Fintech is primarily focused on startups and their attempts to de-bundle financial services. How are banks responding? They have not responded to this upstart movement despite their wealth, talent, and rich history of innovations.
This article offers four suggestions on how banks can better adapt to the fintech threat and change their approach.
Fintech is not just for banks.
Fintech is a shortening of Financial Technology. Although it is a relatively new term, the use of technology in financial services has been around for a long time. The financial services industry introduced credit cards to the world in the 1950s. Internet banking was developed in the 1990s. And since the turn of the millennium, contactless payments have been available. Fintech has only recently become a major part of the public consciousness:
This term is gaining popularity among startups, which are actors outside the financial services industry. They play a larger role in the ecosystem. This emergence is due to three core trends:
Technology Financial Services was traditionally an industry that required fixed assets to scale (for instance, branches), acting as a barrier for newcomers. Upstarts can now run complex operations virtually thanks to technological advancements. Neobanks, for example, rely solely on technology infrastructure. Revolut, a UK-based company, has accumulated 1.5 million users (of whom 350,000 are active every day) without having any customer-facing functions.
Customers After the Financial Crisis of 2008 and other scandals, the customers demand more from their banks. The technology empowers customers to scrutinize providers more, and startups are using it to deliver cleaner and more efficient customer service.
Regulation According to estimates, increased regulatory oversight of banks after 2008 will cost the six biggest US institutions approximately $70 billion each year. Citigroup employs 30,000 people in its compliance division. Compliance with regulations aside, lending restrictions have increased fully-loaded loan costs for consumers as well as diminished the banks’ ability to offer them. Startups, who are not defacto banks and therefore have less oversight, can now offer attractive alternatives.
Fintech suggests that startups are using tech to disrupt existing banks. There is no evidence to suggest that the banks are about to have their own Blockbuster Video or Kodak moment. The businesses are still profitable and have a lot of cash. This article will focus on how they can better respond to the “fintech against banks” movement, as I believe their response has been suboptimal.
Fintech startups are not yet addressing the disruption of financial services in general. McKinsey’s analysis shows that 62% of startups are targeting the retail banking sector, while only 11% focus on large corporate banking. The most common area targeted by startups is payments, while lending is the area with the highest revenue.
Fintech is still in the early stages of development, so the response from banks to Fintech’s disruption is crucial. Fintech startups focus on unbundling the banks and offering a single type of product or service.
The innovation has been driven primarily on the front end of these specialized services by improving aspects of financial services that are aimed at customers. Here are some examples of this:
Better Service: Traditional banks bind customers by offering a variety of services, which makes them stickier due to increased switching costs. Fintech firms without this luxury follow the mantra of earning trust by providing better customer service. They also rely on referrals to acquire new clients. 90% of fintech companies attribute their competitive edge to improved customer experience.
Better brand: By bringing in employees with non-traditional backgrounds, FinTech is refreshing the branding for legacy services it wants to replace. Modern marketing tools such as gamification make mundane tasks, like budgeting, more appealing to consumers.
Lower prices: Fintech startups can offer lower prices because they have a leaner virtual operation, are less regulated, and do not collect deposits. They also receive venture capital funding.
FINTECH AT THE BACKEND FINANCIAL SERVICE
Fintech firms can validate their product by bringing in new customers, getting feedback, and buying some time before they move on to the second paradigm, improving backend financial services. The ” rails ” of the financial industry are the infrastructure used by banks to transact and interact with one another, including clearing (NSCC), payments (ACH), and messages (SWIFT). Although there have been no widespread movements to change these norms, the potential for new technologies, such as blockchain, within these areas is enormous. In 2017, ClearBank opened the UK’s first clearing house in 250 years. It will be able to offer modern rail solutions and build new ones for financial service stakeholders.
Fintech startups are largely the same as banks in terms of their backend. They offer better customer service, but they also have beautiful apps. You are not using a new financial system when you use Venmo to pay, SoFi for a loan, or Betterment to invest. These firms use the same legacy infrastructure as banks. These firms do wonders in making the system look better for consumers by covering up cracks and bureaucracy. They sometimes make audacious claims, like Transferwise’s peer-to-peer FX model, which is almost impossible to achieve. Startups’ front-end-driven business model poses two existential risks to the fintech ecosystem.
Fintech will be at a strategic disadvantage until it can create its rails and move to Fintech 2. Fintech startups must create a technologically driven back end to succeed in the financial services sector. If they continue to use a tech-driven front-end with a back-end based on a rented process backend that was designed decades ago, this will result in margin compression and operational risks.
It will be backending to create new back-end banking processes due to the format adoption topics (think Bluray and HDDVD) that will come up and the regulators’ involvement. At the backend, startups can get a seat at this table and compete on an equal playing field; they will be able to mitigate any existential threats. They may only be able to cover the cracks in a crumbling financial system until then.
Their responses so far have erred more towards Kodak than Koninklijke Philips, which sold its music business in the 1990s to prepare for the MP3 revolution. They have responded more to Kodak than Koninklijke Philips. Koninklijke Philips had sold their music business back in the 90s.
Fight or Flight
The figure below shows a Framework from MIT Sloan that categorizes the responses of incumbents to disruptive innovations. Two factors, motivation and ability, affect their response:
According to their current actions, the banks are in the upper left quadrant. In spite of their ability to respond quickly to Fintech, they have shown a lack of motivation. Their responses are either dismissive or indifferent. In the first case, rarely, a chief executive of a financial service company does not mock robo-investing or bitcoin. As far as being passive is concerned, banks have mainly engaged with Fintech via soft-touch accelerators and direct equity investing, which, in its purest form, is an outsourced innovation.
If banks want to be able to react constructively to the fintech revolution, I think they should increase their motivation and either choose to fight or to flee.