Fintechs and banks are learning to coexist. How did we get here, and what’s the opportunity now?
“Banks should be “scared s***less” of fintechs,” said JP Morgan Chase CEO Jamie Dimon, in the company’s January 2021 quarterly call to analysts. That may sound harsh, but it points to what most leaders in the financial services industry already know — fintechs and other new entrants in the financial services arena are redefining the industry.
How the rise of fintechs changed banking
Fintechs (companies that offer technology to support or enable banking and financial services) are not a new phenomenon. The first version of PayPal’s digital wallet and payments system was launched in 1999. Less than a decade later, PayPal was making USD 1.8 billion annually.
In the last two decades, countless other fintechs have entered the financial services arena. Larger companies — such as Apple, Google and Amazon, who started out as innovative tech companies and weren’t traditional financial services players — also entered the field, offering competing platforms that threatened the banks’ traditional dominance in some areas.
PayPal alone now takes in USD 25 billion, and growth is accelerating. Google and Apple wallets housing debit and credit cards are now common, forcing banks to either “get with” their digital programs by allowing their cards to be stored in those wallets (for a fee) or potentially lose access to large numbers of customers.
The emergence of fintech, combined with economic shifts and regulatory impacts, changed the game for all financial services providers. For some banks, it meant an erosion of revenue as clients opted for different financial services from other providers, while for some, it meant a reluctant partnership or contract with newer entrants. Traditional banks are now challenged with finding new models for one of the oldest industries in the world. Do the banks have reason to worry? Yes and no.
The new digital-first reality
Banks have always had to adapt to newer ways of serving clients. Digital banking and payments — once only a dream — are now so well established in the mainstream, especially in the consumer space, that most people can’t imagine life without them. Some can’t even recall the last time they used a bank machine, which was a novelty only fifty years ago. The ability for individuals to conduct almost all their financial transactions online is now standard.
Of course, the pandemic simply accelerated this existing shift to “touchless” banking and payments. Banks, in most cases, were already well-positioned on most fronts in their digital channels — their digital consumer experiences were already well entrenched for most clients, and the shift away from cash and checks had already occurred. To wit, the world’s economies did not fall apart because people couldn’t access their funds when bank branches closed or provided limited services for extended periods. You may have seen line-ups for toilet paper, but you didn’t see line-ups for cash.
While this may be true in consumer land (at least superficially), the same cannot be said for the underlying payment infrastructures and wholesale and corporate banking, which are now racing (some would argue “walking”) to catch up to market demands and regulatory shifts.
How fintechs got ahead
But this is no simple foot race. Traditional financial institutions (FIs), domestic regulators and the domestic and cross-border market infrastructures through which FIs connect have all recognized the need to change — to accommodate the shift in customer demands, speed, volume and market conditions, while ensuring safety and soundness in the system. While they can undertake some changes — either alone or in cooperation with each other — none of the traditional players can afford to fail very often or on a grand scale (the public and especially shareholders tend to get antsy about such things), so they are prone to taking less risk with depositor and shareholder funds.
The challenge occasionally cited by traditional FIs is that fintechs often don’t have to meet the same regulatory and compliance requirements that they do, and thus, fintechs are able to move more nimbly into some fields of business. While this may be true, this is not the only reality.
It is true that traditional FIs are governed closely: deposit-taking in most jurisdictions is limited to financial institutions that comply with a host of regulatory and legislative requirements to ensure that deposits are only accepted from, or loans made to, legitimate parties and business activities. Essentially, governments have made banks their police force in meeting the objectives of trust, safety and soundness in the system.
This does not mean, however, that FIs cannot innovate. Many can and do, but they are careful to do so on a smaller, incremental scale so that a failure doesn’t have a wider public or shareholder impact.
Fintechs, on the other hand, do not usually take deposits or do any lending themselves, so the same rules don’t apply. They can afford to take greater risks and often rely on one person or a small team of creative entrepreneurial folks to hatch and develop a new idea that may or may not be successful. That is, if they fail, there are usually fewer victims. Moreover, the creative entrepreneurial minds that lead fintechs would often be uncomfortable working in a more traditional environment.
This leads to fintechs playing a valuable and needed role — they act as the de facto research and development arm of the financial services economy. The other advantage for fintechs is their use of the latest technology; unimpeded by mainframe and legacy architecture, they can innovate quickly at a fraction of the time and cost for a traditional bank. Tech excels at messaging, and much of banking is a messaging business. Payments and investment purchases rely on simple messaging between parties and easy-to-use digital channels. Fintechs have outpaced FIs by executing messages faster and providing better, user-friendly interfaces. Companies like Questrade, Venmo (a PayPal company) and Wise (formerly TransferWise) continue to double down on speed and convenience, while also branching into every field of finance.
How banks can get ahead
A traditional bank, and even their large-scale service providers, then, are left to evaluate if a fintech is a potential partner, acquisition target or competitive threat — or if it can be safely ignored.
When answering that question, it’s useful to flip to the fintechs’ perspective. Fintechs need banks or the service providers that serve banks for primarily one reason — access to client relationships and the associated volume of activity. A fintech always dreams of “making it big” but can only do so if it is able to access a large client base quickly. Banks and their service providers offer an easier path to that goal, rather than fintechs trying to build the client base themselves. The bank and the fintech need each other’s skill sets to meet the desired outcome of enhanced and expanded market access and growth.
To accommodate and integrate services offered by fintechs, legacy banks need to have some agility and flexibility not offered by their traditional platforms and systems. Globally, where some changes are more advanced, banks have already started harnessing platforms that use newer code bases, deployment models and APIs and that don’t rely on traditional mainframes with their batch jobs and files.
The transition is no easy feat, but banks (and especially their service providers, such as IBM) can make the transition happen by doing two things well:
Deploying a platform that can accommodate the old methods while providing and migrating to the new.
Allowing the service provider to be the eyes, ears and hands for banks by integrating fintech capabilities into the platform’s ecosystem, so that the FI has lower barriers to adoption without the pain of integration.
Replacing fintech services is not the only model for success. Banks and fintechs have already been successful in directly filling gaps that the bank cannot fill on its own in other ways that don’t rely on a platform shift. But the ability to integrate more often and quickly does mean that a flexible core banking and payments platform and ecosystem will likely be the more successful route in the long run.
We are in exciting times in financial services as banks and fintechs continue to seek out partners that meet their strategic goals. Closing the gaps between fintechs and legacy banks relies on both independent thought and collaboration among banks, service providers and fintechs to ensure their future mutual success.
IBM Payments Center and IBM Cloud for Financial Services
Legacy banks are rapidly modernizing their payments platforms to compete with fintechs and even surpass their capabilities. The IBM Payments Center™ delivers the latest cognitive and AI technologies to drive efficiency and value in payments services.
Deploying a comprehensive platform in financial services requires security and compliance above the usual standard. IBM Cloud for Financial Services™ helps banks reduce risk while expanding and accelerating services to compete in a crowded market. Bring your financial institution onto a new standard for secure, compliant cloud computing.