Too much has been written and discussed about the 'disruption of banking' when the real power of new market entrants is the 'power of collaboration' between fintech firms and the legacy banking organizations.
The fintech start-up global rise is posing a fundamental challenge to the business models that have long dominated financial services. In areas such as banking and wealth management, in particular, traditional institutions are seeing their competitive advantages being eroded and their market shares squeezed.
However, established financial institutions would benefit from viewing fintech companies less as upstart rivals and more as innovative, disruptive businesses from which they can learn, adopting some of their methods and even partnering with leading fintech firms. Taking these steps could usher in an era where collaboration not competition helps spur the growth of both traditional and fintech players.
We are at a crossroads in the banking industry, where legacy banking organizations can embrace the change being brought by digital transformation and new competitors. The benefits to collaboration and partnership include a new cultural perspective on innovation as well as a way to become both more responsive as well as agile.
The benefits include an improved consumer experience, reduced costs, new opportunities for growth and potentially the ticket to long term survival.
‘Tipping Point’ in Banking
A report released in March by Citi noted that international investment in private FinTech companies has exploded more than ten-fold in the last five years. These nimble, innovative competitors, warned the report, are “forcing banking to a tipping point” in markets such as the US and UK, by targeting the industry’s most profitable areas.
Lending Club, the world’s largest online credit marketplace, issued USD $8.4 billion in loans to consumers and small businesses last year. In the P2P (peer-to-peer) asset management space, Betterment was recently valued at USD $700 million – up from USD $450 million a year ago.
What seems clear is that the world of finance has changed irrevocably. The next generation of tech-savvy customers are hungry for the advantages that emerging competitors to traditional banks profess: significantly lower fees, more transparency, accessibility to all, and fast and easy-to-use online and mobile interfaces. Banks cannot turn back the clock.
Nor can they hope that competition is confined only to certain segments of their customer base. It is true that areas of FinTech are targeted at specific demographics – for example, in the wealth management industry, robo-advisors tend to structure their fees to appeal to small investors. Yet, as noted by one study from CapGemini , almost two-thirds of the world’s high net worth individuals expect to manage most or all their wealth digitally in the near future – and would consider switching to providers that offer such services.
Regulation could also help tip the balance. The Obama administration has implemented new rules to ensure US brokers managing retirement accounts adhere to more rigorous standards, mandating that they put customers’ interests ahead of their own. This could transform the way traditional advisers interact with their clients – and potentially send more investors towards lower cost alternatives.
Yet, in important ways, traditional banking organizations have an edge over their younger competitors. Though banks’ reputations have taken a hit over recent years, customers are still typically more comfortable entrusting their finances to institutions with a long history, legacy and brand recognition. Not least because banks can pour a much greater pool of resources than P2P start-ups into protecting their customers from fast emerging threats such as cybercrime and the theft of private data.
While fintech providers have lowered their fees by reducing overheads, this comes at the cost of restricting customer service, particularly face to face. Online lenders with few differences between them are being increasingly commoditised, whereas banks should be better at expanding their offerings to include advisory services and other long-tail engagement tools. Similarly, automated wealth managers have an important place in the new financial world, but will supplement – not replace – the personalized human expertise that banks have the experience and resources to offer.
But these advantages will not remain intact indefinitely. As Citi puts it: “To remain competitive, banks need to get innovation before the fintech companies get scale”.
Importance of Big Data, Relationships and Capital
One essential step is to embrace the potential of ‘Big Data’. In the lending space, banks need to look further than the conventional indicators of credit risk they have relied upon for decades. These are often stale and sluggish compared to the innovative measures used by tech-savvy start-ups, when, for example, it comes to younger generations that may not yet have ticked the traditional boxes of creditworthiness.
There are many such indicators, from education and work history to utility bills and even social media. P2P providers routinely check online reviews posted on sites such as Yelp and TripAdvisor to help make lending decisions. Often the most important asset prospective customers own is their business. Yet three quarters of the 200 million small businesses across the world do not know what they are worth.
By using Big Data to arm themselves with up-to-date business valuations and performance metrics – everything from management strength to risk management and security practices – banks can more accurately assess their customers’ risk profiles and reliably determine whether they are underinsured or underfinanced.
Whether they choose to become proficient with advanced analytics in-house or by building upon third party platforms, banks which are being undercut on their price by P2P start-ups can use their expertise to provide value – a deeper, more complete relationship with their customers which looks at their full range of financial needs.
While fintech start-ups may have fresh ideas and a nimble approach, banks have the resources to outspend their digital investment many times over. Goldman Sachs announced plans last year to compete in the P2P space with a new business line offering loans through its own website and app. Banks can pour money into innovation centres where they can test new ideas at arms’ length from the parent institution, or harness the creativity of start-ups by running incubators with free co-working space and access to legal and regulatory resources.
Collaboration Over Competition
Increasingly, however, both traditional financial institutions and P2P providers are coming round to the idea that building partnerships could be more productive. At the end of 2015, J.P. Morgan Chase & Co. announced a deal to use the online lender On Deck Capital to ramp up its lending to small businesses, by processing applications more rapidly and at a lower cost, and integrating OnDeck’s technology into its checking-account website. The thinking behind this is that there are some areas in which banks may not be able to compete on their younger rivals’ terms: as Jamie Dimon, J.P. Morgan’s CEO, said, “The kind of stuff we don’t want to do or can’t do, but there’s somebody else who can do it and do it probably well. So this is going to be collaborative.”
Collaboration is equally plausible in the asset management industry. In January, Alabama-headquartered BBVA Compass teamed up with the online investment company FutureAdvisor, with the hopes of reaching a new segment of customers with an appetite for lower-cost automated advice. Again, this kind of tiered offering – robo-algorithms, supplemented with personalised human guidance at a higher price depending on customer requirements – is intended to expand and enhance, rather than replace, banks’ current services.
This trend is only likely to continue. Embracing P2P should not be seen as banks sabotaging their tried and tested business models; it is the recognition they can have a stake in reaching entire groups of customers they may have ignored in the past. Whether developed in-house or harnessed through partnerships, it is a potentially lucrative new distribution channel.
And while some fintech start-ups see their purpose as disrupting the traditional financial services industry, many equally recognize the importance of what banks have and can offer them: deep pockets, long-established brands, and a history of customer relationships. It is worth pointing out that as they grow, P2P players are likely to come under increasing regulatory scrutiny, with the associated compliance costs that will invariably entail.
The rise of fintech and P2P providers is no passing fad, but nor will it make traditional financial institutions obsolete – provided they take the competition seriously. The optimal bank of the future will likely combine the best of both worlds, embracing the technologies that is central to customers’ lives while maintaining the intimate, personalized service that requires a human touch.
P2P start-ups are increasingly recognizing that they can harness banks’ competitive advantages to thrive. Similarly, banks may need to acknowledge alternative providers not as threats but as partners spurring innovation in a rapidly changing financial world.