Innovation In Retailbanking

Innovation in Retail Banking S e p t e m b e r 2 0 0 9

Contents 04 Executive summary 07 Innovation in the context of retail banking 13 The impact of the crisis on innovation 21 Innovation strategy 33 Strategic versus incremental innovation 41 Innovation and growth 53 Innovation and efficiency 59 How banks can become more innovative 65 The role of IT in innovation 70 Conclusion 71 About the research 72 List of participants 74 About us 75 References

I n n o v a t i o n i n r e t a i l b a n k i n g Preface inacle from Infosys and the European Financial Management & Marketing F Association (Efma) are pleased to present this major report on innovation in European retail banking. In this time of crisis, there is a danger that banks will allow other priorities to slow down their pace of innovation, but this is precisely the time when innovation can lay the platform for future growth and efficiency. The market environment will remain challenging for some time and banks need to consider new business models, as well as make continuous, incremental improvements to their business. Innovation is a very widely used term which can apply to any aspect of the business. This report takes a high level and strategic view of the issue and does not focus on one specific type of innovation, or one area of activity. Innovation in operations is just as important as innovation in marketing. We look at the issue of strategic versus incremental innovation, and the importance of innovation for both growth and efficiency. We also assess the barriers to innovation, what actions banks are taking to increase their level of innovation, and recommend areas where we feel they could improve. Information technology has a key role to play in helping banks to drive innovation, as is clearly illustrated by the feedback from our research. Nevertheless, it can also be seen as a significant barrier, so we have explored this issue in more detail. A number of case examples are included in the report in order to illustrate various aspects of innovation. We believe these cases are good examples of interesting innovations but we have not run a competition to select the best, and there may be other banks in Europe not mentioned who are also innovating in similar areas. As is always the case with Efma reports, one of the key objectives is to share best practice across Europe. 89 banks from 26 countries contributed to the research either by completing an online survey or participating in an interview. For the purposes of the analysis we have divided Europe into 3 regions: Western Europe, Central & Eastern Europe, and Russia & CIS. There are clear differences between the regions but also many similarities which show how best practices are diffusing relatively quickly around Europe. The respondents included a broad range of senior management in the Retail, Marketing, Operations, Information Technology, Strategy and Innovation areas of banks. We found a huge amount of interest in the subject of innovation when talking to banks across Europe, and we hope that the insights we have been able to draw out of the research prove useful. This report was prepared, on behalf of Efma and Finacle from Infosys, by Michael Pearson of Clarus Investments. Haragopal M Patrick Desmarès Global Head - Finacle Secretary General Infosys Technologies Limited Efma 3

Executive summary • Innovation continues to be important for banks, even in the current financial crisis 78% of the banks in the survey believed that the importance of innovation was high or very high for both growth and efficiency. The perceived importance of innovation was high in all 3 regions covered by the survey, but slightly higher in Central & Eastern Europe and Russia & CIS compared to Western Europe. • More banks need a clear innovation strategy 37% of banks said that they have an innovation strategy, which is low given the perceived importance of innovation and the fact that 73% of banks are aiming to be innovation leaders in their domestic market. We believe more banks need to develop a clear innovation strategy (including objectives, processes and measures of success), which should be linked to the business strategy. • Approaches to innovation are determined by a range of factors Innovation strategy should be determined by a bank’s business strategy, but there are several generic factors which will have an impact. Market specific factors (stage of development, regulation, culture) and company specific factors (market share, ownership, resources) provide a framework for understanding some of the innovation issues which any particular bank will face. • Strategic innovation is a high priority for many banks but concrete examples are rare 54% of banks said they are working mainly on strategic innovation, or an equal mix of strategic and incremental innovation. According to some banks, the financial crisis is a catalyst for a new focus on strategic innovation. However, this view was not supported by evidence yet of radical and innovative changes to business models. • The strategic risk from disruptive innovators is low but banks need to plan for change The banking industry has not been disrupted by new technologies or new entrants. Change tends to take place relatively slowly compared to some industries, giving followers a chance to keep up without significant risk. It is nevertheless important to devote some resources to looking at where strategic innovations might disrupt the existing business, and experiment in these areas if possible. • Banks in Central & Eastern Europe, particularly Turkey, are leading in growth innovations 54% of banks we surveyed in Central & Eastern Europe believed that their level of innovation in product, channel and customer relationship activities was high or very high, compared to only 28% in Russia & CIS, and 48% in Western Europe. Within Central & Eastern Europe, the banks in Turkey perceived themselves to be the most innovative. •Customer relationship development activity exceeds product and channel development Across the 3 regions, 69% of banks said that their customer relationship development activities were high or very high, which was slightly more than for product or channel development. Some banks told us they intend to shift even more effort from product to customer relationship development in the future. 4

I n n o v a t i o n i n r e t a i l b a n k i n g • Innovation in customer relationship development activity could be improved For example, 70% of the banks in Western Europe rated their level of customer relationship development activity as high or very high, but only 53% rated the level of innovation in this activity as high or very high. This perception was supported by our interviews and survey which revealed fewer customer relationship innovations than either product or channel. • Innovation efforts targeted at efficiency improvements do not match its importance 90% of banks in Central & Eastern Europe and Russia & CIS said that the importance of innovation for efficiency improvement was high or very high. However, the level of innovation in the efficiency improvement efforts we surveyed does not match this perceived importance and we believe there is substantially more scope for banks to look at innovative ways to become more efficient. • Information Technology is important for innovation but is also seen as a barrier Inflexible IT systems and bottlenecks in IT development were the top 2 barriers to innovation in all 3 regions. Banks who have been able to invest in newer systems, either by starting more recently or going through a major change programme, naturally regard this as less of a problem but it remains a significant challenge for more mature banks who want to both grow revenues and reduce costs. • Other views on barriers to innovation were mixed Investment was not seen as a particularly high barrier in spite of the financial crisis. The lowest barrier was a lack of innovative ideas – most banks have idea generation processes, at least for employees, but would probably benefit from more open innovation. Regulation and compliance was seen to be a high barrier to innovation for banks in Western Europe and Russia & CIS, but less for banks in Central & Eastern Europe. • Employee training for innovation and creativity is low and should be increased Best practice research shows it is crucial to focus on employee-related issues to increase innovation and creativity – including recruitment, training, performance management and rewards. It was surprising that less than 25% of banks had increased employee training on innovation. There were some cases of innovation being included in performance management, but this was not widespread. • The differences between regions are relatively small indicating good best practice diffusion While there are some differences between the regions, the similarities in terms of product, channel and customer relationship development focus, and in terms of approaches to efficiency improvement, highlights how industry best practices are being diffused across Europe. 5

Innovation in the context 1 of retail banking 7

Defining innovation One of the challenges in carrying out research on innovation is that people can have very different ideas of what constitutes an innovation. We have defined it in the following terms: “to innovate” means to introduce changes and new ideas, and “an innovation” is a new idea or method, which creates value for the customer or the company itself. It should be something that is new to the market, not simply copied from another bank in the same market. There is a tendency for all of us to think of innovation in terms of new products and services, like the iPhone from Apple, particularly ones which are technology related. It is much harder for us to think about innovation in activities like operations and finance, especially when no new technology is involved. Innovations also range in scale from “incremental” to “strategic”. There are no hard definitions of what these terms mean and we came across a wide range of views as to what constitutes a strategic innovation. In Section 4 we look at this issue in the context of retail banking. Comparing innovations across countries and regions The economies and banking sectors in countries around Europe are in different stages of development and an innovation in one country may not constitute an innovation in another country. The flow is not just one way, however, from more developed to less developed markets. We found many cases of innovations in less developed markets which have not been introduced yet into more mature markets. One development we will explore further in the report was the larger banks with operations in several European countries transferring systems and practices across borders – usually from the home country to markets where they have made acquisitions. In some cases these banks are taking a very different approach to innovation than the more local banks in a particular market. The fact that there are different innovation strategies does not mean that one or other is right or wrong, but reflects the specific circumstances of the banks concerned. It is also the case that what makes sense as an innovation in one country may not, in the short term, make sense in another country due to the different customer needs, competitive dynamics, regulation etc. so we have to be careful not to generalise. However, in time, innovations do tend to diffuse across all markets and so it is important for banks to be fully aware of what is happening in other countries. In Section 3 we explore how country and company specific factors combine to influence the approach a bank might take to innovation. 8

I n n o v a t i o n i n r e t a i l b a n k i n g The history of innovation in retail banking Many people do not think that retail banking is an innovative industry. An annual survey by Business Week and Boston Consulting Group1 ranked Apple, Google and Toyota as the most innovative companies in 2009. The only banks featuring in the top 50 were HSBC and JP Morgan Chase and we don’t think this was particularly for their retail banking activities. Academic research has typically concluded that retail banking is not very innovative. According to one study in the Journal of Marketing Management, “weak consumer demand for unique products and services is a major reason why imitative incremental innovation is more common than radical innovation in retail banking2”. Of course this particular observation relates to product innovation, but you could reach the same conclusion about channel innovation when you consider the current approach to mobile banking being taken by a lot of Western European banks. However, we should recognise that there have been many significant innovations over time which has made the industry unrecognisable from 30 years ago. It takes time for innovations to become widely adopted, so the impact is perhaps less dramatic than we see in some industries where a failure to innovate (or innovating in the wrong direction) can lead to extinction quite quickly. 9

One bank we spoke to described its transition several years ago from being a product-centric organisation to a customer-centric one – clearly a major change to the business model and believed to be innovative at the time, but no longer perceived to be an innovation. For some banks in the less developed European countries, this transformation remains a big challenge. Internet banking is the most significant innovation in the last 15 years. Many banks launched internet banking in the mid 1990’s, but there remained some wide discrepancies in adoption as of the end of 2008 (see Figure 1). In Norway, internet banking use (measured over the previous 3 months) reached 75%, whereas in the UK it was 40%. In Spain, the usage was just 20%, and in the Czech Republic which is still catching up, the usage is 14%. The average usage rate for the 5 largest European economies was just 28%, and that is after 15 years of internet banking services being available. Proportion of individuals over 16 years of age using internet banking in previous 3 months Norway UK Spain Czech Republic 80% 70% 60% 50% 40% 30% 20% 10% Figure 1 0% 2003 2004 2005 2006 2007 2008 Source: Eurostat 10

