“Fintech” is one of this year’s most ubiquitous buzzwords as it has spawned many colorful infographics about the future of finance and banking. Some of these are merely a collection of logos, while others represent a more structured attempt to classify this new generation of players taking on financial services. All, however, convey the same idea: Tech is coming for banking, and unwary banks will quickly be replaced by startups. While such illustrations make great clickbait, they also, unhelpfully, oversimplify what’s going on. The truth is less alarming and more interesting. The financial technology space has always been a happening area as banks and financial firms have always been early adopters of technology. This continues today with this new generation of Fintech companies that are leveraging the Internet, mobile and social technologies, cloud computing and Big Data to build and take to market innovative solutions that are changing the way financial services are accessed, delivered and experienced. Some of these Fintech companies sell their solutions to banks while many others are bypassing their traditional banking client base and are offering their solutions directly to financial services customers over the Internet with innovative and cost effective value-based offerings. They include companies that offer credit/lending services (including peer to peer, crowdsourced and other varieties), payments services (and as a result, small amount deposits for payments) and financial management services targeting retail and small business customers.

 

6 Reasons Why Millennials Adopt Consumer end Fintech Solutions
43% of millennials find that it is easy to set up an account with a fintech mobile app rather than a checking account in a bank.

15% or so of millennials in US, UK, Hong Kong, Australia, Singapore and other countries find that fintech startups have more attractive rates for their services rather than traditional banks. This point especially related to money transfers and loans.

12–13% of millennials find fintech solutions more attractive because they think that they can access more services and products “while watching a TV show” or “driving to office” rather than only a specific service for which they should visit a bank.

11% of millennials are sure that financial technology innovative solutions provide better online experience and functionality and instead of spending time in a bank’s website to learn about their services they intuitively get familiar with features of fintech startups as the user experience is much better and focused on getting results rather than providing tons of unnecessary information.
10% of millennials are sure that traditional banks cannot compete with fintech solutions in terms of quality and 75–80% of millennials are sure that fintech solutions have better quality than banks. This is especially important when talking about services like loans, savings, insurance, investing and other retail banking, personal finance, and insurance services.

6% of millennials consider the products and services of fintech startups more innovative compared to financial services provided by traditional financial institutions. Banks or insurance companies usually offer “better bundling” to introduce new financial products, but this is just adding something on top of the existing traditional services and this is for sure not the service that is expected by millennials. They usually desire something new rather than something on top of existing traditional financial services.

 

 

Institutional Banks: Too Big To Fail?
To get a more accurate picture of the fintech craze, we must first understand where banks actually stand in the larger financial picture. Unlike startups, banks have had decades to build extensive infrastructures, develop solutions for regulatory challenges, establish networks with other financial institutions, and earn consumer trust. Startups may dismiss these foundational building blocks as just “dumb pipes” or point to the damage done to banks’ reputations in the last financial crisis, but the truth is that the average consumer is far more likely to put their cash into a major bank than a months-old startup — even if both are overseen by the same regulator.

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. 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.

 

The Startups That Should Have Banks Worried
That said, banks as we currently know them are vulnerable. Today’s fintech startups have learned to leverage banks’ weaknesses and offer improved services and ease-of-use not by imitating banks but by creating a new layer on top of existing infrastructure. In time, these startups, which are amazing user acquisition tools, will increase the flow of money and increase transactions settled by banks — so much so, that customers may eventually switch for good, relegating the bank to just an infrastructure and operations play. If that happens, it could have a detrimental effect on the banks’ branding, visibility and, ultimately, their role in the market.

This trend is not just limited to banking. Startups such as Robinhood are disrupting investing by targeting millennials and offering simple, app-driven free stock trades. These companies promise transparency and accessibility and hope to turn an area of finance previously the preserve of the wealthy into a mass-market proposition. Traditional brokerages look slow and expensive in comparison. Other new entrants are targeting niches such as international money transfers, loans, and payments.

With fintech becoming such a hot area, here is an analysis that potentially highlights trends on how major banks across the globe are reacting to the finTech phenomenon. Banks are responding to fintech Innovation in many different ways. In most cases banks seem to learn, adapt, buy, partner and profit from the latest innovations brought to the market by the large fintech investments since 2011.

 

Chasing Entrepreneurs
Small businesses can thank internet ventures for simplifying loan applications, speeding decisions and providing much-needed credit when many traditional banks were pulling back in the wake of 2008’s financial crisis. Nonbanks now provide about one-quarter of the $800 billion in loans outstanding to the sector, according to research by QED Investors and Oliver Wyman. But the interest rates aren’t always low.

