of financial services industry, shared value creation can be pursued in the following avenues:
• Rethinking markets and products
In the globalised world, no business entity operates in isolation – market conditions, political tension, regulatory environment and social sentiment can make or break a company and its activities. Take the example of Flowe bank – a new challenger on the Italian market, focused on empowering their customers make more ethical and sustainable choices in their daily banking activities. In addition to allowing customers to offset the CO2 emissions of their expenses, Flowe’s operations are completely paperless (Fintech Times, 2020) and since its foundation, the challenger bank has also initiated a research collaboration on carbon conscious purchasing trends (Stockholm School of Economics, 2021).
• Rethinking the full value chain through the lens of productivity and ethics
Institutions such as First Abu Dhabi Bank and Habib Bank have been supporting initiatives such as the Closing the Skills Gap Accelerator Model, led by the World Economic Forum with the purpose of enabling 1 billion people in the next 10 years to re-skill and upskill, thus providing opportunities for meaningful work and creating space for collaboration between the private sector, governments and civil society. In short, changing practices in the company’s value chain to drive productivity through better-utilizing resources, employees, and business partners is one of the key pillars of creating a true shared value initiative.
• Rethinking role and purpose across the board
By spearheading the establishment of industry clusters, financial institutions can reinforce the networks they operate in, thus making them more resilient and better-equipped for future challenges. The Finance Innovation Cluster in France is a great example of creating shared value in the country– between 2005 and 2016 alone, the cluster has completed 1681 collaborative R&D projects, received public financing of €6,8 billion including more than €1.7 billion granted by the French State through the dedicated fund (FUI). The current membership base includes over 600 enterprises, ranging from large corporates, VCs, fintech and SMEs as well as a number of leading universities and educational institutions (Finance Innovation, 2022).
Challenges and opportunities
It is important to note that while the majority of brick and mortar banks are just beginning to think about the implications of shared value opportunities, neo banks, impact and ESG (environmental, social and governance) investing firms, and technology companies have started to capitalize on these opportunities. According to the Global Impact Investing Network (2020), more than 88% of impact investors (a type of investor that directs capital to enterprises that generate social or environmental benefits), reported that their investments met or exceeded their expectations. The median impact fund realized a 6.4% return, compared to 7.4% from non-impact funds.
Some of the challenges that banks face when it comes to shared value creation are associated with concerns about insufficient scale of the opportunities in the space as well as the inability to accurately assess risk associated with impact-oriented opportunities. Where challenges are observed however, opportunities soon follow – opportunities pioneered by a new type of market entrants dubbed as “green neobanks” or “impact fintechs”. In addition to being fossil fuel free and carbon-neutral, the financial institutions driving the green agenda hold certifications such as B Corp or Community Development Financial Institution (CDFI) and/or are members of the Global Alliance for Banking on Values (GABV) (SustainFi, 2021). The products on offer are similar to the product offering of a traditional retail bank, e.g. a current account, IBAN, debit card, lending and deposit capabilities; however, the sustainability drive is clear. For instance, impact fintechs can offer incentives (investing the interchange earned on transactions in deforestation and carbon-offsetting initiatives, cashback on purchases made from conscious brands) or provide verified ESG investment recommendations as well as enable consumers to track and offset their carbon emissions footprint by examining their spending patterns and transforming the data into actionable goals.
One thing is clear, despite the obstacles that both neo and traditional banks face, the financial services industry is essential to solving society’s most imminent challenges, and addressing these challenges is vital to banks’ business. Offering products with a clear ESG benefit, striving towards a transparent and ethical value chain and employing a systemic change approach that brings tangible benefit to society at large will be the main strategy pillars of any future-proof, resilient financial institution.
MX Technologies. How the Four Biggest US Banks Generate Income and Revenue (2021)
Available from: https://www.mx.com/moneysummit/top-us-retail-banks-income-revenue
McKinsey&Company. Rewriting the rules in retail banking (2019)
Available from: https://www.mckinsey.com/industries/financial-services/our-insights/rewriting-the-rules-in-retail-banking
World Bank Group. Growing Impact. New Insights into the Practice of Impact Investing (2021)
Available from: https://www.ifc.org/wps/wcm/connect/8b8a0e92-6a8d-4df5-9db4-c888888b464e/2020-Growing-Impact.pdf?MOD=AJPERES&CVID=naZESt9
Global Impact Investing Network. 2020 Annual Impact Investor Survey (2020)
Available from: https://thegiin.org/research/publication/impinv-survey-2020
Shared Value Initiative. What is Shared Value (2022)
Available from: https://www.sharedvalue.org/about/what-is-shared-value
The Fintech Times. Sustainable Challanger Bank Flowe Launches With Temenos (2020)
Available from: https://thefintechtimes.com/sustainable-challanger-bank-flowe-launches-with-temenos
Stockholm School of Economics. New research collaboration between Misum, Doconomy and Flowe on carbon conscious purchasing trends (2021)
Available from: https://www.hhs.se/en/about-us/news/news-from-misum/2021/doconomy-and-misum
World Economic Forum. Platform for Shaping the Future of the New Economy and Society. Closing the Skills Gap Accelerators (2022)
Available from: https://www.weforum.org/projects/closing-the-skills-gap-accelerators
Finance Innovation. France’s official innovation Cluster for the financial industry (2022)
Available from: https://finance-innovation.org/wp-content/uploads/2022/02/Europe-Flyer-projets-UE-1.pdf
SustainFi. The Top 7 Green Banks in 2022 (Fossil Free Bank Review) (2021)
Available from: https://sustainfi.com/banking/green-banks