Israel: Land of Startups

Israel is currently one of the hottest places for high-tech companies to establish themselves, with the country featuring one of the highest numbers of start-ups per capita in the world. With such a fertile ground for developing cutting-edge technologies, it was only a matter of time before the capital markets became involved, always on the lookout for innovation. Marina Daras looks at how Israeli financial institutions are trusting local start-ups to educate them about the latest technologies that will ultimately improve their businesses.

Second only to its Californian cousin, Silicon Wadi is a thriving technology hub on the outskirts of Tel Aviv where high-tech start-ups blossom, gathering expertise and capital, before leaving for the US. Then, in the majority of cases, bigger vendors step in and acquire them, a scenario that the local banking sector is keen to curtail as great ideas and innovative technologies leave the country in seek of bigger markets and better funding.

The capital markets are still dealing with the consequences of the financial crisis, and in this respect, Israeli financial institutions, too, have been forced to do more with less, while demanding better performance and improved functionality from their technology platforms and infrastructure at the lowest possible cost. This explains why some of Israel’s local financial services players are now taking advantage of this fertile ground for innovation by going directly to its source.

Bank Leumi, the largest banking group in Israel, in partnership with the Elevator fund, launched the joint FinTech Innovation Hub in August 2013 to provide companies that focus on developing new technologies—in the areas of payments, investment management, personal financial management, trading, risk management, and security—access to its resources and funding in exchange for their knowledge and expertise.

“The FinTech incubator is part of the shift that we are trying to initiate at Bank Leumi to make the bank more technology-oriented,” says Ilan Buganim, CTO, security information and CRM manager at Bank Leumi. “With the incubator, above all we wanted to understand what the solutions were out there that could accommodate us and our challenges. We chose five companies, each one of them tackling different issues, and we are now working with them to see if we can develop and work out something together.”

“The FinTech incubator is part of the shift that we are trying to initiate at Bank Leumi to make the bank more technology-oriented. Above all we wanted to understand what the solutions were out there that could accommodate us and our challenges.” —Ilan Buganim, Bank Leumi

Lowering the Cost
Many solutions currently being implemented by capital markets firms have cost-reduction components to them, helping buy-side and sell-side firms shrink their fixed operating costs. Setting up an incubator, or making the decision to start working with one, can help financial services firms make the changes they require, while also helping to reduce various costs, given the more modest price tags associated with technology developed by start-ups compared to large, well-established vendors.

“It is a winning situation for both the bank and the start-up,” Buganim says. “These companies are looking for their first customer to proof-check their products and technologies, and we, as a bank, are always on the lookout for new ways to improve our infrastructure. When we find a company that offers a product we want, we are usually among their very first clients, so not only do we get it in advance—relative to the rest of the industry—but we also get it at a really good price.”

It is especially advantageous for local start-ups to gain global exposure, especially those firms aiming to be acquired. The most successful ones, or those lucky enough to possess sufficient capital, often end up relocating to the US, with the intention of selling either the entire company or certain key technologies to a larger provider, which then incorporates them into its existing product suite, usually at a significantly higher price point. It therefore makes sense for banks to quickly identify products or services that they would like to adopt, before prices start to rise.

However, according to Andrew Tarver, co-founder and CEO of Boldrocket, an initiative set up by financial technology consulting firm Capco, large financial institutions often find it easier to justify expensive, complex projects, using well-established external providers, and running into the tens of millions of dollars, but they struggle when it comes to approving much smaller and more affordable projects from unknown providers, or a vendor that is not part of an approved master-service agreement. Working closely with start-ups is often seen as an unnecessary investment in time and money, and sometimes those firms are perceived to be unreliable or technically inadequate for the job, which is, Tarver says, a naïve attitude that can be hugely detrimental to start-ups.

About the Journey
For Paul Rowady, principal at Tabb Group, the investment made in a start-up, through an incubator or otherwise, is irrelevant. Rather, the knowledge transfer is what really matters, which is why major banks justify having entire teams in place to conduct technical due diligence on innovation relevant to their business. “The aim of the investor is to understand the shifting goal of the landscape in terms of technology,” he says.

On the start-up side, the journey can also be educational. For Eran Drukman, CEO of Pythia Systems, one of the five start-ups selected to be part in the Bank Leumi incubator initiative and which specializes in issues relating to big data, the program gave start-ups like his the opportunity to use the bank’s resources and knowledge to launch a pilot product, which the bank then evaluated and decided whether to endorse. The companies selected were given business and technical support from the Leumi Group and experts from Israeli FinTech companies who served as mentors. Leumi and Elevator provided them with consultation and business development services, including budget planning, preparing a business plan, a link to the best service providers in the industry, Amazon’s cloud services, and a package of related offerings, including accounting, public relations, legal support, and human resources management. The program also provided entrepreneurs with design services and workshops dealing with user experience and included a month-long road-show trip to the US to meet potential investors and strategic partners.

