The world of banking shaped by FinTech
Banking is always one of the business sectors that has leveraged the technologies of the time to improve its products, services, and processes. According to Facebook’s report of Millennials + Money: The Unfiltered Journey; 92% of millennials, the largest single generation ever with an average age of 26.5, don’t trust traditional banks. This shocking observation can be attributed to the 2008 financial crisis and its effects on the global population. Moreover, during the global financial crisis, the profitability of the banks was found to undergo a dramatical decrease because of the slowing revenue growth.
Global VC-backed fintech companies with a private market valuation of $1B+ (1/25/19)
One of the most surprising development in the post-crisis period, was the rise of start-ups, companies and big technology firms offering financial technologies (FinTech) to provide different methods to the clients worldwide, especially new ways of payment services. In other words, the actors of the financial landscape in the business environment were not only the banks anymore. There has been an attention-grabbing shift away from established banks toward new players of financial services. Given that today, financial technologies are growing at an unprecedented pace, the most thorny questions to answer are as follows; How can the banking sector be adapted to the recent trends in FinTech for the next generation? Is the rise of FinTech a threat to the traditional banking industry or is it an opportunity that the banks should utilize to achieve better functionality in a new competitive landscape?
To understand the extent of the challenge for banks to be adapted to the rapidly emerging FinTechs, first, let’s take a look at the evolution of modern banking throughout the 20th century. As the phrase goes, before the flood, it was possible to have a customer record only by filling out a physical card in a specific bank branch. And, since the bank account details of customers were stored on these cards, people could not move from one branch to another without opening another account. However, after Electronic Record Machine for Accounting (ERMA) was built by MIT for the Bank of America in 1953, people could use new unique bank account numbers for the first time, rather than being defined by their name and surnames. In the mid-1990s, with the introduction of internet, we met with ATM Machines, which could contribute to the emergence of self-service banking. Considering the evolution of banking until the 2000’s, we can properly state that the world of banking has successfully harnessed the technology an applied it on a comprehensive scale after a fifty years of dormant period.
Our experience today tells us a different story from what it was about 30 years ago. Game-changing technologies are now coming into our lives once every 2- 3 years, which means that the global banking industry is challenged by the necessity of adapting to these rapid changes in FinTech. As stated by Brett King, Co-Founder of Neo-Bank Moven, you can bank anywhere, any time in today’s world. As the new channels for banking such as mobile wallets, digital payment platforms, and social media have rapidly emerged, the banks are no longer those old branches that you have to pay a visit but something you do because you can now do 7/24 from anywhere through prepaid credit cards and mobile payment systems without the need for a traditional bank account. Today, this new wave of technology is unprecedently altering the conventional definition of banks and banking.
With the rise of innovative technologies over the past decade, people became aware of how their lives were reshaped by the “blessings” of technology. However, there are still some areas that are underdeveloped such as the idea of non-human beings such as technological tools are not allowed to follow the changes on a large scale by themselves without the individuals who can contemplate and put these tools into practice depending on their temporal demands and expectations. Therefore, it should be kept in mind that to understand better the main reasons behind the transformation in many areas of our lives in conjunction with the technological developments, it is necessary to be aware of people’s changing needs and demands in time to have the technical knowledge of game-changing innovations.
At this point, we can rightly state that in today’s banking world, the critical issue should be the utility of services embedded in the functionalities of emerging technologies. The term utility is accompanied by the combination of three core elements; the ability to store value, the ability to move money, and the ability to access credits. In other words, channels and devices in the banking ecosystem are now preferred according to their ability to provide easiness and, the speed for the customers who are trying to open and access their accounts, conduct transactions, and get service issues resolved. Therefore, established banks must meet the requirements of their customers through easier and more convenient services to continue their businesses and thereby, survive in a new banking landscape.
“Banks were so focused on getting rid of their bad loans and reducing their staff headcount that they’d forgotten about customers. Customers had changed-but banks hadn’t noticed.”
FinTech can help the banking industry to create a personalized user experience based on customers’ needs and demands. The concept of FinTech can be identified as the innovative use of technology in the design and delivery of financial services. Therefore, financial technologies have the potential to transform the world of banking through technological innovations such as equity crowdfunding platforms, mobile payment systems, peer-to-peer lending, big data, robo advisors, blockchain, artificial intelligence, and machine learning.
So, why should the banking business harness such “sophisticated” technologies?
