This article was produced in collaboration with Knowledge@Wharton.
The fast-moving world of financial technology, better known as fintech, is settling into a global pattern. Disruptive fintech startups not long ago were thought to threaten important revenue streams of even the biggest financial institutions. But they are now pursuing business models based on collaboration with banks or even being acquired by them. And banks increasingly see ways they could improve customer service by working cooperatively with the nimble entrants, which are unconstrained by layers of bureaucracy, regulation and conservative corporate cultures unused to rapid change.
But don’t expect total harmony, say experts. Some fintechs will aggressively go it alone and challenge the legacy banks in their most lucrative markets. And recent rule changes in Europe, which force banks to transfer closely guarded customer information to fintechs upon customer request, will add new momentum to the upstarts.
Still, the drive towards collaboration is well underway, as the following on-the-ground examples suggest.
- ICICI Bank, India’s largest private bank, and Paytm, the country’s largest digital payments platform, have jointly launched a digital credit account on the Paytm app. Paytm-ICICI Bank Postpaid gives customers access to instant micro-credit for everyday expenses — from bill payments to movie tickets. Its algorithm – from ICICI – is based on a customer’s financial and digital behavior and evaluates credit-worthiness in seconds.
- Bocom International, the investment banking arm of China’s Bank of Communications, has partnered with Hong Kong fintech firm FDT-AI to develop intelligent, personalized investment research based on bank clients’ past transactions. The hope is to offer more tailor-made investment advice.
- ING Group has partnered with Scalable Capital, a leading online wealth manager and robo-advice firm in Europe, to offer a fully digital investment solution to ING’s retail customers starting in Germany. Customers do a paperless registration in under 15 minutes. With a minimum investment of 10,000 euros they can monitor their portfolios on both Scalable Capital and ING mobile apps and online portals.
- Kabbage, a U.S.-based leading online lender, has partnered with large players such as Scotiabank, for streamlining online lending; MasterCard, for business loans through MasterCard’s network of acquirers; ING, to provide capital to small businesses; and Santander Bank, for loans to small and medium enterprises.
These moves by financial institutions and fintechs in India, China, Netherlands and the U.S. show just how globally the imagined natural differences between traditional financial institutions and creative, disruptive fintechs continue to shift from competition to collaboration.
“Incumbents that don’t seek to partner will die.” –Mike Sigal
The financial services sector is going through the same kind of digital transformation that media and commerce went through in the 1990s and telecom went through in the 2000s, says Mike Sigal, Partner, 500 Fintech & Co-founder, Upside Partners and founding executive producer of Innotribe, an initiative of the SWIFT bank messaging cooperative. History suggests that when the industry shakes out the leaders left standing will be a mix of incumbents that move aggressively to adopt new technologies, and some new entrants. Incumbents that don’t partner “will die,” he says. “Smart incumbents realize that they can benefit from the insights and agility of startups, while startups have understood that the scale, reach, stability and regulatory management of incumbents can be helpful.”
Indeed, fintechs can pose an existential threat to banks. Kartik Hosanager, Wharton professor of operations, information and decisions, sees fintechs as “definitely a big threat to banks,” especially in service areas that are capital-light and where “fintech products offer new capabilities that are hard to offer in non-tech products.” A classic example is marketplace lending. Here, fintechs take advantage of the capital-light aspect of a marketplace to offer lending services at lower costs. Further, they can leverage new data from social platforms and elsewhere to improve their analytics. “In areas like student lending, fintechs have already made sufficient inroads. Companies like Square (credit card processing) and others who use mobile devices as cheaper point-of-sale systems are another example.” But Hosanagar thinks fintechs will likely find it hard to penetrate capital-heavy services such as wholesale banking and mortgages.
Hosanagar expects “a lot of co-opetition.” Take mobile wallets. Most big banks like Chase and others have mobile wallet solutions that compete with Apple Pay and Android Pay. These companies also work together to offer a seamless service to any user independent of which device and card she uses at a retail store. Robo-advisors is another case. Incumbents like Schwab and Vanguard have robo-advisors that compete with fintechs like Betterment. At the same time, banks like Citizens Bank have partnered with fintechs to offer robo-advisor capabilities to clients.
According to the World FinTech Report 2018 produced by Capgemini and Linkedin, in collaboration with the European Financial Management Association, 75.5% of fintechs surveyed want to collaborate with traditional financial services firms. Only 18.1% want to compete on their own. The rest want to be acquired by other fintechs or traditional firms.