“Once we applied, we went through a screening process in order to explain to the bank what our solution was, what the innovative piece of technology was, and how it could answer its big-data needs,” says Pythia Systems’ Drukman. “We then started working with the bank to try and better understand the challenges it was facing and the limitations of all existing solutions in order to refine the system design and the technology to fit its purposes,” he says, explaining that it helped him and his team a lot in terms of understanding the bank’s needs and expectations—valuable knowledge for a high-tech start-up.

Disrupt or Be Disrupted
“One of the challenges we are facing today is that we need to ensure that Bank Leumi continues to be one of the leading banks, and for that we need more innovative solutions that are going to make a difference,” says Bank Leumi’s Buganim. “And since banks all have to do much more with fewer resources, we need to implement more connections between IT and the business, and for that we need to adopt more innovative and disruptive technologies,” he says.

As financial institutions globally are looking at ways to re-invent themselves in terms of their business models, revenue streams, and the underlying technology that becomes the enabler for much of that change, the need to evaluate and possibly adopt “disruptive technologies”—technologies that replace incumbent systems, applications or platforms, but which are invariably considered unreliable, immature or unstable—is needed more so than ever. If banks rely on their difference from the competition as a differentiator, then they cannot be afford to be laggards when it comes to their approach toward new technologies, the early adopters of which will be the ones reaping the rewards.

“Innovation is good for the customer, but it can be dangerous for the companies,” Buganim continues. “We are trying to use innovation for our sector to be stronger, not weaker.”

Cutting Their Teeth
In Israel, many of those who occupy the ranks of technology start-ups cut their teeth in the Israeli Army, where they were exposed to the most sophisticated technologies the Israeli military uses and helps develop.

“We are happy to work with and invest in those Israeli start-ups that specialize in the security sphere, for example, because they have great ideas and they often figure out what the problems are before the largest vendors do,” says Eldad Herstig, senior vice president, CIO and chief of operations at the Tel Aviv Stock Exchange (TASE). “This is partly due to the fact that a lot of people get exposed to cutting-edge technology when completing their military duties, and they are encouraged to create new solutions and products with almost unlimited budgets.”

Herstig explains that while stock exchanges like TASE might be slow compared to the rest of the financial services industry, when it comes to implementing new, non-mission-critical technologies, when their security is at stake, adoption of new technologies becomes a priority. “Stock exchanges are usually very traditional structures, but when it comes to cyber security we are quick adopters of new technology,” Herstig says. “Start-ups are easy to talk to, they are very approachable, and they often agree to make changes to their products to really fit our purposes.”

When it comes to security and cyber threats, developers who worked for the Israeli Army have been exposed to some of the most advanced tools available anywhere in the world. Once they have completed their military service, they continue building tools of their own that can fit different industries and needs, such as the ones rolled out by financial institutions like TASE or local banks.

“Every financial institution needs to go back to their core competencies, what they want to be known for, and where they are best-in-class. Whichever category is considered their core, they should commit the resources to build the best technology solution and associated processes. The delta should be externalized, through technology vendors, start-ups, and utility providers that will be able to fill in the gaps for them in the most cost-efficient and flexible manner,” Herstig says.

According to Boldrocket’s Tarver, the majority of the financial institutions need to re-invent their operating models and to change their mindset if they want to ensure their corporate health going forward. Finding new ways of approaching technology, both in terms of its delivery models and managing down its overall cost, can be achieved through partnerships with the start-up community rather than by trying to compete with in-house-developed alternatives to their offerings.

Salient Points

• Israel is one of the top countries supporting the establishment and growth of high-tech start-ups. Some financial institutions have taken full advantage of this fertile ground to work closely with local start-ups and familiarize themselves on the latest technologies and solutions that could improve their businesses.
• Working with start-ups can help banks be more efficient in terms of adopting some of the latest technologies available on the market, at reduced prices.
• When launching an incubator, what matters most is not the end result, but the educational journey in which the financial institutions are engaged. Institutions are exposed to the latest technologies in their fields of interest, while start-ups have the opportunity to use their resources and knowledge to launch pilot products before going to market with them. 

 * Marina Daras' visit to Tel Aviv transpired some six weeks prior to the escalation of the ongoing Israel-Gaza conflict. The publication of this feature (in terms of its timing) is purely coincidental and was in no way influenced by the current situation.

Victor Anderson, Editor-in-Chief, Waters and WatersTechnology.