The Fintech Revolution

How Young and Hungry Fintech Companies are Disrupting the Status Quo

If traditional banks can’t beat them, then perhaps they should join them.

In 2004, Blockbuster was a vibrant company that employed 60,000 people and provided home movie and video game rental services through a network of 9,000 retail stores throughout the United States. Then everything got disrupted.

Two Blockbuster competitors—Netflix and Redbox—began experimenting with alternative forms of distribution, Netflix through the mail and Redbox through, yes, red boxes located at grocery and convenience stores. These low cost delivery systems gave Netflix and Redbox a significant competitive advantage.   Blockbuster, slow to respond to the disruptive impact on its brick and mortar business model, went into a downward spiral that eventually led to bankruptcy in 2010. The company was later acquired by Dish Network Corp., which closed the last of its Blockbuster stores in 2014. Today, the brand name survives only as video streaming services to Dish customers and the general public.

Is there a lesson to be learned here for the banks? You better believe it. The digital financial services space is exploding in activity as new technology companies push their way into markets and product lines that traditionally have been the banking industry’s turf. Usually, these so-called fintech companies focus on one or two product lines, which they distribute online at a significantly lower cost than traditional banks because banks still are holding on to their expensive branch networks. And doesn’t that sound a lot like the Blockbuster scenario?

Blockbuster did try to expand its distribution channels to include mail and streaming video, but it probably waited too long to make that change. There are in fact countless examples of disruptive business trends in U.S. history (airplanes taking passengers and trucks taking freight away from trains, or mobile phone carriers supplanting traditional telephone companies), and they share a common theme: The incumbents often responded to disruption too slowly and either failed, like Blockbuster, or managed to survive but at a permanently reduced state, like the railroads.

Often the disruptors were initially dismissed by the incumbents as not posing much of a threat, and you have to wonder if we’re seeing a similar scenario playing out today in banking. “Banks look at these upstarts with a kind of, hey, they are nice little experiments but what the fintech companies are doing isn’t really relevant,” says Anand Sanwal, chief executive officer at New York-based CB Insights, which tracks investor activity in the fintech space. “The problem is, today’s nice experiments are tomorrow’s disruption.”

In a March 2015 report on the emerging fintech sector, Goldman, Sachs & Co. estimated that over $4.7 trillion in revenue at traditional financial services companies is at risk of disruption by new, technology-enabled entrants. In a report two years ago, the consulting firm Accenture saw an equally challenging future for traditional banks. “A number of emerging trends—including digital technology and rapid-fire changes in customer preferences—are threatening to weigh down those full-service banks that limit themselves to products and services that get distributed primarily through physical channels, particularly the branch,” the report said. “Given the scale of these disruptions, our analysis shows that full-service banks, as a group, could lose 35 percent of their market share by 2020.”   

Disruption is not new to the banking industry. It has been occurring in the payments space where companies like PayPal, Google, Square and American Express Co. have developed alternative payments systems that threaten to chip away at the banking industry’s market share over time. But it isn’t clear whether most banks see payments as a profit center or just the necessary plumbing to facilitate transactions. However, since the financial crisis there has also been a great deal of activity by fintech companies in the lending space—which is squarely where most banks make most of their money.

The new fintech lenders fall into two general categories. One group is made up of those companies that focus on consumers and small businesses and hold some loans on their balance sheet. These are often referred to as direct lenders and examples include Kabbage and CAN Capital. (For an interview with Kabbage CEO Rob Frohwein, see page 42.) A second broad group, often called marketplace or peer-to-peer lenders, originate consumer and small business loans and sell them to investors, and increasingly banks, instead of keeping them on their balance sheet. Companies that fall into this category include Lending Club and Prosper Marketplace Inc.

The strategy of most fintech companies is to focus on a specific activity rather than compete with traditional banks across the full spectrum of their consumer and business product lines. So while fintech companies individually might pose little, if any, threat to banks, in the aggregate—and across all their full range of activities—they are doing everything that banks do. The infographic on the facing page, provided by CB Insights, shows many of the fintech companies that offer the same products that are provided today by San Francisco-based Wells Fargo & Co.—the country’s fourth largest bank at approximately $1.7 trillion in assets—and brings to mind a modern Gulliver who is under assault by the Lilliputians. “They are being attacked on all these fronts now by companies with new technology,” says Dan Latimore, a Boston-based senior vice president in the banking practice at the consulting firm Celent.

The emergence of such a large and vibrant fintech sector is driven by a variety of factors, beginning with the widespread acceptance among borrowers of conducting financial transactions online or with their smart phones. “Consumer behavior is changing pretty rapidly,” says Halle Bennet, a managing director at the investment bank Keefe Bruyette & Woods in New York. “Technology is now involved in everyday life and financial services is part of that. People like convenience and expediency and that is almost antithetical to conventional banking.”

It’s also true that the banking industry has been distracted by a series of events during the last several years while the fintech revolution was unfolding, first by the financial crisis and Great Recession and later by tough new laws and a more vigorous regulatory environment that forced them to raise capital and focus more of their attention on compliance. The result was a pull back from some consumer and small business markets just when newly emerging fintech companies were beginning to focus on them. “It would be hard to overestimate the extent to which banks pulled back from small business and consumer lending,” says Brendan Dickinson, a principal at Canaan Partners, a New York-based venture capital firm that invests in technology companies including several in the fintech space.

There are actually two kinds of investors in the fintech companies. One category, like Canaan Partners, provides debt and equity funding to the companies themselves, where they see an opportunity to leverage advancements in technology and create a significant competitive advantage in the marketplace—especially since the banking industry has been slow to embrace the fintech revolution. “There is a lot of money going into fintech startups,” says Sanwal. “Investors see a massive industry where there has been a lot of incremental innovation but not a serious shift in how things are done. Banks are pretty terrible at innovation.” To Sanwal’s point, banks have incorporated new technologies like mobile into their distribution system, but the system itself hasn’t changed all that much. The branch is still the focal point for most banks.

A second group that has shown a great deal of interest in the fintech space is comprised of institutional investors who see consumer and small business loans as an attractive asset class in the current low interest rate environment, where the search for yield has forced them to broaden their horizons. “Fintech companies have developed a fundamentally less expensive way to originate loans while giving investors access to an asset class that they want,” says Dickinson.

