A Money and Information Business

This year’s State of Financial Services examines the industry’s greatest opportunity, and its greatest threat: information. But it is not a paper about “big data”. Rather, it is a paper about the migration of trillions of dollars of market value, and where that value will settle.

You may be reading this paper on a tablet. You would not have read our 2008 report that way. You may use your smartphone for travel directions, reading the news, getting stock quotes, making bookings and listening to music. You didn’t five years ago. You may connect with your friends on Facebook or watch movies on your laptop, streamed from the internet. Again, you probably didn’t do those things five years ago.

Yet, if you are a banker or an insurer, your work life has probably been little affected by the rapid growth of information. How do you now set prices, underwrite loans or policies, assess performance, segment customers and measure their satisfaction? Chances are your practices are much as they were in 2008 (or perhaps even 1998 or 1988). Though traditional financial firms produce, consume and transmit vast amounts of information, they have yet to use it to change the way they make their most critical decisions.

Traditional financial services firms have two significant problems: they are under near term earnings pressure and their business model is under strategic threat. Fortunately, both problems have the same solution, and it is a very powerful one: information.

Info Advantage

The initial boom of the information era, from the early 90s through the pre-crisis years, happened to coincide with a golden era for financial services. The core, non-information business was booming. High leverage ratios, an interest rate environment that delivered strong deposit and treasury profits and strong growth in relatively low-risk assets drove up the value of the money business. In this environment, financial firms operated profitably without much use of information (by today’s standards).

Financial firms were favoured in this “information-light” environment. Banks and insurers tended to make mistakes about risk. But because economic conditions were good, the underlying chances of credit defaults were held down and the values of collateral were held up. So banks’ errors were not nearly as costly as they could have been. Savers, on the other hand, typically failed to appreciate the true value of their money, which was then high. So their choices generated substantial earnings for banks and insurers, more than compensating for their own risk-related misjudgements.

Meanwhile, better information was costly.

1Why should financial services companies become information-driven companies now?

Financial services companies are now part of an information-driven industry. The growth of information will continue to impact financial services companies regardless of what they do. Increased price transparency and client mobility will pressure margins. Differential use of information by competitors will change the mix of clients for every firm. Earnings are going to be driven by the growth of information. The question therefore is only whether a firm is going to have a strategy to understand, control, and benefit from those changes or not.
2What is the information balance sheet?

We conceived the idea of the information balance sheet as a mechanism by which executives can begin to get a grasp on their information assets, exposures, opportunities and threats. In short – how changes in information are going to change their earnings. Conceptually it is relatively simple:
1) In what areas will the growth of information threaten current margins
2) In what areas can new sources of information be used to improve margins
The information balance sheet provides a framework to understand the aggregate impact of information.
3In terms of information, what is the distinct lesson that can be drawn from the financial crisis?

Prudence is critical. The opportunities to use information to improve earnings in financial services are tremendous. They can drive revenue growth, cost reduction and risk management. But the lesson from the crisis is that information and misinformation are two sides of the same coin. How far a firm pushes its use of information must be dictated by how strong its analytical capabilities are, and perhaps more importantly, how sound its controls are.
4Do traditional financial services firms need to become technology experts or analytics experts going forward?

In the near-term, no. A wide array of information specialists now exist in the financial services space. These companies can deliver technology and analytics capabilities to help traditional firms improve performance.
In the longer-term, the answer is still no, but every financial services firm will ultimately need to identify the core capability that is going to differentiate it in the market. A ‘commoditized’ firm that licenses distinct information capabilities from others is not likely to generate sustainable growth of earnings.
5What is the single greatest challenge to becoming an information company for a traditional financial services firm?

Deciding that it wants to. Information is not a panacea and change is difficult. Executives (well aware of failures of the past) should rightfully be skeptical. But the power of information to drive earnings growth at financial services companies is now extraordinary. The information available is now wholly different than what was available even five years ago. The cost to store it and process it is dramatically less. And there is a universe of partners available to help those firms that don’t yet have all of the necessary capabilities.

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A Money And Information Business