Specialized financial technology companies, known as fintechs, are continually creating new marketplace innovations to compete with banks for business.
Fintech can broadly refer to any innovative tool or new technology used to operate or deliver financial services. The fintech industry is most active in retail banking, fund transfers and payments, according to an online article, “The Fintech Boom and Bank Innovation,” published by Forbes in December 2015.
The industry is nearly as advanced in trading, lending, asset management, insurance, currency exchange and other functions, the article said.
Not coincidentally, fintech companies are enjoying a financial boom. From 2014 to 2015, start-up funding doubled to more than $12 billion, according to the March 2016 Global Fintech Report, published by PwC a worldwide professional services network.
Customer demand
Fintech’s rise is driven by customer demand, as consumers look to their financial providers for the same smooth engagement they enjoy in their daily online transactions with social, commercial, entertainment and informational content.
Many fintech company officials believe they are uniquely positioned to meet these new customer expectations. As evidence, they point to some significant differences between their industry and traditional banking:
- Banks shouldered big financial burdens after the recession of 2008, and regulatory penalties and ongoing new rules are forcing them to shift significant resources to risk management and compliance. That has left less money for technical innovation, an area in which banks already lagged behind many other industries, according to the Forbes article.
- A steady drop in the cost of technology innovation has lowered barriers to entry into the financial services marketplace. Fintech companies work within their core competency (unlike a bank running its own IT). And since most fintech companies were started after 2008, they never encountered its consequent financial burden.
- Fintechs, in general, are governed by laxer regulations than banks. Some online lenders, for example, face lower capital requirements than a brick-and-mortar bank, and consequently can earn higher returns.
The good news for banks may be that fintechs aren’t threatening the core of banking: deposits. Nothing has yet replaced or seriously undermined the confidence level implicit in an FDIC-insured institution, and even most fintech startups tend to keep their money there.
“Banks have spent years gaining something valuable that fintechs don’t have: trust,” said Bianca Lopes, vice-president of the identity-authentication firm Bioconnect. For her, that spells not the end of traditional banking, as some fintech proponents predict, but an era of partnership in which each leverages the strengths of the other.
And in matters of technology, banks are still players. Even though they may be lagging behind fintech companies in some areas, they are capable of creating and deploying innovative technologies.
Either way, banks can expect the present fintech upheavals to increase sharply in the coming years. By 2020, fintech companies likely will compete for up to 28% of banks’ retail, transfer and payments trade, as well as for some 22% of their insurance and wealth management business, according to the PwC March survey.
Innovative technologies are transforming insurance and investment activity as well. In both, data analytics software helps firms understand their customers’ behavior and needs more precisely. Then they can tailor policies and products ever more closely to individuals. Technology is facilitating automatic investing, wider lending opportunities (e.g. crowdfunding), and access to investment classes, like commercial real estate, formerly closed to individuals, according to the PwC survey.
The foundation of fintech today is “customer centricity,” according to the PwC survey. While just over half of the bank executives surveyed believe their institutions to be fully customer-centric, more than 80% of fintech respondents are confident their companies are.
Leading trends identified in PwC’s survey include:
• Banks must streamline operations to provide a better customer experience, accelerating a shift from physical banking to online interactions and mobile banking. Software-as-a-service, or SaaS, and application program interfaces will be central to this, helping please customers without heavy investment in technology research and development.
• In mobile fund transfers and payments, the technical priorities will remain speed, ease of use and security.
• Data analytics is driving the major changes in both insurance and investing, by permitting much more accurate risk assessment. Wealth and asset managers, meanwhile, are using analytics to open a long-sought path to profitability with lower-asset customers.
• Another coming trend is blockchain technology. Essentially a platform for a secure and distributed ledger that shares databases among multiple organizations, without the delay of third-party validation or resolution, blockchain promises automated transactions and contracts, major back-office savings, and a new level of transparency to satisfy regulators. Acquaintance with blockchain, however, is in the early stage in the financial services industry.
Choices for banks
Financial institutions are facing some tough choices with regards to financial technology. Should a bank build a stronger in-house IT staff to develop technology? Should it acquire an existing fintech company? Could it partner with a fintech? And if banks choose to partner with fintechs, how can they do so successfully?
John Schaub manages fintech integration for Central 1, a credit union that serves members across Canada. He maintains an ongoing inventory of fintech players and any bank history with them.
“When one appears interesting from a business perspective, we begin discussions and a technical evaluation,” Schaub said. He said usually the credit union begins a discussion with a fintech when it sees a new service or product it wants to offer but can’t do so in a cost-efficient way.
“You have to look closely at any startup,” he said. “Are they a credible company, or a couple of guys in a garage? What are their expenses, legal history? That can be a danger zone, and you have to eliminate the chaff.”
In other cases, Schaub said a perfectly good fintech “might not be able to pass a traditional due diligence process due to their small size or relative immaturity.” He advised banks to hire employees with startup experience, who’ll be better able to assess a prospective partner.
In Schaub’s view, banking fintech may follow a course similar to Amazon, which neither makes nor sells its own products but rather brings it to a massive customer base. “Banks bring a trusted relationship while a vendor provides a platform” for seamless transactions, he said.
Freelance writer Steve Marshall contributed to the writing and research of this article.
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