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Fintech Strategy - Digital Transformation in Retail Banking

Digital Transformation in Retail Banking: Your Fintech Strategy

For some banks, “fintech” is a swearword, for others you will be talking about their new best friend. One thing is for sure, they are not going away, so you might as well accept the fact.

What is also certain is that every financial institution needs to map out a fintech strategy. This is a subset of a digital transformation strategy, examining what facets of the banking business could be unbundled and refreshed by outsourcing them to the new kids on the block, that is, fintech startups.

If you are not ready to free up that part of the business just yet, you do not have to go so far as a partnership or an acquisition. You can invest in a startup so that they are still around when you want to make the change, and have not been snapped up by a rival bank. Some banks have already partnered with fintechs who retain their independence, such as personal lender Prosper, invested in by JP Morgan, or Kensho, who provide data analytics to top tier banks like Goldman Sachs.

The common perception is that fintechs are giant-killers, created to bring about the demise of banking as we know it. While there are plenty of fintechs and direct banks that operate in traditional payment and savings spaces, there are also many newcomers out there who are niche players and intend to stay that way. What is more, the niche they fill may be a market gap, like blockchain, and the services they offer can be a disruptive alternative to traditional offerings in areas such as business lending. They may even be based in a country where you have absolutely no footprint, such as Vietnam’s MoMo.

Here is a brief examination of what is out there today (there will be some more new entrants tomorrow), and how you can mutually benefit from a partnership or acquisition. The truth about fintechs is that even in direct competition with banks it is virtually impossible for them to scale up to the size where they are a real threat; the barriers to entry are still too high. However, there is no nook or cranny in traditional banking that has not been penetrated, as this infographic by CB Insights on Wells Fargo illustrates.

Unbundling of a Bank

Image Source: Cbinsights

Traditional Banking Products are Struggling

While fintechs competing in the traditional banking domains are just scraping away at the brick walls surrounding traditional banks, with enough persistence those walls could fall. These small companies have a low-cost structure, which makes it easy for them to offer competing products at prices that do not affect the customer’s wallet. When it comes to loans, their competitive advantage is not on their lending rates, which are dauntingly high, but rather on the ability to grant small loans very quickly with the minimum of fuss, such as Kabbage. Their real value proposition, however, is in totally rethinking these tired old products, coming up with solutions that will have a far more disruptive effect than poaching customers.

The banks, with their huge staff overheads, real estate and running costs cannot compete. Those that understand this have invested, partnered and acquired shares in these innovators. In most cases, this is done while maintaining their traditional products and infrastructure, but there could be a long-term intention to cast off the old and replace it with the new. And there are very few of the major banks that haven’t got a few fintechs in their portfolio. While some banks prefer to keep their digital transformation in-house, like BBVA, even they have taken an interest in a few startups, notably Atom and Saveup. Other banks, such as Citibank, have aggressively acquired stakes in fintechs in every category. A balanced portfolio would include both fintechs that compete and fintechs that partner. In their report on the top 100 Fintechs of 2016 (the 2017 report should be out soon), H2 and KPMG separate these fintechs into “disruptors” and “enablers”, with some fintechs, such as Credit Kudos, managing to be both an enabler and a disruptor.

Fintechs That Compete

Most of the startups that compete have developed consumer and retail products, such as payments and money transfer, personal finance and lending to consumers and small businesses. Some of them combine these offerings and can be classed as direct banks.

Others have created a new market among the previously unbanked, using mobile technology. M-Pesa, a payments system developed in Kenya, has a business model that has been adopted globally, even in developed nations. It is a simple system, relying on minimal infrastructure – just a cellphone.

Lenders and micro-lenders have steadily increased their market base. The ability to get a loan from such fintechs is straightforward and painless, although their interest rates are punitive.

