The disruption (threat from FinTech)
A Goldman Sachs research report in early 2015 estimated that a part of the traditional financial services’ revenue ($4.7 trillion out of $13.7 trillion) is at risk of being displaced by new technology-enabled entrants which include FinTech players lending, wealth management, payments and others. The threat of FinTech is more real than before.
McKinsey’s report The Fight for the Customer: Global Banking Annual Review 2015 reveals that as much as 40% of revenues and up to 60% of the profits in retail banking businesses – consumer finance, mortgages, small-business lending, retail payments and wealth management – are at risk from a combination of various factors such as dwindling margins and competition from FinTech startups which target origination and sales, the customer-facing side of the bank.
According to a recent research report published in March 2016 by PricewaterhouseCoopers (PWC) titled How FinTech is Shaping Financial Services, top banking executives fear that more than more than 20% of the financial services businesses will be at risk to FinTechs by 2020. If we look closely into the PWC report, the majority of the participants in the survey feel consumer banking & fund transfer and payments as the sectors mostly likely to be disrupted by 2020. The PWC report also reveals that disruption is expected in the asset management and insurance sectors.
Reasons behind this disruption
- Cost and quality of delivering financial services: FinTech players are looking to cut costs for customers and improve the quality of financial services as they don’t carry the burden of regulations & branch networks and their expenses are low. Examples: Lending Club’s ongoing expenses as a percentage of the outstanding loan balance is about 2% when compared to conventional lenders’ 5-7%. Close to 50% of the loan applications Funding Circle gets from small businesses are received outside its working hours. Transferwise is less expensive compared to banks for sending money across borders.
- Consumer experience: FinTech startups have realized that dividing banking services into separate segments and specializing at least one of them is the best way to ensure maximum customer satisfaction and provide best consumer experience. For example, Betterment, a robot-advisor firm offers clients a goal-based approach; most of its customers have several targeted accounts from retirement funds or deposit for a house, with specific investment portfolios. To create the best customer experience, Betterment provides an integrated advice which is updated in real time. Robinhood, a FinTech startup became the first financial app to receive an Apple Design Award which enhances the way people view and interact with their investments.
- Innovative ways of assessing risk: FinTech startups such as Kabbage and One Deck leverage information which includes social media reviews to evaluate how small businesses are doing. Avant uses machine learning to underwrite consumers whose credit scores were hit during the financial crisis. Data-driven and algorithmic decision-making has clear advantages over decisions based on credit scores or meetings between banks/financial institutions and clients.
-“Millennial” effect: Millennial preference for the best customer experience, speed and convenience will accelerate the adoption of FinTech Solutions.
How can banks and financial institutions react to the disruption?
Banks and financial Institutions (FIs) are exhibiting a willingness to transform themselves by working with the FinTech ecosystem. They have adopted different ways to work with the new global FinTech (ecosystem) and those initiatives largely fall into two buckets: internal programs and open innovation initiatives.
To be successful in these initiatives, banks and FIs need to put in place a strategic roadmap to embrace innovation as opposed to being opportunistic. If they are in a hurry to take decisions which lack clarity because of the fear of missing out, it might have an adverse effect on them. For example, with respect to banks/FIs and startup relationships, bank/FIs must have clarity on the possible synergies that they share with the startup and a plan of action of working together. For example, BBVA has a lot of clarity in terms of its innovation process. BBVA is one of the few banks that has gone ahead and launched consumer-facing services using the startup’s product Future Advisor to offer robo-advisor services to customers
To draw up a strategic innovation plan, banks need to answer these questions (and some more):
- Why do we need to innovate? (impact of digital, smartphones, millennials, data opportunity, messaging, on-demand, real-time)
- What should be changed or replaced in our current service offering to serve customers better?
- In order to do #2, do we have the talent and internal know-how?
- What will be the time to market vis-à-vis the competition if we do #3. What are the areas that need external support?
- Should we work with IT vendors and large product companies for that?
- What are the costs and timelines involved?
- Are there areas where we need to make changes fast to respond to market needs?
- Can we work with new FinTech companies for that? What are the pros and cons considering all the above questions?
- What are the areas and FinTech startups we need to focus on? How do we engage with them?
- How do we prepare our management and our engineering team to embrace this change?
Not every bank or FI is at the same stage. We had discussions with many banks in the last one year; some banks that we talked to are still evaluating how to work with startups. They have done some work but are not at a stage where they can run an accelerator of their own because they don’t know what they would do with the selected startups and how to integrate them into their products/services. A lot of it has to also do with the lack of talent to run such programs and the culture (especially in emerging economies).
Looking at all of these interesting developments around how banks and FinTech startups are working together, LTP has come up with an “Innovation Readiness Index” for banks. It is based on a careful study of 50+ banks across the globe where we talked to teams, looked at their current activities and their future plans. The following is a very high-level example of an external innovation mapping of a bank from the outside.
The above methodology is a very initial diagnosis that can be used to benchmark the efforts taken by banks in the past. The next stage will be to do a deep-dive analysis, and for that, LTP will conduct a workshop with the senior management of the banks. That will include finding answers to the questions mentioned in the beginning of the article. The deep-dive involves a look into both internal programs and external innovation initiatives. In this workshop, LTP will use the Innovation Readiness Framework. With the help of this framework, banks will be able to develop a roadmap for a holistic external/open innovation linked logically to internal programs.