By Stephen Ptohopoulos ACIB, CCBI*
Disclaimer: Views and opinions expressed are those of the author and are not necessarily those of his employer.
What is a fintech? Let’s start with a working definition.
‘A business that aims at providing financial services by making use of software and modern technology’ (FinTech Weekly)
It could be argued that incumbent banks were an earlier generation of fintechs. In the 1960s and 1970s they adopted new technology – mainframe computers – developing electronic data processing (EDP) capabilities and there was subsequent technological innovation in the industry, most notably the Automated Teller Machine (ATM).
The ‘present’ generation of fintechs has its origins, and was in response to, the financial crash of 2007-2008. The financial crash culminated in an erosion of trust of general publics in banks and other financial intermediaries, as well as a sentiment that the financial system had become morally (and financially) bankrupt. Crucially, it also saw the emergence of a new breed of mostly young, tech-savvy entrepreneurs, launching innovative, digital financial services. Fintech is about providing a better product at a lower cost.
It is no coincidence that fintechs emerged at the same time as the latest demographic cohorts, namely Generation Y (‘Millennials’) and Generation Z (‘Zoomers’) were coming of age and constitute a growing percentage share of the workforce and overall population. While not wishing to make sweeping generalisations, it is probably fair to stay that these cohorts, aside from being ‘digital natives’, typically have different socio-economic and educational profiles, different work and career aspirations, have different lifestyle and consumption behaviours and have different political and ethical values (including their concerns about ecological, environmental and sustainability issues) when compared to older generations.
As implied in their name, technology has been the key enabler for fintechs. There were many enablers related to the technological environment: the world wide web and the internet; more reliable and higher data transmission speeds (4G / 5G); the falling cost of distributed computing power and data storage (e.g. the ‘cloud’); widespread usage of digital mobile handheld devices connected to the internet; ‘tools’ that make it possible for different IT systems to ‘talk’ to each other (APIs); apps and chatbots; machine learning and artificial intelligence (AI), etc.
‘push’ factors (why customers are unhappy with incumbent banks)
- The ‘hassle’ factor
- Impersonal (‘one size fits all’) service
- Often in the dark about how products work
‘pull’ factors (reasons why fintechs are appealing to customers)
- Convenience (any time, any place, using a smartphone or any other digital advice connected to the internet)
- Superior user experience (U/X)
- Personalised service, with products tailored to the profile of the customer
- Connected to customer’s digital lifestyle
- Greater transparency (in terms of pricing, how the product works)
- Purpose-driven, with values that resonate with the customer
Typical strengths of fintechs
- Entrepreneurial mind-set
- Have a digital core
- Focus on customer needs
- An iterative process of constant innovation
Typical weaknesses of fintechs
- Limited start-up capital; difficult to access/raise capital to finance growth/expansion
- Not able to ‘monetise’ traffic / transactions routed to them, do not generate cash-flow / revenues; not profitable / loss making
- Limited brand recognition (although there are fintechs that have managed to build ‘cool’ consumer brands)
- No customer base
- Lack of critical scale
- Question marks about their business models; no track record (over a full economic/business cycle)
- Not licensed / regulated (although there are fintechs / digital banks that have obtained banking licences)
It is apparent that the strengths of the fintechs generally correspond to the weaknesses of incumbent banks and the weaknesses of the fintechs generally correspond to the strengths of incumbent banks.
Fintechs are niche players, tending to focus on one component, doing one thing really well (e.g. payments, customer KYC/AML on-boarding) in what amounts to the ‘un-bundling’ of banking services, addressing ‘pain points’ in the customer journey. It has been said that fintechs typically are providers of a single, best in class product, whereas in contrast incumbent banks typically are providers of a complete range of average and (mostly) proprietary bank assurance and other financial products.
Another important way fintechs differ from incumbent banks is their business models. Whereas an incumbent bank generated profit essentially from maturity transformation, with interest payable on advances exceeding the interest paid on deposits, fintechs employ different ways to make profits. These could include the monetisation of data, earning fees for making connections by acting in a broker/intermediary role, advertising, subscriptions, etc.
