Divining fintech’s future calls for separating a lot of cool, wow, new, and, frankly, hubris about digital finance from what’s really going on in the present and what is likely going to happen. Fintech players often bash banks for being stodgy and behind, though there’s increasing talk about partnerships, joint ventures, and acquisitions.
But what is realistic? All players in every camp can give convincing presentations—making a seven-minute case for your app or website is a basic of fintech meetings. You can come away from every speaker thinking “hey, they’ve got ‘it’.” Until you hear the next one. Venture capital and other aggressive investors will give newcomers lots of money—to burn or perhaps to launch a rocket. We’ll see.
That’s private capital. But when it comes to the stock markets, is fintech a starter? What is its long game? On the flip side, does banking have a future in the face of often-amazing fintech?
This fall Keefe, Bruyette & Woods published FinTech Revolution: When The Wind Of Change Blows, Some Build Walls & Others Build Windmills. The fat report was put together by a large team of analysts whose specialties included public companies in multiple financial product areas and in multiple forms of fintech as well. The idea of the group approach was to assemble the firm’s experts in each area to come up with a combined viewpoint on how stock investors should play the fintech movement.
Not dead, but not immortal
The conclusion of the KBW team is that it is not too late for traditional players to be part of the evolution of financial services, that they are not immediately approaching dinosaur status. Further, how much that future will look like which side of the evolution—banking or fintech—remains to be seen. From the report’s summary:
“Will incumbents be distintermediated? Our view is that venture capital-backed startups and established companies that are committed to long-term strategies and acknowledge the potential (and risks) associated with technology can succeed together rather than a binary outcome where only one succeeds and the other fails. Together, through partnerships, acquisitions, or direct investments, both parties can benefit as synergies such as enhanced distribution channels, capital, and veteran industry experience can be combined with fresh, innovative creative thinking along with new capabilities and technologies.”
Banking Exchange interviewed KBW’s Tai DiMaio, assistant vice-president, who specializes in card and payments companies. DiMaio served as lead author of the firm’s special report, pulling all the expertise together. The heavily researched project has some comfort for traditional bankers in that it takes a balanced look at fintech as it has played out so far—chiefly looking at the consumer financial services side.
“Banks have a significant distribution platform,” says DiMaio. “They have a lot of excess capital—arguably that may be trapped. But they do have the ability to go on the offensive in M&A.”
So long as banks see and act on the change that’s out there, the situation isn’t as dire as some would have banks believe.
“This situation is not analogous to Uber and its impact on the traditional taxi and limousine industry,” says DiMaio.
Piercing the typical fintech enthusiasm, KBW notes four factors that it said should underlie any assessment of fintech today:
• Look beyond the wow. Overall market share of most new players is generally small.
• Don’t discount inertia. Consumers are creatures of habit, and just because a new product comes out doesn’t mean it will gain traction.
• Don’t ignore experience, or its absence. Fintech startups often lack experience in two key areas: They haven’t been through a business cycle yet, and many of these players don’t know bank regulation. (Who knew compliance could be a competitive edge?)
• Don’t start the count on banks yet. Incumbent players haven’t been asleep, but have taken notice and some have invested in fintech themselves.
“We’re saying in our report that it’s not ‘Game Over’ yet,” says DiMaio, “because now you’re starting to see banks discussing fintech.”
CEOs are talking about it—and not scoffing. “You don’t see executives discussing market share and saying these new startups don’t have any,” says DiMaio. “There is acknowledgement that these new technologies can be leveraged and integrated into the banking industry. Now there are aggressive discussions about how fintech can be harnessed, instead of the sort of defensive mannerisms that had been going around.”
KBW believes it is important to see that pending fintech evolution affects more than strictly banking’s part of financial services.
“This is not just a banking phenomenon,” says DiMaio.
Consumer insurance, such as property and casualty coverage, and investment advisory services, now being disrupted by robo-advisor companies, are also part of the report’s scope, as is e-commerce.
Quick start, slowing in the stretch
DiMaio says KBW believes time is finite for the traditional players. “We don’t argue that there’s obviously significant change coming down the pike for financial services players,” says DiMaio. The report makes the point that this has been going on, albeit at slower speed, since financial services companies first ventured onto the internet.
In the firm’s view, fintech managed to gain its lead over the traditional players because of a confluence of events, notably rapidly improving and expanding technology and the aftermath of the financial crisis, including its many regulatory ramifications.
Indeed, KBW’s report makes an interesting point about bank branches, where the population peaked in 2012.
“During the financial crisis,” the report states, “many institutions found that having a physical presence helped solidify the perception of financial strength as well as client reassurance. Banks made investments in branch infrastructure despite the trends in smartphone development … ”
“Fintech was really able to explode” during the post-crisis period, when many banking leaders were preoccupied, says DiMaio. “You saw the niche players take up certain spots of the industry, such as consumer lending, where they targeted some traditionally high return areas from banks. Now you are seeing banks take notice.”
Obsolescence is a risk, DiMaio says, but only if banks do nothing about fintech and allow themselves to be turned into a utility that does little more than deposit safekeeping.
