By Paul Gillin, Senior Contributing Writer, Connected Futures
You pay for your double mocha latte by tapping your iPhone to a terminal in the coffee shop. From your laptop, you check the balance on the auto loan you took out with Prosper and log in to your E*TRADE account to authorize a payment. Checking your Etsy account, you see that a new PayPal payment has come in for the handcrafted jewelry your wife sells. She started that business with funding from a Kickstarter campaign.
All of these money-related activities have one thing in common. Not one involves a traditional financial institution. They are indicative of the growing disruptive power of so-called “fintech” companies, which apply cloud computing, social media, mobility and deep analytics to create new financial products and services.
Investment in fintech companies totaled $15 billion last year, and PricewaterhouseCoopers LLP estimates it could cumulatively exceed $150 billion over the next three to five years.
With fintech building momentum like that, you’d think the financial services industry would be quaking in its boots. Strangely, it isn’t.
Not that disruption isn’t a worry. Burdened by regulations, encumbered by historically low interest rates and hobbled by the costs of numerous mergers and acquisition, banks and their brethren are as weak as they have been in decades.
A 2015 study by the Global Center for Digital Business Transformation and Cisco ranked financial services fourth out of 12 industries in vulnerability to competitive disruption by digital technologies. A 2014 Accenture report estimated that 35 percent of banking revenues will be at risk by 2020 due to disruption in the financial sector.
Financial services firms captured only 20 percent of the potential value of digitization in 2015, according to a Cisco analysis. That translates into $144 billion left on the table.
But traditional banks and brokerages aren’t hiding in their foxholes. Having witnessed the toll that bits and bytes took on the recording, publishing, hospitality and transportation industries, many are choosing instead to embrace their disrupters. They’re partnering with fintechs and adopting digital tools to reduce costs, reduce friction from customer interactions and even identify new revenue streams.
“Financial services firms are scrambling to take advantage of big data, artificial intelligence, machine learning, digital experience, and Blockchain to reinvent the customer experience and streamline traditional business processes,” said Randy Bean, CEO of NewVantage Partners, a consulting firm with a large base of financial services customers.
“Rather than put banks out of business the way iTunes and digital cameras did, the fintechs are becoming clients to the banks,” says David Poole, senior strategist at SapientNitro Boston and author of a recent report on the future of retail branch banking.
- J.P. Morgan Chase & Co. last year partnered with online lender On Deck Capital Inc. to improve loan processing for its small business customers using the proprietary algorithms that On Deck has created to evaluate credit-worthiness. J.P. Morgan brings four million small business customers to the table, and On Deck can process loans in a fraction of the time.
- Cardlytics, Inc. has struck deals with more than 1,500 financial institutions who use its digital advertising platform to better connect advertisers with interested buyers. Banks can use the information to form tighter bonds with sellers and drive more credit card transactions.
- Sensibill Inc. has partnerships with Canada’s five largest banks to integrate its automated receipt management functionality into their digital banking apps. Scotiabank was the first to go live with the technology in December.
- Twenty of the world’s largest banks are partnering on the FinTech Innovation Lab, a four-year-old global effort to nurture new technology that they hope to integrate into their product lines.
Financial institutions have certain advantages that earlier victims of digital disruption didn’t. Regulation. While often cumbersome and expensive, regulation also creates barriers to entry for newcomers.
In addition, customers of financial institutions also tend to stick around. While they may not have much affinity to the institutions they do business with, the cost and disruption of leaving is too great to bother. “For the most part, people are still banking with traditional institutions,” said SapientNitro’s Poole.
Banks, in particular, see a lot to like about the new digital tools, such as lower costs. A survey of 75 U.S. senior banking executives by the law firm of Manatt, Phelps & Phillips, LLP found that more than 80 percent of regional and community banks are currently collaborating with fintechs. Nearly nine in 10 respondents said such collaborations are “absolutely essential” or “very important” to their success.
A recent survey of UK financial services providers by the law firm Mayer Brown LLP found that 87 percent said partnerships with Fintech companies had helped them cut costs. A nearly equal number said the deals provided an opportunity to refresh their brands, and more than half said the partnership had boosted revenue.
For a banking industry that’s struggling with historically low margins, digital efficiency has strong appeal. Online banking, for example, costs just 19 cents per transaction, compared to four dollars in a branch, according to Poole of SapientNitro. And banks see online services as their best way to attract young customers, who overwhelmingly favor digital tools.