For a time, banks were content backing the loans. Goldman Sachs was among firms that entrusted more than $300 million years ago to fund lending by On Deck Capital Inc., one of the largest providers of small business loans over the internet.

Now, established lenders are taking a more active role. JPMorgan announced a deal in December, letting it access On Deck’s proprietary credit-scoring system to quickly evaluate applicants before using its own balance sheet to make loans. On Deck, in turn, gets a foothold in the burgeoning “fintech as a service” market. But the arrangement has done little to stop a 49 percent slide in the company’s stock this year.
Wells Fargo & Co. said in May that its new “fast decision” platform will help it reach a goal of providing $100 billion in new loans to small businesses by 2019. AmEx, which already provides more than $200 billion of funding to entrepreneurs for business purchases on their credit cards, expects a new online-loan portal will let it handle even more of their spending.

 

 

Mortgage Apps
Fintech ventures starred in Super Bowl ads this year, with Quicken Loans toutingRocket Mortgage, a platform letting users apply for home loans on smartphones.

The tidal wave is benefiting banks, too. Behind the scenes, many of the upstarts get support from traditional banks. Detroit-based Quicken, for example, raised $1.25 billion for itself and its parent company last year in a bond sale underwritten by JPMorgan and Credit Suisse Group AG. It also used lines of credit from banks to help close $80 billion in home loans that year.

 

How Banks use Machine Learning for An Analytical Advantage 
“The future is already here — it’s just not very evenly distributed.” Banks are increasingly using machine learning to power part of their operations, but the adoption of these new technologies is not uniform.
Top data scientists are employed by financial institutions and working with programming tools like SPCC and R, they filter and analyze huge data sets in order to perform analytical tasks. “No human being can wrap his head around that amount of data,” said Daniel Druker, CMO of Ayasdi, a machine learning company that partners with financial institutions, like Citi and Credit Suisse. Instead, using machine learning algorithms, a computer can surface insights and recommendations from those data sets, while the quants examine and take actions based on those learnings.

According to McKinsey’s 2015 Global Banking Report, banks that have replaced older statistical modeling approaches to credit risk with machine learning techniques have experienced up to 20 percent increases in cash collections from outstanding loans.

Out of over 20 banks that work with Ayasdi, Drucker said, 100% are either already operating in this stage or actively exploring implementing such technology.

The highest level of machine learning application is the fully automated business process. Take a life insurer, for example. When a customer applies for a policy, he might be asked to fill out a 40-page long form and get a physical examination. That information is then sent back to the company for approval. The entire process can take over a month to complete.

According to McKinsey, some European banks using these techniques report 10 percent increases in sales of new products, 20 percent savings in capital expenditures, and 20 percent declines in customer churn.

CB Insights has identified 41 companies providing machine learning solutions in the financial industry. Together with the explosion of general applications of AI, deals and investments in AI companies reached record levels in 2016. Since the beginning of 2016, over 15 fintech AI companies have closed investment rounds.

 

How Digital Investment Is Changing the Face of Banking
Investment in digital banking is driving increased customer acquisition, cross-selling and satisfaction while decreasing branch traffic and related costs.

This is confirmed by the J.D. Power research that showed that there is an immediate lift in overall satisfaction when customers use mobile banking (+27 points on a 1,000-point scale), and this impact increases even more when banks provide their mobile banking customers with a highly satisfying experience (+82). According to J.D. Power, “The outlook for Big Banks remains positive, driven by their (big banks) ability to invest in customer-centric innovations (e.g., digital channels, analytics, and branch transformation), as well as their success in growing customer segments.”

 

 

The Future of Fintech
So where are we headed? Consumers, led by fickle millennials, will gradually switch to these newcomers. However, it’s unlikely that banks will fade away entirely. Even though a few more startups will force their way into the ecosystem and compete directly with banks, for now and in the near term, the majority are continuing to depend on banks’ infrastructure.

The response from banks will be mixed, as some learn to innovate themselves, while others just copy — or acquire — the solutions created by entrepreneurs. In my view, at least one bank may become a true infrastructure bank for startups, and we might even see some startups begin to merge, developing a full-service banking play one piece at a time. Finally, we might see new challengers come along in the form of the big tech firms. Apple, Google or even PayPal might begin to leverage their consumer relationships to deliver financial services, edging out both the incumbents and the newcomers.

It’s an exciting time to be a part of the technology and financial services sector. We are beyond the stage where it’s easy to get impressed by the number of new fintech startups on a chart. Now is the time to start considering what the future truly looks like, and plan how to get there!

Please reach out to Trevor Nesse at tnesse@princeton.edu for any questions, comments, or concerns.

Written by thefinancier

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