More than 55% of fintech executives said “gaining visibility, achieving economies of scale, earning customer trust and establishing a better distribution infrastructure” are crucial reasons for partnering with incumbents. “Such a mindset and logical fit of complementary strengths make a strong case for collaboration for today and the future,” says Sankar Krishnan, executive vice president for banking and capital markets at Capgemini.
The Trust Factor
For the upstarts, tapping into the goodwill and trust that incumbents have created is a strong draw. Hosanagar says: “Trust is extremely important for financial services and is not easy to build overnight. Institutions that have been around for decades, if not centuries, have an edge with trust.” Rob Morgan, vice president of emerging technologies at the American Bankers Association, adds: “I may be willing to get into someone’s car for a few minutes without a lot of trust. But when I give you my money, I really need to trust you. When banks and fintechs pair together, you get the best of both worlds and customers can get the new innovative services they crave from a trusted partner.”
Morgan also points out that fintechs typically focus on narrow areas and develop competitive solutions. But unlike, say Uber, which provides a full replacement for the service it has disrupted, fintechs do not replicate the entire suite of banking services. This limits their ability to disrupt the industry as a whole.
“Trust is extremely important for financial services and is not easy to build overnight.” –Kartik Hosanagar
Another huge impetus for fintech-bank collaboration is the growing threat from large technology players such as Google, Apple, Facebook, Amazon and Alibaba — popularly grouped as GAFAA. Vivek Belgavi, partner and India fintech leader at PwC India, points out that they can “develop unique solutions because of their huge base of frequent customers, large data sets and technology pool.” Jean-Philippe Vergne, strategy professor at the University of Western Ontario in Canada, notes that in China big tech is “already reaching more fintech customers than big banks.” Suggesting that the banks must “leverage the technology developed by fintech startups to compete against big tech by using licensing agreements, acquisitions, partnerships or direct investment,” Vergne considers fintechs at present to be “more of an opportunity for big banks than a threat.”
Yet, it’s not as if the marriage between the large, veteran firms and the upstarts do not carry risks. Ravi Bapna, professor in business analytics and information systems at the University of Minnesota, “doesn’t see a natural cultural fit.” Since legacy financial institutions “haven’t really focused on reducing frictions faced by consumers and organizations,” the threat to banks “is real.” Fees charged by credit cards to merchants, he thinks, will be disrupted in the same way that brokerage fees are going to shrink in the era of exchange traded funds and innovators such as Robinhood (a zero-cost trading platform), and how the investment banking business is threatened by the direct listing of Spotify’s IPO. The newer models are made possible by automation, machine learning and artificial intelligence (AI).
Bapna also points to disruptive models in places such as China and India. Ant Financial in China, as an example, has regular interactions with 450 million consumers for payments. That is the “stepping stone for every imaginable financial product” like credit, working capital loans, insurance, pensions, etc. “at a fraction of the cost of legacy institutions, which are encumbered by the pre-Internet, pre-AI-based operating models.”
The India Stack ecosystem, he notes, is another interesting model. “By designing an open, application programming interface (API) platform that others can innovate on, it has the potential to even disrupt the disruptors like Paytm,” says Bapna. He adds: For now, “the Indian government has completely waived transaction fees for person-to-person transactions. This should send shockwaves to credit card companies that charge 3% to 4% of transaction value.”
Banking on Tech
Traditionally, financial institutions have been more process-oriented. This, along with legacy systems and regulatory framework, has restricted their ability to quickly leverage new technologies and roll out new products and services which address customer pain points. Fintechs, on the other hand, are typically more customer-oriented (rather than process-oriented), asset light, have lean operating models, are free of legacy system issues and have better regulatory arbitrage. This allows them to nimbly leverage new technologies like cloud and artificial intelligence to offer a highly differentiated customer experience centered on personalization, speed, relevance, and seamless delivery.
“When banks and fintechs collaborate, innovation and speed-to-market foster a better customer experience like never before.” –Sankar Krishnan
Vijay Shekhar Sharma, founder and CEO of India’s Paytm, says what sets fintech’s apart is the way they approach a problem and their ability to continuously evolve. Banks and fintechs, he points out, are essentially trying to solve the same problems. But unlike banks which use “age-old wisdom,” fintechs are “resetting business models by experimenting with newer opportunities.” In Sharma’s view, it is not fintech companies that pose a threat to banks: “If banks don’t adapt to the new world where consumer behavior is tilting toward technology-led banking, technology could become a threat.”
