Yes Bank in India gained millions of new potential customers in one fell swoop when it partnered with a fintech upstart called MatchMove to offer people without a credit card, credit history or even a bank account, a way to store and spend money.
The Sept 30th deal is just one example of how banks are beginning to collaborate with start-ups to seize new market opportunities and cope with the deluge of changes facing the financial services industry. Spain’s BBVA bought U.S. digital bank Simple last year, made an investment in January in bitcoin exchange and wallet provider Coinbase and has launched an instant funds transfer service through Dwolla, an all-digital payments start-up. And for the past year Spain’s Banco Santander has been referring small UK businesses to peer-to-peer lending service Funding Circle as part of a partnership between the bank and the fintech company.
Has To Be Collaboration
To realize the opportunity of “fintech 2.0” a white paper prepared by Santander InnoVentures, Oliver Wyman and Anthemis Group says, “banks and fintech [start-ups] will need to collaborate, each providing the other with what it now lacks be that data, brand, distribution or technical and regulatory expertise.”
“There has to be collaboration,” says Nadeem Shaikh, founder and CEO of Anthemis Group, a digital financial services investment and advisory firm, which helped prepare the white paper. “Incumbents will be playing a big role. I don’t see this happening as it has in other industries with some unicorn coming in and obliterating everyone. That said, the industry as it exists today has to rethink how they are approaching their customers. There is a really huge opportunity for reinventing financial services as we know them today.”
Millennial Shift: A Different Kind of Trust
Nearly three out of four young people would rather visit their dentist than their bank and half think banks are essentially like toothpaste — indistinguishable from each other, according to a recent three-year survey. One-third think they won’t need a bank at all.
If the future of money will be very different it will be due in part to these digital natives. The Millennial Disruption Index, a study of industry disruption at the hands of “millennials,” the generation born between 1981 and 2000 and more than 84 million strong in the U.S. alone, paints a challenging picture for the banking industry. (The Millennial Disruption Index was created by researchers Scratch, which surveyed more than 10,000 millennials in the U.S. about their attitudes to 73 companies spanning 15 industries over a period of three years.)
Most of those who responded believe the way they will access money and pay for goods and services will be totally different in five years’ time, with over two-thirds more excited about new financial services from a tech company such as Google or Apple than those from their bank.
Millennials reject their parents’ banks because they trust technology even more than face-to-face relationships, according to a white paper about millennials prepared by Innotribe, the innovation arm of SWIFT, in collaboration with Wharton FinTech, a student-led initiative co-founded by MBA candidates and scheduled Sibos 2015 speakers Daniel McAuley and Steve Weiner.
“Millennials don’t see lack of human relationship as a drawback, they see it as a feature,” says McAuley. “That is part of the reason they want to use digital products, because they are faster, cheaper, cooler and more functional and enable other types of interactions.”
Companies that are providing digital products and services to other age groups are also gaining traction. For example, Abaris, an online marketplace for annuities aimed at people looking to retire, is attracting clients because it provides a platform that allows clients to see annuity quotes from different providers in one place.
“Being shaped by a digital world in constant and rapid change is not a phase people grow out of, but is the essence of the new customer,” says a September report from Claro Partners and Athemis Group that focuses on rethinking banking. “The behaviors, needs and expectations of this customer will go viral across older age groups, as we have seen through other digital behaviors,” the report says. “The next generation of customers — no matter what their age — will be shaped by an ‘always in beta’ world.”
Customer choices will also be changed by personal values. Some 89% of millennials polled in the Innotribe white paper demonstrated a stronger likelihood to buy a product from a company with a social or environmental mission and 91% trust those companies more. Services with a social bent, such as Venmo, a digital wallet that lets you share payments with friends, are also resonating with digital natives. Understanding this emerging, dynamic customer segment, says the white paper, “will separate the leaders from the laggards in financial services over the next decade.”
That means the days of vertical integration will likely be numbered. Banks are taking an “if you can’t beat ‘em, join’em” attitude because technology is revolutionizing conventional financial services, and disruption is occurring at an exponential rate. U.S. investment bank Goldman Sachs projects an estimated $4.7 trillion in revenue and $470 billion in profits from the traditional banking marketplace is at risk of being displaced by fintech companies.
A Sept 30th report by McKinsey predicts that over the next decade competition from start-ups will reduce profits from non-mortgage retail lending, such as credit cards and car loans, by 60% and revenues by 40%.
Attacks are coming from all fronts. Banks don’t just have to worry about Google and Apple. Three Chinese Internet giants have obtained banking licenses this year.
Over $11 billion in personal loans have been issued through just one start-up: Lending Club. And Uber’s integrated payment service is an early indicator that many financial functions that are key revenue sources for banks will soon be free or disappear, notes a recent report prepared by Claro and Anthemis Group.
Don’t Want To Become A Bank
Most of these start-ups don’t want to become banks themselves. They just want to skim the cream off by having a direct relationship with customers. McKinsey says that leaves banks with two choices: “Either banks fight for the customer relationship or they learn to live without it and become a lean provider of white-labeled balance sheet capacity.”