I n n o v a t i o n i n r e t a i l b a n k i n g One of the features of the industry is that more or less all banks tend to adopt the same innovations, and there is not generally a lasting competitive advantage for the first mover. Of course, we have not examined all the banks that have failed or been taken over in the last 30 years to see if they were less innovative than surviving banks, but we do not think this would be the case. Banks fail for many reasons other than not pursuing innovation, and in some cases more innovative banks are taken over by less innovative banks with greater financial resources. However, it is clear that banks cannot stand still and we will discuss the strategic issue of being an innovation leader or follower later in the report. Entrepreneurship and innovation Innovative start-ups have generally made relatively little impact on the retail banking industry in Western Europe, but there has been considerably more potential for entrepreneurial activity in the developing markets of Central & Eastern Europe and Russia & CIS. In these regions there are several examples of start-up banks in the last 10 years (e.g. Russian Standard Bank in Russia and Alior Bank in Poland), and also examples of established banks expanding into retail banking (e.g. Turkish Economy Bank). These banks have been innovative in the context of their local markets and have created an entrepreneurial culture which tends to encourage continuing innovation. Entrepreneurs don’t always need to be innovative, but typically it helps. Entrepreneurship and Innovation – Russian Standard Bank Russian Standard Bank was founded in 1999 by Roustam Tariko, and is now the leader in the Russian consumer finance market, with more than 25 million loan customers and 25 million credit cards in issue. The bank was started in the middle of a financial crisis in Russia, which illustrates how there are opportunities for entrepreneurship and innovation even in adverse conditions. The bank has over 400 branches and representative offices, 46,000 POS locations and in addition to consumer finance offers deposit products and private banking services. Source: Russian Standard Bank 11

The impact of the crisis 2 on innovation 13

The financial crisis first took hold in the middle of 2007 and went through various stages before reaching a critical point in September 2008 with the bankruptcy of Lehman Brothers. The initial phase was a liquidity crisis for banks reliant on wholesale funding, and this was followed by a solvency crisis as banks were required to significantly reduce their leverage by shedding assets or raising capital. The financial crisis has led to the worst recession in the real economy since the depression of the 1930’s, and mounting credit losses are causing more problems for banks. The impact is staggering as you can see from Table 1 which shows the expected writedowns due to the crisis, and the actual support measures put in place for European banks. The support measures add up to 27% of European GDP . Projected Writedowns as of April 2009 (Euro bn) Loans 424 Securities 143 Support Measures as of June 2009 (Euro bn) Capital injections 160 Guaranteed bond issuance 544 Other guarantees 237 Table 1 Asset support 612 Source: IMF3, ECB4 Following significant government efforts to stabilize the banking system, the crisis has moved into a phase which will involve a longer term profitability challenge. Some research by the Bank of England has shown that the level of profitability achieved by the banking industry in the last 10 years was based on increasing leverage rather than improvements in the underlying business5. In the short-term, margins have widened in some product areas, and competition may have reduced, but funding costs are expected to rise and banks will need to continue to work very 14

I n n o v a t i o n i n r e t a i l b a n k i n g hard for revenue growth while at the same time becoming more efficient. The impact of the crisis on countries across Europe has been varied and some of the emerging economies have been quite resilient. The IMF assesses the risks in these countries by looking at current account deficits, short-term external financing needs and real credit growth in the last 5 years3. Countries such as the Baltic states and Ukraine are in a relatively weak position, whereas Poland and Turkey have so far been much more robust. It is also a mixed picture for Western European countries. The UK, Spain and Ireland have been particularly impacted by falling property prices. The UK also has a very high level of indebtedness in the household sector, and its economy is relatively more dependent on the financial sector in general. In the UK, the government has taken significant ownership stakes in 2 of the 5 major banks. This was required due to over expansion in property lending (HBOS) and poorly timed overseas acquisitions (RBS) among other things. Santander has taken the opportunity to consolidate its position in the UK market by buying some failed small banks (see box). Innovative Expansion during the Crisis – Santander Santander is pursuing an ambitious growth strategy which is innovative in the sense that the bank is leading the way in the global integration of retail banking – an example of business model innovation to drive efficiency. In the UK, Santander acquired Abbey in 2004 as a stepping stone and in 2008 this was followed by the acquisitions of Alliance & Leicester and Bradford & Bingley. Formerly Building Societies, none of these banks had been able to build a viable, independent long term business model. Santander is driving down costs by migrating all of the acquired banks onto its existing Spanish core banking system, Partenon. This kind of pan-European integration of IT and back-office operations has been long talked about but is now actively underway at some banks such as Santander. 15

BNP Paribas has also used the crisis to pursue acquisition opportunities, notably of Fortis in Belgium. Banks in the Euro area have to some extent fared better than UK banks but the Bank for International Settlements believes that their balance sheets have not fully reflected expected losses and has urged them to make realistic writedowns and recapitalise6. Some would argue that innovation has played a major role in causing the crisis. The UK mortgage lender Northern Rock was one of the first banks to fail – in September 2007 – after aggressively building its business with innovative lending products, like the 125% loan-to-value mortgage, and an innovative wholesale funding structure for a mainstream lender. The Financial Services Authority in the UK has even questioned the need for some kinds of innovation – “given too much choice consumers often prefer not to act at all for fear of making a wrong choice and too much choice causes confusion. Is there too much innovation in some markets – such that it is a barrier to consumers engaging with them effectively?7” Until now, the banking sector has been remarkably immune to innovative disruption from new entrants which we discuss in more depth in Section 4. However, the crisis may provide the opportunity that others have been looking for to exploit both financial weakness and a loss of consumer confidence in banks. Are banks now more focused on efficiency? Not all banks have been affected in the same way by the crisis, but it was clear from our research that the majority of banks are focused more on efficiency than growth, and only between 5% and 15% were focused on growth more than efficiency in the 3 regions (see Figure 2). Proportion of banks focused on growth or efficiency Growth Growth & Efficiency Efficiency 100% 80% 60% 40% 20% 0% Figure 2 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results 16

I n n o v a t i o n i n r e t a i l b a n k i n g However, we should also note that between 20% and 40% of banks in each of the regions are equally focused on growth and efficiency. One major bank which has performed well during the crisis told us that “the crisis has reinforced our strategy to pursue a balance of growth and efficiency – it is not a viable long term strategy to be focused only on efficiency and banks who have done this in the past have not been successful”. Several banks we spoke to from the developing markets who had until recently been almost exclusively focused on growth are now adopting more balanced strategies and emphasising the need for profitable growth. Also, not surprisingly, the vast majority of banks in all regions have either decreased the level of investment in innovation this year or have made no change (see Figure 3). Very few have increased the level of investment, although the proportion doing this was higher in Central & Eastern Europe at 29%. The international banks operating in that region however were much more likely to have reduced innovation investment. One bank pointed out that it was hard to separate what represents investment in innovation from general ongoing business projects and we would agree with that, so the survey can only really be an indication of perceptions rather than a precise answer. But it does raise the question about how good banks are at defining and measuring their level of investment in innovation. Change in investment in innovation this year Increase No change Decrease 100% 80% 60% 40% 20% 0% Figure 3 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results 17

We tend to think of innovation in terms of new products like the Apple iPhone or Nintendo Wii, and innovation is certainly very important for growth according to the banks we surveyed. As you can see in Figure 4, between 71% and 77% of banks in each region rated its importance as either high or very high on a 5 point scale. The results for Central & Eastern Europe were impacted by the response from banks in Turkey – excluding these banks, the level dropped to 61%. Banks rating the importance of innovation for growth as either high or very high 100% 80% 60% 40% 20% 0% Figure 4 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results We were surprised to find that banks in Central & Eastern Europe and Russia & CIS rated the importance of innovation for efficiency improvements even higher – approximately 90% in each region scored it as high or very high (see Figure 5). In contrast, only 66% of banks in Western Europe felt that the importance of innovation for efficiency was either high or very high. Again, Central & Eastern European banks excluding Turkey rated the importance lower, but still quite a lot higher than Western Europe. Banks rating the importance of innovation for efficiency as either high or very high 100% 80% 60% 40% 20% 0% Figure 5 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results 18

I n n o v a t i o n i n r e t a i l b a n k i n g Some banks talked about how innovation in products and channels, such as instant loans in Turkey, were also driving significant efficiency improvements by eliminating unnecessary processes. Other banks in Central & Eastern Europe and Russia & CIS saw a lot of potential still in adopting practices like centralisation of operations or process reengineering which in their context were seen to be relatively innovative actions to take. We explore the issues underlying these views in the relevant sections on growth and efficiency. 19

Innovation 3 strategy

How common is it to have an innovation strategy? Several of the questions in our research focused on the issue of innovation strategy. When asked if their bank had an innovation strategy we found that slightly more than one third of banks in each region said they had an innovation strategy as shown in Figure 6. The result was remarkably similar across the regions. Proportion of banks with an innovation strategy 50% 40% 30% 20% 10% 0% Figure 6 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results Actually we think these figures slightly overstate the real picture because our interview experience suggests that if we were to apply a rigorous definition of what constitutes an innovation strategy – including for example objectives, processes and measures of success – the proportion would be lower. The question also needs to be considered in the light of how many banks were aiming to be innovation leaders in their domestic market. This percentage was very high in all regions, and particularly in Central & Eastern Europe due to the ambitions of the banks in Turkey. Proportion of banks seeking to be innovation leaders 100% 80% 60% 40% 20% 0% Figure 7 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results 22

I n n o v a t i o n i n r e t a i l b a n k i n g In fact, almost 80% of the Turkish banks responding to the survey were also aiming to be innovation leaders using an international benchmark, not just in their domestic market. These banks are very ambitious and are keeping up-to-date with global developments in retail banking. More than one Western European bank we interviewed believed their operations in either Turkey or Poland were more innovative than the operations of the parent company in the home market. There is not necessarily a problem with so many banks aiming to be innovation leaders so long as it is a focused strategy which supports the value proposition. The concept of value propositions was introduced in “The Discipline of Market Leaders” by Treacy & Wiersama: “companies that have taken leadership positions in their industries typically have done so by narrowing their business focus. They have focused on delivering superior customer value in line with 1 of 3 value disciplines – operational excellence, customer intimacy or product leadership.8” In other words, banks should be clear about which areas they want to be innovation leaders in, how they are going to achieve that objective, and how they are going to measure success. There may be a rationale for being at the forefront of product and service innovation if this helps to create an “image” for the bank which supports customer acquisition activity or other objectives. In this case, innovation investment can be seen partly as a marketing investment, and individual innovations may not all need to be justified on their own business cases. For example, a bank may aim to be the first to market with a new iPhone mobile banking application, or a new contactless payment card, in order to support its brand image, even if the specific investments are difficult to justify financially. A few banks, like BBVA and BNP Paribas, have set up innovation showcases which have a practical value but can also help to create a strong innovation image. Factors which explain different approaches to innovation If business strategy is the main driver of innovation strategy, it is difficult to be prescriptive about what the innovation strategy of any particular bank should be. However, there are some generic factors which will determine some of the differences in approach: • Market related factors Stage of market development Regulation Culture (including how this affects consumer attitudes) 23

