There are many traps to fall into with an innovation strategy, but perhaps the most dangerous comes at the very beginning: Jumping on a bandwagon without a sober assessment of the opportunities, liabilities, and commitment required to be successful.  The end of two gold rush-like events over the past few years show how attempts at innovation can go very wrong for financial institutions (FIs) in this way:

The crypto meltdown: The rapid growth of crypto made it a tantalizing opportunity for FIs with a strong — and maybe misguided — risk tolerance. However, things went poorly for some of the FIs highly leveraged to crypto, as we wrote in our 2023 retrospective, which pulled down the space overall. Signature Bank in particular was a big player in banking services for the crypto industry and helped tee off a crisis when it failed. Other banks that dabbled in crypto via custody provided to customers or fiat deposit accounts or payment cards provided as a service to crypto companies were caught in the crossfire. At best, crypto strategies fell short of expectations set at the peak of the hype cycle. At worst, poor attention paid to the risk involved led to deposit flight and bank closures.

The BaaS realignment: Banking-as-a-Service (BaaS), an extremely popular innovation strategy over the last few years, especially for community banks, began to display deep issues with risk and compliance that came to a head when banking regulators stepped in. This led to a flood of regulatory actions against banks that operate in the space, causing many to adjust their strategies, some to exit entirely, and casting an overall dark shadow over the white-labeled approach to banking. The BaaS market had many new entrants at its height, according to CCG Catalyst research, amplifying compliance problems — most prominently deficient board governance, third-party risk management, and BSA/AML. Some FIs gave too little attention to the commitment and resources required to start a compliant program in favor of getting started quickly.

Innovation gone wrong doesn’t mean that FIs should shy away from novel business opportunities. A large addressable market gave FIs real reasons to participate in BaaS, for example, and despite the hype, the crypto industry showed business potential. The problem with any attempt at innovation is “shiny object syndrome,” which we discuss in our report Successes in Transformation — FIs often will go after an opportunity because it’s hot, but without enough forethought.

The key to a successful innovation strategy is focus — being good at identifying where an FI’s capabilities align with its opportunities, taking advantage of that alignment, and conscientiously managing risk. FIs need to double down on their strengths and to build their expertise in areas they want to innovate. They should put aside hot new technologies and first assess their business strategy — then decide what will work for them based on their goals and ultimate capabilities.

What will work depends in large part on how the FI is organized. Successful innovation is fundamentally a people issue — it depends on a clear, well-articulated board vision and the right talent to administer an innovation program. Also important, as recent events have highlighted, is the compliance staff and expertise. Jumping into a new line of business, particularly one that involves unfamiliar products and new partners, depends on careful planning and thorough evaluation of the associated challenges.