To fight back, banks are trying to become platforms and open their application programming interfaces — i.e., exposing their proprietary software to outside developers so they can develop their own applications. France’s Crédit Agricole, Citigroup and Bank of America are among those doing this. By sharing APIs with nimbler, unregulated tech start-ups, the argument goes, banks can innovate much faster.
New approaches are needed to attract and keep digital natives as clients and to tackle new opportunities such as adding millions of unbanked and underbanked people, including refugees,. as customers.
Many banks are now reaching out to developers and start-ups for help — opening incubators, accelerators and blockchain labs — but pundits say none has yet really perfected the best way to bring innovation in from the outside.
The challenges don’t stop there. Some traditional bank jobs are being replaced by machines. Loan approvals are being automated. Personal finance management services, such as estate planning, life insurance and basic tax planning, may be next. Robo-advisor offerings could be extended to include serving high-net-worth individuals who are currently supported face-to-face, according to the Fintech 2.0 white paper. Cognitive computing — computers that can ‘think’ — is already being used in banks.
These developments will require major organizational changes as well as a complete overhaul of the type of people banks hire and the services they offer.
Blockchain Threatens To Disrupt Everything
Meanwhile, the very rails that are used to transfer trillions of dollars globally are being called into question by new, more efficient technologies such as blockchain, a digital ledger technology that can serve as a distributed financial exchange mechanism.
“The blockchain protocol threatens to disintermediate almost every process in financial services,” says a World Economic Forum June white paper [PDF] that will be discussed at Sibos 2015, an annual industry conference that attracts more than 8,000 banks from around the world.
It is little wonder then that at this year’s Sibos, Innotribe, the innovation arm of SWIFT, has organized a session entitled, “The Future of Money: A Burning Platform.”
To be sure fintech — and all the changes it brings — is a threat. But it is also an opportunity. “Banks are really bad at innovation — they are awful at it — but the good news is that it doesn’t matter,” says Dan Marovitz, a former Deutsche Bank executive who now heads European operations for Earthport, a London-based company that has built an alternative to correspondent banking.
“This is the greatest time to be a banker because there is so much choice and so many options,” says Marovitz, a scheduled speaker at Sibos 2015.
“For the first time ever we have entrepreneurs trying to fix the financial sector’s problems. There are thousands of really smart people thinking about the entire ecosystem, everything from sending, lending, borrowing, managing wealth and evaluating risk — that has never happened before in this industry.”
Among those people is Hank Uberoi, a former head of Goldman Sachs’s global technology systems, and now CEO of Earthport. He and other fintech start-ups see revamping the antiquated infrastructure used by the financial services industry as one of the biggest opportunities.
$21 Trillion Moves Through Banks A Year
Today, some $21 trillion a year moves around the world through a network of thousands of correspondent banks. A single cross-border payment can be handed off to two, three or even four different institutions. Each one takes a “landing” fee and, if relevant, currency exchange charges. Each also decides how and when to transmit the money along the way, making the system inefficient, error prone and expensive.
The Automation of Credit
Replacing traditional tests for a person’s creditworthiness with digital signals — including mobile phone behavior — can speed up the loan process and slash costs, making it possible for both start-ups and banks to extend credit to millions more people at lower cost.
Take the case of MODE, a London-based fintech company that is using mobile phone behavioral data to make decisions on nano loans in over 24 countries. MODE offers payday loans through employers. The amounts loaned range from $5 to $50. Some 280 million people have applied and MODE has approved 130 million requests. It claims a default rate of less than 1%.
“We are starting to work with banks and we are showing them that by not giving credits of $50 or less they are losing out on billions of dollars,” says MODE CEO Julian Kyula, a scheduled speaker at Sibos, the global banking conference taking place October 12-15 in Singapore.
Then there is Kreditech, a German start-up that is using big data, algorithms and automated workflows to identify and underwrite underbanked or unbanked customers within 35 seconds. Since its founding, Kreditech has scored more than two million individual loan applications, using up to 20,000 data points per application.
Kreditech’s global subsidiaries offer products from individually-tailored installment loans and microloans to payment and other financial services, including a digital wallet and a personal finance manager designed to help customers manage their credit scores and plan their spending. The company, which has raised $360 million in equity and debt, from backers that include PayPal co-founder Peter Thiel, operates in Poland, Spain, Russia, the Czech Republic, Mexico, Australia, Peru, Dominican Republic and Kazakhstan and has plans to enter Romania and Brazil.
Like MODE, Cignifi, a Cambridge, Massachusetts-based start-up funded by eBay founder Pierre Omidyar’s investment firm and American Express Ventures, calculates a person’s credit-worthiness from their mobile phone calling history. But the company does not grant loans directly to consumers. It offers its technology platform to banks and telcos so they can make highly-predictive risk assessment decisions about people who have never had a bank account or credit card.
