Digital transformation has ostensibly been on the do-list of most banks and credit unions for over a decade. The problem is that many institutions either don’t get very far, go down the wrong road, or simply reject what circumstances dictate they should be doing.
The result often comes out the same place: the fintechs that are eroding their market share keep doing so and they regain little ground.
“Far too many banks’ strategies for dealing with fintech are backward-looking — focused on protecting established products and business models — or dependent on broad, vaguely define digital transformation initiatives,” says Ron Shevlin, Chief Research Officer at Cornerstone Advisors, in the opening of his report, “Counterattack: Banks’ Field Guide to Fintech Disruption.”
In the report Shevlin identifies five areas where fintechs have been winning while many banking institutions either take the wrong tack or just don’t respond at all.
“Banks spend far too much time and energy fighting change rather than embracing the competitive possibilities that change inevitably brings,” says Shevlin. Instead of mourning inevitable loss of the past, they should look for opportunities as fintechs shake things up.
“If they don’t,” Shevlin adds, “the market will pass them by.”
It’s not too late to make the fixes that can better position banks and credit unions for today’s conditions.
1. Get Real About Open Banking
The report defines open banking as “the ability for consumers to share data from their financial accounts and providers in order to enable other products or experiences.” Put that way, it’s pretty straightforward. But Shevlin cites banking industry attitudes that banks own their customers’ data and that they shouldn’t have to share it with any competitors.
Time to get over that one, Shevlin argues, especially since consumers increasingly favor spreading their data where it needs to be for them to run their finances the way they prefer.
“Banks that make it difficult for customers to share data are putting those customer relationships at risk and painting a regulatory bullseye on their backs.”
— Ron Shevlin, Cornerstone Advisors
More banks now see where things are headed and are working with data aggregators in order to move past screen scraping. A key element of this is the API standard for sharing financial data that is maintained by the Financial Data Exchange.
But Shevlin sees that only as the first step. More critical, he suggests, is for institutions to embrace the new technologies and use them to build new products and services
“Open banking is going to happen, whether banks want it or not,” he says. “They might as well benefit from it.”
2. Embrace the ‘Niche Neobank’ Movement with Your Own Entries
A subtle evolution has been going on in the founding of neobanks. The first wave consisted of entries with broad consumer appeal, such as Chime and Dave. Shevlin indicates that the current wave is more focused, with the creation of neobanks set up to serve consumer and business segments.
Segmentation and niche strategies have a long history in banking and affinity marketing is decades old. But this new wave of whole institutions devoted to segments reflects the incredible speed to market that banking as a service enables.
As a result, traditional broad-based players run the risk of being pecked to death by sparrows.
“Niche neobanks’ intense focus on specific customer segments gives them an advantage over most traditional banks in understanding the pain points of their target customers (at a very granular level) and building products and experiences that address those pain points,” Shevlin writes.
Banks that want to emulate the niche neobank strategy can look at such brands as Cheese for Asian-Americans, TABbank for truckers, Karat and Nerve for creators, Panacea Financial for new physicians and Purple for the disabled.
The key is to cultivate agile product development to then build the bank’s own niche plays for customer groups that have pain points that need solutions.
3. Help America Save and America Might Save You
Old habits have returned after the early days of Covid and Americans once again have trouble building savings.
Shevlin says the two key needs in this area are setting money aside in the first place and then enabling people to get a decent return. Acorns and Stash have been leaders among the fintech apps designed to help.
The threat here is not the obvious one of fintechs grabbing away deposits.
“Banks are already flush with more deposits than they know what to do with,” says Shevlin. The threat lies in “the potential for these apps to wrest control over the allocation decisions that fund those products.” Specifically such apps use automatic transfers to savings and investments and “roundups” to force users to put money by. This reduces consumers’ use of their bank touchpoints.
Cornerstone’s research indicates only a fraction of consumers use automated savings tools provided by banks and credit unions. This provides lots of potential, if banks provide improved versions of what they have tried. Two suggestions in the report: come up with ways to give consumers an easy view of all of their accounts and provide better opportunities than savings accounts with continuing meager rates.
4. Balance Overdraft Reform with Consumers’ Need for Liquidity
Pressure from fintechs providing fee-free overdrafts and political pressure has pushed more banks to reform their overdraft policies.
Shevlin separates the two ways overdrafts tend to be used. On the one hand, not penalizing accidental overdrafts, or helping consumers to fix them, addresses one side. But the other aspect is that many consumers rely on overdraft service to get through the month.
The solution, suggests a banker quoted in the report, is to stop trying to treat overdrafts as all one thing. For those consumers who need something like it — really, short-term credit — institutions that can underwrite to meet that need will have a product people will value.
Fintechs offer services like Chime’s SpotMe that serve as a differentiator from traditional accounts. But banks without venture capital to burn through need something that pays.
As one banker told Cornerstone: “For institutions that are really good at underwriting short-term consumer credit, this moves the battleground from an undifferentiated commodity to a space where you can meaningfully differentiate based on the relationship you have with the customer and the data that you can incorporate into your underwriting.”
Rethinking an Old Tool:
It could be argued that the same software approaches that ushered in many banks' dependence on overdraft as a profit center could be re-purposed.
5. Find the Less-Obvious Opportunity in Buy Now, Pay Later
In the report the attitude of many bankers towards BNPL is summed up in one word: “blasé.” Shevlin suggests that many are dismissing the younger users of BNPL as credit risks that banks wouldn’t want to touch with credit cards anyway. But the analyst sees them as the desirable customers of the future who will be lost to BNPL players, who are already pursuing broader business lines.
“BNPL is their first credit product,” he writes. “Basically, BNPL is their on-ramp into the credit system.”
Shevlin suggests an off-beat play to get in on the BNPL players’ own game:
“The emerging evidence suggests that some consumers will struggle to use BNPL responsibly (especially across multiple providers). There is an opportunity for banks to help these consumers more effectively manage these loans. If banks care about acquiring younger customers or helping consumers manage their financial health, they can’t sit BNPL out.”