It’s not surprising that fintech companies are very tough competitors in their product niches. Advances in technology have given them several very important advantages over traditional banks, including significantly lower costs, super-fast decisioning and simplicity. “At the end of the day, what the customer wants is a product they can understand at the lowest possible cost,” say Jeff Bogan, head of the institutional group at Lending Club, a marketplace lender that offers unsecured personal loans from $1,000 to $35,000 with three- or five-year terms, and more recently, unsecured business loans up to $300,000 with repayment terms between one to five years. One of the earliest fintech companies in the consumer loan sector—the San Francisco-based company launched its service in 2007—it has also been one of the most successful. Lending Club went public in 2014 and is listed on the New York Stock Exchange.

Bogan believes there are two components that have helped drive Lending Club’s success:  operating cost efficiency and the customer experience. “I really think that is the core behind our growth and why we’ve been so successful,” he says. Lending Club has focused on providing a positive user experience built around its easy-to-use website, simple application process, transparency of loan terms and fees, and quick response time. Bogan contrasts Lending Club’s approach to that of most banks, which he says tend to offer “a clunky online user experience.” “That alone is a huge source of competitive advantage relative to the traditional banking system,” he adds.

Just offering a good user experience isn’t enough, and Lending Club also tries to exploit its significant cost advantage compared to most banks. One metric that the company uses to measure efficiency is operating expense as a percentage of its outstanding loan balance, which Bogan says is 2 percent and declining. Capital One Financial Corp.’s unsecured consumer loan business operates at 7 percent, according to Bogan. “The way we run our business, there’s substantial operating efficiency,” he says. “It’s really a combination of both of those elements that has driven the success of Lending Club today.”

This significant cost advantage is something that is common to the entire fintech space. “The cost of origination is a fraction of what it costs the banks,” says Ethan Teas, a managing director based in Australia at the consulting firm Novantas. “They have figured out how to keep costs super low.”

Prosper, also based in San Francisco, bills itself as the oldest peer-to-peer lender, having started operations in 2006. The company offers unsecured personal loans from $2,000 to $35,000, with repayment options of either three or five years. To date the company has made over $3 billion in loans, and derives its revenue from loan origination fees that it charges borrowers, and loan servicing fees that are paid by investors. CEO Aaron Vermut says that when banks scaled back their consumer lending during the financial crisis, it left high interest credit cards and payday lenders as the only loan options for many consumers. And one of Prosper’s goals, as Vermut puts it, was to “democratize credit.”

Like many fintech lenders, Prosper takes a broader approach to credit underwriting than most traditional banks, which tend to rely heavily on credit scores. Vermut says that Prosper uses credit scores as a “guardrail” to keep itself within certain parameters, but not to determine the final decision. The company’s underwriting process relies on over 400 data points including such factors as the applicant’s relationship with suppliers, shipping companies and credit card processors, e-commerce activity and cell phone records.

CAN Capital, a New York-based direct lender that offers up to $150,000 for business loans and merchant cash advances based on future credit card receivables, also takes other information into consideration during the underwriting process to identify those applicants that might have a lower-than-optimal credit score but have a track record of making good business decisions. “A credit score is a blunt instrument that is based more on personal credit than on business performance,” says CAN Capital CEO Daniel DeMeo.

The underwriting process at all of these fintech companies is driven by algorithms that can make quick decisions with little, if any, human intervention. CAN Capital’s approach is “faster, quicker and has a higher yes rate” than most banks, says DeMeo. “We can do our job in a day if we can get all of the information that we require.”

Given the vibrancy of the fintech sector and the vast amounts of investor funds that are pouring into it, how should traditional banks assess the competitive threat posed by the new upstarts? Unsecured credit, whether it’s to consumers or small businesses, is not a market that most banks—especially smaller community banks—are all that focused on these days. It would be difficult for them to offer a similar consumer or small business loan at a competitive price because their costs are too high. And this might explain why many banks view the fintech sector as something of a sideshow, a phenomenon that does not impact them directly since they are more interested in auto loans, first-lien home mortgages and home-equity loans—and on the business side—commercial real estate and commercial and industrial loans secured by collateral.

And yet there are two reasons why banks should pay close attention to what is happening in the fintech space. At a time when they are experiencing severe margin pressure due to low interest rates and intense competition for good commercial loans, banks should consider working with fintech lenders and see them as collaborators instead of competitors, particularly since most of them don’t have a good unsecured loan product of their own. And for their part, most of these fintech lenders—including Lending Club, Prosper and CAN Capital—would be happy to partner with banks and in effect become an outsourced loan origination platform, selling them the loan in return for a fee. The consumer and small business markets in the United States are massive and the banking industry serves only a relatively small part of it. Goldman Sachs—a high end Wall Street firm with a long roster of corporate clients throughout world—thinks so much of the opportunity that it plans to start a new online consumer lending business next year.

Some fintech lenders are already working closely with banks, including Lending Club. “You’ll find that the products that we’re very successful in are small balance loans where you need the data algorithm and significant scale to make the economics work,” explains Bogan. “So the banks that work with us today don’t have a great personal loan product because they can’t efficiently underwrite it and don’t understand it. Their approach is essentially, if you haven’t had a bankruptcy in the last few years and you have a 700 FICO score or greater, you’ll get a loan at 12.99 percent. That’s the extent of their sophistication in the personal loan business. We can bring significant value to them.” Lending Club, which doesn’t have a balance sheet, gets fees for originating and servicing the loan while the bank gets an earning asset with an attractive interest rate and quite possibly a new customer relationship.

There’s another reason why banks need to pay close attention to the fintech revolution. Technology is beginning to alter some of the basic economics of the lending business and to redefine the customer experience—and banks are being impacted by those changes. Kabbage CEO Rob Frohwein says that 95 percent of his company’s customers start and finish their loan application online with no human intervention. And Bogan says that the demographic makeup of Lending Club’s customer base is quite diverse. We tend to assume that fintech’s growth is driven by the entry of millennials into the economy as spenders and borrowers, and while there’s considerable truth behind that assumption, the acceptance of online financial services today is widespread. Bogan says that Lending Club originates loans across a broad cross section of the U.S. population. “We actually have very few 18 year olds because they don’t have the credit history necessary to get a loan,” he says. “And we probably have very few 70 year olds. If you look at our customer base, it’s really correlated with the general U.S. population.”

