Inside the Disruption and the Challenges of the Fintech Revolution

In this episode of the Banking Transformed podcast, The Financial Brand’s Jim Marous sits down with Matt Harris, a leading investor and thought leader in the fintech space and a partner at Bain Capital Ventures.

As traditional banks, neobanks and fintech firms navigate an increasingly complex and competitive landscape, Harris offers a unique perspective on the future of the financial ecosystem, drawing on his deep industry knowledge and keen eye for disruptive technologies and innovative business models. Here’s the edited Q&A.

Key Takeaways:

Regulators are creating most significant disruption in the fintech ecosystem, particularly for the sponsor bank and banking-as-a-service (BaaS) model. Sponsor banks will need to be much more sophisticated and have their own technology platforms to satisfy regulatory scrutiny.

Neobanks like Nubank and Revolut are showing a path forward by obtaining banking licenses, which allows them to leverage their customer data and advantage of owning the customer’s direct deposit account (DDA) to offer lending products more effectively.

Generative AI is being used by a new crop of technology companies to help banks with digital transformation, particularly in areas like chatbots and customer service. However, the long-term implications of customers having access to generative AI could pose an existential threat to retail banks.

Stablecoins are growing quickly and being used primarily by consumers outside the U.S. who want easy access to U.S. dollar-denominated instruments. The introduction of yielding stablecoins by BlackRock and the potential for more tokenized real-world assets could make crypto wallets more appealing than traditional bank accounts in the coming years.

Q: How are regulatory changes impacting the Fintech ecosystem and the relationship between traditional banks and non-traditional organizations?

Matt Harris: The thing that’s causing the most waves right now, frankly, is the regulators. We had evolved to this architecture where you had fintechs doing their thing. You had sponsor banks of various types underneath who were actually bearing the regulatory burden and holding the cash — things that only banks can really do.

And then you had these middleware companies that are generically kind of known as banking as a service companies (BaaS).

That architecture, which underpins much of the payments, lending and banking innovation that we’ve seen, has now been called into question by regulators and is being litigated as we speak.

Q: Where do you see this evolving and how will it impact other areas beyond the sponsor bank and BaaS realm?

Harris: I think where this ends, Jim, is with a bunch of much more capable banks providing sponsor bank services. So, this idea that you can have kind of an unsophisticated sponsor bank that basically just has a regulatory license and all the work being done by a Synapse-type middleware company is gone.

If you’re going to be in the business of underpinning a Chime, or a MoneyLion, or a Dave, or frankly even a payments company, not a sort of retail banking company, you need to be sophisticated, you need to have your own technology platform.

And when the regulators come in and ask you, you need answers. You can’t say, “Well, let me get Synapse on the phone.” It has to be, “Oh, the transaction you’re worried about, that took place in Seattle at 5:24 at the gun shop”

“Yeah, we can look at that. Yep. That owner was of the appropriate age and we authorized that transaction. Here’s why:” Not, “We’ll get back to you.”

The Neobank Challenge: Profitability, Scale and the Path Forward

Q: What are the key challenges facing neobanks today in achieving profitability and scale?

Harris: One question that you ask is how the neobanks end up in the situation they’re in. One reason is that there was very undisciplined funding. And you can look to venture capitalists, of course, for this. But during the period of zero interest rates, when you had this incredible buoyancy around everything to do with technology, there were billions of dollars deployed into neobanks without a lot of questions being asked and answered about the fundamental business model.

That was true in many sectors of technology. So, we can’t just pick on fintech or neobanks, but it was certainly true in neobanks. What that meant was that customer acquisition costs skyrocketed because dozens and dozens of entities were being funded to compete with each other to acquire customers. Obviously, that increased the cost for those customers.

Q: How can neobanks overcome these challenges and position themselves for long-term success in the competitive financial services landscape?

Harris: To me, that points to the future, which is looking at what Nubank has done, looking at what Revolut has done, getting a banking license, buying one, applying for one and putting those deposits to work in lending products with the unfair advantage of having already acquired the customer, having all the data that comes from owning their DDA. Leverage that unfair advantage to actually serve them with the lending products they need.

Generative AI: The Game-Changer for Financial Services

Q: What are you seeing that’s interesting right now in the Fintech and venture capital space, particularly when it comes to the potential of generative AI?

Harris: The most important theme right now is the implications of generative AI for financial services and, not least of all, retail banking. What’s being funded right now are basically vendors. So, this new crop of technology companies is springing up to serve banks and financial institutions more generally and help them with digital transformation as it relates to generative AI.

So, you could think of chatbot companies as being probably the most advanced wedge on this and customer service generally as a way to introduce generative AI, lower OpEx and create more customer delight.

