The headlines may give the impression that fintech startups are coming to eliminate traditional banks. That may not be the case yet.
Unlike startups, banks have had decades to build extensive infrastructure, develop solutions for compliance and regulatory challenges and establish close networks with other financial institutions. Banks also have leverage over startups because someone still needs to hold the world’s money, ensure compliance and so on, and building a mature institution’s full technology stack—or its equivalent—from scratch is expensive, difficult and time-consuming.
As can be expected, banks are also investing heavily in financial technology innovations. E.g. approximately one-third of Goldman Sachs’ 33,000 staff are engineers–more than LinkedIn, Twitter or Facebook. Paul Walker, Goldman Sachs’ global technology co-head, has said that they “were competing for talents with startups and tech companies”.
Fintech startups that are solving superficial problems without strong defendable USPs will run out of steam at some point. As an illustration, why would a small entrepreneur want to take a working capital loan from an independent startup when his regular bank, where he maintains his savings/current account, implements its own FinTech solutions and offers its customers a loan at similar or lower rate with as user-friendly a process as the independent fintech startup does?
While the current situation of exponential growth in fintech startups differs from the earlier dot-com boom, the failure rate for FinTech businesses is still likely to be high. However, fintechs focused on specific market segments and solving real world consumer problems will break through and build sustainable businesses. They will reshape certain areas of financial services – ultimately becoming far more successful than the scattered and largely sub-scale FinTech winners of the dotcom boom.
In five major retail banking businesses—consumer finance, mortgages, lending to small- and medium-sized enterprises, retail payments and wealth management—from 10% to 40% of bank revenues (depending on the business) could be at risk by 2025. Fintech attackers are likely to force prices lower and cause margin compression.
The real disruptors
The fintech startups best positioned to create lasting disruption in the financial industry will be distinguished by the following six markers:
Lower cost of customer acquisition – Fintechs that are able to acquire customers at a lower cost and at a faster speed have major competitive advantage. That may mean developing win-win partnerships with other players in the value chain. E.g. during the dot-com boom, eBay, a commerce ecosystem with plenty of customers, was able to reduce PayPal’s cost of customer acquisition by more than 80%. Today, many business lending FinTech players are partnering with various electronic networks, like e-commerce portals, centralised air-ticketing platforms, credit card transaction processing platforms etc to acquire consumers in bulk. The startups that are able to execute such unconventional approaches have a higher chance of sustainable growth.
Lower cost to serve – Fintech startups are providing their services with no or very little physical infrastructure. Online lending platforms conduct most of their processes online in an automated manner. In some cases such online lending platforms have an up to 400 basis points advantage over traditional banks in their cost to serve consumers. Similarly, fintechs in point-of-sale payment processing space are providing innovative solutions that significantly reduce the time and cost for small business owners to set-up electronic payment systems at their premises.
Innovative uses of data – Traditional business and individual credit rating systems seem outdated today. They also lost their credibility during the 2008 financial crises. Many fintechs are experimenting with alternate credit scoring methods that involve looking at online transaction history, educational backgrounds, social media activity, travel patterns, mobile phone usage and so on.
Big data and advanced analytics offer transformative potential to predict “next best actions,” understand customer needs, and deliver financial services via new mechanisms like mobile phones. Credit underwriting in banks often operates with a case law mindset and relies heavily on precedent. In a world where more than 90% of data has been created in the last two years, fintech data experiments hold promise for new products and services, delivered in new ways.
Segment-specific propositions – The most successful fintech startups will not begin by revolutionizing all of banking or credit. They will cherry pick, with discipline and focus, those customer segments most likely to be receptive to what they offer. Across fintech, three segments – millennials, small businesses and the under-banked – are particularly susceptible to this kind of cherry picking. These segments, with their sensitivity to cost, openness to remote delivery and distribution, and large size, offer a major opportunity for fintech attackers to build and scale sustainable businesses that create value.
Leveraging existing infrastructure – Successful fintech startups will embrace “co-opetition” and find ways to engage with the existing ecosystem of established players. E.g. PayPal partners with Wells Fargo for merchant acquisition. Some business lending platforms enable banks to participate as credit providers on their platforms. Conversely, some banks partner with P2P lending platforms to provide credit to those borrowers who would otherwise not qualify for banks own credit lines. Some enterprising banks may even realize that running a banking framework might be very lucrative if it is done thoughtfully and cost-effectively. A few could embrace being an infrastructure firm supporting today’s new wave of fintech companies, becoming banking’s equivalent of Amazon Web Services. Others may open up more to startups through their own “App Store,” offering customers startup apps running on their infrastructure.
Managing risk and regulatory stakeholders – Fintech startups are flying under the regulatory radar so far. However that may change in the near future. Regulatory tolerance for lapses on issues such as know your customer, compliance, and credit-related disparate impact will be low. Experience of microfinance industry in many developing countries the past is a good indicator of the high impact of regulation on an unregulated industry. Those fintech players that build regulatory capabilities will be much better positioned to succeed than those that do not.
The path to fintech nirvana will invariably be covered with the blood of thousands of wannabe disrupters. But as in nature, so in business – Protein is never wasted when death occurs. Good ideas put into motion by some of the failed startups will be picked up by more mature players and taken to their logical conclusion.
The startups that play successfully on combinations of the above six dimensions are the startups that have the most potential to disrupt the financial sector — something that’s difficult to see in a large infographic of hundreds of fintech startups today.
Rantej Singh works with a boutique Swiss management consulting firm specialising in emerging market financial institutions. He has previously worked with Thomson Reuters, Bank of America Merrill Lynch and ICICI Bank in strategy, innovation, product management and operations roles, and founded/co-founded two businesses. He is a co-author of ‘Practitioners book on Trade Finance’, the recommended course book at Indian Institute of Banking and Finance.
This is the second of a two-part column. Read the first part here.
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