•Company specific factors Market share Ownership Resources (related to financial strength in view of the crisis) The matrix in Figure 8 depicts these different factors with examples of banks from Poland and Spain, which are markets at very different stages of development. COMPANY SPECIFIC Other factors to overlay: Ownership, Resources Market share of the bank Smaller Larger Other factors to overlay: Regulation, Culture Earlier Stage of market development Alior Bank PKO MARKET RELATED Later Bankinter Caja Madrid Figure 8 To illustrate how these factors might combine in determining the approach to innovation: • A large bank in a market which is at an earlier stage of development, such as PKO in Poland, has opportunity for improvement by adopting best practices to become more efficient, extend its product range and channels, and focus on its existing customer relationships. To be successful, it would not necessarily need to be the most innovative bank in the market, though it could still chose to make that an objective. 24

I n n o v a t i o n i n r e t a i l b a n k i n g • A smaller bank in the same market, such as Alior Bank (a recent start-up), will typically need to be more innovative to attract customers – either customers new to banking, or customers from more established rivals. As a start-up, this bank has some advantages in being able to begin operations with a clean sheet of paper and adopt the latest operating processes and technology innovations, but on the other hand it does not have economies of scale. • For a large bank in a more mature market, such as Caja Madrid in Spain, customer loyalty and cross-sell rates are already quite high, and the bank is already relatively efficient. The challenge is to embed a culture of continuous and mainly incremental innovation, while at the same time looking out for opportunities for strategic innovation or risks of market disruption. • In the same market, a smaller bank such as Bankinter is at a scale disadvantage and there are fewer new to banking customers to target. Arguably, such a bank needs to be innovative to prosper and may therefore have to consider more radical innovations than one of the larger banks. The other market related factors come into play because, for example, regulation and culture is not the same even for countries within the same region. Hence when we compare say Poland and Turkey, they have very different characteristics and a bank’s innovation strategy needs to reflect that. The other company specific factors come into play because banks that are part of larger pan-European groups (“ownership”) will have different options to consider on how to focus their innovation efforts, and banks with stronger financial resources will also have more innovation strategy options. Taking these and other factors into account you would not expect all banks to have the same innovation strategy even if, superficially, there are some similarities. 25

Do you need an innovation department? Not surprisingly, banks that had created a department responsible for co-ordinating and driving innovation were more likely to have an innovation strategy. As you can see from Figure 9, the creation of an innovation department was most common in Central & Eastern Europe and least common in Russia & CIS. Proportion of banks with a department responsible for co-ordinating innovation 30% 25% 20% 15% 10% 5% 0% Figure 9 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results Examples of banks we spoke to in Western Europe with innovation departments were BBVA and Caja Madrid. In the case of Caja Madrid, the desire to focus on making the bank more innovative led to the creation of the department and the development of an innovation strategy in 2007. Examples of banks we spoke to in Central & Eastern Europe with innovation departments were Garanti Bank and Turkish Economy Bank (partially owned by BNP Paribas). One of the roles of these departments is to provide a focal point to monitor innovation developments from around the world, in banking and in other industries that might impact banking. The need for an innovation department is not seen to be universal. One quite innovative bank in Poland felt that this would distract from each department and employee being innovative, and this was quite a common view. However, for some of the Western European banks who had struggled with becoming more innovative, it was seen as a catalyst for change. 26

I n n o v a t i o n i n r e t a i l b a n k i n g Innovation Strategy – Turkish Economy Bank In 2005, Turkish Economy Bank was a small bank focused on corporate and private banking. It has since then developed a retail banking business with more than 1m customers and over 300 branches across Turkey. Key to the bank’s successful development has been a clear innovation strategy, co-ordinated by the innovation department but involving all areas of the bank. This includes the following components: • Innovation leadership from senior management • Innovation strategy, aligned to the business strategy • Idea generation and screening – including the Spark innovation portal • Change management processes and innovation competency development • Evaluation, measurement and rewards, creating innovation champions • Internal and external communication to generate interest and ideas Source: Turkish Economy Bank, Presentation at the Efma CRM Conference in June 2009 A disciplined innovation process Even without an innovation department, it is clear from our interviews and from best practice research more generally, that there are real benefits from having a disciplined approach to innovation based around a number of key stages. These stages could apply to any type of innovation, but particularly where a significant investment is required: • Idea generation • Idea screening • Business case preparation and review • Concept development • Prototyping • Implementation 27

As we will see later in the report, banks do not see idea generation as a barrier to innovation although we think they would benefit from more “open innovation” (see below). However, we believe the idea screening process is also critical and needs the proper attention. Even banks without an innovation department might have some sort of Innovation Committee to review ideas but these can become politicised and dysfunctional if not carefully managed. The speed of implementation is a key factor for some types of innovation project. Both Turkish Economy Bank and LCL described how they had been able to develop and introduce significant product and channel innovations in just 6 months. Such an approach means being pragmatic and accepting that not everything will be perfect on launch, but can provide a number of competitive advantages. Measuring success is another key management issue which most companies struggle with. In a report on this subject, Boston Consulting Group recommended the use of multiple measures such as revenue realized from launches in the past 3 years, projected versus actual performance, and the total investment in growth projects9. Of course, this depends on being able to identify what is an innovation investment, and how to allocate costs to it. The potential for open innovation There has been growing interest in the concept of “open innovation” as pursued by companies like Procter & Gamble (see box). This recognises that a company’s own employees are not able to generate or pursue all of the most innovative ideas, so it makes sense to work with external partners to maximise the opportunities. For an R&D focused company like Procter & Gamble, this might involve drawing on external scientific resources, but it can also involve working with smaller, innovative companies who are able to explore more radical innovations. Another development along these lines is “co-creating” where companies engage their customers in the product development process. 28

I n n o v a t i o n i n r e t a i l b a n k i n g Open Innovation – Procter & Gamble Procter & Gamble has for a long time been one of the world’s leading consumer products companies with a strong reputation for product development and management. However, according to the CEO, AG Lafley, “by 2000, it was clear to us that our invent-it-ourselves model was not capable of sustaining high levels of top-line growth.” The company realized there were many scientists, engineers and small and mid-size entrepreneurial companies globally working on the innovations that P&G was interested in, so they developed an approach called “Connect and Develop” to exploit these external sources of innovation. Open innovation now plays a part in 35% of P&G’s innovations, accounting for billions of dollars in revenues10. In our research, we asked how banks saw the potential for partnerships and collaborations with other companies to drive more innovation. Not surprisingly, partnering with competitors was seen as the least likely approach for banks in all regions. In most cases this was either due to regulation against anti- competitive behaviour, or for the larger banks, being happy to work alone. 29

In fact, it was the smaller banks who rated this approach to innovation most highly, for example Bankinter which has worked in partnership with other banks to develop the HalCash remittance product. Of course, there are some payments related innovation activities which require collaboration between competitors and so this is still important for all banks. Importance of partnerships for future innovation (scale 1-5, where 5 is very high) Western Europe Central & Eastern Europe Russia & CIS 5 4 3 2 1 With competitors With companies With companies With major With small, Figure 10 from other industries from other industries suppliers innovative companies for distribution for combining partnerships capabilities and technologies Source: Infosys - Efma Innovation Survey Results Banks in Central & Eastern Europe saw a much higher potential for distribution partnerships to drive innovation compared to Western European banks. In general, Western European banks have found these relationships to be disappointing and new opportunities are in any case relatively limited. For the Central & Eastern European banks there are still many distribution partnerships to go for and there is some potential for innovation. Examples include Garanti Bank’s “Money Card” in partnership with Migros in Turkey which combines the benefits of a retailer’s co-branded card with a multi-loyalty card, and includes a number of innovative product features. Working with other companies to combine capabilities and technologies was seen to have good potential by banks in all 3 regions. However, we were provided with few examples of how this was working in practice and most of the comments related to partnerships with mobile telcos. Perceived as slightly less important were partnerships with major suppliers. There are challenges for suppliers getting too close to individual customers but there are examples including the recent technology partnership agreement between Caixanova, IBM and INSA to create a technology innovation centre in Spain. 30

I n n o v a t i o n i n r e t a i l b a n k i n g There is also a difference in attitude to working with smaller, innovative companies, with Central & Eastern European banks the most likely to think of this as an important driver of innovation. Such a partnership can go beyond a normal supplier relationship if the bank takes an equity stake in the company, or develops a deeper and closer relationship, perhaps with exclusivity for a period of time over some key technology. Examples include Credit Mutuel Arkea’s small investment in UpandNet the online giftcard company. A Review of Innovation Management Best Practices We have reviewed a wide range of sources on best practice covering all elements of the innovation process, some of which are described below. The four common themes to highlight from all of this expert opinion are: • Start with a clarity of objectives, and link these to strategic objectives • Give support to innovation from the highest level and integrate it into the management process • Focus on the people and cultural issues at least as much as the process • Ensure rigorous measurement of innovation and accountability for results In a Strategy & Business article, “P&G’s Innovation Culture”11 , Chairman & CEO AG Lafley describes how P&G built a world-class organic growth engine by investing in people. In 2000, P&G’s success rate with new products was 15-20%. It is now 50-60%. According to Lafley: the consumer must be central to the process, innovation should be integrated in everyone’s job and must be scalable, employees should be recruited and developed emphasizing flexibility and agility, and there needs to be integrated thinking across the company. The Harvard Business Review article, “Reverse Engineering Google’s Innovation Machine”12 , describes the 6 major components of Google’s approach to innovation. Google allocates time in employee job descriptions for innovation, actively cultivates an environment of experimentation and rapid failure, and uses rigorous analysis and objective decision making to assess ideas. Google is also particularly good at leveraging innovation partnerships while keeping control of the core architecture. AT Kearney research with 250 companies worldwide, “Innovation Management – Strategies For Success and Leadership”13 , identified the traits of successful innovators and found that leaders clearly focus more time on the early stages of the process: innovation strategy, idea generation and idea screening. Best practice for innovation strategy requires creating an explicit and well articulated strategy. Best practice for idea generation means involving a wide array of partners and embracing open innovation. Leading companies review more ideas and use well-defined screening criteria; they also take bigger bets initially but are more rigorous at pruning ideas. McKinsey & Co, in the article “Leadership and Innovation”14 proposed that companies should focus on 3 areas: integrate innovation into the strategic management agenda; make better use of existing talent for innovation and allow innovation networks to flourish; foster an innovation culture based on trust among employees where ideas are valued. The main motivators of behavior to promote innovation are strong leaders who encourage and protect it, and senior executives who actively manage and drive it. Companies need to define the type of innovation that drives growth and meets the strategic objectives, add innovation to the formal management agenda, and set performance metrics and targets. 31

