Banking is necessary, banks are not

Banking is necessary, banks are not was stated by Bill Gates all the way back in 1994, and has served as the mantra for the first wave of fintech. Following the Silicon Valley obsession of disrupting incumbent industries, numerous fintechs were ready to challenge every aspect of banking and deliver better banking services directly to consumers. Armed with the recent Millennial disruption index, where 71% of respondents claimed to rather visit the dentist than listen to their bank everyone was convinced that the days of incumbent banks were numbered.

As the sector matured, something else happened. Customer willingness to switch away from incumbents has been overestimated. Customer switching costs are high, and the perceived usefulness of innovations has proven insufficient to warrant a shift from incumbent service providers. Fintechs have also struggled to create new infrastructure and establish new financial services ecosystems, such as alternative payment rails or alternative capital markets. They have been much more successful in making improvements within traditional ecosystems and infrastructure.

As a result, rather than eating the incumbents lunch, banks and fintechs sat down to eat lunch together, acknowledging that collaboration allows both parties to benefit from complementary strengths and weaknesses between banks and fintechs. On the one hand, fintechs are agile and innovative. On the other, banks have consumer trust, familiar brands, large distribution networks and a well-equipped war chest. Collaboration between banks and fintechs should therefore be a win-win, improving the incumbent’s capacity for innovation and giving the fintechs scale and route to market. As a result we see weekly announces of banks collaborating with fintechs in order to boost their innovation efforts.

Payments is still the biggest and most mature field within fintech. Changing consumer behavior, eCommerce, smartphone adoption, digital currencies and PSD2 are just some of the trends that is making payments ripe for disruption. As the competition intensifies, margins are under pressure, and payments is merely an entry point to the banking sector. iZettle has expanded into lending, and several challengers coming from the payment side are now applying for a full-fledged banking licence. Klarna received its banking license in Sweden earlier this year and Square has filed an official application for a US banking license, proving the need to become a bank in order to fulfil their potential.

Marketplace lending was once viewed as one of the business models that enabled non-banks to serve customers financial needs without becoming a bank. However, marketplace lenders have despite having lower legacy than banks proven to be at a cost disadvantage compared to traditional bank in order to reach significant scale. The cost of capital as a marketplace lender is significantly higher than the cost of capital with a traditional banking license. As a result, peer-to-peer lenders such as Zopa are now applying for a banking license to launch a retail bank alongside its core peer-to-peer operation.

The benefits of being a bank has also encouraged challenger banks to pick up the mantle and compete head on with behemoth counterparts. With little to no legacy and an open platform, challengers like Starling, Monzo and N26 focus on creating a state of the art digital user experience as competitive advantage, while offering complementary products and services from strategic partners as part of the customer journey.

Incumbents have in no way sat idle by to watch this development unfold, and are starting to adapt to a changing landscape for financial services. In the regard, the big uncertainty is whether banks are ready to put their money where their mouths are and start innovating at the core of their business models.

Even though it has proven more cumbersome than anticipated to eat the banks lunch, that should be no excuse to rest on ones laurels. Even though fintechs could be viewed as a source of innovation rather than an existential threat, Facebook, Alipay and Amazon are still looming on the horizon as the real concern for incumbents.

Where fintechs have pivoted towards collaborating with the banks or becoming banks themselves, online platforms as Facebook have a different starting point, as they are omnipresent in our everyday lives. Tech giants excel at digital service design and convenience, but still lack the trust represented by the banks. However, tech giants already define customer expectations, and will surely give the banks a hard time if they choose to offer digital banking services as part of their platforms.