The answer to that question can be found, considering the new gap between the traditional banking system offers customers and what people came to expect to meet their needs and demands. To survive in today’s financial ecosystem, banks must actively listen to their customers and have a user-centric perspective. The impact of innovations mentioned above that are central to fintech on shaping the banking industry in many aspects such as mobile, online and retail banking, e.g. are covering more area every day.
The future of banking in the digital age
Rather than visiting the high street bank branches, people have long preferred to use the mobile banking system to make deposits, account transfers and, monitor their expenditure and earnings. According to Business Insider Intelligence’s Mobile Banking Competitive Edge Study, 89% of the participants in the survey said that they actively use mobile banking. As the number of people using mobile banking grows in popularity, we can observe the growth in mobile application downloads worldwide as well.
The main reasons behind the growing interest in mobile banking are related to its ability to offer easiness, speed, and security through smartphones that allow customers to make purchases online or in-store without the need for any physical credit card or visiting a branch. As people also become more agitated about large scale data breaches of leading financial institutions, they increasingly rely on technology companies with their digital data more than their traditional banks to eliminate their concerns about transaction security. With the help of some unique properties of mobile devices, mobile banking apps have the potential to provide consumers with more robust measures against cybercriminals such as identity thieves than what established banks can offer in the online environment, according to Aite Group’s research.
According to Business Insider Intelligence experts,, the popularity of online banking is strikingly surpassed by that of mobile banking. As their data have shown, mobile banking is growing at five times the rate of online banking, and half of all online customers are also mobile banking users. As also figured out by Eric Wilson, Co-founder of Xinja;
“The next evolution of online banking is to be a last-century business model built by specifically smartphones.”
However, despite the popularity of mobile banking, some banks still cannot satisfy the demand for some mobile tasks such as paying the bills and reward redemption, and they push users to use online banking. Although mobile banking and online banking are mostly viewed as interchangeable concepts, there are some differences between these two terms. While mobile banking refers to the opportunities provided by banks that enable customers to make their transactions through short message services, mobile application or websites, via internet banking, customers can conduct their transactions over the bank’s website on their computers. More importantly, in mobile banking, fund transfers can be made through the National Electronics Funds Transfer System (NEFT), and Real-Time Gross Settlement, (RTGS). On the other hand, in online banking, it is possible to make fund transfers from one bank or branch to another with the help of Immediate Payment Service (IMPS) as well as NEFT or RTGS.
As another payment method, today, cryptocurrencies increasingly started to receive attention from the financial ecosystem. For example, U.S. Bank J.P Morgan Chase’s launch of JPM Coin, and Facebook’s Libra go beyond the basics of today’s commerce industry. As a stable coin representing fiat currency, JPM Coin is launched in February 2019 for the transfer of payments on a decentralized blockchain network between the institutional clients. Libra is also created by Facebook to provide those without access to financial services through the integration of digital wallet capabilities into Facebook’s existing messaging services. David Marcus, the head of Facebook’s blockchain subsidiary Calibra, has often emphasized that:
“The very people who say they lack the money to open a bank account are actually not saying that they have no use for modern financial services. They’re just saying they can’t afford to access the system.”
As well as mobile and online banking, retail banking has also been reconceptualized by the “disruptive” technologies over the past few years. Traditionally, retail banking provides consumers with some financial services such as savings and checking accounts, credit and debit cards, and loans. With the rise of digital technologies, the operating efficiencies of retail banking considerably improved. According to Business Insider Intelligence, %39 of retail banking executives accept the impact of new technologies on reducing costs and increasing transparency, while 29% say that new technological trends are more effective in improving customer experience.
Another game-changing technology with a strong impact in retail banking is the blockchain. According to the Matt Hinginson, the management consultant in McKinsey, because of the cost pressure in the retail banking market, banks have started to consider blockchain-based projects. Blockchain infrastructure enables financial transactions to be verified by each computer in a decentralized network without the need for any central authority, which means that there is no single point of failure, an effective solution to data breaches.
Because of such transparent and decentralized nature of this technology, retail banking started to leverage the blockchain. Santander Bank, for example, launched a new international money transfer service, known as Santander One Pay FX, using blockchain technology in cooperation with California-based Ripple in 2018. After the launch of the blockchain-based service, Ana Botín, Executive Chairman of Banco Santander, stated that:
“One Pay FX uses blockchain-based technology to provide a fast, simple, and secure way to transfer money internationally- offering value, transparency, and the trust and service customers expect from a bank like Santander.”
