The financial services business, including banking institutions, fintechs, big techs, digital platforms and other providers may be heading towards an overall industry structure that looks like a barbell.
The implications for all financial players will be that if the markets continue to evolve this way, they may have to fall in and follow the pattern, one way or the other, in order to survive.
This comes at an economic crossroads. There is much speculation about the impact in the near future of rising interest rates and other economic forces on the willingness of venture capital investors to continue to fund formation of new fintechs. Some speculate that we are in a recession and JPMorgan Chase Chairman and CEO Jamie Dimon even declared that a “hurricane” is coming.
Another factor is the growing trend of more neobanks being formed to serve segments of consumers or business, rather than general neobanks like Chime or Dave. In addition, a small but growing trend is for community banks themselves to found and run neobanks, rather than merely providing processing for fintech founders tapping banking as a service capabilities.
The prediction, and analysis of the trends pointing to it, come from “Fintech and the Digital Transformation of Financial Services: Implications for Market Structure and Public Policy.” This is a paper from the World Bank Group, and part of a massive special report published by the organization, “Fintech and the Future of Finance.”
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What a ‘Barbell’ Financial Services Structure Could Look Like
The World Bank report, while written to encompass global trends, fits a good deal of what’s been happening in the U.S. in the last few years.
More specifically, a number of current trends could, in time, result in two extremes.
On one hand, there would be a set of larger financial firms providing multi-product offerings. On the other, a set of small niche players providing a much narrower and focused selection of products and services for selected users.
The large, multi-product players could include traditional players, fintech and big tech firms — that is, both incumbents and new entrants,” the paper states. “These may include banks that master the digital transformation, along with new financial services entrants that achieve scale, and big tech and other firms that have customer data and can link to banking as a service.”
The mix among entities on the other end of the barbell would likewise draw from multiple segments of financial services.
“The small, niche players could also include some traditional players alongside fintech firms,” the paper states. “Niche players may directly serve customers with a focused product set, or may serve large players with B2B services.”
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Stuck in the Middle Won’t Be a Good Place to Be
There will also be firms in between the ends of the barbell, the paper suggests. However, often these will be companies that decide either to broaden their services and acquire other companies and customer groups, or, alternatively, focus on niches. An example of the latter are the growing number of hyper-focused neobanks that are being formed using a backbone of banking as a service providers.
The paper makes the point that the speed and shape of this evolution will vary from country to country depending on the regulatory regime that’s in place.
The middle of the barbell, while it will support firms in transition to one end or the other, will not be a comfortable place to try to remain, according to the paper.
“Left to market forces, the dominance of the two sides of the barbell may very well squeeze out the middle… Those providers that cannot achieve the scale to compete with the larger providers but fail to focus on a sustainable niche may be forced to exit.”
— World Bank report
The report admits that the barbell scenario is not the only possible outcome of what going on in financial service, but is the one it judges most likely under current circumstances. It cites multiple factors to support its case.
Among the forces driving the need to evaluate future strategies are simple financial services facts of life. All players face customer acquisition costs and in spite of increased digitization, overcoming inertia on the part of both consumers and businesses costs a lot. Marketing is a major expense for fintech entrants. The need for diversification arises because broader product mixes can produce greater profitability and mutual product support.
Slender Players Have Started Bulking Up with Broader Product Lines
Many fintechs began by attacking a single slice of the financial services business, often by seeing a weakness in what traditional institutions were doing, finding a friction point that they could solve with technology, or seeing a regulatory gap that they could step through without obtaining a charter.
Now, as some maturing of the market has occurred, strategies are changing.
Fintech Does a 180:
Having 'unbundled' banking when they started, some fintechs have started 'rebundling.'
Part of the challenge for those attempting to produce evasive profitability is that banking long depended on a particular mix of businesses. Taking one or the other as a standalone product didn’t always have long-term potential. The classic model of accepting insured deposits which in turn funded loans serves as an example.
Re-bundling is a bit of coming full circle, then.
“For some, this is the result of opportunities to provide a better customer experience and increase revenue,” the paper says. “For others, it is a matter of necessity.”
Examples of such expansion include Klarna’s entering credit and card areas beyond buy now, pay later service, and PayPal’s expansion into multiple payment channels, including BNPL options. In addition, the report points out, some institutions that began as fintechs have obtained charters or licenses in order to be able to expand beyond their original reason for being.
The report cites SoFi, which began as a student lender and which now, with a bank charter, has grown far beyond its original segment of the business. Likewise, LendingClub acquired Radius Bank, becoming LendingClub Bank and becoming regulated in the process. Along the way, the company gained the ability to fund its loans through deposits, rather than solely through sale to investors.
Big Isn't Just About Bulk:
At the far end of re-bundling is the super-app, the avowed goal of PayPal and others.
Also in the mix in the U.S. are big techs, which participate in financial services in multiple and varying ways. Apple, for example, partners with Goldman Sachs to offer the Apple Card. Block (formerly Square) offers its Cash App payment service and has been moving into lending. Amazon offers financing in multiple ways, including partnerships with both Chase and Synchrony in credit cards. Google, on the other hand, dropped its Google Plex project at the eleventh hour, forsaking partnership with large and small banks and credit unions.
Such players will clearly be on the big end of the barbell.
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Meanwhile, on the Smaller End…
Just how much smaller fintechs and incumbent banks that aren’t giants can maneuver remains to be seen. There has been speculation that the days of fintechs obtaining bank charters one way or the other may be coming to an end and meanwhile the banking industry and the Biden Administration have very different views of the role, purpose and desirability of bank mergers.
The one strategy that may not work is doing nothing.
“Smaller institutions can take advantage of on-demand infrastructure and external service providers to undertake a rapid and less-costly digital transformation,” the World Bank says. “Incumbents that are not able to adapt in time may perish or be acquired.”
Trust from customers is a factor that institutions enjoy more so than any of the other players, according to the paper, and they have a birthright in their ability to navigate compliance, which is creeping into areas like BNPL that formerly faced few official rules. For many, however, finding ways to go narrow and focused will be the way to succeed, the paper implies, because they can never get to the other end of the barbell.