How incumbents can survive the fintech onslaught

Maxim Rokhline, SVP Financial Services, Tradeshift, speaks about how traditional banks and financial services incumbents can survive the fintech offensive.

In the age of disruption, protecting and expanding market share is no longer a simple feat for traditional banks and financial services incumbents. Not a day goes by without a startup announcing that they’ve built a better mousetrap for mobile payments, loans, money management, transfers, and so on.

Today, disruption in finance has many faces. Algorithms replace brokers, online banks proliferate without physical branches, and blockchain threatens to rewrite entire business models. Incumbent banks have moved slowly in the face of digitization, further widening the gap for Fintechs to creep in.

TransferWise, SoFi, and PayPal are among many names staking a claim. With moderate barriers to entry, vast digital versus physical infrastructure, and wide-ranging product lines, it’s a lot easier for these firms to overcome the key hurdle that big banks have relied upon: customer trust and relationship.

Established banks must jump through hoops to please shareholders by defending margins and market share on a wide range of lines of businesses, and, are therefore, limited to fintech experiments, such as launching small innovation divisions.

Fintechs, on the other hand, simply need to rethink one financial product in order to get on the map as a player. The recipe for success is straightforward: make a rapid play on a niche currently dominated by a major bank with a compelling offering underpinned by labor-unintensive, proprietary technology.

An April article in the Harvard Business Review (HBR) by Karen Mills and Brayden McCarthy suggests the future of small- and medium-sized enterprise (SME) financial services will be influenced substantially by the conflicting forces of competition and collaboration.

“Established banks have real advantages in serving the SME lending market, which should not be underestimated. Banks’ cost of capital is typically 50 basis points or less,” Mills and McCarthy assert. “These low-cost and reliable sources of funds are from taxpayer-insured deposits and the Federal Reserve’s discount window. By comparison, online lenders face capital costs that can be higher than 10%, sourced from potentially fickle institutional investors like hedge funds.”

The authors also point to other advantages, such as an established customer base and proprietary data. Online lenders, meanwhile, have limited brand recognition and face the uphill struggle of acquiring small business customers online.

However, new online lenders have made the loan application process much more customer-friendly. By contrast, banks — particularly regional and smaller banks — have traditionally relied on manual, paper-intensive underwriting processes, which draw out approval times to as much as 20 days.

Survival hinges on adaptation

Financial services companies that are adapting to this new wave of information technology are pursuing strategies that springboard off of their differentiating strengths.

The aforementioned HBR article suggests that incumbent banks adapt through low-integration strategies, such as “contract for new digital activities in arms-length agreements” or simply invest in separate emerging companies. For example, banks can buy loans originated on an alternative lender’s platform, which gives them more business while freeing up capital for online lenders.  

On the other end of the spectrum, banks can choose deeper integration. For instance, In 2015, JPMorgan Chase and OnDeck announced a partnership to collapse the process of providing loans to millions of small-business customers to just hours. New technologies can be white-labelled and integrated into the bank’s loan application and decision process.

In fact, there are myriad ways that online lenders and banks can stitch joint offerings. An online lender can power the bank’s online loan application, using  its own credit model to underwrite and service bank loan applications. The bank would need be comfortable with forgoing its own underwriting criteria and entrust the algorithms developed by its digital partner. And it would  need to abide by the rules of federal “third party” oversight, which makes banks responsible for the activities of their vendors and partners.

In the sphere of trade finance, banks can offer solutions like factoring and supply chain financing digitally and widen the scope of potential customers by partnering with technology providers that connect networks of global trading partners. With over $9 trillion of working capital locked up in the global supply chain, such partnerships and joint offerings can go a long way to help small and medium sized businesses access liquidity.

Other options for banks include building greater digital front ends, adding digital capabilities through acquisitions, or build them. Banks that choose to develop their own systems to compete head-on with new players face significant investment to automate routine tasks, better integrate proprietary data, and create a better customer experience. Another option is to emulate what many Fortune 500s have done to drive innovation: establish autonomous or semi-autonomous internal innovation centers or incubators.

Whether competing, collaborating, or developing capabilities in-house, the dynamics of the financial services industry are causing changes across the landscape. Fintechs are finding ways to serve target customers in ways that alter how financial services are delivered causing banks to rethink age-old models and processes. What we do know is that change is inevitable, and we are well into the next chapter of this industry.