Specifically, the three specific areas retail banking prefers to integrate blockchain technology into its roadmap are remittance payment processing, fraud prevention, and risk scoring system.
As we all know, cross border payments take a long time and have a much higher cost than local payments. However, fintech plays the role of a new “panacea” in reducing the costs of remittance services for a while now. According to World Bank report on global trends for remittance prices published in June, 2019, the global average cost for sending remittances was 6.84%. However, the cost of sending remittance from low and middle-income countries such as in South Africa are still somewhat upwards of 20% level. However, as stated by McKinsey authorities, with the help of distributed Blockchain ledger, up to 4$ billion could be saved in a year in cross-border payment costs. Blockchain-based digital currencies can create value by fixing certain inefficiencies since they are not required to be controlled by a central regulating body, which means that through decentralized blockchain, the payments can be made in a matter of seconds.
Therefore, many banks have, for a while, started to implement blockchain technology in their current remittance systems. For example, Visa Europe and BTL Group’s Interbit Platform are collaborating to provide cross-border settlement solutions through cryptocurrency BTL acting as a bridge currency to create instant and nearly free global money transfers of any size.
Similarly, we can talk about the partnership between blockchain-based platform, Digital Trade Chain, and a few major European banks, including such as Spain’s Santander, along with IBM to manage open account trade transactions globally. As we mentioned before, Santander is also one of the first banks in the UK harnessing blockchain-based Ripple for international payment transfers through mobile applications. Furthermore, UBS, Royal Bank of Canada, and the National Bank of Abu Dhabi have, for a while, used Ripple’s payment protocol and exchange network to provide real-time affordable money transfers for their customers.
Second, the problem of identity fraud can also be solved with the distributed blockchain ledger enabling retail banks to conduct their businesses with greater transparency and immutability since no data cannot be possibly altered or attacked without the “consensus” of majority in the decentralized blockchain network. Identity fraud has been a real challenge for the banks because it leads to an approximately 20$ billion loss a year. For protecting the customer data, retail banks now mostly attempt to combat fraud, prevent money laundering, and introduce real-time information sharing based on the predictive models. However, such efforts of the retail banks to provide their customers with ID protection cause longer onboarding times and higher costs which can be resolved with blockchain. For onboarding or account opening, customers have a chance to use the digital fingerprint as a unique identifier to prove their identities globally since these fingerprints can be stored on a distributed blockchain ledger and referenced by any bank in the network.
As data clearly show in CB Insights report, blockchain-based solutions can reduce the annual costs resulting from identity fraud, which can amount to as high as 7$ billion to 9$ billion by cutting the risk of financial crimes, and thus improving efficiency. In that sense, Bluzelle networks, a blockchain-based data storage startup, has started to work with HSBC, OCBC, and Mitsubishi UFJ Financial Group in Singapore in 2017 to try their proof of concept for a platform for KYC, Know Your Customer. As another example, IBM and the National Bank of Canada, Scotia Bank, and TD have collaborated with the Secure Key, Canada-based FinTech firm, to develop a digital identity and authentication service that provides their customers with an easier access to online services in the scope of digital banking.
Third, the credit decisions are mostly made by the banks with the limited data of potential borrowers, which means that some parts of society still cannot get access to most of the financial services such as opening a bank account, taking out a loan, e.g., due to the deficiency of traditional credit scoring mechanisms of banks in assessing potential borrowers’ credit-worthiness.
Blockchain technology can offer a new solution for collecting data of borrowers from a wide range of sources such as social media, smartphones, etc. to fairly measure borrowers’ eligibility for bank credits. As detailed in the article of McKinsey company, the process is as follows;
“…Data carried on a distributed ledger could be accessed without at the time permission (customer consent can be granted via pre-programmed smart contracts.) Banks could theoretically view data that has been uploaded by any bank in the network. The result should be faster decisions, more efficient processes, and the potential for a more informed credit allocation process…”
Latest Trend in Banking: Partner Bank Model
As can be understood from the developments mentioned above, many startups and companies started to take place in the global finance industry besides established banks. As the list of fintech startups such as Paypal, Zelle, Venmo, Stripe, and Coinbase, e.g., increasingly grows, the fintech unicorns are mostly viewed as a “threat” to the dominant position of the traditional banks in the sector. In fact, these new fintech companies were further boosted with the help of open banking rules of the EU that led them to gain access to data and accounts of clients who authorize it.
