Partner Or Compete? Banks Can Take Hybrid Approach With Fintech Innovation
In a mid-January conference call with analysts, J.P. Morgan Chase CEO Jamie Dimon told analysts that his firm, and other banks, should be scared s—tless by Fintechs. The sentiment speaks volumes about the innovation and shifting competitive landscape that has brought financial services into the digital age, where speed to market with new products and services reigns supreme and wins share of wallet.
As Dimon said, “we have plenty of resources, a lot of very smart people. We‘ve just got to get quicker, better, faster,” as he eyes the competition over payments to be particularly brutal over the next decade.
So, banks vs. Fintechs may shape up to be the battle of the roaring 2020s. Some believe that the two parties can work together where tech-focused upstarts can fill in the holes for traditional FIs’ payments infrastructure through partnership and collaboration. However, the argument that banks must cede tech and innovation to Fintechs is simply unrealistic. As Jim McCarthy, president of i2c, told Karen Webster, though they‘re not necessarily operating as “technologists,” banks have plenty of competitive advantages to deploy.
“I’ve got a lot of friends who are in banking, and they all want to be innovative,” said McCarthy. “There’s not a person that doesn’t want to be on the cutting edge and on the front line – but given the challenges that banks face, they’ve got regulatory and compliance pressure. They’re the ones that are on the hook.”
Generally speaking, he said, the banking industry is built on a foundation of risk mitigation and risk avoidance. Against that backdrop, for traditional FIs – and even for their processors – there is little room to be innovative when building new, digitally sophisticated user experiences.
“When you think about where the bank has to spend its time, money and resources, it’s very difficult to come at [innovation] in the ‘de novo‘ way that a Fintech will,” said McCarthy.
However, that’s not to say that banks are simply sticking to their core competencies and are unaware of the challenges being lobbed their way. The awareness creates tension and conflicts among bankers’ own minds about how to pivot and compete – and speed is the biggest hurdle, said McCarthy.
The landscape has evolved to the point where the paths open to bankers in regards to the way they view Fintechs is either-or. On the one hand, you can go head-to-head with them. On the other, you partner in what might be seen as a hybrid approach.
McCarthy stated that most Fintechs do not have banking licenses (though some have made strides to get them). By and large, they‘ve avoided “real banking services” for regulatory and compliance reasons, and so banks have had the opportunity to offer “compliance as a service” – where traditional players get something in return and don‘t have to worry about losing customers. They get to leverage their core competency (compliance) and the deposits and assets from the digital challenger bank to lend to small businesses in their communities, for example.
Many Fintechs have been able to solve real pain points, because they‘ve been able to – as small businesses or entreprenurs – examine the ways in which traditional banking has been done and the ways they can improve on it. The Squares and Stripes of the world have never had to view innovation through the traditional P&L and risk mitigation silos. Instead, they choose to focus on problem solving and building tech stacks – and the processes around it all.
The Real Threat
McCarthy said the real threat may not lie with Fintechs, but with some of the tech giants such as Google, Apple, Facebook and the like – who have developed ecosystems with the most loyal customer relationships and platforms (and, in PayPal’s case, networks). These businesses have made conscious strides into commerce and financial services.
Banks that worry about these fintechs are still busy scrambling after them to do deals. The bigger banks have a large market share when it comes to deposits and checking – but then again, they‘re not as omnipresent as Google, said McCarthy, “and they don‘t own the ecosystem the way Apple does.” The numbers are simply mind-boggling when it comes to the interactions that people have with Big Tech.
Regarding the threat Big Tech poses for larger FIs he said, “I wouldn‘t say it’s existential at this point – but you have to have a strategy for these things, and you probably don‘t want to wait for the world to move around you.” One move banks have been making to get bigger and to form ecosystems of their own is data aggregation.
And for banks, too, there’s a proverbial leg up up, said McCarthy: embedded finance, where payments are invisible but tightly woven into the consumer experience. Payments have always been critical to commerce.
Thus, the competitive dynamic and the very nature of the conversation shifts a bit when (and if) banks examine their core competencies.
If you shift the conversation to banks focusing on their core strengths, it’s no longer a matter of capturing all of the pie – it’s about “how do I take what I do really well and expose it as part of a broader ecosystem?”
The argument that Fintechs and platforms will be able to sidestep the rails does not hold water, McCarthy said. Alternative credit providers may opt to ride card rails rather than bank rails, but the basics always win out. This is clear by looking at the recent problems that hit the stock trading platform Robinhood, where a “great front end” UX and “interesting value proposition” were diminished when the firm had to go out and raise capital amid frenzied trading in GameStop and other stocks.
Banks have an advantage in terms of security, safety and trust because they‘re where consumers keep what’s important to them (namely, their finances). Pushing out tokenized credentials, and turning them on and off, can reduce friction in commerce, said McCarthy – but when consumers start to worry about how their data is being used, banks become an even more trusted partner.
“It’s kind of similar with what Apple’s tried to do with some of its subscription payments, where it’s become very easy for consumers to see the payments and say ‘I didn’t realize I was still paying for that. I want to turn it off,’” said McCarthy. “And so, I think the banks are coming around to that.”
There will be a continued upswing in demand for Banking-as-a-Service (with demand coming out of the Fintech space, too). Some Fintechs are trying to package banking services with processing services to make it easier to issue, for example Credit-Cards-as-a-Service, and banks are taking a page from that model.
As McCarthy said, banks are mulling: “‘If I’m already outsourcing compliance and some of the risks here, why don’t I take a bigger piece of the profit and get into the processing space?’”
Watch the full masterclass with Jim McCarthy: