November 7, 2019
Every year since 2014, someone or the other has asked us the same (or similar) question: what is the bank of the future? This is probably because we engage with the finserv and FinTech community all over the world on an ongoing basis. The people who pose this question are sometimes our banking/tech customers or someone from our FinTech blog audience. We try to answer this question responsibly and inasmuch fact-based fashion as we can. Addressing this very question, in 2016, we had said that banks would become the following (see below) for the financial services ecosystem in the future. We presented a view that the bank of the future will look like a modular construction housing array of FinTech startups where each player services a specific banking requirement.
If we look at the developments over the last three years, the ecosystem has started to shape up in the above fashion a little bit. FinTechs today represent 3–5% of the financial services market by revenue, size and in a few segments, FinTechs are amongst the leading players in their respective markets. And now, with a clearer picture, we present a more nuanced version of the same infographic, with the concept being the same.
Let’s start examining this image from the top, starting with B2B FinTech, which acts as an engine for the digital transformation of banks and FIs.
Individually, B2B FinTechs typically address a single problem within the present financial system. As they work in their respective areas, they are also helping to build a new future for banking. Previously, many financial solutions were only available to firms that had the funds to build custom solutions themselves. B2B FinTechs are changing that with off-the-shelf tools that are now available to everyone.
Many B2B FinTechs aim to make it easier, faster, and cheaper for banks to operate. Signzy in India makes it possible to perform digital onboarding of customers. And RPA firms like UIpath help in back-end automation. All of this increases speed and reduces cost. Online fraud is a pressing issue, and services like Fraugster and Feedzai are giving financial firms ready-made tools for detecting it. Feedzai reported that in the last several years, risk managers became more concerned about online fraud compared to insider fraud. International payments are another area where B2B FinTechs are thriving.
Other tools focus on internal operations. Thought Machine and Mambu assist financial firms with cloud computing. Blend promises to speed up mortgage lending, while CreditOn also helps existing firms become digital lenders. Trulioo makes it possible to comply with know your customer (KYC) and anti-money laundering (AML) laws for a flat monthly fee. Paysafe also offers ID verification; they also found that 74% of businesses want to improve verification to reduce fraud.
Customizable Solutions for Larger Firms
One size does not fit all, so B2B FinTechs offer numerous custom solutions for larger financial institutions. B2B partnerships help banks to catch up with technology in areas where their internal efforts may have fallen behind. What’s more, partnerships enable banks to become more flexible and shift strategies as markets and technology change.
Security is one area where customizable B2B FinTech solutions are making a difference. When it comes to cybersecurity, Darktrace uses machine learning to detect suspicious behavior. Once customized for an organization, this approach is very effective for detecting insider fraud, which remains a significant concern in larger organizations. As customized smartphone apps for banks proliferated further, so did security issues. AuthBase focuses on finding and resolving those security issues. Shift Technology is an InsurTech company that specializes in detecting claims fraud. Shift has already partnered with Accenture and dozens of other firms.
The other major area for customized solutions is AI and automation. At the most basic level, companies like Kasisto and Active.Ai are already reducing customer service costs. On a deeper level, robotic process automation (RPA) from firms like UiPath and Kryon Systems allows banks to save on labor costs. According to Leslie Willcocks of the London School of Economics, RPA usually has a return on investment between 30% and 200% in the first year alone. At the highest level, CognitiveScale and Digital Reasoning are working on the cognitive computing solutions of the future.
If you refer to image 2 again, you will observe that even in the middle layer, banks have new neighbors. Some FinTechs are opting to become banks as they grow up. I call this the great rebuilding and talked about it in my previous article.
Online-only neobanks are gaining new customers by focusing on underserved markets. New financial firms have been particularly successful in the areas of payments, lending, and remittances.
Making Inroads in Payments, Lending, and Remittances
Although payment services like Google Pay can be used with any bank, the spread of these services tends to help neobanks. The ATM networks and branch offices of traditional banks give them an edge with cash, but all banks are on an equal plane when it comes to payment services. The move away from cash is a growing trend. Industry reports indicate that non-cash transactions grew by 12% annually around the world; meanwhile, Asia saw a faster growth rate of 32.5% between 2016 and 2017.
Lending is another area where the new players have made real progress. Firms such as OnDeck Capital and Kabbage offer simpler approval processes and shorter approval times, but they also charge higher interest rates. Traditional banks often avoid lending to small and medium enterprises (SMEs). According to the World Bank, 70% of SMEs and micro-enterprises do not have access to credit in emerging markets.
The remittance space has been a strong market for FinTech startups – to the point of some of them turning into neobanks in their own right. For example, two Estonians working in the UK founded TransferWise because they were frustrated by how difficult it was to send money between countries. Less than a decade later, TransferWise has a banking license in almost every state in the US.
Focusing on Underserved Markets
The reason behind the rise of the neobanks has been their unrelenting focus on underserved markets. This strategy is very much in the spirit of Sun Tzu, who advocated “attacking where the “enemy” was not.” The difficulty that SMEs have in obtaining loans from traditional banks has already been mentioned as one of their weak spots. The gig economy is another growing area where new players are finding openings.
Neobanks are also popular among millennials and others who are new to credit. N26 and other neobanks focus heavily on creating the best mobile apps with regard to UI/UX and many more factors, which we know is very important to millennials. It has traditionally been difficult for new customers to establish credit. Without credit, they were limited to cash and unable to access most financial opportunities on the Internet. Today, apps like PhonePe are helping many people participate in the digital economy for the first time.
Other groups targeted by neobanks include early adopters and the upwardly mobile. There are early adopters that want to try innovative new services, but banks are famously conservative. The neobanks let early adopters create the future today. The FinTech upstarts also offer a way up for the ambitious. The records of financial transactions generated on payment services make it easier for them to measure risk and extend credit.
This overall trend of banks becoming pipes or nodes won’t happen overnight and won’t be universal. It will be a long cycle of change, only affecting some segments in some markets in a major way.
Dominating WealthTech and InsurTech
Some FinTech firms have gained visibility and market share in WealthTech, but established financial institutions have been relatively quick to respond. Betterment grew substantially by introducing many investors to robo-advisors. However, Vantage and Bank of America's Merrill Edge and most other large wealth management firms now offer some form of robo-advisory service. The story of traditional wealth management firms copying WealthTech innovations continues with Robinhood. Robinhood gained notoriety and customers with zero-commission trading. However, one large brokerage after another began offering free trades for all US stocks in late 2019. New startups will have difficulty following in Robinhood's footsteps now that Charles Schwab and Fidelity no longer charge commissions for stock trades.
Building on Advantages
The key to the transformation of traditional banks? Building on their existing advantages. We've seen how the big brokerages repeatedly fought back against upstarts by matching their new services and pricing. Why does this approach work for them? The reason is that existing wealth is more important in WealthTech than any other field. The trillions of dollars already in accounts at the top banks and brokerages will stay there if they remain competitive. New customers who want commission-free stock trading are also more likely to turn to established brokerages in the future.
By observing the other areas in FinTech, we can deduct that established institutions have some of the same advantages in InsurTech. Potential customers could be concerned about issues of solvency with insurers. If traditional insurance firms offer the same products as startups, consumers may trust them more. In particular, they have a spectacular opportunity to retain customers as they leave their employers.
The diverse networks of competing apps and financial services will likely make it so that no single vision will completely dominate the future. However, B2B FinTechs, neobanks, and emerging roles of conventional banks are providing some strong indicators about what the near future holds. Also, it is not necessary that the front-end players in this future banking ecosystem will only be FinTech companies. There will be consumer tech companies/platforms such as Alipay, Google, and Facebook and high-engagement apps such as WeChat, WhatsApp, or Apple Pay. These companies – with their high user engagement, rich customer data, and high volumes of non-financial transactions – will have a really good chance of becoming key players in this ecosystem. This will pose a huge challenge to incumbents as well as the FinTech players by signing up lots of users for the financial services offerings.
Examples from China show that superapps (or high-user-engagement apps) are miles ahead of anything else happening in the financial services landscape. Some would argue that the number of these superapps will increase in the future, and the bundling of financial services in these high-user-engagement platforms will create some formidable industry players.
Looking at the details, we can start to see the shape of the future of banking where banks will position themselves as ‘nodes’ or ‘pipes,’ and FinTechs and tech companies will offer amazing experiences using these pipes. B2B FinTech will keep making small enterprises more efficient and better able to compete on an international level. The next big battle will be on the experience layer while the last one was on the infrastructure layer, which means that in the future, whoever, if able to provide the most seamless and immersive experiences, will win!