Even if they don’t partner with fintech companies, banks at least need to pay attention to how the technological innovations they are pioneering are changing their industry. They can’t afford to fall behind their fintech competitors in the innovation race. “Banks have processes and procedures that are very slow to change,” says Teas at Novantas. “And they look at what’s happening in financial technology and say it’s not big enough to be interesting. But when it does become big enough to be interesting, you’ve missed the boat.” – |BD|

Serving Up Kabbage to Small Businesses, with a Side of Technology

Is Kabbage a competitor, or a potential collaborator that could help banks increase their consumer and small business lending?

One way to look at Kabbage is that it’s a company of mostly millennials who are helping to recreate finance in their own image. Formed in February 2009 during the waning months of the Great Recession, when many commercial banks had curtailed their lending and some were taking capital from the federal government to strengthen their balance sheets, Kabbage provides unsecured consumer and small business loans through its online platform. It is one of the leading players in the emerging fintech sector, and to date has made over $550 million in loans.

Neither Chief Executive Officer Rob Frohwein nor the rest of his leadership team are millennials (the company does have a sense of humor, playfully describing the team on its website as the “heads of Kabbage”), but there are plenty of them working at the company. And if you’re going to hire millennials to work at a fintech company, you’ve got to offer them cool stuff like daily catered lunches and snacks, on-site yoga, top-of-the-line Macs and 27” Thunderbolt displays. And of course, you need to give them stock options for the day when the privately-held company either goes public or is acquired. The irony of the company’s name is that many millennials probably wouldn’t know, unless it was pointed out to them by their baby boomer parents, that “cabbage” is slang for money.

The financial services industry is experiencing a wave of innovation where several upstarts like Kabbage are taking an old product—money lending in some form has been around for more than two millennia—and using technology to create a 21st Century delivery and customer experience.The company provides small business lines of credit from $2,000 to $100,000, and more recently began offering consumer loans from $5,000 to $35,000, with repayment terms of either three or five years. Unlike most banks, which base their underwriting decisions primarily on the credit scores of the borrower, Kabbage takes a diverse range of information into consideration, and because the process is fully automated, the applicant receives an immediate decision.

Although conventional wisdom would argue that Kabbage is a threat to traditional banks, particularly in the consumer lending space where much of its activity is focused on consolidation of credit card-related debt, Frohwein says that he wants to work with banks and would rather be seen as collaborator than a competitor. Kabbage’s principal offering is an unsecured business line of credit. Most banks won’t provide that kind of funding without some form of collateral, and they can take weeks to make a decision. Prior to this issue going to press, the company was expected to announce agreements to work with two international banks, and Frohwein was hopeful that similar conversations with U.S. banks would also bear fruit.

Like all fintech companies, Kabbage has benefited from growing consumer comfort with doing financial transactions online. According to Frohwein, 95 percent of Kabbage’s customers never interact with a human at any point in the process. And many of them seem to like it that way. Kabbage might be a company with a culture that has been influenced by the many millennials who work there, but it has created a product that is finding acceptance among borrowers of all generations, and that adds up to a lot of cabbage. Frohwein spoke recently with Bank Director Editor Jack Milligan

Let’s talk about why there is a Kabbage.

There is a Kabbage because you can actually access data from online sources on a real-time basis allowing you to do a couple of different things.

First, you can permit a customer to have a very elegant online experience.  The customer lands on the Kabbage website, which provides access to information relating to their entire business, and receives a decision within just a handful of minutes.

Because Kabbage gains access to these data sources through the customer’s authorization, we have ongoing access to data. As a result, we understand how that small business operates, not just today—at the time of qualification—but how they’re operating today and any point in between. It gives us a very rich understanding of that small business.

When we started the company, we believed this information would better reflect how a business was going to perform as a customer rather than relying on the personal credit score of the small business owner. The whole premise of the company was based on data access and technology. Our DNA is technology and data access and how that access can provide us with unique insights and customers with better experiences. I think that’s probably what separates us from some of the other players that are in this space who continue to have a lot of manual processes residing within their customer experience even though most have adopted the “data and technology” marketing speak.

When the company formed, did you feel as though you were stepping in and filling a void that was out there for small business borrowers? In 2009, obviously, we were just coming out of the financial crisis. The banking industry had closed up like a clam in terms of lending, and there was a real credit crunch, especially for smaller companies.

For sure. Despite being responsible for most of the growth in our economy, small businesses have historically been treated as the redheaded stepchild of the financial services industry. They’ve been largely ignored over the years. Though we serve all small businesses now, when we started, we focused on online retailers. Traditional lenders are reluctant to provide an online retailer with a loan. It’s not that they’re not good customers, but they’re hard-to-reach and they often have limited operating histories. They don’t have a physical presence so you can’t walk into the store and hear the cash register ringing, and see the smiles on the customers’ faces. If you can serve that audience as Kabbage has, then you can serve all small businesses, because you start with the most challenging segment of businesses.

Explain the products that you provide.

We provide a working capital line credit for small businesses. In the fourth quarter of last year we also launched a personal loan product. We have both a small business direct product and a consumer direct product.

We also started licensing our platform to third parties, which allows them to start lending in the small business and personal consumer lending space. We announced the first deal with Kikka Capital, out of Australia, a couple months ago.

Have you also had conversations with domestic banks about the possibility of working with you under a licensing arrangement?

Yes. In the U.S., we are working currently with two banks. Those discussions are in a slightly earlier stage, but we believe we will execute agreements with both of them. One relationship will center on a small business product and the other is on the consumer side.

The reaction from U.S. banks has been very positive, but it’s a difficult regulatory environment, and there’s a lot of caution that goes into that decision. It’s a process of working with the financial institution and getting them to the point where they really understand how we operate, how this compares favorably to their existing approach and how this grows their core business.

