This article is one of three posted regarding partnering and otherwise working with fintechs. You can find links to the others at the bottom of this article.—Steve Cocheo, executive editor and digital content manager
Today, analysts expect fintech startups to disrupt 25%-30% of the banking value chain. That statistic is pretty exciting for startups, but obviously gloomy for traditional banks.
The development and expansion of “alternative” financial services providers and blockchain disruptors has already had a huge impact on financial services. Consumer behavior and loyalty have been shifting away from long-term relationships to ones that favor immediacy, autonomy, and lower costs.
For financial institutions, the question has shifted. “Will the disruptions that we are witnessing today transform banking and capital markets?” has turned into ‘’When will we hit an inflection point?”
The banking industry has experienced a broad move away from institution-centric to individual-centric models. More than ever, fintech start-ups have been forcibly unbundling banking services and essentially breaking up banks’ key activities. The start-ups can deliver those individual services better and more cheaply than banks.
Thousands of startups are disrupting the distribution and the experience, providing services that put the consumer first, leaving established players flat-footed.
New industry leaders are providing new models, and in some cases delivering end-to-end financial services across lending and payments, especially in the areas of mobile and cross-border exchange. To me, they have proven that it’s not possible for banks to survive this transformation on their own.
Making partnering work takes work
But new challenges present new opportunities, and there is no shortage of buzz around fintech companies and banks collaborating. The excitement makes sense because, on paper, fintech providers and traditional financial institutions have complementary strengths and weaknesses in terms of size, speed, regulation, and access to funding.
While the idea can often seem like a match made in heaven, there are several factors fintech companies and banks should think about before partnering.
Some analysts have recommended that banks would be smart to work with fintech startups while at the same time searching separately for ways to compete against them.
That’s a delicate balance. Such a strategy requires banks to think like tech companies—which for most financial institutions simply won't be possible and will further accelerate the drive to partner for innovation.
Though the upstarts are much smaller, their ability to use new technology, such as machine learning and big data, is seen as a longer-term threat (and opportunity) by the big banks.
Increased regulatory scrutiny may be the catalyst that drives banking and fintech together. The tenfold increase in regulatory oversight over the past three years comes at a significant cost that may be more than a startup company can bear without a larger partner.
[Editor’s note: The Comptroller’s Office recently stated that the “fintech charter” under consideration at the agency would not indicate a lighter degree of regulation. Read “OCC’s ‘responsible innovation’ effort moves forward”]
No matter the underlying motivations, over the long run the concept of extended partnerships will prevail. Despite the significant hurdles to overcome in the early days, where there is an increasing reliance on a network of partners, service providers, and industry utilities, this model will become more common across the industry over the next decade.
To make these relationships work, banks will need to develop alternate contracting and partnering models. Working with a technology firm as an equal partner is fundamentally different than today’s traditional relationships with outsourced service providers or IT vendors.
Blockchain and the changing landscape
Across the banking industry, particularly the payment ecosystem, financial services will look vastly different as a result of continuing technological advances across multiple domains. Blockchain innovations could be the most transformative factor, and the industry will likely see a number of real-life applications of blockchain applied to payments, beyond digital currencies, in the next five years.
Private, permissioned chains among a finite set of counterparties and clients could become common, with payment processors and the large banks owning and operating possibly multiple private chains to facilitate a range of payments.
A master-private chain (a “blockchain-of-blockchains”), much like the Automated Clearing House network, is a likely scenario. But its time may be further down the road, given the complexity of establishing such an infrastructure.
These new financial technology currents and partnerships are changing the way services are delivered to customers, and expanding the boundaries of risk for institutions. They are also opening up new avenues to connect with an existing client base.
That isn’t to say that all the current players will survive by partnering. Markets are efficient. Increased choice for consumers will create winners and losers. There will be many casualties, in both banking and fintech.
No matter what, the traditional financial institutions that survive will need to become more agile and more responsive—not their usual strengths.
Similarly, alternative providers will need to deal with increased regulation, and find a way to scale to obtain access to capital and customers.
Innovation can overtake innovation
What is clear is that the next generation of financial services is being developed now, regardless of whether large financial institutions are ready for them. With the pace of technological change moving from linear to exponential, institutions will either innovate or die.
A nugget for thought: Kodak created the modern imaging business on a history of technological firsts, which took the company to more than 140,000 employees. The company then ignored the dawn of digital photography and went bust.
By comparison, Instagram had just 14 employees when it was bought for $1 billion by Facebook
The stakes are high, the risks are significant, but the opportunity is huge.
About the author
Hugh Cumming is Chief Technology Officer at D+H.