The landscape for financial services is changing

This blog post is a transcript of my lecture, Fintech from a banking perspective.

The landscape for financial services is changing, innovation is coming from outside the industry, and traditional banking is losing its relevance for the next generation of customers. This is backed up by the way-too-often quoted Millennial Disruption Index, which states that 71% of millennials would rather visit the dentist than the banks, 53% does not distinguish between incumbent banks, and 33% of the respondents do not see the need for banks at all. Accenture’s Banking 2020 report confirms this and draws a parallel to the challenges the telecom industry faced 20 years ago and states that non-banks will take a third of incumbent banks revenues by 2020. In this landscape, players that once were customers and partners can quickly become new digital competitors.

Large retailers and airlines are launching their own consumer banks and credit cards based on customer data, brand loyalty and capital reserves. The telecom industry is targeting the “underbanked” segments in developing countries through mobile banking. The media industry is developing proprietary payment solutions in order to secure valuable transaction data for targeted ads. In addition to this the investment activity in fintech reached $102 billion observed across a variety of investment types in 2014 ranging from seed funding in small tech startups to acquisitions by behemoths like Apple, Google and Facebook. A number of trends are behind these changes to the financial ecosystem.

Mobile applications make the bank and banking services available 24/7 in one’s pocket. Customers are already shifting from internet banking to mobile banking, and the next step is mobile payments and mobile wallets.  Several companies are experimenting with personal biometrics through the built in gyroscope and GPS, and the mobile phone may act as a tracking device for both insurance and spending statistics. But this is still only touching the surface of the technical possibilities that lies within the use of smart devices in banking. With the rise of internet of things, your smart phone could easily become a central processing unit for your personal network of all your wearables and sensors. This creates unlimited possibilities for those who embrace the technology.

Big data analytics and machine learning enables automation of complex tasks. Challengers are utilizing visualization and big data in order to compete with incumbents. This is becoming clear in credit rating services where newcomers are using predictive analysis based on real time behavior to determine one’s credit worthiness. What is your purchase history? In what time of day did you conduct your purchase? Are you using correct capitalization when submitting forms online? What is your job description on LinkedIn? Who are your Facebook friends? All these metrics are potential variables that can be used in determining one’s credit rating.

Sharing economy with services like Airbnb offers homeowners insurance and host-protection insurance as an integrated part of the service. Both Uber and Lyft have expanded their liability insurance for ridesharing, and companies like TaskRabbit include an insurance policy covering property damage to make trusting strangers easier. You may ask yourself, when was the last time you really wanted to purchase travel insurance? Chances are you wanted to travel, and insurance was a necessity. Just imagine the implications for the auto insurance industry in a possible future of ridesharing in self-driving cars with integrated liability coverage.

Social media needs no further explanation, but for the financial industry the majority of social media services are implementing financial services as an integrated part of the platforms. Facbook has announced the launch of Facebook Pay. Snapchat launched Snapcash last year, and Kakao Talk in South Korea entered the mobile payment space through Kakaos own Payment platform, just to name a few. On the consumer side, the customers want to meet their needs in an easy way on their own premises. These are basically payments, lending and savings.

Payments are of little value itself, but are the main traffic source for banks and the basis for 80% of all customer interaction. For challengers payments are considered the bridgehead into financial services. These challengers have little to no interest in the transaction fees, but consider transaction data as the primary value object. Ownership and analysis of the information gathered through transactions is the new competitive advantage in the digital payment processing space, which makes loyalty and analytics is the growth driver for mobile payments. With the introduction of Directive on Payment Services (PSD) 2, the road is paved for new and innovative third party payment providers.

Lending is the primary source of income for most banks, and we are starting to see significant growth in the marketplace lending industry. Foundation Capital estimates the total value of this market to be 1 trillion USD by 2025, with recent IPOs by Lending Club with a valuation of $5,4 bn. Alternative lenders are currently disrupting both unsecured loans as well as small business loans, but companies like Social Finance have announced that they are aiming for the mortgage market in the long run. Marketplace lending is considered shadow banking for many, but it is closer to actual banking than we think. A closer look at lending Clubs loan process shows that the actual loan is issued by Webbank in Utah. Lending Club then buys this loan and places it in their balance. Lending club then issues a structured note and sells it to the investor. The lender pays Lending Club, and Lending club passes they payment forward to the investor.  There is never a direct link between lender and investor, and lending club keeps it all in their balance sheet without having any capital risk.

Savings is also challenged by P2P-leding as this acts as an alternative investment class outside the banking world. In addition automated investment platforms with robot advisors based on intelligent algorithms and deep learning is replacing your traditional investment advisors. Wealthfront secured $70 million in growth capital to secure further growth after reaching $1 billion in assets under management since its launch in 2011.

Where yesterday’s customers went to the bank as a one-stop shop for all financial services, the customers of the future can choose from a wide range of financial services delivered from third-party solutions without ever needing to contact or log on to your bank. Google recently announced Google Mortgage, a comparison service for mortgages, and Cost per Click for loans are reaching up to 44 USD for one single click. This challenge the distribution model, as the customer journey for many financial services begins with a Google search.

The combination of these challenges creates a perfect storm for incumbent banks with numerous tech companies aiming to unbundle banking services. When facing fierce competition from the tech world banks still have a competitive advantage on the supply side through cost of funds tied to the banking license by being able to ‘create money’ in the process of lending. This is also the part of the value chain with most distance from the customers, and it is important to consider that regulations can be both a friend and foe for incumbents. Iceland recently announced a reform in the monetary system, where commercial banks should no longer be able to create credit.  According to Marc Adreesen of Andreesen Horowitz, there are regulatory arbitrage opportunities every step of the way.

If the regulators are going to regulate banks, then you’ll have nonbank entities that spring up to do the things that banks can’t do. If we look to Iceland, the financial sector should be prepared for more changes the next twenty years than we have experienced the last hundred years.

To stay relevant, banks must embrace the technology-driven changes and look for new opportunities rather than protecting and preserving antiquated business models. After all, fortune favors the prepared mind.