Do you see banks as competitors, or do you see them as potential partners? Or both?

I don’t think I see them as competitors, I actually see them as partners.  I try to help them recognize that this is a market they can serve, it’s not a market they should ignore, and there’s a legitimate partnership opportunity here. They don’t need to take a competitive stance with us. We think we can actually work with all the banks.

How about in the consumer space?  Or do banks not really focus on the size of personal loans you provide?

In the consumer space, our loans average about $15,000 and many of our customers are consolidating credit card debt so this is a segment in which banks are interested. Although banks may or may not see that as competitive, they should see what we are doing as important and core to them.  However, again, banks do not need to look at us as competitive.  We are working with a large U.S. bank right now to help them enter this space directly.

Though very focused on the consumer lending space for many years, small business lending has been another story for them. It’s been traditionally difficult for banks to make profitable, and that’s because there’s typically high acquisition costs, and also there’s a lot of operational inefficiencies. Banks apply the same requirements and invest the same resources for a $30,000 loan as they do for a $3 million loan.  It’s just not reasonable to expect small business owners to go through that hassle for that amount of money.

Explain a little bit more about your underwriting process. It sounds like it’s a very sophisticated approach, and one that’s a little bit different than what most banks employ.

When a bank underwrites a small business loan they will have a checklist of many items they need to collect: three years of financial statements, FICO score, an asset list, whatever it might be. A bank would expect every small business lending applicant to come to the table with the exact same set of documents and information. We take a different approach.

Kabbage must meet the small business owner where that small business owner is. That means if they have a specific set of relationships with accounting companies, or credit card transaction processing systems, or social networks, or shipping companies or whatever it might be, that’s the data we need to collect and decision on. The data helps us determine the capacity, character and consistency of small and medium-sized businesses, or SMBs, just as the items the bank collects attempt to determine.

We’ve had to figure out a way to basically say, “Give us access to any number of data sources.” Without getting too technical, it’s an API, or application programming interface, approach where we’re given automated access on these electronic accounts for specified information. We don’t have the ability to write to the account, so we can’t manipulate anything within it. It does give us the right to read the information that’s contained within the accounts.

As you would imagine, it also provides us with a lot of historical information. It doesn’t just relate to the most recent period, it oftentimes goes back many months or many years in the past so we can see how these customers have performed over time.

The real key to what we do is a couple of different things. One is we are able to take all that information and make it relatable. If somebody gives us access to their credit card transaction processing information and shipping information, and another person gives us access to their marketplace information, personal credit score and social data, we’ve got to figure out, “Okay, how do I make a decision on both of those customers, and make a decision that is consistent and fair across the board?” We have developed that capability over time, and we did that through a lot of trial and error, to be frank, where we made educated decisions as to how we were going to view information. Until you get repayment information back and see the customer’s actual behavior, you really don’t know how well correlated that information is to actual performance. We’ve gone through that process over the last several years.

The nice thing about the way our product works is once somebody takes cash from our line, they pay it back within, on average, less than four months. Therefore, we are able to determine how effective our models are very rapidly.

How do you find your customers?

SMB owners do not congregate in a single place. There’s not a hall where SMB owners meet each evening and you can advertise there. They’re everywhere the population is. Therefore, we have had to become experts at locating them.

We have a blended approach. We do both traditional and digital marketing. If you log on to Kabbage.com, we’ll probably follow you for a long time online, and you’ll see more ads from us in the future. On the traditional side, we do radio and direct mail. If you watch TV, you’ll be seeing ads in the fall.

We also have a pretty robust business development arm where we enter into relationships with other businesses that have a lot of small business customers. It can be those that are offering phone systems to small businesses, or packaging for small businesses, or selling accounting software to them or whatever it might be. We try to work with the folks that work closely with small business owners.

When you look at the personal demographics of who your customers are, is there anything that’s distinctive from a generational perspective? What do you find interesting about your customer base?

We work with SMB owners that are super young and we work with folks who are much older.  However, they all embrace technology at least in some manner. Although we started with online retailers, over the last couple of years, we’ve grown to include all small businesses, so you get your restaurants, your dry cleaners and your professional service firms, and everybody in-between. We see a much broader demographic than we did in the past in terms of their technology savviness.

You’d be amazed, 95 percent of our customers have a 100 percent fully automated experience. Not only do they not have to interact with anybody specifically at Kabbage, we don’t have a person on the backend specifically reviewing that file.  It’s all done through our system. You’d be amazed at how many of our customers are comfortable just interacting with our system. That didn’t happen overnight; we had to figure that out the hard way. We made a lot of mistakes, and we created some bad experiences, and we worked hard to make it as comprehensible as possible. That’s what we’ve really focused on over the last five years.  Now it seems easy, but we had many sleepless nights on the road to getting there. – |BD|

How Technology is Redefining the Customer Relationship

Increasingly, bank customers want help managing finances—and they want that help delivered digitally.

You can visit a lot of banks and never see one that looks like this.

Located in Portland, Oregon’s trendy Pearl District, Simple is one of the leading firms at the intersection of banking and technology.

The design is consciously industrial. Bike racks crowd every nook and cranny. There’s a piano. A sunroom. A large meeting room stocked with healthy snacks. The atmosphere is casual, yet charged with energy. The employees wear t-shirts and jeans, roughly a third of them work at standing desks, and you can count the number of non-millennials on one hand.

It’s too early to predict how the fintech revolution will play out, but there’s no doubt that this is the front lines of finance. And as in any commercial battle, it’s first and foremost about capturing the hearts and minds of consumers.

A growing cast of companies has emerged to meet millennials where finance and technology converge.

Simple, which teamed up with Spanish banking giant Banco Bilbao Vizcaya Argentaria, S.A. (BBVA) at the beginning of 2014, offers a personal checking account accessible online and through its mobile app that’s designed to help people save. It does so by giving customers the ability to create compartmentalized savings goals.

Let’s say you need $50,000 for a down payment on a house in 24 months. By entering this goal into your Simple account, it will automatically deduct $68.50 ($50,000 divided by 730 days) each day from your “Safe to Spend” figure, which is essentially a person’s checking account balance less previously earmarked money.