In the early days, with the experience of the financial crash still fresh in people’s minds, coupled with a build-up of excessive hype and unrealistic expectations about the potential of fintech, there was a view expressed in some circles that the incumbent banks had no future and would be replaced by fintechs. This clearly did not happen, albeit that the fintechs continue to be a threat to the incumbent banks with the latter seeing many parts of their business being disrupted by the former. The incumbent banks considered which strategic methods – organic development/in-house innovation, mergers and acquisitions (M&A) or strategic alliances – to pursue in order to respond to the threat from fintechs.
There are many examples of incumbent banks acquiring fintechs. Over time the incumbent bank-fintech relationship has evolved and matured. Nowadays, incumbent banks are more often eyeing fintechs as potential partners (albeit at the same time competitors), forging collaborations that are well described by the term ‘coopetition’. This is the result of the realisation that often the respective parties stand to gain more by working together whereby each party’s strength is complemented by those of the other party, to produce a ‘win-win’ outcome.
Examples of the benefits of such collaborations from the perspective of an incumbent bank could be:
- Access and ability to deploy new technology
- Faster product development and ‘product to market’ time cycles
- New products
- Market development
- Improve customer service
- Outsource (and thus ‘turbo-charge’) innovation
Fintechs have helped incumbent banks in other ways too, such as automating and digitising routine operations or transactions, enabling incumbent banks to outsource non-core activities and in the process reduce their operating costs.
While the merits of such collaborations may seem compelling, success is not assured. From the perspective of the incumbent banks there are challenges and risks which need to be assessed, such as:
- Vendor management
- Culture clash: analogue (incumbent bank) – digital (fintech)
- Strategic ‘lock-in’ to vendor technology
- Ownership of the customer-facing interface
- Risk of forward integration
- Due diligence of the fintech
- Cybersecurity and data protection
- Liability of the incumbent bank to its customers due to misconduct on the part of the fintech partner
The fintech landscape
The categories/classifications used below are arbitrary; the list is not exhaustive. Note also that there are no standard or industry definitions of the terms used below and the boundaries as time goes by are becoming even more blurred.
- Payments and remittances. This includes ‘peer-to-peer’ (P2P) and mobile payments.
- PayPal, Apple Pay, Android Pay, Samsung Pay, TransferWise, Venmo, Klarna, Square, ripple
The revised Payment Services Directive (PSD2) recognises the role of fintechs in the modern payments landscape. PSD2 opened up the market to Third Party Payment Service Providers (TPPs), which can be Payment Initiation Service Providers (PISPs) and/or Account Information Service Providers (AISPs).
- Digital Banks. Confusingly, they may also be referred to as digital-first banks, neobanks or challenger banks.
- Revolut, Monzo, N26
Here we could also include providers (‘utilities’) of infra-structure to non-financial firms, enabling the latter to offer financial services to their customers i.e. Banking-as-a-Service (BaaS). An example of an infra-structure / BaaS provider is Starling Bank.
- Fintechs that provide technology solutions to digitise and/or address pain points with respect to regulatory data and reporting (RegTech)
- Fintechs that provide technology solutions to digitise and/or address pain points with respect to the insurance industry (InsureTech)
- Alternative finance. Here we could include ‘peer-to-peer’ (P2P) lending
- Zopa, Lending Club, OakNorth
- Fintechs related to wealth management and investments (Robo-advisors and personal finance)
Fintechs emerged from changes in the external operating environment. A strategic position analysis by incumbent banks should not be confined to the ‘industry’ level (their peers / direct competitors), not least because benchmarks in customer service levels are now being set and defined by new entrants and providers of new products outside the traditional industry. Engaging with fintechs has resulted in users / customers having higher expectations of service providers, including incumbent banks. Incumbent banks face threats of their business being disrupted. By addressing their weaknesses, exploiting their strengths and given industry barriers to entry (e.g. licensing) incumbent banks should be in a position to respond and defend their customer franchise.
*A knowledge worker with analytical capabilities, Stephen follows developments in topics including the digital economy, digital banking, DeFi (decentralised finance) distributed ledger technologies and Blockchains; finance and economics; international trade finance and supply chain finance; the political economy and international relations. Stephen is an Associate member of the London Institute of Banking & Finance; holder of the Certificate in Bank Strategy, Operations and Technology professional qualification (and Certificated member) of the Chartered Banker Institute