Because of the combination of tech advantage and post-crisis distraction, many startups had great traction out of the gate but that hasn’t continued, says DiMaio.
“They are starting to hit walls of growth and they need to push for greater distribution,” he explains. “They are starting to draw regulatory scrutiny. And this is where you start looking at traditional banking’s advantages. They have the pre-existing distribution platform. They have regulatory know-how. And they’ve been through multiple business cycles.”
Those who would write the banking industry’s obituary with a wide brush don’t distinguish between the various sectors of financial services. DiMaio and the report point out that different sectors have been reacting differently to the current trends.
“Look at the cards and payments industry,” says DiMaio of his own specialty. “The established players are actually very much involved with the way that startups are interacting in their space. They do a lot of partnerships and they operate many innovation labs. They are doing a lot of technology investment themselves, to make sure that the way the industry evolves is favorable to them, or at least to be in touch with what’s going on.”
DiMaio points to lack of wide acceptance in his own specialty to illustrate the point that there is time to catch up. Mobile payments have been in financial headlines since 2010, he says, yet it’s only recently that Apple Pay and more-recent competitors have launched.
“We haven’t seen the traction there,” says DiMaio. “It’s probably going to take a generational change, where it will take five to ten years to become mainstream.”
EMV adoption in this country, while not precisely a fintech play but more an anti-fraud initiative, has a good lesson to teach, DiMaio suggests. Many merchants have yet to make their move to EMV-compatible terminals. While there is clearly a beneficial impact on fraud, as seen in Europe, DiMaio says many merchants dealing in low-ticket business have not yet seen the benefit of the tradeoff in slower speed at point of sale versus the liability shift. Two such examples are fast-food restaurants and convenience stores. “Their fraud risk is relatively low,” says DiMaio, hence the lack of urgency. But he believes adoption will come in time.
Banks that embrace fintech
KBW’s report devotes an entire chapter to fintech-focused banks. A notable point made here is that fintech disruption could wind up being a positive for banking in the long term, a catalyst for change.
States the report: “The intersection of technology and banking is not a new theme: technological development has been improving banking since the days of papyrus. What makes this wave of innovation different is the fact that it directly disrupts the relationships between banks and their customers, putting the onus on banks to adapt and react.”
The report says that the most forward-thinking banks have been using fintech methods to improve the customer experience and to get a jump ahead of other institutions. This chapter specifically cites four companies that KBW follows—and which it rates as “outperform” stocks: BofI Holding, EverBank Financial, Live Oak Bancshares, and SVB Financial Group.
The list—and other banks are cited in the report as well—doesn’t include the very largest players such as Wells Fargo and JPMorganChase because, according to DiMaio, the analysts wanted to concentrate on more-typical banks. The largest banks have been very active in fintech strategies, directly or through purchases or partnerships, he explains.
“We were trying discuss banks that are trying to do something while they don’t have the sorts of resources that the top 25 banks do,” says DiMaio.
Two themes explored by the report are branchless banking and white-label banking. The latter entails banks that make money by providing services behind the scenes for fintech players such as marketplace lenders and bank card operators.
The report cites SVB Financial, parent of Silicon Valley Bank, as “the largest U.S. bank exclusively focused on the technology and innovation industries.” The report points out that the bank has “embraced financial technology as a key business driver from many angles.” Among these are its participation in a startup incubator lab, but most of all, the bank’s business model and clientele. Silicon Valley Bank serves the venture capital and private equity firms, and the firms those companies have invested in.
Spread income will still dominate
An important point to relate from the report is KBW’s belief that even as more fintech evolution takes place, banks will continue to be banks. Fintech startups will have their growing pains, DiMaio says, and will increasingly work with traditional banks.
“We think that banks that find the right combination can use the technology to either gain more customers or solidify their existence,” says DiMaio.
However, banks won’t become a different category of company. “It’s not as if traditional banks are moving towards different kinds of revenue streams. They are probably going to end up repackaging how their traditional products are sold and provided,” says DiMaio. “At the end of the day, they still going to be spread-based businesses. They are just going to be leveraging technology to execute on that spread business.”
Something that sets many fintech players apart is their lack of transparency. Through tools as simple as the FDIC’s bank database, public company filings, and related records, analysts can learn a great deal about the nation’s banks at the touch of a keyboard. No comparable database exists where an analyst or investor can look up a nonbank fintech player’s results in terms of results or company performance. Only a comparable handful have gone public and that is only quite recently.
While some data providers have been attempting to build comparable information bases, “it’s a very opaque area,” says DiMaio. When dealing with venture capital and other private investment, that works because critical business information can be shared privately in exchange for potential funding.
“It really depends what your end game is,” says DiMaio of the fintech startups.
However, while things are far from “game over,” as DiMaio mentioned earlier, the report stresses that the clock is running:
“Are banks sleepy? Not necessarily. Historically, with bank technology related to infrastructure, there was not a first mover advantage to being an early adopter—it was better to be a quick follower, adopting the second generation of technology, with bugs worked out and enhancements added. The current, new wave of innovation is disrupting revenue streams and, in our opinion, there is value to being a first mover. But, engrained approaches do not change overnight.”