Fintechs That Partner

A general bank (one that offers both corporate and retail services) needs a huge workforce for many areas of the business that are not customer-facing. Like all businesses that have many bases to cover, some of this work is managed competently, while some business units just scrape by, as no company can be excellent in everything it does. Normally, if a product, service or business unit is struggling, the parent company will discontinue their efforts in that area, if they can. Banks are not so fortunate, because they have onerous administrative work that they cannot dispose of. Most of this work is in the governance, risk and compliance areas (GRC). Ever since the sub-prime debacle of 2008, banks have been loaded with more and more compliance and risk reporting by the regulatory authorities.

While some banks have no problems with compliance, most banks are less than competent in risk management. Between 2008 and 2015, a massive $321billion was levied in fines on banks by regulatory authorities.

Enter the fintech category that fixes all that: the regtech. These are companies that focus on risk and threat detection and/or report to the necessary authorities on disciplines ranging from Sarbanes-Oxley to Basel III. These fintechs offer a huge opportunity for banks to unbundle much of their GRC infrastructure and outsource it to these specialist companies. This is a growing trend, and will probably be the norm in a decade’s time (if there will be still any banks around). Droit and AcadiaSoft are two leaders of the pack, with investment and usage by leading banks such as BNP Paribas and Goldman Sachs. Related services, such as cybersecurity and identity management, are also classed as regtechs. We will discuss regtechs in a separate article, because of the depth of services.

The State of Regtech 2017

Image Source: The State of Regtech 2017 – CB Insights (p. 57)

There are other niche fintechs that offer services that banks value, such as data analytics and credit management. While banks in general have mature data analytics in their traditional data management, their ability to apply AI and machine learning to unstructured data is not always enough to beat the competition, and they make use of fintechs who have an expert and focused team of data analysts and data scientists. Many fintechs use AI and machine learning as a matter of course as part of their business model, such as the regtech Feedzai.

There are also quite a few fintechs that are disrupting the space of traditional credit management companies such as Transunion and Experian. For instance, Lenddo operates in the Asian market, focusing on the Indian market and offering a new approach to credit management in Asia. The US contender CreditKarma serves consumers by giving them free and extensive access to their own credit ratings, thus benefiting both the consumers and the lenders.

The Way Forward

Fintechs are here to stay. Some of them may be built to last, some may not make it, but their disruptive effect on banking will be permanent. There are many alternative routes to take. Citibank has taken a deep dive into investing in fintechs.

BBVA, on the other hand, wanted to keep a firm control on their digital transformation, which was managed internally. This has not stopped them from engaging fintechs like Feedzai. The only problem with fintechs is that demand exceeds supply; with 20,000 banks in existence globally, there are not enough fintechs to go around.

250 fintech companies transforming financial services

No need to despair, you are not limited to looking to fintechs for innovative and disruptive tech services. In its reports on fintechs, IDC has a very different view on the definition of a fintech company. Names such as IBM and Accenture appear on their list of fintechs. Their list makes an interesting reading, because all of the usual suspects in banking appear along with the brightest startups.

You do not have to engage one of these heavyweight companies like KPMG to help you in your digital transformation. There are IT development companies that have good banking experience and can help you in your digital transformation from back-end processing and building your digital platform to customer-facing channels. There is a lot of information available on what various fintechs offer, which you can use as a guide to gaps you need to plug in your current business model and find the best web development partner who can fulfil your need, rather than join in the fight to make friends with a fintech.

Darya Shmat

Darya has spent over a decade in the banking industry, working on various projects and in multiple capacities since 2003. In the early 2000s, a lot of the processes were manual, and no one had even conceptualized mobile payments and other technologies that are prevalent in the niche today. Darya witnessed the technological growth of the industry from within, as banks digitized and embraced mobile technology. Over the span of her career she has participated in a variety of projects that deal with operations automation, analysis, beta testing, auditing, efficiency evaluation, and other modernization efforts undertaken by banking institutions. She knows firsthand about the technological transformation that the banking industry is steadily going through. Today, Darya works as a business development representative at Iflexion and expertly applies her practical experience to help our banking and financial industry clients find the right development or QA solution.