Another technology-driven financial firm, Moven, offers a similar service. Described as the “debit account that tracks your money for you,” its home screen shows how much a person has spent during a month compared to previous months. If you typically spend $2,000 by the middle of a month, but are currently at $2,250, Moven’s app lets you know with each successive transaction.

“We create value by helping people build better money habits,” Moven’s president and managing director Alex Sion says.

A third player in the rapidly expanding fintech space, Betterment, builds customer relationships from a different angle. It offers an automated investing service. Give it your money, tell it your goals, and Betterment’s algorithms implement a strategy tailored to your financial objectives.

According to Joe Ziemer, Betterment’s business development and communications lead, it began the year with $1 billion in assets under management and now has $2.1 billion from 85,000 customers.

Finally, a growing number of Internet-based lending marketplaces connect yield-hungry investors with people and businesses in need of funding.

The best known of the group, Lending Club, offers personal loans of up to $35,000 to consolidate debt, pay off credit card balances, and make home improvements. Businesses can borrow up to $300,000 in 1- to 5-year term loans.

Funding Circle does much the same thing, though it focuses solely on small businesses. “There’s a perception out there that everyone is efficiently banked,” says Funding Circle’s Albert Periu, “but that isn’t true.”

Beyond using technology to refine the banking experience, a common set of objectives motivates these companies. The first is their missionary-like zeal for the customer experience. Their vision is to seamlessly integrate financial services into people’s lives, to proactively help them spend less, save more, invest for retirement and acquire financing.

“We created a product that allows customers to take control of their financial lives,” says Simple’s Krista Berlincourt.

This is done using elegantly designed mobile and online products that simplify and reduce friction in the relationship between a financial services provider and its customers.

To this end, a universal obsession in the industry revolves around the onboarding experience. “The onboarding experience is the moment of truth,” says Alan Steinborn, CEO of online personal finance forum Real Money.

Lending Club claims you can “apply in under five minutes” and “get funded in a few days.” Betterment’s Ziemer says that it takes less than half the time to set up an account with Betterment than it does at a traditional brokerage.

Finally, these firms compete vigorously on cost, with many forgoing account and overdraft fees entirely. In this way, they’re not only driving down the price of financial products, they’re also more closely aligning their own incentives with those of their customers.

Fueling the fintech revolution is the fact those millennials—people born between 1981 and 2000—now make up the largest living generation in the United States labor force.

Millennials see things differently. They “use technology, collaboration and entrepreneurship to create, transform and reconstruct entire industries,” explains The Millennial Disruption Index, a survey of over 10,000 members of the generation. “As consumers, their expectations are radically different than any generation before them.”

To millennials, banks come across as inefficient and antiquated. Two years ago, 48 percent of the people surveyed for Accenture’s “North America Consumer Digital Banking Survey” said they would switch banks if their closest branch closed. Today, less than 20 percent of respondents said they would do so.

This doesn’t mean that millennials will render in-person branch banking obsolete. A 2014 survey by TD Bank found that while they bank more frequently online and on their mobile devices, 52 percent still visited a branch as frequently as they did in 2013, mostly to deposit or withdraw money. “Those who do their banking in a branch feel it is more secure and enjoy the in-person service,” the survey concluded.

Wells Fargo’s recently appointed chief data officer, A. Charles Thomas, makes a similar point, citing a Harvard Business Review study that identified “customer intimacy” as one of three “value disciplines” exhibited by long-time industry-leading companies.

The net result is that the personal element of branch banking, while still relevant and necessary to build and maintain customer relationships, is nevertheless taking a back seat to digital channels. For the first time in Accenture’s research, the firm found that “consumers rank good online banking services (38 percent) as the number one reason that they stay with their bank, ahead of branch locations and low fees, both at 28 percent.”

It’s for these reasons that many observers believe the banking industry is prone to disruption. According to The Millennial Disruption Index, in fact, banking is at the highest risk of disruption of the 15 industries examined by Viacom Media Networks for the survey.

Of the millennials queried, it found that:

Sixty-eight percent believe the way we access money will be totally different five years from now.

Nearly half think tech startups will overhaul the way banks work.

And 73 percent would be more excited about a new offering in financial services from companies like Google, Amazon and Apple, among others, than from their own bank.

This isn’t to say that younger Americans don’t trust banks. In fact, just the opposite is true. According to Accenture, “86 percent of consumers trust their bank over all other institutions to securely manage their personal data.”

It boils down instead to the simple reality that millennials are “genuinely digital first,” says Forrester Research Senior Analyst Peter Wannemacher.

More than 85 percent of America’s 77 million millennials own smartphones according to Nielsen. An estimated 72 percent have used mobile banking services within the past year, says Accenture. And, based on the latter’s research, approximately 94 percent of millennials are active users of online banking.

Banks need to think about the customer experience differently. Millennials, and increasingly people in older generations, want more than physical branches to deposit money and get a loan. They want digitally tailored solutions for their financial lives. 

In Plain Sight: The Extraordinary Potential of Big Data

Advances in data storage and analytics can drive revenue and lead to better credit decisions. And in this game, traditional banks actually have an advantage.

The era of big data has arrived, and few industries are better positioned to benefit from it than banking and financial services.

Thanks to the proliferation of smartphones and the growing use of online social networks, IBM estimates that we create 2.5 quintillion bytes of data every day. In an average minute, Yelp users post 26,380 reviews, Twitter users send 277,000 tweets, Facebook users share 2.5 million pieces of content and Google receives over four million search queries.

Just as importantly, data centers have slashed the cost of storing information, computers have become more powerful than ever and recently developed statistical models now allow decision makers to simultaneously analyze hundreds of variables as opposed to dozens.

But while fintech upstarts like Simple, Square and Betterment are at the forefront of harnessing data to tailor the customer experience in their respective niches, no companies know their customers better than traditional financial service providers. The latter know where their customers shop, when they have babies and their favorite places to go on vacation, to mention only a few of the insights that can be gleaned from proprietary transactional data.