Strategic versus incremental 4 innovation 33

We have defined strategic innovation as innovation which is more significant for the business model of the bank, or part of the bank, and which creates real competitive advantage. Strategic innovation is not exactly the same as “disruptive” innovation, a term that was adopted by Clayton Christensen and Joseph Bower to describe situations when new competitors enter a market at the “low end” and then from this position disrupt the market for the established competitors, or expand the size of the market by drawing in previously un-served customers. Examples of disruptive innovators are low-cost airlines such as Ryanair15 . More recently, in the Harvard Business Review article “Reinvent Your Business Model”, Christensen and his colleagues have written about business model innovation, using several examples including the iPod and iTunes which 3 years after launch was a $10bn business accounting for 50% of Apple’s revenues . Business model innovations of this type can reshape or even destroy whole industries but are rare. Examples of strategic innovation in banking are also relatively rare. We have already mentioned some previous innovations which in our view are strategic – like the diversification of banks into the selling of insurance products – but they tend to be adopted by most banks and take time to become established. Unlike the Apple iPod/iTunes case there is not usually a significant first mover advantage and no “winner- takes-all” outcome. One banker in Western Europe we spoke to said that he would only expect to see one or two strategic innovations in his lifetime. Another banker in Central & Eastern Europe said that the crisis has provided the impetus for his bank to take a fresh look at all aspects of its business model, but they were still at an early stage of reviewing this. A particularly useful insight from one of our interviewees was that they see a cycle of strategic innovation followed by implementation, and then a continuous refinement of the business model. Where you are in the cycle will determine where your innovation focus and resources are targeted. Between 5% and 20% of the banks in our survey said they were working mainly on strategic innovation. 57% of respondents in Western Europe and 79% in Central & Eastern Europe said they were working either mainly on strategic innovation or on an equal mix of strategic and incremental. 34

I n n o v a t i o n i n r e t a i l b a n k i n g What kind of innovation are banks mainly working on? Mainly Strategic Strategic & Incremental Mainly Incremental 100% 80% 60% 40% 20% 0% Figure 11 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results A few of the banks who said they were working mainly on strategic innovation were relatively small, start-up banks, or banks with a recent entrepreneurial history. Other examples included banks operating in countries still at a very early stage of market development, for example in Romania. Two of the best examples of potential strategic or business model innovation we identified from the interviews and the survey were: • Setting up a Mobile Virtual Network Operator (see box) • Expanding in a new market through franchising (see box) We think that banks setting up as Mobile Virtual Network Operators is a good example of what may prove to be a strategic innovation as it takes them into a new business and allows them to control more of the value chain in mobile banking. It may also be a good defensive move if mobile telcos start to set up their own banking operations. There are several examples of this strategy such as Rabobank (Netherlands), PosteMobile (Italy) and Bankinter (Spain) (see box). Franchising is also a business model innovation, though it has been used in some markets for many years, such as Belgium, and may not be applicable to all markets. ING Romania and Volksbank International have successfully introduced a version of the concept into Romania in the last few years. At the end of 2007, ING had 170 agent offices, and Volksbank had 95 agent offices supporting 135 traditional branches (see box). 35

Other suggestions from our interviews included Web 2.0 strategies and Mobile Banking strategies. These are relatively speaking leading edge for some of the banks involved, but it remains to be seen how the business model of the bank will fundamentally change as a result. Also mentioned were back-office optimisation and increased co-sourcing/outsourcing, but in both these cases it was recognised that the changes being pursued would not necessarily be viewed as innovative in an international context. It might be more appropriate to describe these as major change initiatives. Strategic Innovation – Rabo Mobiel and PosteMobile With Rabo Mobiel, Rabobank offers its customers a multichannel bank that is open 24/7 making it possible to consult and manage bank accounts via internet or mobile phone. As a MVNO on the Orange network, Rabobank also offers its customers a “low cost” telephone offer to encourage them to use mobile internet. The logical continuation from this positioning is the use of the mobile as a virtual purse and a secure medium for payment cards. PosteMobile, the Italian postal company MVNO, was launched in November 2007 and more than 200,000 BancoPosta customers used these services in the first six months. PosteMobile decided to give a further boost to its innovation strategy by launching mobile payment and shopping services. The Gemalto MVNO portal management solution allows PosteMobile subscribers to pay their bills with their mobile phone, send a telegram or a fax, manage their account and transfer funds from their BancoPosta account and their BancoPosta PostePay prepaid credit card. Source: Banks and Mobile Telephones (Efma, Capgemini, Microsoft, Crédit Agricole, Novamétrie, May 2009) Strategic Innovation – ING Romania In 2004, ING started a new greenfield operation in Romania by combining its “Self’Bank” business with a franchise formula imported from ING Belgium. Exclusively tied entrepreneurs work as “ING Partners” in “ING Offices”, promoting financial, banking and insurance products and services, including loans, savings products, credit cards, etc., as well as post-acquisition services. In a separate “Self’Bank” section owned and maintained by ING, clients can perform payments and cash transactions as well as exchange money, etc., without any involvement of the agent or his/her staff. The agents have a mandate from ING to represent them, while ING is responsible for everything they do. ING has 170 offices operating under this scheme in Romania. With an annual network growth of 40%-50%, the bank has attracted over 540,000 clients since the launch of the concept. Due to its automated operations, ING Offices reach a high productivity, employing half the staff of a traditional branch, between 3 and 10 people on average. Source: Entrepreneurial Banking in Europe (Efma, ZEB, Centea, November 2008) 36

I n n o v a t i o n i n r e t a i l b a n k i n g Iceland Sweden Finland Norway Russia Estonia Latvia Denmark Lithuania Netherlands Ireland Belarus UK Poland Germany Belgium Czech Rep. Slovakia Ukraine Switzerland Austria Moldova Hungary France Slovenia Romania Croatia Italy Bosnia & Herz. Serbia Bulgaria Montenegro Albania Portugal Spain Entrepreneurial banking models... Greece already exist seem feasible are possibly feasible are not possible n/k Source: Entrepreneurial Banking in Europe (Efma, ZEB, Centea, November 2008) One of the characteristics of the banking industry is that the timescales are quite long for strategic innovation to make a difference. It would probably not make sense for banks to devote significant resources working on strategic innovation at the expense of incremental innovation, but there is a case for investing in exploring strategic innovation possibilities in order to be ready to move on these when necessary. The example of ABN Amro Netherlands “Dialogues Incubator” shows how this can be done using a corporate venturing approach which is common in other industries (see box). 37

Incubator Strategy – ABN Amro ABN Amro’s Dialogues Incubator was set up to develop ventures which made use of ABN Amro’s intellectual capital and contributed more widely to society. The incubator has strong support from senior management and has set up several ventures including: • Mkbnext: a service to help small businesses with mergers and acquisitions • Brightbox: to provide ABN Amro’s HR expertise to other businesses • Associates: an employment service for independent knowledge workers The incubator is a catalyst for innovation in the bank more widely, and is able to explore new business models without some of the constraints of the core banking business. As an example it has experimented with “agile” IT development approaches which are of interest to the bank. Source: ABN Amro Start-up companies have had very limited success so far in disrupting the retail banking industry, even though many observers see it as ripe for change. Comparison services, such as moneysupermarket.com in the UK, have become well established and are a useful channel for distribution of bank products. Online payment services like Paypal have also had some success but have posed a limited threat to the banking industry. More recently, peer-to-peer lending services have been launched in several countries, for example Prosper in the United States and Zopa in the UK and Italy (although Zopa has recently had its license suspended in Italy). At present these are very small businesses which have had minimal impact on established banks, but they have potential to grow. In the box we have highlighted some other recent financial services start-ups from the United States that are worth keeping an eye on. 38

I n n o v a t i o n i n r e t a i l b a n k i n g Examples of Recent Innovative Start-Ups in Financial Services There is a steady stream of financial services start-ups, particularly in the United States, many of whom are focused on the payments space. These companies can be disruptive to the banking industry, but in some cases they also partner with banks. We have selected 4 examples here which illustrate the type of innovation being developed by start-ups. Obopay is a service that lets consumers and businesses purchase, pay, and transfer money through any mobile phone using Obopay’s mobile application, text mes- sage, mobile Web, or Obopay.com. As the first mobile payment service created exclusively for the mobile phone, only Obopay works on any phone and any carrier to empower consumers and businesses with the convenience of mobile payments. Obopay partnered with MasterCard in June 2008 to provide mobile P2P payment services in the U.S., and received an investment of $35m from Nokia in March 2009. Bill Me Later enables online retailers to offer transactional credit to consumers at the point of sale using sophisticated underwriting techniques and credit decision models. In the small business sector, Bill Me Later is pioneering payments with the Bill Me Later® Business service tailored specifically for the small business buyer. The Bill Me Later network includes hundreds of top-tier retailers including Apple, Borders, and Walmart. The company was acquired by eBay in October 2008 for $945m. SmartyPig allows customers to open goal-based savings accounts and invite friends and family to contribute to their goals. Goals range from saving for a child’s college education, to planning for a new baby or wedding. It is based on proprietary, patent-pending technology and the latest security standards. According to an investor in the company “SmartyPig is a safe, proven platform providing unique opportunities for consumers to maximize their savings. It has been successful inside and outside the U.S. and I believe that within 5 years it will be recognized as a global leader in the consumer banking space.” SimpliFi is a free online financial planning and advice service that lets anyone plan for their financial future. It was created to give middle and lower income consumers access to the kind of professional financial planning and advice usually available only to those in higher income brackets who work with financial planners. SimpliFi’s Virtual Financial Advisor is Sophie, and she guides the user through the online planning process covering long-term savings, debt management, insurance and investments. The company won the Best of Show award at FinnovateStartup 2009. Source: Company websites 39

Innovation 5 and growth 41

Innovation for growth is typically the type of innovation most people can relate to because it covers new products and services, often using new technology such as mobile banking. In exploring the issue of innovation and growth, we started by asking banks about their level of development activity in the areas of product, channel and customer relationship. We recognise this is a simplification because in some ways these activities are interconnected, but in general the respondents did not have a problem making a clear distinction. The differences overall were quite small. On average across all the regions, there was a slightly greater focus on Customer Relationship developments than on Product or Channel. Banks in Russia & CIS rated their Channel development activities lowest of the 3 types, whereas banks in Western Europe rated Product development as their area of least focus. There were some very mixed views underlying these results. For example, we spoke to one bank in Central & Eastern Europe which was mainly focused on Product development, and another bank in the same country which was mainly focused on Customer Relationship development. The two banks were of a same size and had other similarities such as foreign parents, but they were pursuing opposite development priorities. It was also the case that a number of the banks we interviewed scored Product development activity as the highest to reflect their current focus, but at the same time they were planning to shift more towards Customer Relationship developments. We would therefore expect to see Customer Relationship development activity becoming more clearly the most important area of focus. We also asked banks to score their current level of innovation in the areas of Product, Channel and Customer Relationship. First of all, looking at the average scores across the banks in each region, you can see from Figure 12 that the perceived level of innovation was highest in Central & Eastern Europe, but this was driven by the responses of the banks in Turkey. Otherwise, the highest level of innovation was in Western Europe, and the level of innovation in Russia & CIS was quite low. 42

