Academic journal article ABA Banking Journal

Banking's 'Amazon Moment': If Banks Partner with Fintech Companies, They Will Be Positioned to Deliver Leading Solutions to Their Customers in a Secure Environment-And Become the Universal Financial Services Platforms of the Future

Academic journal article ABA Banking Journal

Banking's 'Amazon Moment': If Banks Partner with Fintech Companies, They Will Be Positioned to Deliver Leading Solutions to Their Customers in a Secure Environment-And Become the Universal Financial Services Platforms of the Future

Article excerpt

Simply put, fintech is the process of leveraging technology to deliver traditional financial services. Technology has changed the way consumers interact with all products and services, and banking is no different. Banks have pioneered important innovations in banking, such as the ATM, credit cards and online banking. More recently, a new crop of innovators, enabled by mobile technology and data availability, have begun offering innovative banking services directly to customers. Most of these competitors are customer-facing, origination-based and monoline--which has significant implications for how they will shape the bank-led financial services market.

Fintech is the intersection of banks and technology. Global venture capital investment in fintech has increased nearly fourfold in the last two years, reaching $19.1 billion in 2015, according to KPMG. This figure excludes bank investment in the area, which is also tremendous. For example, J.P. Morgan Chase recently announced that 40 percent of its $9 billion annual IT budget would be spent on innovation.

Consumer technology has empowered a new generation of startups to connect directly to customers, without the need for a costly physical network. Sixty percent of Americans own smartphones that allow them to engage with products and services from the palm of their hand. What sets technology startups apart from traditional players is their superior user experience.

Most (if not all) fintech startups have focused their efforts on building a seamless digital customer experience that is not offered by all banks today. This focus on user experience, however, means that few startups have developed the back-end systems to handle financial transactions. As such, they rely heavily on bank partners to perform these functions.

Just as they have relied on banks' technology infrastructure to operate, fintech startups also typically rely on third parties to hold the assets that they originate. Rather than hold onto the loans or relationships they originate, most fintech firms choose to offload the risk and make their profits from originations.

McKinsey estimates that while 54 percent of global banking revenues are driven by balance sheeting assets, this accounts for just 41 percent of after-tax profits. Moreover, when the cost of capital is considered, the ROE for balance sheeting assets is just 6 percent compared to 22 percent for originations.

Finally, the vast majority of startups focus on a narrow line of business, cherry picking the most profitable businesses for banks. A prime example of this is Promise, a company offering only wedding loans--taking the old "something borrowed" maxim perhaps too seriously. Funding for startups confirms this focus, with 46 percent of fintech investment going to lending and 23% to payments. A bank would be hard pressed to find a line of business that is not challenged by one startup or another, but few, if any, startups today compete with banks across multiple lines of business.

Collaboration, not competition

"Silicon Valley is coming," J.P. Morgan Chase chairman and CEO Jamie Dimon direly warned his shareholders in 2014. Fortunately, this narrative has changed dramatically in the past two years. Today's fintech startups have pivoted to a collaborative model in which they actively seek partnerships with banks.

Banks and startups both have a unique set of strengths. When the two collaborate, they are able to deliver their customers innovative products that are safe and secure.

Fintech startups bring a culture of innovation that is difficult to replicate at financial institutions that specialize in managing risk. Their technology expertise and lack of legacy systems have allowed them to build a digital customer experience that does not exist at most banks today.

Banks provide tremendous value that is not replicable by startups, the most important being their role as trusted custodians of their customers' money and information. …

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