When it comes to big data, in turn, banks have a potent competitive advantage given their ability to couple vast internal data repositories with external information from social networks, Internet usage and the geolocation of smartphone users. In the opinion of Simon Yoo, the founder and managing partner of Green Visor Capital, a venture capital firm focused on the fintech industry, the first company to successfully merge the two could realize “billions of dollars in untapped revenue.”

Few financial companies have been as proactive as U.S. Bancorp at embracing this opportunity. Using Adobe Systems Inc.’s cloud computing services, the nation’s fifth-largest commercial bank “integrates data from offline as well as online channels, resulting in a truly global understanding of its customers and how they interact with the bank at multiple touch points,” says an Adobe case study.

By feeding cross-channel data into its customer relationship management platform, U.S. Bancorp is able to supply its call centers with more targeted leads than ever before. The net result, according to Adobe, is that the Minneapolis-based regional lender has doubled the conversion rate from its inbound and outbound call centers thanks to more personalized, targeted experiences compared to traditional lead management programs.

Along similar lines, a leading European bank studied by Capgemini Consulting employed an analogous strategy to increase its conversion rates by “as much as seven times.” It did so by shifting from a lead generation model that relied solely on internal customer data, to one that merged internal and external data and then applied advanced analytics techniques, notes Capgemini’s report “Big Data Alchemy: How Can Big Banks Maximize the Value of Their Customer Data?”

Another European bank discussed in the report generated even more impressive results with a statistical model that gauges whether specific customers will invest in savings products. The pilot branches where the model was tested saw a tenfold increase in sales and a 200 percent boost to their conversion rate relative to a control group. It’s this type of progress that led Zhiwei Jiang, Global Head of Insights and Data at Capgemini, to predict that a “killer app” will emerge within the next 18 months that will change the game for cross-selling financial products.

The promise of big data resides not just in the ability of financial companies to sell additional products, but also in the ability to encourage customers to use existing products and services more. This is particularly true in the context of credit cards.

“In a mature market, such as the U.S., Europe or Canada, where credit is a mature industry, it is naïve for a bank to believe that the way it is going to grow revenue is simply by issuing more credit cards,” notes a 2014 white paper by NGDATA, a self-described big data analytics firm. “The issue for a bank is not to increase the amount of credit cards, but to ask: How do we get the user to use our card?”

The answer to this question is card-linked marketing, an emerging genre of data analytics that empowers banks to provide personalized offers, savings and coupons based on cardholders’ current locations and transactional histories.

The venture capital-backed startup edo Interactive does so by partnering with banks and retailers to provide card users with weekly deals and incentives informed by past spending patterns. Its technology “uses geographical data to identify offers and deals from nearby merchants that become active as soon as the customer swipes their debit or credit card at said merchant,” explains software firm SAP’s head of banking, Falk Rieker.

Founded in 2007, edo has already enrolled over 200 banks in its network, including three of the nation’s top six financial institutions, and boasts a total reach of 200 million cards.

Poland’s mBank offers a similar service through its mDeals mobile app, which couples the main functions of its online banking platform with the company’s rewards program. “What makes this program so innovative is its ability to present customers with only the most relevant offers based on their location and then to automatically redeem discounts at the time of payment,” notes Piercarlo Gera, the global managing director of banking strategy at Accenture.

A third, though still unproven, opportunity that big data seems to offer involves the use of alternative data sources to assess credit risk.

The Consumer Financial Protection Bureau estimates that as many as 45 million Americans, or roughly 20 percent of the country’s adult population, don’t have a credit score and thereby can’t access mainstream sources of credit. The theory, in turn, is that the use of additional data sources could expand the accessibility of reasonably priced credit to a broader population.

One answer is so-called mainstream alternative data, such as utility payments and monthly rent. This is the approach taken by the VantageScore, which purports to combine “better-performing analytics with more granular data from the three national credit reporting companies to generate more predictive and consistent credit scores for more people than ever.”

Another is to incorporate so-called fringe alternative data derived from people’s shopping habits, social media activity and government records, among other things. Multiple fintech companies including ZestFinance, LendUp and Lenddo already apply variations of this approach. ZestFinance Vice President for Communications and Public Affairs Jenny Galitz McTighe says the company has found a close correlation between default rates and the amount of time prospective borrowers spend on a lender’s website prior to and during the loan application process.

“By using hundreds of data points, our approach to underwriting expands the availability of credit to people who otherwise wouldn’t be able to borrow because they don’t have credit histories,” says McTighe, pointing specifically to millennials and recent immigrants to the United States.

While this remains a speculative application of external data by, in certain cases, inexperienced and overconfident risk managers, there is still a growing chorus of support that such uses, once refined, could someday make their way into the traditional underwriting process.

This list of big data’s potential to improve the customer experience and boost sales at financial service providers is by no means exhaustive. “It’s ultimately about demonstrating the art of the possible,” said Wells Fargo’s chief data officer, A. Charles Thomas, noting that big data could one day help the San Francisco-based bank reduce employee turnover, measure the effectiveness of internal working groups and identify more efficient uses of office space.

It’s for these reasons that big data seems here to stay. Whether it will usher in a change akin to the extinction of dinosaurs, as Green Visor’s Yoo suggests, remains to be seen. But even if it doesn’t, there is little doubt that the possibilities offered by the burgeoning field are vast.

The Innovation Game

Think bankers are too conservative to innovate? Take note: Here’s a handful of banks that are very creative.

What would Amazon look like if it were run by a banker?

First, you’d have to go to an Amazon branch to buy a novel. When you asked for a novel, the teller would tell you that you weren’t signed up for any novels. When you asked to buy one, they’d tell you that you had to go over to the fiction department.

This critique comes from JP Nicols, formerly the chief private banking officer at U.S. Bancorp, now a management consultant. He was up at midnight in Hong Kong recently after a business meeting, Skyping and talking about innovation in banking, a passionate topic for him.

“The world is moving faster and faster, and the banking industry is not moving that fast,’’ says Nicols, the chief operating officer of Menlo Park, California-based Innosect. When bankers tell him that they are “fast followers” when it comes to technology, he tells them, “You’re only half right. There is nothing fast about what you’re doing.”