I n n o v a t i o n i n r e t a i l b a n k i n g Banks rating their level of innovation in Products, Channels and Customer Relationship as either high or very high 60% 40% 20% 0% Western Central & Eastern Central & Eastern Russia & CIS Europe Europe Europe Figure 12 (excl. Turkey) Source: Infosys - Efma Innovation Survey Results The typical reasons put forward by some of the banks we spoke to in Turkey for their focus on innovation were: • The relatively young population with an interest in trying new technologies like mobile • The focus on customer acquisition in markets where banking penetration is still increasing • The desire to increase geographic coverage rapidly but at the lowest possible cost The first of these points about having a young population may well be unique to Turkey as you can see from Table 2 which illustrates the differences between some of the markets we studied on a range of dimensions. Turkey clearly does have a much younger population but Poland, Russia and Ukraine are more or less the same as Western Europe on this dimension. However, mobile phone penetration is actually higher in Poland, Russia and Ukraine than it is in France or Turkey. In terms of other technology use, Internet penetration is more consistent in declining from West to East. The second and third of these points about the focus on customer acquisition and increasing geographic coverage could apply equally to many of the other developing markets in Central & Eastern Europe and Russia & CIS, and so are not unique to Turkey. France Spain Turkey Poland Russia Ukraine GDP per capita (PPP US$) 34,045 31,955 13,920 17,625 16,139 7,271 Population < 25 yrs old 31% 26% 44% 31% 29% 28% Internet penetration 51% 59% 33% 44% 21% 23% Table 2 Mobile phone penetration 93% 112% 89% 109% 133% 121% Source: World Bank, Eurostat, International Telecommunications Union (all data for 2008) 43

We should recognise there are also big variances within countries – the main cities in Turkey or Russia are not comparable with their less developed regions. A number of banks stated that there are customer segments in these countries which need to be targeted with different types of product and channel propositions than the more affluent or younger, urban consumers. Several Western European banks we spoke to said that customer inertia was a rationale for not having to invest in the latest channel technologies, and so their focus was much more on finding innovative ways to deepen customer relationships. Product innovation We asked an additional question on product innovation, which was about the importance of 4 different factors – technology, bundling or packaging, personalisation and pricing (see Figure 13). For the Central & Eastern European banks and for the Western European banks, product personalisation was seen to be the most important factor, followed by bundling or packaging. However, many of the Western European banks we spoke to were concerned that regulation would make it more and more difficult to bundle products, and hence they were less inclined to focus on this. Product technology was the least important factor for the Western European and Central & Eastern European banks, but the most important for banks from Russia & CIS. Importance of different factors in Product innovation (scale 1-5, where 5 is very high) Western Europe Central & Eastern Europe Russia & CIS 5 4 3 Figure 13 2 1 Technology Bundling or Personalisation Pricing packaging Source: Infosys - Efma Innovation Survey Results 44

I n n o v a t i o n i n r e t a i l b a n k i n g In-spite of the fact that Product innovation was the area of least focus for the banks in our survey (although there is increasing interest in the development of new deposit products), there are a wide range of product innovations apparent in the market. We have selected a few of the more interesting ones here to illustrate some of the main developments. Deposits. Caja Madrid has won awards for the Barrilete Cosmico savings product which enables customers to earn more interest if they have more products with the bank. This is a good example of pricing innovation linked to the goal of increasing customer loyalty. LCL has developed a unique current account product for the French market called “a la Carte”, which improves on traditional package accounts by offering more flexibility for personalisation, and a simulation capability when making choices (see box). In the Russian market, AlfaBank was the first to develop a single contract to enable customers to more easily open different accounts with the bank without having to go through the same process each time. Payments. Bankinter developed the HalCash remittance product which enables users to send money by SMS, and the receiver to pick up the money from an ATM without having a card. Bankinter has also partnered with banks in other countries to increase the scale of this business. There are other examples of this type of product, for example from Garanti Bank in Turkey. Other P2P payments by SMS services have recently been launched, such as the Pay2you service from Credit Mutuel Arkea. Cards. Garanti Bank’s FlexiCard is a good example of personalisation, where the user can select 10 different parameters when taking out the card (see box). Other banks we spoke to also offer the opportunity for customers to select a photo to put onto their card, including AlfaBank in Russia with the MyAlfa card. Contactless cards are a major area of development with many examples now across Europe, one of the latest being People’s Bank of Georgia which is launching a Visa payWave contactless card. Banco Sabadell offers its customers the option at the point-of-sale of selecting an installment payment plan when making a purchase with a credit card – this is done by sending an SMS as the payment is being approved. Prepaid cards on an open platform such as Visa are also a big growth area with potential for banks to be innovative in developing customer propositions. Banks in Italy are currently leading these developments in Europe with Poste Italiane being the largest issuer. The Visa CodeSure card is an example of a card innovation from Visa. This card has a battery, keypad and LED screen built in which enables the user to generate one-time use codes for secure e-commerce transactions. 45

Personal Loans. Several banks in Turkey offer “instant” loans by SMS or from an ATM/Kiosk, where a customer can get immediate approval and receive the money from a branch after providing supporting documentation, or in the case of the kiosk from Akbank without having to go into a branch at all. This is both extremely convenient for the customer, but also drives down costs for the bank by simplifying the process and removing paper. Of course, there are regulatory barriers to this type of product in many countries and in the current environment, personal lending is not the area in which banks want to take any additional risk. Mortgages. In the current crisis, we can observe that mortgages are not the focus of banks for innovation. Some banks have even suspended new mortgage lending for the time being and several product innovations from the last few years will probably be discontinued. One notable innovation was identified by Millennium bcp in Portugal which is offering price discounts based on the cross-sales of other products – this is similar to the loyalty-based deposit products mentioned above. Product Innovation – LCL à la Carte and Garanti Bank Flexicard "LCL à la Carte" is a new concept based on interactivity and simplicity. A new customer composes a day-to-day banking cart, by the user-friendly simulation on the Internet or with his bank adviser in a branch, and benefits from permanent discounts on the standard rate of each product. These discounts increase according to the number of products and paying services subscribed and can represent up to a 20% saving on their total cost. If the customer domiciles his income at LCL, he will benefit from a further 10% discount. As his cart progressively grows, the customer discovers in real time, thanks to the simulator, the cumulated cost of the services he selected. This new approach is aligned with the LCL development strategy based on customer knowledge, the quality of customer advice and the price transparency that is now expected by all customers. *** Garanti Bank FlexiCard allows customers to choose the interest rate, reward rate, card fee, campaigns, redemption type, and card design. During the application process, applicants can manipulate over 10 parameters to create their preferred combination. Customers who want a simple approach can choose to select one of the 4 ready made packages. They can determine not only their reward ratio and type, but also choose from where they prefer to get additional Bonus points (whether it be a merchant category such as restaurants, or a retail store). From a redemption point of view, cardholders can use their Bonus points as cash, or they use their points to buy air tickets. The customised design also allows the option of having a 'vertical card', where the text and card number appears on the card in portrait rather than landscape layout. 46

I n n o v a t i o n i n r e t a i l b a n k i n g Channel innovation The level of development activity and level of innovation in Channels was the highest in Turkey, and significantly higher than the rest of Central & Eastern Europe as you can see from Figure 14. Most of this activity in Turkey was focused on alternative distribution channels, but there are also some branch innovations taking place. Banks rating their level of development activity and innovation as either high or very high Channel Channel Development Activity Innovation 100% 80% 60% 40% 20% Figure 14 0% Turkey Other CEE Turkey Other CEE Source: Infosys - Efma Innovation Survey Results As was the case for Product innovation, there are many examples of Channel innovation around Europe as banks experiment with new channels and also the re-alignment of branches to meet current needs. Banks in different parts of Europe face different challenges and opportunities as we have already mentioned. The rate of deployment of new ATMs is much lower in Western Europe than elsewhere for example, which means that there is less opportunity for innovation. Western European banks are also opening fewer branches. Having said that, there is no reason why Western European banks should not be at the forefront of innovation in Internet or mobile banking services. Branches. Deutsche Bank’s Q110 is an example of a showcase branch being used to experiment with new concepts and technologies, as is one of Barclays’ branches in London. Several banks are developing low-cost branches, for example ING Belgium’s branches without cashiers, or Turkish Economy Bank’s “lite branches”. One of the most dramatic new branch designs is from CheBanca! which launched in Italy in 2008. However, it’s worth noting that in the United States, Washington Mutual’s radical branch design has been dropped following the bank’s acquisition by JP Morgan Chase in favour of a more traditional design. 47

ATMs and Self-Service Kiosks. Banks are significantly expanding the range of services that can be delivered from ATMs in many markets, and also experimenting with more targeted marketing to ATM users. Bill payment, cash deposits, contactless card operations, and multiple operations without having an ATM card are all examples. Several of the Turkish banks are leading in this respect, with for example Akbank’s loan kiosks which won a technology innovation award from The Banker in 2008. Internet. Internet banking functionality is improving all the time but mainly in an incremental fashion. The focus and interest now seems to be on how to use the Internet as a sales channel, not just a service channel, improving user interfaces, and exploiting Web 2.0 opportunities. Examples of innovators in this channel are Yapi Kredi of Turkey who recently won the 2009 award from Global Finance for Best Consumer & Corporate Internet Bank in Europe. Call centre. The main innovation here is the growing use of voice over internet protocol and collaboration software to enable customers to speak to an adviser interactively, either from their own PC, or from a branch terminal. This innovation has the potential to significantly change the way that service and advice are provided to customers. It is not just a “call centre” innovation but more broadly a customer service innovation. Bankinter was one of the first banks to implement this service (see box). Mobile. There are a large number of mobile banking projects underway across Europe so picking one or two is difficult. DnB NOR’s SMS based banking service is a notable success – it was launched in November 2007, and within 12 months around 25% of the bank’s retail banking customers were using the service which has some unique features. There are several examples from Turkey, but Garanti Bank was one of the first with a browser based service called Cep Subesi. It is linked directly to internet banking using the same PIN and password, and 12 months after launch in September 2007, the service had over 100,000 users. The use of the mobile handset itself as a payment device, using contactless technology, is set to take off in the not too distant future with several experiments underway across Europe, such as the joint pilot by 6 French banks and Visa in Caen and Strasbourg. 48