Sharma points to another major difference: Unlike banks, fintechs have access to risk capital and are not under continuous pressure to be profitable. Fintechs, therefore, can experiment while traditional banks mostly experiment with what has always worked. “By then, the product moves many notches ahead in the market. It’s a classic problem, where fintechs produce technology, and banks, that typically use outsourced IT service providers, can only be customers of technology.”
PwC’s Belgavi notes that fintechs initially focused primarily on disrupting customer-facing areas. They introduced innovations like chatbots to respond to customer queries, authenticated users in near real-time, enabled frictionless, contactless and seamless transactions and offered deeply customized financial products. Financial inclusion of unserved and underserved segments by assessing unconventional data sources and behavioral characteristics, such as willingness to pay, has also been a focus.
Now, fintechs are also developing solutions for non-customer facing areas. For example, they are trying to combine capabilities of AI and robotics to develop new-age solutions for fast processing. Regtech — assisting firms in next generation know-your-customer (KYC), compliance and regulatory reporting — is also gaining traction. “Fintechs are trying to disrupt the entire financial value chain through innovative offerings,” says Belgavi. “New-age banks such as Openbank, Monese, Monzo and Fidor — with new- age models and differentiating solutions — are seriously challenging the business of traditional banks.”
According to Capgemini’s Krishnan, fintechs can take market share from banks “very quickly and often times without any signals to the big banks that they are losing market share.” He cites examples like PayPal, TransferWise, SoFi, Better Mortgage, Stripe, Square and Ant Financials. Paypal (digital payments firm) has over $450 billon of annual payments. Square, founded in 2009, crossed $2.2 billion of revenue in 2017. Ant Financial has a valuation of over $100 billion — about the same as Goldman Sachs.
Trying to Keep Pace
Banks are trying to stay relevant in this fast-changing landscape through different initiatives. For instance, they are setting up their own centers of excellence and developing in-house solutions, introducing chatbots and voicebots, offering online banking and mobile banking, and launching their own cloud-based digital offerings.
There are also instances where banks have tried to digitize the existing broken, manual processes rather than reimagining them. A few have tried to develop new technology stacks over the existing technology ecosystem. But such an approach doesn’t help in fundamentally transforming customer experience. To remain relevant, banks need to think beyond the obvious and reimagine their offerings with customers at the center, says Belgavi.
This is where collaboration with fintechs, which are highly customer-centric, is expected to bring gains. “When banks and fintechs collaborate, innovation and speed-to-market foster a better customer experience like never before. Banks don’t have to reinvent the wheel as they are able to take successful fintech models and apply them to their customers and their environment,” adds Krishnan.
Will regulations prove to be a challenge? ABA’s Morgan points out that the regulatory framework was written in an analog era and digital technologies are challenging some of the assumptions that those regulations were written under. In the U.S. for example, there are a number of states where taking a picture of a driving license is not legal. “It’s hard to do things like opening a bank account on a mobile phone when you can’t take a picture of the driving license,” he says. But regulators are trying to adapt.
Changes are already taking place. Europe has recently introduced two ground breaking regulations that could redefine consumer finance – the Open Banking Initiative and the revised Payment Services Directive (PSD2). These make it mandatory for banks to share their customer data with third parties provided the customers give their consent.
“Partnerships should not be just for branding, but must significantly transform the nature of offerings.” –Vivek Belgavi
In a Knowledge@Wharton article discussing the impact of these regulations, Pinar Ozcan, professor of strategy at the University of Warwick in England, says banks could benefit from this. Companies that have the largest customer base are in the best position to turn their businesses around and make it a platform. Ozcan further notes that if banks were able to act fast and get these fintechs on board to provide a platform or build a platform to offer better services to the customers, they “wouldn’t need to go anywhere else.”
The Right Moves
Some banks have been quick to see it. Spain’s BBVA made eight of its APIs commercially available through the BBVA API Market in May 2017. This allows startups and developers to build new products and services by accessing and integrating the banking data of BBVA’s customers – with their permission – into their applications. Derek White, global head of customer solutions at BBVA, said in a statement that “by opening commercially our data and services, BBVA is turning ‘open banking’ – a model that is going to speed up the transformation of the financial industry – into a reality. Not only are we adapting to EU standard PSD2, which aims to boost competition in the industry, but are actually aiming to become the best platform on which to build new digital experiences. This is a customer-led business opportunity.”