Going online also means less need for brick-and-mortar branches. For example, Bank of America has trimmed its portfolio of branch offices from 6,000 before the financial crisis to a little more than 4,600 today. With more customers taking care of their own banking needs, the company can shift resources to low-cost kiosks and videoconference consultations. Citigroup closed seven percent of its branches in 2016, in the process, “significantly improving the profitability of our retail bank," CFO John Gerspach said on the firm’s third quarter, 2016 earnings call.
Banks are also finding that active mobile users are a great source of credit card business. JPMorgan said more than three quarters of its new accounts now come through digital channels, and mobile payments grew 17% in the third quarter of 2016.
Not long ago blockchain, a technology that permits anonymous parties to conduct secure and verified financial transactions without an intermediary such as a bank, was considered a threat to the industry. But today financial services firms are rallying around it, seeing potential to streamline transactions and serve customers more quickly.
The Blockchain Collaborative Consortium, an alliance of companies promoting the use of blockchain technology, has more than tripled its membership in one year from 34 to 109 partners. Ethereum, a platform that is intended to fix some of the security and scalability shortcoming of blockchain, is being supported by CME Group, Credit Suisse, J.P. Morgan and Santander, among others. In an unusual move for a historically secretive industry, several big banks are partnering on a version of Ethereum for corporate use. “We need to collaborate. We need to build this together,” Sandra Ro, digitization lead at CME Group and a member of the alliance, told IEEE Spectrum.
One reason money firms are moving so confidently is because they believe they have more time than their predecessors in the photography and recording industries. “No matter the types of disruptive forces that are out there, we still have the customers,” said Ursula Cottone, chief data officer at Citizens Financial Group Inc. Partnerships with fintechs make sense because “they don’t have the customers and we don’t have the technology.”
Among the fintechs Citizens is partnering with is a service that marries customers’ investment goals and tolerance for risk to an ideal set of products. Another startup provides a matchmaking service for clients that seek non-bank funding sources, such as venture capital. The company is also harmonizing its internal and external data sources to develop more detailed customer profiles bankers can use to make customized product and service recommendations. “There may not always be a bottom-line benefit to us, but it’s another way to keep our clients in the fold,” Cottone said.
But while financial institutions have the luxury of some time, they can ill-afford to be over-confident. Customer retention rates may be relatively high, but affinity isn’t. Accenture reported that nearly three-quarters of U.S. banking customers consider their relationship with the bank to be “merely transactional, rather than driven by advice or a broader relationship.”
Accenture also found that nearly half of bank customers would be willing to switch to a company they like doing business with, even if it isn’t a bank. Among consumers aged 18 to 34, that number exceeds 70%. The consulting firm estimated that “35% of banking revenues will be at risk by 2020 due to disruption in the financial sector.” Perhaps that’s why reports that Amazon.com Inc. is considering acquiring Capital One Financial Corp. shouldn’t be dismissed out of hand.
Traditional financial services firms may be able to survive for some time by partnering, cutting costs and delivering basic services, but that approach also carries the risk that “competitors from other industries will consign them to a limited role as utilities, just as industry profitability stagnates and customer loyalty becomes more tenuous,” Accenture wrote. Mobile and online banking can be a two-edged sword. While costs may be lower, all online banking or brokerage services look pretty much the same.
In order to thrive, experts agree that financial institutions must develop more personal relationships with their customers and offer services that go beyond simply managing money to become what Accenture calls Everyday Banks. To this end, many are experimenting with a variety of new ways to engage with customers, ranging from walk-up terminals that offer expert advice via videoconferencing to art galleries or full-service coffee shops like those being tested by Capital One. They’re also partnering with fintech companies to improve existing online services. For example, GEICO General Insurance Company Inc.’s mobile app helps customers organize ID cards and get roadside help.
Financial institutions that focus on corporate customers or wealthy investors are also vulnerable, but in their case the disruptors are predictive analytic algorithms, artificial intelligence and real-time decision-making tools that provide customers with insights in speed that human analysts can’t match. A recent Boston Consulting Group report warned that the internet of things will have ripple effects throughout the financial services industry. Traditional industrial companies will be able to enter new markets selling services along with equipment, significantly increasing the number of transactions and partnerships that need to be tracked. These rapidly evolving industries will create a small number of dominant players to coordinate these complex relationships. “Corporate banks that don’t participate will find themselves excluded from large portions of the revenue pools of such industry-specific ecosystems,” the firm wrote.
Ultimately, institutions that reimagine the relationship with the customer could become the next super-bank. SapientNitro’s Poole draws an analogy to Netflix Inc.’s disruption of the video rental industry. “You never knew you needed Netflix until you saw it,” he said. “The bank that can be like Netflix will break through.”