I n n o v a t i o n i n r e t a i l b a n k i n g Channel Innovation – Bankinter Bankinter customers using the Internet can click on a button and connect directly to the call-centre If they have a query or need help completing a transaction online. Since introducing the video call service, Bankinter’s customer satisfaction ratings increased and its online product sales improved by 25 percent according to Dialcom Spontania. Using the video call and collaboration technology, Bankinter’s sales force now has the ability to see when a customer is online allowing them to interact and close a deal with customers immediately rather than over the phone or in-person. “Our customers tell us that data, voice and video collaboration perfectly balances the convenience of online banking with the personal service of an in-bank teller,” said Jorge Andreo, project manager of video and VoIP for Bankinter. Source: Bankinter, Dialcom Spontania Customer relationship innovation This was the activity that was receiving the most development focus by banks in Western Europe, and also had a high degree of focus for banks in the other regions. However, in Central & Eastern Europe, the level of innovation in Customer Relationship was not particularly high, and was very low in Russia & CIS. One bank pointed out that you don’t need to be particularly innovative when you are trying to drive the customer’s product holding from an average of around 2 to around 4. In many cases, banks with foreign parents are bringing their home country customer relationship management strategies to these new markets – this can be innovative locally, but not in a European context. In Western Europe on the other hand, the level of innovation in Customer Relationship was perceived to be slightly higher than for Products and Channels. Customers of banks in this region often hold an average of 5 products and driving this average higher in a mature market will require more significant innovation. From the interviews and surveys, it was clear that there are fewer examples of Customer Relationship innovation than Product or Channel innovation, even though many banks are implementing a variety of CRM systems, improving their data mining and analytical capabilities, and developing better systems for lead management. Banco Sabadell is using multi-channel, real time marketing campaigns at the level of one, and others are working on similar approaches such as DnB NOR with event based marketing. A few banks talked about the need for innovation to improve the efficiency of sales staff, or provide better support to relationship managers. 49

In terms of more radical innovations however, probably the most significant is BBVA’s “tú cuentas” personal financial management service (see box) which is similar to a number of the services now taking off in the United States. ING is testing a similar service. These are based on the “aggregation” concept which has been in development since the Internet bubble 10 years ago but is finally getting some traction. Customer Relationship Innovation – BBVA BBVA launched the “tú cuentas” service in 2008 and has achieved a strong take- up since then. Based on the Strands tool which was developed in the United States, it aggregates all types of information that are relevant to the customer which includes financial information, not just from BBVA, and also non-financial information such as electricity and phone bills. The program catalogs the information into predefined categories and allows customers to re-categorise if necessary. “tú cuentas” then presents customers’ information more visually, providing them with an instant snapshot of all their finances to better understand what they are spending their money on. The service permits users to compare anonymously their finances with a group of their choice, allowing them to make a comparison of different expense categories with the chosen group. “tú cuentas” then offers the user personalised advice based on knowledge of their tastes and preferences. This can include more sophisticated options which use artificial intelligence to help find opportunities tailored to the customer’s preferences and needs. The user can also evaluate the utility of these suggestions, in such a way that the platform learns their tastes and preferences in order to make recommendations that are more adapted to their profile. Source: BBVA It is important to mention social media even though the impact of this is still relatively small in banking. At a recent Efma conference on social media, banks such as ABN Amro and Banco Sabadell described their activities, which include experimenting with virtual worlds, and setting up on Facebook and YouTube. Rabobank has also been actively working on social media ideas and some banks in the United States are now “tweeting” on Twitter. A small start-up bank in Germany, Fidor Community Banking, is experimenting with social media concepts, creating a community of customers who share ideas, help to design new products and vote on various issues. We expect large banks to gradually embrace these approaches but as we have noted for other innovations, customer inertia will most likely prevent mass desertion. We also surveyed the importance of technology, staff capability and process design when innovating customer relationship management and found that technology was the least important factor. In all 3 regions, staff capabilities were seen to be the most 50

I n n o v a t i o n i n r e t a i l b a n k i n g important factor, emphasising the need to focus on staff related issues, and not just technology or process. One bank told us that they had implemented advanced CRM systems a while ago, but the biggest challenge had been to get staff to use them in the most effective way, which required better training and different incentives. Importance of different factors in Customer Relationship innovation (scale 1-5, where 5 is very high) Western Europe Central & Eastern Europe Russia & CIS 5 4 3 2 Figure 15 1 Technology Staff capabilities Process design Source: Infosys - Efma Innovation Survey Results SME Banking Our research also covered SME banking and this business line deserves a separate mention. Many of the channel innovations already described, such as in Internet and mobile banking, also apply to SMEs. Other innovations more specific to SMEs that were identified during our research were: • Tailored packages for very specific SME segments, such as those from Turkish Economy Bank, Raiffeisen International and OTP Bank. • Stream-lining of loan application processes down to 1-2 days in Russia by Société Générale (an innovation for the Russian market). • Better local servicing and decision making through “integrated financial solutions centres” at National Australia Bank’s Clydesdale and Yorkshire banks in the UK. • Additional, non-financial services such as eConta (accountancy and tax) and Virtualdoc (document management) from BBVA. 51

Innovation 6 and efficiency 53

Cost management has been a top priority for banks in the more developed European markets for many years, as revenue growth rates have barely exceeded the rate of inflation (see Figure 16). It was until recently less of a focus for banks in Central & Eastern Europe and Russia & CIS who were experiencing very rapid market growth, and their priorities were acquiring new customers and managing the growth. As we explained earlier in the report, banks from Central & Eastern European and Russia & CIS now regard innovation to be more important for improving efficiency than it is for growth. This may well reflect the sudden need to focus on efficiency in these markets. Annual revenue growth by region for retail banks, 2002-2006 70% 60% 50% 40% 30% 20% 10% Figure 16 0% Western Europe Central & Eastern Europe Russia & CIS Source: Retail banking in Europe, Efma/Roland Berger/Nordea, April 2008 In a 2008 report, Arthur D Little ranked European banks by their cost/income ratios in the period 2004 to 200616 . What is striking from this research is that of the 10 most efficient banks in Europe, 5 have failed or been bailed out by their governments. Of course there are many reasons for this, but clearly efficiency alone will not guarantee long term success. However, Banco Popular and Svenska Handelsbanken were both in the top 3 of this survey, and illustrate how a differentiated business model and focus can lead to higher levels of efficiency. Not all banks can or should copy the strategies and business models of these banks, but they can learn something from them. One banker in Western Europe said that efficiency improvement needs discipline more than innovation. However, another bank said that efficiency innovation was very difficult to copy, unlike for example a mobile banking application, so it could be used to create real competitive advantage. There are many different possible approaches to efficiency improvement. Some banks are able to pursue acquisitions and benefit from economies of scale within countries or increasingly across borders. Generally, this would not be described as “innovation” but to some extent it is an innovative strategy for banks in 54

I n n o v a t i o n i n r e t a i l b a n k i n g Europe. Another efficiency improvement approach is to encourage customers to use direct channels in order to reduce costs and most banks are doing this so as a strategy this is no longer viewed as being particularly innovative. Banks also have the challenge of managing channel migration without damaging their ability to build customer relationships and make cross-sales. It is also the case that product and channel innovation can simplify processes and reduce costs, such as instant loans in Turkey. Video-calling to relationship managers based in central locations should also help to drive lower costs. We asked our survey respondents what their focus was on 4 types of activity to improve efficiency: • General cost reduction exercises • Operational process redesign and simplification • Core technology and systems redesign or replacement • Outsourcing There are some differences between the regions (see Figure 17) with general cost reduction and outsourcing being relatively more important in Western Europe. Outsourcing was a much less common activity than general cost reduction and process redesign in all regions, and was particularly irrelevant for banks in Russia & CIS. Core technology & systems redesign or replacement as an efficiency improvement activity was more important in Western Europe than in the other regions. We don’t think this means that banks outside Western Europe are investing less in IT, but rather that they do not see the investment as an efficiency improvement exercise. Importance of different efficiency improvement activities (scale 1-5, where 5 is very high) Western Europe Central & Eastern Europe Russia & CIS 5 4 3 2 Figure 17 1 General cost Operational Core technology & Outsourcing of reduction exercices process redesign systems redesign activities and simplification or replacement Source: Infosys - Efma Innovation Survey Results 55

There were fewer differences in the views on the level of innovation in the efficiency improvement activities we surveyed (see Figure 18). However, the average score from all regions for all activities was less than 3 on a scale of 1 to 5. This is quite significant because it is very low, particularly considering that innovation was perceived to be so important for efficiency improvement. Across the 3 regions, less than 30% of respondents perceived the innovation in their efficiency improvement efforts to be high or very high. Level of innovation in different efficiency improvement activities (scale 1-5, where 5 is very high) Western Europe Central & Eastern Europe Russia & CIS 5 4 3 2 Figure 18 1 General cost Operational Core technology & Outsourcing of reduction exercices process redesign systems redesign activities and simplification or replacement Source: Infosys - Efma Innovation Survey Results This observation is supported by the fact that our interviews and survey yielded relatively few examples of efficiency innovations. We also reviewed a number of sources on best practice in cost management and did not find many mentions of “innovation”. Again, to some extent this is an issue of what is perceived to be an innovation. One Western European bank we spoke to was taking a radical look at its business model with the aim of introducing more outsourcing and co-sourcing as a result of the crisis, but they were reluctant to describe this as innovation. Our interviews with senior bankers responsible for operations revealed some very different approaches: • A large bank in Central & Eastern Europe is in the middle of a 5 year programme to replace its core banking system, achieve full multi-channel integration, and re-engineer all processes. State-of-the-art tools for process management and measurement are being implemented but largely this is a catching up exercise. • A large bank in Western Europe is making a continuous effort to reduce costs. Replacing legacy systems is believed to be too difficult, but new “middleware” is making it easier for mainframe applications and data to be integrated. Where possible, straight-through- processing is being implemented to remove the need for back office functions. Call centre operations are being run more effectively by “virtualisation”. 56

I n n o v a t i o n i n r e t a i l b a n k i n g Innovative new cost management tools and techniques come along every so often but, like new business models, they are relatively rare. Bain & Co carry out an annual survey of the usage of different management tools and in their 2009 survey the following efficiency related tools were found to be used by companies across all industries: benchmarking (76%), outsourcing (63%), business process re-engineering (50%), shared service centres (41%), total quality management (34%), and lean six sigma (31%)17. Lean six sigma was highlighted in some of our interviews, and several large Western European banks are rolling out this management tool across their pan-European operations. In one example, at a recent Efma conference on Cost Control & Efficiency, Nordea explained how they are using lean methodologies in a group of test branches (known as LiveLabs) to improve branch efficiency and free up branch staff to spend more time with customers. At the same conference, Raiffeisen International described their overall cost management framework, which included the use of six sigma (see box). In Russia & CIS, Sberbank’s 5 years development strategy includes a commitment to continuous improvement techniques. According to Sberbank, “based on lean technologies, this approach calls for integrated action to streamline and rationalise all bank procedures bottom-up, and build a systemic capability for renewal and continuous improvement.” From an IT perspective there can be conflicts between having the most flexible systems for innovation and the lowest costs. A few of the banks we spoke to are deploying standard systems into their subsidiaries around Europe, creating a low cost platform, but perhaps losing something in terms of local flexibility. As we noted in the section on innovation strategy, there is normally a conflict between a value proposition based on operational excellence, and one based on either product leadership or customer intimacy, so trade-offs have to be made. Approaches to Cost Control & Efficiency At a recent Efma conference, several banks described the approaches they have been taking to improve efficiency. Typically, these included: • Lean six sigma • Business process management • Procurement optimisation • Back-office centralization • Shared service centres • Cross-border, regional service centres These initiatives are normally supported by benchmarking and KPI dashboards. After the initial adoption of new approaches like the ones listed above, there is a focus on continuous improvement. Some banks such as Raiffeisen Interna- tional, have wrapped all their activities within a “cost management framework” which provides a strategy and structure for ongoing efficiency improvement. Source: Efma conference on Cost Control & Efficiency, May 2009 57

