On Wednesday I attended a discussion on ‘Envisioning the Future of FinTech’ at the Google Campus, where fintech pioneers and traditional financial players came together to understand how the most promising FinTech technologies and startups will shape tomorrow.
Since 2008 a slew of startups have been busy raising billions of dollars in venture capital, and disrupting traditional financial services at the same time. In 2014, they attracted $12 billion of investment, adding to a pot of revenues that Goldman Sachs estimates is worth $4.7 trillion. From payments to wealth management, from peer-to-peer lending to crowdfunding, defiant t-shirt wearing prodigies are threatening to do what media streaming did to Blockbuster. In his annual letter to shareholders Jamie Dimon, JPMorgan Chase boss, warned: “Silicon Valley is coming”.
Fintech is clearly remodelling the various niches of finance. In short, digital disruptors are associated with mobile functionality, simplicity, big data, accessibility, agility, cloud computing, contextuality, and convenience. Online remittances startups for example are taking a machete to the hefty fees charged by banks. It’s now significantly less expensive, for example, to transfer money internationally through Azimo than through a local bank. It’s this ability of Fintech firms to specialise – and think narrow and deep – focusing on a singular issue, which allows them to push ahead of the an old guard constrained by existing product lines and silos. Clearly, the insurgents are teaching the banks a thing or two. Players like Kabbage hoover up information on the online world – ranging from social media reviews to usage of logistics firms – and spit out an assessment of a company’s performance. This new form of data-driven lending is providing a more nuanced and sophisticated assessment of risk than any credit score could offer.
To make things harder for the incumbents, banks of today face fundamental structural challenges that are difficult to shift. Take traditional lending, for example: the cost structure of a retail bank means that approximately half of operating costs are absorbed by branch costs. It has been estimated that for every £1 spent offering services to a customer, 60p is typically absorbed by back office spending geared to facilitating the service. Since 2008, regulators have stuffed the banks with capital and turned compliance from a back-office job into a corner-office one. By contrast, startups have no existing structure to change; so they can change everything. They also have flatter organisational structures with fewer barriers to change. This structure encourages not only innovation, but the ability to tear down and rebuild. Peer to peer lending platforms like Zopa, for example, are matching borrowers with savers and slashing lending costs to the point where legacy banks simply cannot compete.
Newcomers to the market might argue that the biggest difference between the old guard and the new is that whilst the banks focus on risk management, FinTechs focus on customers experience. The consequences of this are being felt profoundly. Buoyed by a lack of financial and emotional satisfaction from high street banking, punters are encouraged by new, sexier market entrants. And to make it worse for banks, few consumers who try these new services return to the fold. The average net promoter score (NPI) of Fintech companies – an index that measures the willingness of customers to recommend a company’s products or services – is massive 12 times higher than their traditional counterparts. FinTechs are matching the NPI’s of the likes of Amazon and Apple. This isn’t just a vanity metric – theoretically, it makes the economics of the service work more effectively. It drives a virtuous circle: a loyal and ever increasingly number of returning customers drive greater profits, thereby supporting lower profit margins per transaction; this in turn garners new followers which reinforces the base. And so the cycle is self-perpetuating.
All this is putting pressure on banks – in a bid to hold back the tide, many bank CEOs are ploughing their spare change into buying up newcomers to shore up their own future. But this isn’t yet a swan song for banks – not only do they have sheer scale on their side, they are inextricably woven into the very fabric of our financial landscape. These ingrained advantages means that they won’t be going anywhere any time soon. For one thing, although startups are growing fast, they are still tiny. Azimo, a leading online remittance company, has transferred millions since launching in 2012 but that in an overall market that is worth a total of half a trillion dollars. Peer to peer lender, Lending Club, has facilitated approximately $9 billion of loans since launching in 2007, but this compares to a $885 billion US credit-card debt market. While FinTechs deal in millions, banks do business in trillions.
What’s more, the ace card for banks remains the humble bank account: allowing us to keep money safe yet accessible. For the moment, no fintech product comes close to matching the convenience and security of a current account. Mobile banks – like Atom – which allow customers to open accounts and carry out all their banking activity from just their smartphone, are very much in their infancy. So for the moment, whatever FinTech service is being used, its more than likely that a user’s bank account along with the traditional banking payment infrastructure, will remain an indispensable element of the transaction.
Clearly these upstarts won’t be slaying the giants any time soon; but they are forcing a banking overhaul. Regulators are scrutinising new players; and their regulatory response will be an important element in whether David eventually trumps Goliath. Freedom, pace, energy, adaptability and optimism were the buzzwords of the discussion. In the meantime, incumbents are perceived as shackled by governance, outdated technology and organization, with a fixation on risk. This all makes innovation difficult for the legacy banks and that’s where the problem lies. Because quite simply, if they don’t innovate, they will be reduced to heavily regulated, barely profitable financial plumbing. Hardly an edifying position for our banking giants.
Photo Credit: Professional Advisor