It’s a biting retort for an industry increasingly attuned to the threats and opportunities afforded by financial technology companies, most of them nonbanks. The giants, such as Apple, Facebook and Google, along with
startups such as online lenders and peer-to-peer payment processors, may not make banks irrelevant, but they may certainly put many of them out of business. Some banks are realizing that they have to change to keep up, and are trying to shift their organizational structure and culture to become more innovative, and more focused on what customers want and expect in an increasingly digital age.

Some of the biggest banks have introduced innovation labs in the last few years to experiment and develop software programs and solutions that benefit customers. Some banks are buying tech startups, or investing in them. Banco Bilbao Vizcaya Argentaria Group(BBVA), possibly the most innovative big bank doing business in the United States, is revamping its entire organizational structure to get rid of silos inside the bank that create friction for customers. U.S. Bancorp has 25 people working in an innovation lab in Minneapolis experimenting with new ideas and technologies, and working closely with the bank’s management team to bring new products to fruition. The biggest banks such as BBVA and U.S. Bank obviously have the money to invest, but some smaller banks are trying to get into the game as well. For example, a mutual with less than $10 billion in assets near Boston is spending 1 percent of revenues, or $4 million this year, on research and development with the intent of spinning off technology-related companies for profit. They are all trying to make their banks more innovative, and in the end, keep themselves in business.

But what is innovation, and why does it matter? There is no one definition of innovation. For Nicols, it means putting new ideas into action that move the organization forward. It may mean coming up with a completely new business model, or introducing a product or service that no one has tried before. It may mean solving a problem in a completely new way. Banks are used to identifying, monitoring and mitigating risks, more so than they are adept at innovating. But an argument gaining increasing weight is the notion that banks really are technology companies and need to think more like a technology company. Terms such as “disruptive innovation,” popularized by Harvard Business School Professor Clayton Christensen, have become mainstream, and they portray companies as vulnerable to lower-margin startups with innovative business models that begin taking market share at the bottom of the market and eventually displace established competitors.

Companies such as Amazon don’t worry about “disrupting” themselves, as Amazon did when it introduced its e-book product, the Kindle, even though it would cannibalize its existing print book business. The idea is that companies have to focus on what customers want and expect, not the business’ legacy systems and products.

Investors outside banking are so excited about “disrupters” stealing market share from banks and other financial companies that global investment in financial technology startups jumped 201 percent between 2013 and 2014 to more than $12 billion, across 730 deals, according to New York-based data research firm CB Insights.

Banks have been busy making sure they meet regulatory guidelines and laws, says Somesh Khanna, a senior banking partner at McKinsey & Co. “Meanwhile, their customers’ preferences have changed dramatically, and nonbanks are offering very simple solutions.” There are payment processors who are essentially money transmitters and there are tech companies offering loans, and regulators may eventually catch up to them in the same way they already regulate banks. But according to Kenny Smith, vice chairman and U.S. banking and securities leader at consulting firm Deloitte, the nonbanks will adapt to regulations, and it won’t be as difficult for them because they are more niche-oriented than the banks are. Banks are trying to react by investing in startups and creating innovation labs. They are collaborating in many cases with the “disrupters,” such as online lender The Lending Club and Apple, in an effort not to get left behind. Banks are trying to adjust to the new environment by becoming more innovative, giving people the title “chief innovation officer,” and hiring from tech companies such as Yahoo, Amazon or Google.

Spanish-based BBVA purchased a design firm and a variety of startups, including online banking services provider Simple, whose founders promised it was nothing like a bank. BBVA Ventures makes small investments in startups and introduces them to BBVA management across the globe. The company’s commitment to innovation really comes from the top. Earlier this year, the BBVA board announced it had reorganized to focus on technology in the company, and appointed D. Carlos Torres Vila as president and chief operating officer, a man who had been global head of digital banking and has an electrical engineering degree from the Massachusetts Institute of Technology.

“You’ve got enough bankers in banking. We don’t need more bankers,’’ says Brett King, the author of the books Bank 2.0 and Bank 3.0, and the founder of Moven, a mobile phone application that allows you to track your savings and offers you credit for purchases. “BBVA will be more tech than banking,’’ King says. “[Chairman and CEO Francisco Gonzales] realizes that. They are trying different models. They aren’t married to one way.” Just like a tech company, “they are trying different things and seeing what works.”

Already, the company had tinkered with its organizational structure to get rid of banking silos between departments, silos that didn’t really benefit customers. Jeff Dennes, the chief digital banking officer for BBVA Compass Bancshares Inc., the U.S.-based bank, is charged with digital integration of the bank’s products and services, including online banking, mobile banking, payments, a good portion of information technology and data analytics. He says the bank is “totally committed to investing in digital capabilities” that allow clients to have easier access to money, along with real time advice that helps them make sound decisions with their money.

The $85.5 billion asset BBVA Compass has a development center that employs 500 people in Birmingham, Alabama, according to Dennes. The company renovated an existing operations center into an 80,000-square-feet, open-floor office space that employs teams of five to nine people. They work in two week sprints to develop working software, compared to a more typical timeframe of six to nine months for software development. The compressed time frame creates a different environment. “The energy is off the charts compared to any other area of the bank,’’ Dennes says. “Every day, developers have to stand up and say what they were going to do yesterday, whether they got it done, and what they intend to do that day. It has a way of focusing you,’’ he says. But innovation is also transforming the rest of the bank as well. Even risk management needs to get creative, Dennes says. The vision of creating a digital bank “requires everyone to think differently,’’ he says. “If that was just one guy saying it, it would be tough. But you have senior leadership talking about it, and people tend to get on board.”

U.S. Bancorp’s approach is slightly different, but it has spent a long time making its bank forward-thinking. It has had an innovation group for more than eight years, with the original intent to look at long-term trends in the payments business. The bank realized early on that innovation was happening, and competition was coming from nonbank competitors, says Dominic Venturo, executive vice president and chief innovation officer for the Minneapolis-based bank with $403 billion in assets.

“It’s difficult to run a business as well as our business leaders do today, and at the same time focus on [the] long term and try to decide what’s important,’’ he says.