“Our pitch is monetize the people you have traditionally denied,” says Cignifi CEO Jonathan Hakim, another scheduled speaker at Sibos. “Banks decline a large percentage of applications. Our scores make it possible to quantify tens of millions of people who are currently off the radar screen because of a lack of information. This is a huge new addressable market.”
Instead of this “many-to-many” approach Earthport is using a hub-and-spoke model to build a new set of rails. It acts as a central clearing agency to which all the payments go — so that any bank or big corporate with a single connection to Earthport can send payments around the world. It is already working with institutions such as Bank of America, Standard Chartered and American Express.
“They are not always using us as their core platform but they are using us,” says Marovitz.
Earthport is hoping to lure more customers to a newly-announced service. It recently teamed with Silicon Valley start-up Ripple to enable real-time cross-border payments via distributed ledger protocol, helping banks make the leap from blockchain labs to the real world. The service is scheduled to start transacting in the first quarter.
Earthport is far from being the only upstart focused on helping financial services companies make use of the blockchain. Chain, a San Francisco-based start-up, is working with banks and other institutions to develop ways to trade and transfer financial assets using blockchain technology. NASDAQ has announced it will use Chain’s technology to facilitate the trading of stakes in unlisted companies on its private market. And the company has raised $30 million from investors that include NASDAQ as well as Visa, Citi Ventures, Capital One Financial and Fiserv.
Blythe Masters, a former JP Morgan Chase executive best known for helping pioneer the credit-derivatives markets in the 1990s, is also gunning for the space. She became one of the most high-profile Wall Street bankers to join the crypto-currency sector when she took on the job earlier this year as CEO of Digital Asset Holdings, a New York start-up that is designing software that will enable banks, investors, and other market players to use blockchain technology to change the way they trade loans, bonds, and other assets.
Masters, who is scheduled to speak at Sibos 2015, is one of the industry’s most vocal blockchain proponents.
Bridging The Gap
“I believe that [blockchain] technology has the potential to truly change the way the financial world operates, to reduce costs, improve efficiency, reduce risks and ultimately provide better customer service, which ultimately is what financial services needs to be all about,” Masters said an opening keynote at American Banker’s July Digital Currencies + the Blockchain conference.
In June Digital Asset Holdings bought a start-up called Hyperledger, a distributed ledger platform designed to help financial institutions mitigate settlement risk, prevent trade breaks and cut reconciliation costs. (The company is a finalist in the 2015 SWIFT Innotribe Start-Up Challenge.)
The acquisition puts Digital Asset Holdings in a position to build solutions for its customers using both permissionless networks such as the Bitcoin blockchain but also off-the shelf private networks like Hyperledger.
“We are trying to bridge the gap between existing financial institutions and the new technology of distributed ledgers,” says Sibos 2015 speaker Dan O’Prey, the founder and former CEO of Hyperledger, now Digital Asset Holdings’ Chief Marketing Officer. “We are looking to work with market incumbents to improve, rather than replace, their existing infrastructure using this new technology. We strongly try to avoid the word ‘disruptive’ and would not characterize ourselves as that.”
Not disruptive? That’s a far cry from the way most fintech companies talk. “The language we use when we talk about fintech is usually linked with fear — the words are violent — but the fact is that banks ain’t going away,” says Earthport’s Marovitz.
Sure, fintech companies are raising huge amounts of capital. (The total invested in fintech globally between 2010 and 2015 was just under $50 billion according to IC Dowson and William Geraty Associates.) But that number is dwarfed by the banks’ assets. According to Oliver Wyman’s analysis the top 300 banks control a revenue pool worth $3.8 trillion.
Nobody Can Take The Future For Granted
SWIFT CEO Gottfried Leibbrandt agrees that there is a “huge opportunity” to bring some of the recent technological innovations into the financial services area. “It’s early days, but it is obviously worth exploring what role blockchain technology can play in the securities area,” says Leibbrandt. “I am not surprised that NASDAQ is working with Chain and I wouldn’t be surprised if we see European players do something similar as the technology could potentially allow traditional settlement processes to work better.”
Leibbrandt says he sees a big role going forward for traditional infrastructure providers like SWIFT but acknowledges that his own organization will need to embrace change in order to remain relevant.
“We are looking at these technologies and what they can do for us, and how they can help us improve our own service to our customers,” he says. “We might, for example, consider seeing how some of the nascent technologies could be applied to improve correspondent banking or, for instance, whether we should use blockchain to improve our own processing and network.”
“Nobody can take the future for granted,” says SWIFT’s CEO. “Incumbents in the financial services industry need to do some serious adaptation to meet changing customer demands and reap advantage of the new technologies.”
For many that will mean working more closely with start-ups. “There is a lot to be learned from both sides,” says Anthemis’s Shaikh. For the financial services industry, “the question is how do you bring innovation closer to you without killing it? We are still in the early stages of figuring out the framework of engagement.”