The largest banks have approached the fintech arena equipped with venture operations armed with millions to invest in startups. Regional and community banks have generally been more hesitant to engage with fintech companies, as they can’t afford to throw around that kind of money. Besides having the dollars to invest, larger banks also have more staff and resources to help these startups develop and integrate their technologies with their own systems.
Yet smaller banks can’t ignore the fintech trend.
Tailor your thinking to your size
These institutions rely on legacy technology vendors and must tackle many of the same regulatory requirements as larger banks. This means they are poorly positioned to adapt to the rapid adoption of digital technologies that is a key attribute of fintech companies.
So banks that ignore opportunities to partner with fintech companies are only imperiling their own future, as they will lose customers to competitors that embrace this digital transformation of financial services, including larger banks that are actively acquiring fintech players.
Regional and community banks don’t have to sit through that storyline. They have a unique window of opportunity right now to build fintech partnerships. The fintech market is having a pause, while venture capital temporarily declines and valuations reboot to reflect more conservative expectations.
Fintech on hiatus
After multiple years of almost exponential growth, fintech investment fell sharply over the second half of 2015. Globally, venture capital-backed fintech companies received $4.9 billion in funding in the second quarter of last year, a study by KPMG and CB Insights found. That total fell to $4.7 billion in the third quarter of 2015, and then dive-bombed to $1.7 billion in the fourth.
This drop-off had little to do with trends in the fintech market. Rather it was the result of economic uncertainty driving investors to tighten purse strings across every segment of the venture capital market. Total global venture capital funding across all sectors slipped from $39 billion in the third quarter of last year to $27.7 billion in the fourth quarter, according to additional research by the KPMB and CB Insights.
Initial public offerings have also fallen off a cliff: The first three months of 2016 saw only eight IPOs in the U.S. across all sectors, compared to 34 during the same period in 2015, according to Renaissance Capital, which manages IPO-focused investment funds.
This lull in the fintech market won’t last forever.
The opportunity for disruption in financial services is simply too large for venture capital investors to turn their back on it for long.
Fintech companies now operate in almost every sector of financial services including payments, retail banking, capital markets, commercial lending, and insurance.
Each of these areas represents an opportunity for disruption worth potentially trillions of dollars to companies that can upend incumbents and their business models. But for as long as this respite lasts, fintech companies need to look for new avenues of growth.
That means banks have a window of opportunity to expand their fintech outreach and partnerships.
This opportunity has not been lost on nonbank players. Amazon, for one, is taking advantage of this interlude to build new bridges with the fintech community. Regional and community banks should also use this opportunity to collaborate with fintech companies.
How do you do it with shallow pockets?
These smaller banks might not have the cash that large banks and tech giants have to invest in fintech startups, but that doesn’t shut them out from the fintech sector. There are still less cash-intensive entryways into the fintech sector.
These banks can sponsor hackathons to find the best potential partners out of the constantly growing field of startups—the goal being mutually beneficial collaboration.
Larger banks run such hackathons to find opportunities to invest in and acquire startups. But smaller banks, with the smallest pockets, can still play. These institutions can offer resources besides cash to help startups grow, including co-working space to collaborate on projects.
Banks can also offer up access to some of their technology to help startups learn how to overcome the challenges of integrating their products with traditional financial institutions. They can also provide mentoring for startups, giving them opportunities to learn how to manage compliance and market their products.
Add to this an essential bankers don’t know: Smaller banks can also offer startups the thing they need most—the opportunity to test their products with real-world customers by launching a joint pilot program with a bank. If the pilot is successful, then both the bank and the startup have an incentive to expand their partnership.
Regional and community banks obviously aren’t approaching fintech investment in the same way as other venture capital investors. Banks want to develop solutions and partnerships that can benefit their business, not just turn a profit when a company is acquired or makes an IPO.
This mandates careful selection. They need to focus on reaching out to fintech companies that work in the business areas in which they want to grow.
For example, a bank that handles large volumes of international payments should be focused on partnering with alternative payments providers, and exploring how the blockchain could lower the costs of those transactions.
Another example: A bank that wants to grow its small business customer base should collaborate with companies that help these customers get credit more quickly.
In other words, fintech outreach must support an overall business agenda.
That means banks should actively support early-stage fintech companies that could further their business agenda.
A strategy not so far away from classic banking
Banks are in a much better position to provide support and mentorship for early-stage fintech companies than other angel investors. If these startups mature into successful companies, the banks that supported them win too. And at this early stage in the digital disruption of financial services, the next disruptive idea could still come from anywhere.
So it’s more imperative than ever for banks to grow roots in the fintech community and take advantage of this opportunity to find partners that can help them ensure their future success and growth.