Innovation’s Great, But We Haven’t Seen Fintech’s Second Act Yet

That the fintech movement has been changing bank and credit union technology, strategy, attitude and even dress codes is undeniable. But a veteran bank stock watcher suggests more solid change will wind up happening inside traditional institutions using innovative disrupters' technologies. The human element remains important, and he warns fintech hasn't had its trial by fire, yet.

Fintech and the growing crowd of firms setting out to disrupt this aspect or that of traditional banking can make exciting reading but veteran bank stock analyst Fred Cannon believes predictions for the future of fintech and its impact on U.S. financial institutions need a healthy shot of skepticism taken with a jigger of experience.

“My definition of a fintech a few years ago was a financial firm that wanted a technology stock’s price multiple,” says Cannon. “One of the challenges of fintech startups is that none of them want to be seen as financial companies.”

However, Cannon continues, “if they take liquidity risk and credit risk, they are financials. And sometimes, you know, they might not even realize they’re taking liquidity and credit risk because they so want to be characterized as a tech firm, not a financial stock.”

Cannon is an EVP at Keefe Bruyette & Woods, where he serves as both Global Director of Research and Chief Equity Strategist. He’s been with the firm, which specializes in U.S. and European financial stocks, since 2003 and spent the earlier part of his career as director of investor relations at multiple financial institutions, including Bank of America.

KBW has been stepping up its coverage of fintech firms here and in Europe and has sponsored a conference in London over the last couple of years bringing together traditional financial companies as well as fintechs. The firm makes it clear that fintech has exerted a powerful influence on the direction of traditional institutions on both sides of the pond. It’s beyond argument that the fintech movement, if you will, stimulated changes in institutions’ thinking, and often, action, that can’t be stuffed back in the bottle, even if anyone wanted to.

But Cannon has been watching financial services for decades and argues that we haven’t seen Act II yet.

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Cannon notes that technological change has been a constant in banking since his early days in the industry, going back to the then-significant advent of ATMs. What we have today is an acceleration of a long wave.

“Investment in fintech really didn’t start until after the financial crisis,” says Cannon. “One of the reasons why so much investor money began going into these companies was that big banks weren’t able to invest in technology in those early stages. They were dealing with their financial problems. So you had all this money going into startups.”

Cannon believes the large banks have been catching up on their technology spending in subsequent years. He likens their position vis-à-vis fintechs to the position of very large Silicon Valley tech firms like Intel and Cisco.

“You’ve got all these innovative startups developing new technologies, and those big firms get to pick and choose among small firms whose technology they can adopt, and they buy them,” says Cannon. “It’s similar to the biotech business. You’ve got small biotech companies that develop something successful and they sell out to the big pharma companies.”

For several years now fintech labs and accelerator and incubator programs run by large banks and other financial firms have been working with startups and both firms and technologies have been acquired.

Cannon thinks this is how disruption will continue to play out in U.S. banking, rather than a replay of the impact of Uber and other ride-sharing services on the traditional taxi industry.

Fred Cannon credit downturn quote

“KBW believes that to some extent the idea that startup tech firms are going to have a major disruptive effect on the U.S. banking system seems overstated,” says Cannon. “In my view, the major technology changes will largely take place within the firms that are already involved in finance, rather than seeing a massive move away from such companies that have been in the business for a long time.”

But there’s another aspect to the future evolution of fintech: financial gravity.

Cannon has watched banks themselves go through multiple crises and argues that fintech companies haven’t been through their trial by fire yet.

“Ultimately, a financial business model has to be tested by a credit downturn,” he explains. Politics aside, the country has been going through a very strong economic expansion, so, with one exception, that hasn’t happened yet.

Cannon elaborates on this point. “In the first quarter of 2016, you had a mini-test of fintech business models. And in general, they didn’t work very well,” he explains. “That period brought to light that liquidity and credit risk can’t be dismissed.” A number of credit-oriented fintechs took their lumps then.

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Fintech and the Commercial Side of Financial Institutions

That fintech has exerted strong influence on retail banking is clear, and Cannon says this plays into the ongoing trend of consumer banking’s consolidation. “The consumer side of fintechs’ technology creates a lot of economies of scale for consumer banks,” according to Cannon.

On the other hand, Cannon doesn’t believe fintech will have nearly the same effect on the commercial side of banking. Yes, there will be functions and products that commercial customers will benefit from. But Cannon resists what he’s heard from numerous experts.

“One of the most under-discussed and under-analyzed aspects of tech is that the consumer and commercial side are quite different.”
— Fred Cannon, Keefe, Bruyette & Woods

“I continue to host consultants who come through our offices insisting that it’s just a matter of time before small and mid-sized banks will be out of luck in commercial banking. I have been hearing that for the entire 30-plus years of my career,” says Cannon.

Back in the 1980s and 1990s, he says, people kept telling him that commercial borrowers would be credit scored and that big banks doing so would push all the other players off the gameboard. Tech plays a greater role in commercial service than it once did, but Cannon disagrees with those predicting the demise of all but the giants. For years, smaller institutions needed outside tech, even from larger banks, to provide certain commercial needs. Nothing new there, he insists.

“One of the most under-discussed and under-analyzed aspects of tech is that the consumer and commercial side are quite different,” says Cannon. The personal touch remains a key element of commercial service even as more products go digital.

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Will Millennials Break the Pattern?

Some observers speculate that this will change as Millennials increasingly step into business leadership roles and small business ownership. The reasoning is that they love digital personal banking and won’t tolerate “old-fashioned” approaches for their businesses.

Cannon doesn’t see them being attracted to major banks or fintechs over community and mid-sized institutions — so long as they get personal attention.

He points to Silicon Valley Bank as an example. “It’s a pure business bank,” says Cannon. “They provide commercial services personally and with electronics. And they’ve grown, and thrive, in a tech area with a heavily Millennial client base. There’s been some smaller bank competition for Silicon Valley Bank, but they’ve always been able to out-compete the big guys.”

Cannon acknowledges the thinking that fintechs like Kabbage could become the front-end for traditional institutions’ commercial banking operations. But he’s not impressed with the performance of most business-credit-oriented fintechs yet.

“I think commercial credit is very difficult to systematize well,” he says. Even banks that have made a niche specialty work in their home market have often flopped when they’ve tried to take those efforts to a broader region or even national. In fact, it’s a sign that investors who like to bet against financial stocks look for, as an opportunity, he says.

So Cannon doesn’t see business credit fintechs muscling traditional institutions out of lending.

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Eyes on European Trends, With Perspective

Cannon says that KBW keeps a close watch on fintech developments in Europe for a sense of how things could play out in the U.S. However, he suggests not extrapolating too much from the European experience because significant differences exist between banking here and banking there.

First, he says, European banks as a group are less profitable than major U.S. banks and they have less money to invest in technology. “That has opened the door to fintechs to a greater extent there than here,” he explains.

There’s a governmental factor, too.

“It’s my impression that regulators in Europe and the U.K. are more open to advancing disruptive technologies than U.S. regulators have been,” says Cannon. The movement towards faster payments is one example, he says. And, open banking, a major focus in Europe, “is not being pushed here.”

Cannon sees some irony in that so much of Europe looks towards U.S. tech companies in multiple innovation hubs like Boston and Silicon Valley, but that in the financial space Europe plays a greater incubator role.

“The European regulators seem to be pushing some of these things,” he says.

What about efforts such as the OCC’s Office of Innovation among federal regulators? Cannon is skeptical, seeing them as chiefly reactive measures instead of proactive steps.

“Look at the fintech charter,” again mired in legal action, he says. “Not exactly creating a wave of successful companies.”

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