So, that’s where a lot of the energy is. My view is that generative AI is an existential threat to retail banks in the long run or even the medium run. In the short term, they can use it to lower costs here and there. But the question I always pose to banking industry leaders and CEOs of banks is, what are you going to do when all your customers have generative AI?

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Q: How do you see financial institutions adapting to this new reality, where their customers have access to powerful AI tools that could disintermediate traditional banking relationships?

Harris: The thing that excites me most right now is crypto, which is a very contrarian position to take. But the innovations I’m seeing are, again, mainly benefiting consumers outside the United States, where it’s a true democratization of cutting-edge financial services that could be delivered at this incredibly low cost, low latency and low friction to anyone, anywhere.

That’s why I got into fintech in the first place, Jim, going back to the late ’90s. I just felt that all this friction, extra expense and bureaucracy were getting in the way of providing this vital service to the people who needed it most. And there’ve been many attempts to serve the underbanked with prepaid cards. I mean, none of it worked.

And I finally see in crypto, (and it’s funny that it’s happening first in Nigeria and not in Manhattan) real solutions that are much lower cost and much higher efficacy and better financial outcomes for people who really need it.

The Rise of Embedded Finance: Disrupting Small Business and Consumer Banking

Q: How has embedded finance evolved in recent years and what impact is it having on small businesses and consumers?

Harris: Well, I think where embedded finance has taken hold most dramatically is in the small business category. And there it’s been very dramatic. I mean, if you consider vertical by vertical, look at restaurants and e-commerce sellers. Obviously, there is massive penetration of companies like Toast and Shopify, where 70-plus percent of their base accepts their payments through the software company in question.

But the same is true across, we have a company that’s in auto repair and they have a practice management software. And if you’re using AutoLeap to run your auto repair shop, you’re going to use them to take payments.

They’re started at 10%, then they’re at 30% and they will end at nearly a 100% penetration of the auto repair shop saying no to the brick on the counter and instead taking payments acceptance through the practice management software.

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Tokenization and Stablecoins: Democratizing Access to Financial Services

Q: What role do you see tokenization and stablecoins playing in the future of financial services, particularly in underserved markets?

Harris: Stablecoins are the first real innovation that banks should pay attention to because they’re growing very quickly. In the first case, they’re being used mainly by consumers outside of the United States, who for the first time have an easy-to-access US dollar-denominated instrument.

So, if you’re in Venezuela or in Argentina or in Nigeria and you can use a crypto wallet, which right now, just has Bitcoin, Ethereum, whatever and you can add USDC and start keeping your savings in dollars in a very easy, very liquid way, that’s been a very interesting technology for people outside the US.

Now that BlackRock has introduced a yielding stablecoin, which is really a money market fund but much easier to get in and out of and you can, again, keep it in a crypto wallet, you can start to see where wallets that keep tokenized assets become very appealing compared to a bank account.

You can hold the assets yourself versus having some counterparty risk with the bank. You can also always get a fed funds rate with instruments that are also spendable.

Q: How can traditional financial institutions adapt to the rise of tokenized assets and stablecoins and what opportunities exist for collaboration with fintechs in this space?

Harris: And then as we introduce more real-world assets that are tokenized beyond just money market funds and US dollars, instruments that are more interesting, higher-yielding instruments, maybe even equity-like instruments, I think the future of financial services for consumers over the next 5 and 10 years will include these tokenized assets and savings instruments. And so, now, I think banks must start paying attention to tokenized assets. Maybe not tomorrow, but over the next five years.

The Future of Fintech and the Transformation of Financial Services

Q: As the financial services industry undergoes a profound transformation driven by technological innovation, changing consumer expectations and evolving regulatory frameworks, what advice would you give to financial institutions looking to thrive in this new landscape?

Harris: The successful financial institutions of tomorrow will be those that can harness the power of emerging technologies, put customer needs at the center of their strategies and build agile, resilient organizations capable of thriving in a constantly shifting landscape.

By staying attuned to the trends shaping the industry and being willing to challenge traditional models and assumptions, banks and fintechs alike can position themselves to not only survive but thrive in the exciting and transformative years ahead.

Q: Which players do you see as best positioned to capitalize on the embedded finance opportunity and what challenges do traditional banks face in this space?

Harris: One of the things I mentioned, but I almost mention in every podcast, so I’ll mention here, is what you can do at speed and scale. One-year implementations are no longer valid. You need to get implementations in a three-month, two-month and a one-month process.

Break things down.

You have the ability to do that and work with partners such as Quinte because you can’t do it yourself. Work with the specialists that are out there in the marketplace to help and then move forward at speed.

Justin Estes is an award-winning writer, strategist, and financial marketing expert with expertise in banking, investments, and fintech. His clients include the NYSE, Franklin Templeton, Credit Karma, Citi and, UBS, and his work has appeared in Forbes, Barrons and ThinkAdvisor as well as The Financial Brand.