Many banks’ mistakes are one bank’s opportunity

Revenue at the 10 largest investment banks in the world is down for the third straight year. Average ROE for these firms stands at 7%, below their cost of capital. Much of this pain stems from their Fixed Income, Currency, and Commodities (FICC) divisions, which accounted for 46% of revenue last year versus 61% in 2010. Innovation in the form of ETFs bringing new liquidity to historically illiquid and higher spread bond markets and articles like “The Robots are Coming For Wall Street” hardly provide solace (1). In this environment, McKinsey declares now the “time for real change and bold actions (2).”

One player in the space is notably embodying that spirit. “We are a tech company,” says Goldman Sachs’ CEO Lloyd Blankfein on a podcast posted on the company’s website (3). The firm has asserted this for about two years now, highlighting its commitment to harnessing the benefits of digitization. One interesting way it has done this is by embracing Kensho – a data analytics and machine learning platform. The salespeople and traders on the Goldman trading floor use Kensho’s instantaneous automated analysis around data releases and its incredible processing power to quickly research trading opportunities for clients and themselves. Consequently, their ability to efficiently analyze historical relationships between events and asset prices is significantly enhanced. What now takes them a few minutes “would have taken days, probably 40 man-hours, from people who were making an average of $350,000 to $500,000 a year (4).” In a similar vein, Goldman is moving to share its other technological capabilities with clients. To that end, the firm’s Chief Information Officer gave them access to its centerpiece trading platform, Marquee, providing sophisticated trading data that used to only be accessible by calling a Goldman employee. Upon facing internal resistance, his answer was firm: “If your job is a purely manual job and you are just clicking buttons, you should look to upgrade your skills set now (5).”

The gains from the use and dissemination of these programs are clear: more differentiated client service, higher customer satisfaction, increased utilization rates, and – as exemplified strikingly in the quote above – reduced labor costs. The next applications of Kensho, according to its founder, further highlight that impact. Sophisticated client-facing interfaces will mean clients “will no longer need nor want to work through a human being (4).” As Kensho’s largest investor, Goldman will see additional direct financial benefits even in that unforgiving scenario.

Goldman is also using digitization to add new lines of business. Despite its 147-year history serving just institutional and high net worth clients, it recently launched a consumer lending platform called Marcus. The new unit offers loans through a website and an app, creating a virtual banking structure that allows it to lend at lower rates than banks with a brick and mortar presence. Effectively, this allows Goldman to act like the start-ups disrupting its traditional competitors in the consumer banking space. This initiative is particularly striking to me as it demonstrates Goldman’s readiness to play offense in the face of digitization rather than retreating into itself to just defend its historical business. As articulated by the New York Times, “on Wall Street, Goldman has a reputation for spotting businesses that are being transformed and finding a way to seize the opportunity (6).”

The firm’s workforce composition has changed to reflect its increasing focus on technology and digitization. As of April, Mr. Chavez oversaw 9,000 computer engineers – representing about a third of the staff (5). In line with this, the firm has changed its campus recruiting process – pursuing “community leaders, entrepreneurs, and technologists” within student bodies from a wide range of colleges through targeted ads, an enhanced Snapchat and YouTube presence, and offering connection opportunities on Google Hangouts and Skype (7). These changes are an attempt to compete with Silicon Valley for talent, demonstrating another example of Goldman’s pivoting its operating model to align with its changing business model.

Overall, I think Goldman’s response to digitization impressively bears testament to the firm’s leadership position in the industry. From a cut and dry perspective, it is easy to just see the benefits to the firm and its shareholders of its agile embrace of new technology applications. I would, however, be more cognizant of the human impact of these changes. If the front office functions at Goldman are getting (and will continue to get) eroded by increased digitization, back office functions will have been put through the ringer even more dramatically. In a country (and world) increasingly chaffing at economic inequality, I would be concerned about the public perception implications of significant future layoffs. Given Goldman’s reputation for thought leadership in the space, I see an opportunity for it to institute training programs at the firm to help up-skill employees and protect against this to some degree.

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Student comments on Many banks’ mistakes are one bank’s opportunity

  1. Thank you for this interesting post. In an industry, where the short-term pressure from shareholders tends to be strong and competition among players is harsh, it seems to be likely that replace-able function will be digitized in the near future. A little bit of build-on your last part: even if Goldman doesn’t lead the trend of digitization and replacement of jobs with computers, other firms will do so, putting enormous pressure on Goldman to follow as well. I guess that investment banking job which is threatened for replacement will be functions which do not involve much client-interface element in nature (such as prop trading and middle/back office jobs; for middle/back office job, as long as there is human-interface element within the company, such function will be more difficult to be digitized). Because of digitization, I suppose that financial services will become more communication-oriented, and client service-focused industry. Also, digitization strategy would require more cross-border collaboration within a company (i.e. technological innovation will be led by not only the HQ but emerging markets offices). For example, considering the potential impact of digitization, in the near future, more value could be created not in the US, but in India (in addition to the recruiting channel you mentioned in the post, it would be also interesting to see the change in employees’ location going forward). These changes will impose an additional, but yet exciting challenge on the management in this industry.

  2. Very good post on Goldman, which I believe to be the most well-run company in banking and possible finance. I have several questions about this pivot into technological services:
    – Does it erode Goldman’s core value proposition as an intermediary, helping connect investors with investment opportunities?
    – What does it do to Goldman’s competitive landscape? Specifically, what are Bloomberg or Google doing, and can Goldman do it better? If JPM or MS continue to focus on the human element / non-automated advisory, will they be able to steal clients away?
    – In a business that is currently all about relationships, will such a tech revolution commoditize the business they are in?

  3. Amals,

    Thank you very much for your interesting and timely post. On a somewhat related note, I was just talking to some Goldman employees this weekend who mentioned that Marcus has received significantly more deposits than they initially anticipated, which is putting pressure on some of Goldman’s ratios given that these deposits need to be accounted for as short-term liabilities. Goldman is truly an industry leader in the investment banking sector and incredibly nimble and innovative for such a large institution. It will be very interesting to see how their competitors – and especially the European investment banks – tackle this same issue. Do you think that Goldman’s initiatives here will further differentiate them in the marketplace? As a previous employee of Deutsche Bank, I cannot imagine some of these European institutions being able to keep pace (we were about three years behind Goldman in just VPN capabilities).

    Thanks again,
    Jess Delfino

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