On the other hand, as mentioned at the beginning of the article, we have witnessed the rise of big technology firms, known as “tech fins” that provide alternative financial services for customers globally from the US to China in addition to the small fintech startups. Examples to the concept of tech fin include Google, Amazon, Facebook, and Apple (GAFA) in the U.S and Baidu, Alibaba, & Tencent (BAT) in China. These tech giants provide new alternatives for “financial inclusion” especially for the unbanked, with the new digital wallet services through their both massive customer bases and vast cash reserves.
For example, today, Alibaba’s affiliate company, Ant Financial, approximately serve 1.2 billion customers around the world (data of June 2019) through its digital payment platform, known as Alipay. Another tech giant Tencent has reached a whopping 30% CAGR (combined annual growth rate) in customer acquisition since 2016 with the help of its mobile payment platform, WeChat.
Annual e-commerce revenue of Alibaba from 2010 to 2019, by region (in million yuan)
However, as a common point of “fintechs and techfins,” both of them are doing exceptionally well in collecting and analyzing massive data sets, improving digital engagement in real-time, and focusing on consumer needs and demands more than the traditional banks ever could do.
In this framework, the claim that there is a “tug of war” between the banks and new entrants to the banking market is becoming stronger. However, contrary to what is believed, companies and banks are increasingly open to collaboration to gear their services towards consumers’ voices and thereby, to expand their footholds under the name of “the partner bank model.” For example, by Banking as a Service, the companies can provide their customers with financial services such as branded banking products, and payment solutions, which in turn can make it easier for banks to deliver their products and services over the web. That is to say, as a subset of open banking, Banking as a Service (BaaS) allows third party companies to get access to banking services. A smart partnership between the banks and fintechs can improve banking revenue pools with the help of innovative technologies. While fintechs are more agile and innovative, established banks are viewed as the source of large distribution networks with their familiar brands. Therefore, the collaboration between banks and companies can be considered the best path to take for long-term growth.
Within the scope of the partner bank model, Cross River Bank, for example, lets other companies provide banking products and services for their customers via its application programming interface known as APIs. Gilles Gade – President & CEO, Cross River Bank stated that:
“We are positioning ourselves as a new bank play, somewhere between what a bank should be and what fintech aspires to be with the help of new trends in the technology sector.”
One of these trends in banking technology that contribute to the collaboration between the banks and fintech companies is the opening up of banks’ API to third parties. As we mentioned before, the “open banking” process allows companies to get access to available data provided by the banks, if there is a consumer’s permission to access to it. Therefore, it can be properly said that banking APIs allow third party developers to build fintech applications and services based on the data provided by financial institutions. By this means, all consumer financial data is now callable through a single API, while the data was centrally held by the bank in the past.
One of the most remarkable developments is happening in Africa. There has been for a while various initiatives to foster collaboration between South Africa Reserve Bank and new fintech startups through the “regulatory sandbox” system that was designed to harness innovative technologies in the financial sector in relaxed, but still safeguarded regulatory environment, which in turn can contribute to developing open APIs standards. It is not so likely to close our eyes to such exciting developments in the banking ecosystem. However, there are some key steps that both banks and companies are required to follow to bring off the partner bank model without being distracted.
First of all, we can talk about the need for a continuous dialogue between the partners to have a strategic agreement. Then, as stated by Martijn Hohmann, Co-founder of Five Degrees, to have a robust partnership between banks and companies, fintech partners should be kept up with the developments related to the compliance, regulation, licensing requirements. And lastly, banks and fintechs are required to harness big data models and automated decision making processes, while testing the resilience of their businesses.
As demonstrated by looking at the last breakthroughs in the banking industry, there has been a dramatic change in the nature of financial ecosystem over the past decade. However, today, what the crucial one is to be able to keep up with the developments, and to establish strategic partnerships depending on the necessities of the time, as we mentioned in that article. In the new digital era, the needs and demands of customers are focus for many institutions in especially financial landscape. In that point, it is important not to exclude potential partners such as established banks by labelizing them as “the actors who are behind the times” since for a while, there have been various examples of smart partnership between the banks and fintechs companies on the basis of customer-centric understanding.