Written by Ben Robinson | Temenos
Fintech has attracted a lot of attention, thanks in part to the enormous sums that have been sucked in from investors – over $100bn in the last three years, according to numbers from KPMG and CB Insights. Yet despite all the excitement and cash, and all the predictions that fintech companies would rout the traditional banks, fintechs have so far failed to take significant business from the incumbents: according to the Economist Intelligence Unit, fintech companies have grabbed just a 2% market share. Certainly, it is harder to disrupt financial services than many people envisaged. And banks retain many competitive advantages, as well as the ability to innovate. But to write off fintech would be premature.
The fintech revolution?
Banking is a massive industry, making massive profits; over $1 trillion annually according to McKinsey (see regional breakdown below).
It is also an industry where customer experience scores are low – fewer than 40% of retail customers would recommend their bank, according to Capgemini.
It is, therefore, an industry that should attract lots of new entrants keen to offer better customer service and lower prices and compete away those excess profits.
Historically, however, banking had very high barriers to entry: new entrants needed expensive IT installations, branch networks to distribute services, a banking licence – and few customers ever switched banks.
But when those entry barriers started to come down – as banking moved online, as IT systems and hardware became cheaper and rentable, as regulators lowered the requirements for banking licences – so new entrants did move into the industry.
Today, there are estimated to be between 5,000 and 20,000 fintech start-ups, offering a whole range of banking products and services.
But the impact on banks’ market share has so far been limited and bank leaders seem fairly sanguine about the threat. According to a further EIU report , commissioned by Temenos, fewer than 2% of banks in North America see fintech firms as a competitive threat. Mark Tluszcz, head of Mangrove Capital Partners, writing in the Financial Times in April 2016, said of fintech: “There has been very little innovation and nothing truly transformational.”
So, was the “revolution” just hype?
Fintech issues
For sure, becoming a successful fintech company is hard. The cost of acquiring customers is chief among the challenges: it takes a lot of money to get on the radar of time- and attention-poor consumers and even more to persuade them to change their banking habits. Conversely, only having a small number of products and services gives little opportunity to up- and cross-sell and so spread that high cost of acquisition across a lot of revenues. This is the challenge facing companies such as Lending Club (which spends $200 on average to acquire new customers) and roboadvisors, whose CAC is estimated to be around $300 on average (and who, see below, tend to have much lower customer account balances).
Furthermore, a lot of fintech business models are inherently fragile. Take marketplace lending: either the intermediary does not add much value (by just acting as an introducer, for example) or it takes risks for which it lacks the level of funding needed to do what banks do: provide depositors with instant liquidity and de minimis risk (which, incidentally, is why lenders such as Zopa are applying to become banks ).
Bank advantages
In addition, banks retain many advantages in the digital world. They continue to score much more highly on trust than fintech companies and many other potential competitors. They have the compliance know-how and banking licences. They have the customers. They have access to capital.
They also have data. One of the big themes at this year’s TCF conference is artificial intelligence. But, what many people overlook about AI is that, while the algorithms are important, it is the data that really counts. The best machine-learning AI will be the one that is given the largest data sets to learn on. And this, for now, hands banks another advantage.
Banks also still have the ability to innovate and re-invent themselves. As we will also discuss at the conference, one of the quickest and most successful ways for banks to transform themselves into digital banks is to start a new bank (free of legacy IT, processes, culture) to which they can migrate existing business over time. Temenos’ customers EQ Bank (from Equitable), Pepper (from Leumi) and BforBank (from Crédit Agricole) are all good examples of this approach.
Bank issues
But, it would be remiss not to point out that banks face issues of their own. Traditional banking cultures, for example, will struggle to adapt to a digital world in which the bank analyses, rather than locks down, customer information and one in which the bank potentially offers third-party products and services.
Also, more apt for the discussions at TCF, root-and-branch (front-to-back) renewal of legacy systems will be necessary if bank services are to be scaled to meet the demands of a digital world of instant information, personalised offers and micropayments.
Add the cultural to IT challenges and this explains why banks are typically so slow to innovate. To illustrate this, consider how on average Facebook issues two new versions of its platform every day and Google puts into production over 130 updates per day to its platform. At present rates of renewal, banks are putting into production a new version of their core banking software every 50 years.
Partnering
One obvious remedy to solve banks’ and fintech companies’ issues is for both parties to work together. Banks need access to greater levels of innovation while fintech companies need cheaper customer acquisition costs, compliance and capital.
One example of an excellent partnership lies in the collaboration between Commercial Bank of Africa, a Temenos customer, with M-Pesa to launch the M-Shwari mobile banking service. Launched in just 5 months, the service went from zero accounts to 26.2 million in five years across Kenya, Tanzania, Uganda and Rwanda. It is launching in Ivory Coast later this year.
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Banks are now starting to realise the synergies of partnering with fintech companies. In a survey by Capgemini, two-thirds of banks said they are now actively seeking partnerships. And this is why Temenos set up its MarketPlace, to provide a platform for banks and fintechs to transact with each other. And it is also why we hold the global Innovation Jam competition, to help our customers to find the most interesting fintech companies. The final of Innovation Jam will be live-streamed from Lisbon on 27th of April at 10.30 CET.
Too early to call time
If banks are not already considering fintech partnerships, they should be. The European Payment Services Directive 2 – or PSD2 - is likely to usher in a new era of Open Banking and is another hot topic at this year’s conference. It would be Canute-like not to see how Open Banking will bring about radical change. To our minds, PSD2 will do to banking what smartphones did to the taxi industry. Technology lowered barriers to entry, but it is regulation that will make banking truly online addressable.
Against this backdrop, banks should appreciate that opening up their distribution networks to fintech companies is a smart, but also a necessary move. Open, collaborative business models give customers access to greater choice, create new revenue streams for banks but most importantly provide a set of capabilities that could otherwise easily be offered by internet platforms – such as Amazon or Facebook – moving into financial services.
Moreover, with the fillip that PSD2 could give to the fintech industry, by allowing fintechs to aggregate customers’ banks accounts and initiate payments on banks’ systems via APIs, it would be too early to say that fintech firms can’t take much greater market share or revolutionise banking.
In addition, we should also point out the following: that despite only taking 2% market share, some very successful fintech companies have been born (if PayPal were a European bank, it would be the 6th largest by market capitalisation); that fintech models continue to evolve, expanding product offerings as well as pushing into middle and back office; and, lastly, that while only 2% of market share has been taken, the indirect effects of fintech have been much bigger – in lowering bank spreads, introducing new products and raising customer service levels.
So away from the hype, fintech is delivering real change – so far mostly indirectly - by forcing banks to raise their game. The revolution hasn’t happened yet – but with PSD2 an earthquake may be coming. Banks best bet is to bring fintech companies into the tent: not to compete but to collaborate. To mitigate the threat from internet platforms. To make real-world change together.