Nicols, who worked at U.S. Bancorp, says CEO Richard Davis decided shortly after becoming CEO in 2006 that he needed to make the bank more innovative. “Richard drew a line in the sand and said, ‘We’re going to be an innovative bank.’’’ Davis decided to invest heavily in the payments business. As a result, U.S. Bancorp was one of the first to introduce mobile photo bill pay, in early 2013. It signed up early for Apple Pay and Android Pay, Google’s rival to Apple’s phone-based payments service. U.S. Bancorp is consistently recognized as a leader in mobile banking for the variety of services it provides. The innovation lab has experimented with Google Glass and augmented reality, the concept that reality can be enhanced by computer inputs, such as images or information displayed in your glasses. Two years ago, Venturo published a paper on the privacy implications of the Internet of Things, which involves connecting everything mechanical, including such things as cars, TVs and refrigerators, to the Internet. The bank created a mobile shopping app called Peri that partners, such as retailers, could use to help people shop and compare prices using their smartphones.

But the innovation team isn’t cut off from the bank’s goals. Twenty-five people work on the team in the bank’s headquarters offices. Staff meets regularly with the heads of the four major business groups: wholesale and commercial banking, commercial real estate, trust and wealth management, and payments and consumer banking, which tell the innovation team what their problems are and their customers’ problems. The innovation team then works on solving them collaboratively with the bank’s management team. The team also brings in customers to the lab to collaboratively develop software that meets their needs.

Unlike BBVA, the bank doesn’t have a venture capital arm, and although it does partner with other companies or hire vendors to jointly create solutions, it doesn’t tend to invest in them or buy a lot of startups. Venturo himself has a banking background, having worked 15 years for U.S. Bancorp. Before that, he was with Bank of America Corp., and has worked stints in payments and as a commercial banker. He tends to promote from within U.S. Bancorp.

“One of the misconceptions about innovation is you have to go bring in a bunch of disrupters who don’t know anything about your business to think differently, but I think it’s more helpful to bring in deep domain expertise and give them permission to think differently,’’ Venturo says. “They are more likely to come up with an idea you can actually do.”

Community and regional banks may have a tough time affording an innovation lab, whether they come from in-house or the technology industry. Many of them already struggle with attracting and retaining talented people, and will largely have to rely on vendors to provide many of their technological platforms and services. Just because small banks often are focused on commercial clients, that doesn’t mean they don’t need to stay relevant to those commercial customers. “Those who want to be innovative have to have a plan in place that is executable, to make sure their technology presence is relevant and stays relevant, even if the business line focus is commercial,’’ says Ryan Rackley, a director at Cornerstone Advisors in Scottsdale, Arizona. Moven’s King advises banks to be very careful about picking a core platform vendor, and any technology vendors that they use on top of that. Since they are so dependent on vendors, they must choose wisely.

But a few banks are going beyond picking vendors and are experimenting with in-house innovation as well. After a merger in 2007, Eastern Bank Corp. president Bob Rivers noticed a huge drop-off in branch traffic, which has continued to this day. (The mutual’s busiest branch did 60,000 transactions per month back then, and it’s now half of that.) Rivers began to think, ”The world is changing radically, and if we don’t do something quickly, we are going to be left behind.”

With the support of management and the board, Rivers began networking around Cambridge, near the bank’s headquarters, where there was plenty of technology talent surrounding the Massachusetts Institute of Technology. “We knew we needed to make investments in new technology,’’ Rivers says. Rivers ended up recruiting the former executives of PerkStreet Financial, an online financial services provider with a rewards checking account tailored to each individual’s spending habits. The business ceased to operate after it failed to raise new capital. One of Eastern Bank’s recruits was Dan O’Malley, the enthusiastic, nobody-is-doing-what-we’re-doing co-founder of PerkStreet and now, chief digital officer at Eastern Bank with a team of about 20 to 25 innovators.

About a year ago, the bank put O’Malley and his team in charge of the customer call center, gave them access to a mass of data on the bank’s customers, and let them “build cool stuff, buy cool stuff and change our culture,” according to Rivers. The team’s goal is to spin off technology companies that make the bank a profit. Rivers said Eastern Bank’s directors didn’t need to be sold on the idea. “I would have to say, the board was more enthusiastic about it than management was here, by and large,’’ he says. Last year, when two members reached the retirement age of 70, the board brought in new expertise, including Joe Chung, a venture capitalist, and Bari Harlam, an executive vice president at BJ’s Wholesale Club in charge of membership, marketing and analytics. With such support from the top, the bank already has rolled out voice recognition software for the call center, so customers don’t have to answer a series of maddening questions to verify their identities. “The amount of friction we took out was huge,’’ O’Malley says.

Not all banks would have shareholders supporting long-term investments in research and development. But as a mutual, Eastern Bank doesn’t have the same pressure to meet quarterly earnings estimates that public banks have, and has more ability to invest, O’Malley says. Recruiting talent is always an issue, but O’Malley thinks the bank does have a leg up compared to a startup. The bank has a trove of data that can be harnessed to improve services and build new products. It already has a huge number of customers. It’s not trying to build capital and customers. It already has them. O’Malley is bringing in developers who have never worked for a bank. The head of the data center is an MIT-trained scientist who has been published in Science and Nature magazines. “You need people who know how to build stuff,’’ O’Malley says.

He feels strongly that banks need to adapt or they will lose business. “If we don’t do this right, we are going to lose chunks of our business. There are online lenders who will lend to small businesses within a day. Our traditional process takes a month, and they’re doing it in a day.” He thinks for many banks in the country, the situation is dire.

Judd Caplain, a banking advisory industry leader for the consulting firm KPMG, agrees that banks that don’t make changes will lose business. “As long as banks reinvent themselves, they will continue to exist,’’ he says. “Those that do not risk becoming dinosaurs.” Of course, banks have heard that before. The Internet was supposed to mean the death of branches, and yet they are still a powerful new customer acquisition tool, and a place to solidify a presence in the community. But Brett King has noticed a change. Bankers two years ago downplayed his predictions about a revolution in mobile banking, and countered that the Internet didn’t kill branches. Now, he doesn’t hear that anymore. “Banks are saying, ‘You’re right, it is changing, and we’ve got to do something now,’’’ he says. “It’s real this time.”