The Case for Bringing Innovation Inside a Bank

Some entrepreneurs think bank innovation has to come from some place other than banks. Dan O'Malley went against that theory by joining a bank and may soon have proof of concept.

O'Malley heads Eastern Labs, an initiative he co-founded in April 2014 at Eastern Bank in Boston. Eastern Labs is expecting to release its first development by yearend. O'Malley declined to say what it is specifically, but refers to it as a platform and says it should contribute to the bottom line.

The planned rollout underscores how banks of all sizes are looking to transform their cultures to embrace a much faster tech pace amid a digital era.

"We are getting to the iTunes moment," said O'Malley, referring to the fate of the mall music stores.

Many banks recognize that they need to see digital changes as something that can happen inside the bank if they want to stay relevant in an environment filled with companies trying to cut them out of the financial equation.

"There are a lot of advantages to being a bank," said O'Malley, who previously was chief executive of PerkStreet Financial, a cards reward startup that shuttered.

A bank comes with assets startups don't have, like access to data and customers.

Of course, banks also come with decades-old technologies, expensive branches and fierce regulation.

But O'Malley, along with the PerkStreet team members who joined him at Eastern last year, believed they could build things more quickly if they incubated ideas within a bank.

"Speed is key," O'Malley said.

Eastern Labs is an example of the way banks are trying to step out of their conservative comfort zone and embrace Silicon Valley techniques. Institutions are: hosting hackathons; launching innovation labs; sending their employees to the Valley; creating mobile-first divisions; and working with and acquiring startups.

But such efforts alone won't guarantee success of a goal that's daunting if not elusive, said Hayagreeva Rao, a professor at Stanford University's Graduate School of Business.

"The real challenge is how to create the soul of a startup inside of an organization," said Rao, who co-authored "Scaling Up Excellence: Getting to More Without Settling for Less."

That is going to be perhaps more difficult for banks. All companies face the potential of disruption, but banks have an added difficulty because avoiding risk is often a part of their fabric.

"Banks are, by nature, conservative," Rao said. "The really innovative ideas involve controversy."

Eastern Labs is run by former entrepreneurs, but they understand that they work for a bank and their mission is to build technologies that can be used there and potentially be sold to other institutions.

As a result, they know and care about what other banks might want. O'Malley, who oversees 115 employees, says his talks with banks are going well; he is able to answer their bank-specific questions because he is already living it at Eastern.

"It's been really powerful," he said.

The unit also has something O'Malley says any bank lab would need: funds earmarked specifically for experimenting. Eastern, for example, has committed 1% of revenues to research and development. In 2015, its budget was $4 million.

But in-bank labs have their challenges. Banks root themselves in stability and time-tested consistency. Startups often embrace the concept of fail fast. Balancing the two can be difficult, especially in today's earning environment where banks are laser focused on expenses.

"There are good reasons why bank culture is the way it is and there are good reasons why startup culture is the way it is," said O'Malley.

Some banks CEOs, like Richard Davis at U.S. Bancorp, have said that despite their focus on expenses, they are continuing to invest in innovation to avoid being left behind.

But those striking differences are why acquiring is often banks' paths to innovation, rather than building it.

However, getting startups to care about the company is tough, according to a paper Capgemini published in July on the growing mandate to innovate regardless of industry.

"You need to avoid becoming an innovation theater where all you are doing is interacting with a bunch of startups that don't really care about your company," a large bank respondent told the consulting firm.

While Eastern Bank and others are focused on bringing innovation and entrepreneurs inside, sometimes bankers need to get out of the bank, too.

O'Malley, for instance, worked at Capital One before starting PerkStreet.

There is also Dave Kucera, who scouted for fintech innovations on behalf of BBVA Compass, a bank that acquired Simple and works with Dwolla and Kasisto. He is now the chief executive of Innosect, a software company that aims to help companies innovate.

Kucera is among the ex-bankers who decided to leave the bank to create a company - an idea that crystallized for him when his daily agenda required formal attire, but he was often in meetings with a startup execs in shorts and flip flops.

"Honestly, life is too short to wear a suit every single day," he said.

Others say bankers can benefit from decidedly shorter stays away.

Standford's Rao advocates for employees to get distance from their "motherships" by visiting incubators and accelerators.

Mach49, a Silicon Valley company Rao advises, is one such resource. Through the Mach49 12-week program, banks and others send small teams — usually four to six people — to visit with venture capital firms, startups and others and to develop and test hypotheses the way a startup might.

"It's not just about going to Silicon Valley," said Linda Yates, founder and chief executive of Mach49, the incubator and accelerator.

The program's intent is to improve a practice banks may already do: send employees to visit big tech companies in the hope "the innovation fairy dust" hits them, said Yates.

"The only way to disrupt and to innovate is if they really get down and dirty."

Like Eastern's O'Malley, Yates believes innovation can come from inside the large corporations.

"It's amazing what these guys have as their disposal," she said. "The startups may want to eat your lunch, but you can steal their dinner."