How banks can become 7 more innovative 59

Since most banks believe innovation is very important for growing revenues and improving efficiency, it makes sense to look at the barriers to innovation, and also what steps banks are taking to increase their level of innovation. The table below lists the main barriers in rank order by region. Ranking of the main barriers to innovation by region The 1st is the highest barrier and 10th is the lowest barrier Western Europe Central & Eastern Europe Russia & CIS 1 IT development bottlenecks 1 IT development bottlenecks 1 IT development bottlenecks 2 Flexibility of IT systems 2 IT systems 2 IT systems 3 Regulation and compliance 3 Investment 3 Regulation and compliance 4 Focus on other priorities 4 Co-ordination across departments 4 Ideas 5 Investment 5 Regulation and compliance 5 Focus on other priorities 6 Risk aversion 6 Risk aversion 6 Co-ordination across departments 7 Co-ordination across departments 7 Focus on other priorities 7 Investment 8 Attitudes and behaviour 8 Attitudes and behaviour 8 Senior executive support 9 Senior executive support 9 Senior executive support 9 Attitudes and behaviour 10 Ideas 10 Ideas 10 Risk aversion Source: Infosys - Efma Innovation Survey Results Table 3 60

I n n o v a t i o n i n r e t a i l b a n k i n g The average scores for all 10 barriers to innovation in our survey were in fact remarkably similar in each region, at around 3 on the scale of 1 to 5 as shown in figure 19. Russia & CIS scored slightly higher than the other regions, meaning the barriers are seen to be higher. Average score for the strength of barriers in each region (scale 1-5, where 5 is very high) 5 4 3 2 Figure 19 1 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results It is very clear that the main barriers to innovation are perceived to be IT related – either the inflexibility of IT systems or bottlenecks in IT development. Of course this was not universal because a number of the banks we spoke to had invested in more flexible IT systems and so did not see this as a barrier. We explore the issues for IT further in the next section on the role of IT in innovation. At the other end of the scale, the lowest barrier in 2 of the regions was seen to be innovative ideas. In other words, our respondents felt that there were enough innovative ideas and generating more was not a priority. Most of the banks we spoke to had some kind of employee idea generation process, and some were using relatively advanced internet/intranet tools to manage this activity. Senior executive support for innovation was not generally seen to be a barrier, and the approach of BNP Paribas is not uncommon (see box). This might be expected because most of the people participating in the research were senior executives, but we concluded from our interviews that there was a general commitment to innovation at most banks. However, the challenge lies in the fact that management focus on other priorities was seen to be a very high barrier for the Western European banks, which is not surprising given the crisis. Senior executives therefore need to be careful not to be seen to be paying lip service to innovation by saying it is a high priority but not actually delivering on the ambition. This will be counter-productive to employee attitudes in the long term. 61

Investment availability was only seen as a moderately high barrier. We were slightly surprised by this response considering the financial crisis but often we were told that investment could be made available for good ideas. Some banks were also now finding it possible to get more from less investment. Making Innovation a Top Strategic Priority – BNP Paribas BNP Paribas has made “creativity” one of its 4 core values. Baudouin Prot, Chief Executive Officer, writing in the 2008 annual report said that “because we at BNP Paribas are always striving to be at the leading edge of innovation, without losing sight of our customers’ interests or our ethical values, we have managed to survive the crisis much better than most”. The bank supports innovation with awards which are designed to foster and reward employee creativity and expertise. They are presented at the BNP Paribas Innovation Days by Baudouin Prot and other members of the BNP Paribas Executive Com- mittee. The Innovation Awards are designed to reward initiatives in business innovation. A total of 5 pages were devoted to the awards in the 2008 annual report. Source: BNP Paribas We expected that regulation and compliance would be a high barrier to innovation. In Western Europe and in Russia & CIS it was the 3rd highest barrier, and in Central & Eastern Europe it was the 5th highest barrier. However, approximately half the respondents viewed regulatory and compliance requirements as a driver of more innovation. For example, Akbank in Turkey cited the innovative development of processes to allow consumers to apply for credit at the point of sale, without the involvement of the retailer’s staff who are not authorised to deal with consumer credit applications. 62

I n n o v a t i o n i n r e t a i l b a n k i n g Figure 20 lists the actions taken by banks to increase their level of innovation. The most common action was investing in more flexible IT systems, followed by setting up idea generation and screening processes. Proportion of banks taking actions to increase the level of innovation Investing in more Flexible IT systems Setting up idea generation and screening processes Providing incentives for employees to be more innovative Setting out clear innovation strategy Making innovation a top strategic prority Increasing investment in innovation Creating department to co-ordinate or drive innovation Figure 20 Increasing employee training on innovation and creativity 0% 10% 20% 30% 40% 50% 60% 70% Source: Infosys - Efma Innovation Survey Results A surprising thing to note about these responses is the lack of employee training on innovation and creativity. If banks want innovation to become part of their culture, in order to sustain the innovation process and make continuous improvements, it seems that employee training is essential. Only one bank we spoke to mentioned a specific training programme – they are working with a consulting firm to train teams in how to innovate and get the benefits from innovation. The other area of weakness we have already pointed out earlier in the report is the failure to set out a clear innovation strategy. Less than half the respondents claimed that this had been done, which is actually slightly higher than the proportion of banks who said they had an innovation strategy. However, it still leaves a considerable number without a clear innovation strategy and given that most banks believe innovation is very important, this issue should be addressed. 63

The Role of IT 8 in innovation 65

When we asked banks how important IT was for innovation the response was in most cases that it was important or very important – the average score on the scale of 1 to 5 was 4.5. Only 2 respondents in total scored less than 3 in response to this question, both in Western Europe. There were some differences between the regions as Figure 21 shows. In Russia & CIS, 100% of respondents rated the importance as high or very high, whereas only 80% did so in Western Europe. Banks rating the importance of IT for innovation as either high or very high 100% 80% 60% 40% 20% 0% Figure 21 Western Central & Eastern Russia & CIS Europe Europe Source: Infosys - Efma Innovation Survey Results The difference between the regions was also reflected in our face-to-face interviews where there was a more balanced view from Western European banks, recognising that innovation needed to be more than just IT related, and that IT should be seen as a means to an end and not the end itself. 66

I n n o v a t i o n i n r e t a i l b a n k i n g In response to the question whether the bank was believed to be a leader in the use of IT for innovation Central & Eastern European banks scored the highest with over 40% saying they were leaders in the use of IT (see Figure 22). Most of the positive responses in this region were from Turkish banks. In contrast, the banks in Western Europe were less confident, with only around 30% believing they were leaders. In Russia & CIS, the proportion was below 20%. Proportion of respondents saying they were leaders in the use of IT for innovation 60% 40% 20% 0% Figure 22 Western Central & Eastern Central & Eastern Russia & CIS Europe Europe Europe (excl. Turkey) Source: Infosys - Efma Innovation Survey Results As we have already noted inflexible IT systems and development bottlenecks were seen to be the most significant barriers to innovation. There was a range of views on IT systems, of course, depending on the stage of development of the bank responding. 67

Figure 23 shows that about 20% of banks did not see inflexible IT systems as a particular barrier to innovation, scoring either 1 or 2 out of 5 on this measure. A few of the Turkish banks were in this category, such as Garanti Bank and Denizbank, as well as recent start-ups like CheBanca! from Italy and Alior Bank from Poland. There were also a few of the older, more established banks in Western Europe who did not see inflexible IT systems as a barrier to innovation, such as Caja Madrid and Banco Sabadell. These banks have relatively recently invested in upgrading their banking systems. Proportion of banks scoring 1 to 5 when asked if inflexible IT systems are a barrier to innovation, where 5 is very high 50% 40% 30% 20% 10% Figure 23 0% 1 2 3 4 5 Source: Infosys - Efma Innovation Survey Results 68

I n n o v a t i o n i n r e t a i l b a n k i n g Another bank in Western Europe we spoke to said their systems were very inflexible and therefore a significant barrier to innovation. Even so, they had successfully been able to launch an innovative new product in a short time-frame by taking a pragmatic approach, illustrating that it’s possible to be innovative even if IT is a constraint. Newer banks like Alior Bank, or those upgrading their core systems, have been able to benefit from the flexibility of integration on web based platforms. Also noted in our interviews were two other IT related developments which will have a significant impact on the business models of banks: • “Virtualisation” allows the provision of applications to employees other than just in fixed physical locations, creating the potential for more significant business model redesign. • “Dematerialisation” will significantly change the way banks manage operations and provide customer service, and lead to major efficiency improvements. A number of the Western European banks with pan-European operations are beginning to centralise IT infrastructure and operations across borders, and are moving to common platforms. One of the latest examples is Societe Generale. This can have significant cost advantages but also may result in some inflexibility at the local level, something each bank has to judge for itself. There may even be customer benefits from creating a single platform, as was claimed by UniCredit Bank Austria which has created the first cross-border internet bank in 8 countries in Central & Eastern Europe. The cost of major systems changes in the current climate is clearly a challenge for many institutions. According to research by Gartner in November 2008, “financial services institutions must focus on IT innovation for radical change or hibernate to minimise cost and prepare for later action to survive the economic downturn. Organisations that choose the middle ground risk wasting their IT budget on incremental modernisation for little gain.” 69

