As global banks continue to innovate, should we worry about their products?

INNOVATION IS generally considered a positive thing. Thanks to advances in technology it is now possible to carry around a small library of books in a single hand-held device, while breakthroughs in the field of medicine improve and even save lives.

However, in the complex world of financial services, innovation has proved a double-edged sword.

It is widely accepted that one of the key contributory factors to the credit crunch was the prevalence of mortgage-backed securities (MBSs). Now there are fears that credit default swaps (CDS) taken out by banks as insurance against the risk of a Greek default might not provide them with the level of protection they expected. As global banks continue to innovate, should we be worried about what the financial engineering boffins will concoct next?

In Dublin this week was Citi’s chief operations and technology officer Don Callahan, signing off on further investment in the banking giant’s Dublin innovation centre. Callahan was forthright when asked whether innovation can bring higher levels of risk to the financial services environment. “If not done responsibly, the answer is yes.”

Take MBSs, originally developed by Salomon Brothers which is now part of the Citi group. Callahan says as a concept the MBS is a good one, but only if used responsibly. “We have to think about ‘where is the level that people are starting to take it too far?’,” he says.

Similarly, insurance products such as CDSs started out as innovative ideas to allow people to protect themselves from outcomes they wanted to avoid, he says. When putting insurance products together (regardless of whether it’s insurance against a corporate or sovereign default situation or motor insurance) one has to look at whether or not the product is providing a “false sense of comfort”, he says. On the other hand, if a product starts offering a level of comfort that encourages people to act in a way that’s not responsible, then one has to question the validity, or at least the pricing, of that product.

He says there are hundreds of products that can be used to benefit society, but if misused can cause damage. “So it really comes down to . . . core ethics and making sure that we work with regulators so they have transparency.”

He comes back repeatedly to the idea of “responsible finance”, which is one of the four new core principles unveiled by Citi earlier this year as part of its efforts to redefine its culture. He believes that the financial services industry has learned a lot “from this last cycle”. “We’re going to have to ensure we use it as a chance to change behaviour right across the board.” Citi has put a lot of energy into “re-footprinting” its business, and has made a shift away from a product-driven strategy to a client-driven approach.

“Citi is going through a transformation of moving from product to services, and one of the core changes that we are trying to drive through the organisation is to recognise that we are a services business that has products, versus the other way around,” he says.

The group is now focusing on simplifying the financial lives of its clients – be they individuals, companies or governments – an endeavour in which it has had no small success in the past. For instance, Citi was one of the early pioneers of automated teller machines in the 1970s. These days the group is at the forefront of the next potential revolution in banking – the digital wallet. “It’s not a question of whether it takes off. It’s how it takes off,” he says.

Once a smartphone is secured through biometric protection, he believes there is no reason why it can’t be used as a wallet and indeed for all of the individual’s budgeting and banking needs.

Citi has already worked as Google’s lead banking partner in the development of the Google Wallet app, which is being tested in five markets. It has also teamed up with biometrics firms, and Callahan says technology such as voice authenticity and ear canal recognition are showing great potential. Biometrics are also proving useful in Citi’s dealings with governments, for instance in helping states make their benefit payment systems more efficient.

In Ireland, one of Citi’s innovations involved a study into whether biologically inspired algorithms could help to identify money-laundering activity, and the results of this study are now being used by the funds industry.

Clearly innovation can be a force for good, but that’s not to say the mistakes of the past will never be repeated.