A few years ago, it was fashionable to say that a revolution was coming in the world of banking. Fintech evangelists harkened back to Bill Gates’ 20-year-old quip that “banks are dinosaurs” and claimed that the asteroid strike that would wipe them out was now imminent. Just as industries from retail, to entertainment, to transportation have been shaken up by software-driven disruption, banking would be the next domino to fall in the Uberization of everything.
The reality has been far less dramatic Volume migration to pure digital players remains in the low single digits in the US, multiple challenger banks in the UK are facing funding and regulatory issues before they are even out of the gate, and many of the more successful fintech insurgents have been bought by incumbent banks just as they matured into legitimate competitors. Disruption of the banking industry hasn’t turned out to be a dramatic big bang; instead, the erosion of bank profitability by low inte rest rates and increased regulatory costs has triggered an industry-level response in which banks are using technology to improve efficiency and the customer experience. Instead of going extinct, the dinosaurs have been evolving.
Fintech hasn’t caused the ‘Big Bang’ disruption to the banking industry, as expected. Source: Shutterstock.
One reason why the fintech revolution has been delayed, if not cancelled, is the lack of true innovation in the sector. Many fintechs have found, to their disappointment, that an elegant user interface on top of a traditional product is not enough to pry customers loose from long-standing bank relationships. The digital mortgage origination platforms that promise agreement in principle on your phone are great; that is until you reach the screen wher e it asks you to put a bunch of paper in an envelope and mail it in to get the final loan approved. There are exceptions, of course. London-based TransferWise, which allows consumers to transfer money internationally at a fraction of the traditional cost, is actually disruptive because it lowers fees by smart trade matching between buyers and sellers. In doing so, it marries a nice customer interface with an innovation that actually changes the economics of a business that, in the past, got away with charging punitive fees.
But TransferWise is an exception. Most fintechs have struggled to create sustained competitive differentiation. Where startups have had success, such as in robo wealth management, the decision of established players to self-cannibalize has led to equivalent assets under management (AUM) in months rather than years. In the world of online lending, the challenges for fintechs are likely to get worse in a rising rate environment, as bank funding costs will rise more slowly than those of wholesale-funded platform lenders, eroding the advantage that comes from lower cost operational platforms.
This doesn’t mean that banks can be complacent. The asteroid strike on the banking industry is still possible, but is far more likely to come from existing tech giants than small startups. Amazon is now lending a billion dollars a year to merchants on its platform, a drop in the ocean for the largest commercial banks, but a statement of intent. The comfort that has come from bankers saying that something like Amazon won’t want the hassle of having a regulated balance sheet was probably mirrored in the board rooms of retailers who thought that Amazon wouldn’t want the hassle of managing 400 physical Whole Foods stores. While it hasn’t happened yet, Accenture research suggests that the combined disruption from fintech startups and Google, Apple, Facebook and Amazon could cause full-service banks in develope d markets to lose about 35% of their market share over the next five years. Not quite a Blockbuster-Netflix moment, but still more than enough to give perpetually disappointed bank shareholders something else to worry about.
Part of the answer for banks is to adopt a highly collaborative attitude, particularly with respect to smaller fintech players who can help them renovate their business models. Incumbents have certain built in advantages. They know how to deal with regulations, they have existing customers and many of them now have, or are building, their own infrastructure to develop and support technology innovations.
But, smaller fintechs also have a lot to offer. Even the most technologically forward-thinking banks are often fighting against a hidebound culture that moves slowly and cautiously. Meeting the needs of regulators and dealing with internal rules around security and procurement can trip up even the most entrepreneurial of banks.
The resul ting move from competition to collaboration is now well established. More than 85% of the participating financial institutions working with the FinTech Innovation Lab are creating partnerships with fintechs, according to research conducted by the New York FinTech Innovation Lab, a program run by Accenture and the Partnership Fund for New York City. However, simply putting tattooed developers in a room with Brooks Brothers suits is a challenging cultural match. If these collaborations are to result in synergies rather than mutual disappointment, banks should follow a few simple rules.
A critical foundation is transparency. Set clear rules about deadlines, scope and metrics for projects to help fintechs work more successfully with banks on proof-of-concepts.
Banks also need to make it easier to move at the speed of technology. Procedures around contract closings and security approvals need to take days or even hours, not months, to keep partnerships on track. But s ometimes delays are inevitable, and to ensure fintechs have full understanding of each step, banks should dedicate staffers at the outset to see a project through to completion, providing continuity and institutional knowledge. Finally, banks should create “sandboxes” for fintechs to work in — safe spaces where they can test new products with small groups of actual users in a simulated environment to vet and shape those ideas before having to consider complex regulations and production scale complexity.
Ultimately, the banking industry will evolve and change and fintechs will play an important role in that process. However, the experience of the last couple of years suggests that the highest impact for fintechs will be through working with the incumbents rather than against them.