Conclusion Banks recognise that innovation continues to be important even in the face of the current financial crisis. Innovation is seen to be even more important for improving efficiency than it is for generating growth. Strategic innovation, or business model innovation, is a high priority for many banks but concrete examples are rare. History has shown that the strategic risk from disruptive innovators is quite low but the industry has changed quite significantly over time and will continue to do so. We have observed many similarities in the innovations taking place across Europe, but banks in some parts of Central & Eastern Europe, notably Turkey, are leading the way with growth innovation. They have taken advantage of market growth and consumer attitudes, and have benefited from the use of relatively new and flexible IT systems. In the area of innovation to drive growth, the perception of banks is that product innovation is lagging channel and customer relationship innovation, and there is also a gap between the level of development activity and the level of innovation in each of these areas. The crisis has created a renewed focus on efficiency but innovation efforts targeted at efficiency improvements do not match its perceived level of importance according to the banks in our survey. Business model innovation can provide a step change in efficiency but it is rare and difficult to implement for an established bank. However, there is plenty of scope for incremental innovation to make continuous improvements. IT is believed to be very important for innovation but is also perceived to be a barrier by many banks, either because of inflexible systems or lack of resources. Many banks in our survey are investing in more flexible IT systems but there are also examples of banks innovating without the need for IT, where a more pragmatic approach is required. The key recommendations we can propose from this research are: • More banks would benefit from having an innovation strategy which should be determined by their business strategy and include tangible objectives, approaches and measures of success. • Banks need to find the right balance between incremental and strategic innovation. Most resources should be targeted at continuous, incremental innovation which requires discipline and focus, but some resource needs to be aimed at identifying and testing strategic innovations. • Customer relationship development activity is already important, and is increasing in importance, but the level of innovation could still be improved because there are relatively few examples of significant innovations in this area compared to product and channel developments. • In general, banks need to increase their innovation efforts to drive improvements in efficiency, whether this is by incremental or strategic innovation. • The importance of people in the innovation process should be recognised and more effort needs to be directed to training and development, performance management, and more generally to the values and behaviours required to drive innovation. • Senior management of banks need to not only make innovation a top strategic priority but also follow it through by ensuring appropriate commitment across levels. • The importance of IT for innovation is well established. It means that business and IT need to work as proactive partners in order to develop the innovation strategy and set priorities. The innovation strategy needs to reflect the limitations imposed by existing IT systems and capabilities, but there should also be a long term plan to addresses these constraints. 70

I n n o v a t i o n i n r e t a i l b a n k i n g About the research The research was conducted in June, July and August 2009, and comprised an online survey, plus face-to-face and telephone interviews. The face-to-face interviews were conducted in 7 countries: Russia, Poland, Turkey, Austria, France, Spain and the UK, and provided the opportunity to explore the survey questions and related issues in more depth. A total of 82 different banks completed the survey. Where more than one individual from the same bank in the same country completed the survey, we selected the most complete response, or we averaged the responses from that bank. A total of 45 banks were interviewed. Many of these interviewees also completed the survey either during the interview or separately. Combining the survey and interviews, a total of 89 banks in 26 European countries participated in the research. Desk research covered recent material from Efma – the magazine, conferences and reports – which included many examples of innovation by banks. We also reviewed a wide range of more general sources on innovation best practices. Survey questions • Which department, if any, is responsible for co-ordinating innovation activities in your organisation? • Is your company more focused currently on growth or efficiency? • How important is innovation for the future growth of your company? • How important is innovation for future efficiency improvements in your company? • Does your company have an innovation strategy (including objectives, approaches and metrics)? • Is your company aiming to be an innovation leader? • Would you say that your company is working mainly on incremental or strategic innovations? • What is your current level of development activity, and how innovative is your approach in: products, channels, customer relationship? • How active is your company at the moment, and how innovative is your approach to efficiency improvement in: general cost reduction, process redesign or simplification, core technology redesign or replacement, outsourcing? • How important are the barriers to innovation in your company (list of potential barriers provided)? • What steps have you taken or are you taking to increase the level of innovation in your company (list of potential steps provided)? • Are you becoming more innovative in response to regulation and compliance requirements? • Have you increased or decreased the level of investment in innovation in the current financial year? • Will partnerships and collaborations be more or less important in the future for innovation in your organization (5 different categories of partnerships provided)? • How important is IT for innovation in your company? • Do you believe your organisation is a leader or follower in the use of IT for innovation? • When innovating products, how important are: technology features, packaging/bundling, personalisation, pricing? • When innovating the customer relationship or customer experience, how important are: technology features, staff capabilities, process design? • Can you provide examples of innovation in your company? 71

List of participants Western Europe Central & Eastern Europe Russia & CIS ABN AMRO Bank Switzerland Akbank AccessBank AIB Alior Bank Alfa-Bank Allianz Banque Bank Pekao Alfa-Bank (Ukraine) Banca Carige BRD ATF Bank Banco Sabadell Denizbank Bank of Moscow Bank of Ireland Fortis Turkey Bank Societe Generale Vostok Bank van de Post Garanti Bank Bank VTB24 Bankinter ING Bank Slaski BNP Paribas Vostok Banque Fédérale des Banques Populaires Isbank City Mortgage Bank Barclays France K&H Bank Index Bank BBVA Kredyt Bank ING Bank Ukraine BNL MKB Bank Nadra Bank BNP Paribas NLB Russian Standard Bank BNP Paribas Fortis OTP Bank Sberbank Caixa Catalunya OTP Bank Romania Vneshtorgbank Caja Madrid PKO ZAO Raiffeisenbank Cariparma Credit Agricole Raiffeisenbank Croatia ZAO UniCredit Bank CFS Raiffesienbank Kosovo CheBanca! RBS Romania Citi SKB Credit Agricole Swedbank Latvia Credit Mutuel Arkea Turkish Economy Bank Deutsche Bank UniCredit Bank Austria Dexia Groupe UniCredit Tiriac Bank Romania DnB NOR Volksbank International DZ Bank EFG Eurobank Erste Bank HBOS ING Belgium KBC Group LCL Lloyds TSB Millennium bcp Montepio National Australia Bank Europe Nordea Rabobank Raiffeisen International Royal Bank of Scotland Santander SEB Société Générale Swedbank Titanium UniCredit Western Union International Bank 72

I n n o v a t i o n i n r e t a i l b a n k i n g About us Efma promotes innovation in retail finance in Europe by fostering debate and discussion among the main players involved in change. Formed in 1971, Efma comprises 2,450 different brands in financial services worldwide today, including 80% of the largest European banking groups. Through regular events, publications, and its comprehensive website, the association provides retail financial service professionals with answers to their questions about the main issues at stake in their business: multiple distribution strategies, customer approach, CRM, product and service marketing and improving profitability. Efma is above all a dynamic association, providing a great opportunity for discussion and exchanges without any commercial constraints. It provides its members with a wide range of exclusive services as well as discount rates on non-gratuitous activities. The loyalty of its members as well as their permanent financial support are the best proof of its efficiency. For more information: www.efma.com Infosys (NASDAQ: INFY) defines, designs and delivers IT-enabled business solutions that help Global 2000 companies win in a flat world. These solutions focus on providing strategic differentiation and operational superiority to clients. With Infosys, clients are assured of a transparent business partner, world-class processes, speed of execution and the power to stretch their IT budget by leveraging the Global Delivery Model that Infosys pioneered. Infosys has over 100,000 employees and operates globally from 21 countries. Infosys is part of the NASDAQ-100 Index. Finacle™ from Infosys partners with banks to power-up their innovation agenda, enabling them to differentiate their products and service, enhance customer experience and achieve greater operational efficiency. Finacle™ solutions address the core banking, wealth management, CRM, Islamic banking and treasury requirements of retail, corporate and universal banks worldwide. Finacle™ solutions also empower banks with multiple sales, service and marketing channels including e-banking, mobile banking and call centers. These offerings make Finacle™ a strong innovation-facilitator enabling banks to accelerate growth, while maximizing value from their large scale business transformation. For more information, visit www.infosys.com/finacle Clarus Clarus Investments was founded in 2006 by Michael Pearson to provide strategic research and consulting Investments to financial services firms, and to identify and develop innovative new financial services ventures. In 2008, the Clarus Insight research service was launched which has the objective of helping companies make better use of existing business information and expert knowledge for strategic decisions. Clarus Insight has a particular focus on tracking best practice and strategic insights in financial services and reviews a wide range of leading sources worldwide on a regular basis. Michael Pearson has 25 years experience working for and advising financial institutions worldwide, which included setting up and running a new ventures division for a major UK bank. He has an MBA from Harvard Business School. For more information: www.clarusinsight.com 73

References 1 “The Most Innovative Companies”, Business Week, April 20th 2009. 2 Costanzo, L.A., Keasey, K., Short, H., “A Strategic Approach to the Study of Innovation in the Financial Services Industry”, Journal of Marketing Management, 19, 2003. 3 Global Financial Stability Report, International Monetary Fund, April 2009. 4 Financial Stability Review, European Central Bank, June 2009. 5 Haldane, A., “Small Lessons from a Big Crisis”, Bank of England, May 2009. 6 Bank for International Settlements, Annual Report 2008/09. 7 Turner, A., Financial Services Authority, July 2009. 8 Treacy, M., Wiersema, F., “The Discipline of Market Leaders”, New York: Addison- Wesley Publishing Company, 1995. 9 “Measuring Innovation 2008 – Squandered Opportunities”, Boston Consulting Group, August 2008. 10 Huston, L., Sakkab, N., “Connect & Develop, Inside P&G’s New Model for Innovation”, Harvard Business Review, March 2006. 11 Lafley, A.G., “P&G’s Innovation Culture”, Strategy & Business, Autumn 2008. 12 Davenport, T.H., Iyer, B., “Reverse Engineering Google’s Innovation Machine”, Harvard Business Review, April 2008. 13 “Innovation Management – Strategies for Success and Leadership”, A.T. Kearney, September 2008. 14 Barsh, J., Capozzi, M.M, Davidson, J., “Leadership & Innovation”, McKinsey Quarterly, 2008 # 1. 15 Bower, Joseph L., Christensen, Clayton M., "Disruptive Technologies: Catching the Wave" Harvard Business Review, January-February 1995. 16 “Achieving Cost Efficiency in the European Banking Sector”, Arthur D. Little, August 2008. 17 Rigby, D., Bilodeau, B., “Management Tools and Trends 2009”, Bain & Co, May 2009. 74

I n n o v a t i o n i n r e t a i l b a n k i n g © 2009 EFMA and Infosys Technologies Ltd. All Rights Reserved. EFMA, Infosys Technologies Ltd., Finacle from Infosys, their services mentioned herein as well as their respective logos, are trademarks or registered trademarks of their respective companies. All other company, product and service names mentioned are the trademarks of their respective owners and are used herein with no intention of trademark infringement. No part of this document may be reproduced or copied in any form or by any means without written permission from EFMA and Infosys Technologies Ltd. Disclaimer The information contained herein is general in nature and is not intended, and should not be construed, as professional advice or opinion provided to the user. This document does not purport to be a complete statement of the approaches or steps, which may vary accordingly to individual factors and circumstances, necessary for a business to accomplish any particular business goal. This document is provided for informational purposes only; it is meant solely to provide helpful information to the user. This document is not a recommendation of any particular approach and should not be relied upon to address or solve any particular matter. The information provided herein is on an “as-is” basis. Infosys and Efma disclaim any and all warranties of any kind.

For more information, please contact: Efma — patrick@efma.com Infosys Technologies limited — finaclemktg@infosys.com

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Innovation In Retailbanking

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