At present, popular engagement models include innovation labs where cutting-edge products are built within the bank, accelerator programs and venture investments. Practically all large banks have embarked on these.
Take India’s Kotak Mahindra Bank. It started its fintech partnership program 18 months ago to look at fintech solutions from top to bottom. The Kotak team identifies the bank’s business problems and then looks out for fintechs that can solve them. It also looks at available solutions from fintechs to see if they could work for the bank. Notes Deepak Sharma, the bank’s chief digital officer: Partnering with fintechs allows multiple tests simultaneously. The bank learns fast “whether we should scale a particular offering or pivot to something else.”
Sharma’s team has three engagement models with fintechs. One, it takes their ready solutions and deploys them internally. Under this model, the bank has partnered with fintechs like AI firm Active.ai (for conversational banking), CreditVidya (lending solutions) and RupeePower (real time credit decision). Second, it partners with fintechs that are in the customer-facing businesses like Payso and Ftcash (payment and lending options to small businesses and neighborhood stores) and powers them with its APIs to help acquire more customers. And lastly, it recently launched a payments co-creation program under which it has partnered with six fintechs in the payments space. These include Automaxis (solutions for goods and services tax filings), DairyPlus (payment digitalization for dairy distribution businesses) and Nukkad Shops Technology (retail business solutions for mom and pop stores).
These fintechs were selected from 133 applicants. They get to work with Kotak’s innovation lab in Bangalore, receive mentorship and the opportunity for a pilot launch in a live environment. Over the past 18 months Kotak Mahindra Bank has partnered with over 55 fintechs through these different models of engagement. “The nature of our partnership with a fintech depends on their core strengths and which part of the value chain of financial services they are impacting,” says Sharma.
Many financial institutions including Citibank, Barclays, Goldman Sachs and Nomura have accelerator programs for fintechs, while UBS, Deutsche Bank, Societe Generale, BNP Paribas and HSBC have invested into fintech firms offering solutions across blockchain, data analytics, personal finance, wealth management, lending, payments, and settlement and regulatory technology.
According to the World Fintech Report, the fintechs’ most preferred partnership is in white-labeling their solutions. Here, the financial services firm buys a ready solution from a fintech and implements it under its own brand. For instance, the partnership between JPMorgan Chase and online lending company OnDeck Capital combines the lending experience of JPMorgan and On Deck Capital’s technology platform to accelerate loan processing time. For the customer, the loans are provided through JPMorgan Chase.
The next preferred collaboration model is integrated in-house solutions. Here, the products and solutions are hosted in-house — typically for larger firms — or as a software-as-a-service for smaller firms. For example, ABN Amro has collaborated with Swedish fintech startup Tink to build an application that gives customers greater control over their finances. The bank launched its pilot version to 10,000 clients and solicited feedback to refine the app for the final roll-out. Currently, more than 150,000 clients use the application Grip, which is linked to ABN Amro’s mobile banking application.
Those are the most preferred models of collaboration by fintechs, says Capgemini’s Krishnan. But over time, he expects a shift to full outsourcing and fintechs leveraging APIs, among others. To gauge the success of a collaboration, he says, it is important to ask the following questions: Does it solve a specific problem? Does it improve the cost or risk dynamics for both the partners? Does it improve the culture and foster new thinking and approaches? Did the collaboration achieve superior results vs. build from a go-to-market perspective? “Successful collaborations always achieve better results,” Krishnan adds.
Vergne says banks need to learn to become nimble, learn how to bridge siloes and increase their speed-to-market. Startups must learn to collaborate within highly bureaucratized structures and navigate complex hierarchies.
ABA’s Morgan believes that closing that culture gap is the big challenge. The culture profile of startups is to fail fast. Success after a 1,000 failures is still a success. In banks, the culture is built around managing risks. “Fintechs must understand the regulatory challenges and the need to maintain customer trust, while banks need to adapt to the innovative and iterative culture.”
For Belgavi, the key to a successful partnership is to find a middle ground that transcends differences across various aspects such as culture, project lifecycle and methodology, employee age and background, hierarchical levels and compliance requirements as they seek to develop a “sustainable and mutually beneficial” partnership. Most importantly, he says, “Partnerships should not be just for branding, but must significantly transform the nature of offerings.”