Top 5 Fintech Trends, Now and in the Future

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A version of this article originally appeared on RSM US LLP’s The Real Economy Blog.

Financial technology, or fintech, is rapidly evolving financial services, creating a new infrastructure and platforms for the industry’s next generation. Much remains to be seen, but here are the top trends we expect to shape fintech this year and beyond:

1. Embedded Finance is Here to Stay
Increasingly, customers are demanding access to products and services that are embedded in one centralized location, pushing companies to provide financial services products through partnerships and white-label programs.

Health care, consumer products, technology companies can embed a loan, a checking account, a line of credit or a payment option into their business model and platform. This means large-scale ecosystem disruption for many players and presents a potential opportunity for companies that offer customized customer experiences. This also means the possibility of offering distinct groups personalized services uniquely tailored to their financial situation.

2. A Super App to Rule All
We also anticipate the rise of “super apps” that pull together many apps with different functions into one ecosystem. For example, WeChat is used in Asia for messaging, payments, restaurant orders, shopping and even booking doctors’ appointments.

The adoption of super apps has been slower in the United States, but finance and payment companies and apps including PayPal Holding’s PayPal and Venmo, Block’s Cash App, Coinbase Global’s cryptocurrency wallet, Robinhood Markets’ trading app, buy now, pay later firms Affirm and Klarna and neobank Chime are building out their functionality. Typical functions of these super apps include payments via QR code, peer-to-peer transfers, debit and checking accounts, direct deposits, stock trading, crypto trading and more.

3. DeFi Gains Further Acceptance
Roughly a third of all the venture capital fintech investments raised in 2021 went to fund blockchain and cryptocurrency projects, according to PitchBook data. This includes $1.9 billion in investments for decentralized finance (known as DeFi) platforms, according to data from The Block. DeFi has the potential not only to disrupt the financial services industry but radically transform it, via the massive structural changes it could bring.

DeFi is an alternative to the current financial system and relies on blockchain technology; it is open and global with no central governing body. Most current DeFi projects use the Ethereum network and various cryptocurrencies. Users can trade, lend, borrow and exchange assets directly with each other over decentralized apps, instead of relying on an intermediary. The net value locked in DeFi protocols, according to The Block, grew from $16 billion in 2020 to $101.4 billion in 2021 in November 2021, demonstrating its potential.

4. Digital Wallets
Digital wallets such as Apple Pay and Google Pay are increasingly popular alternatives to cash and card payments, and we expect this trend to continue. Digital wallets are used for 45% of e-commerce and mobile transactions, according to Bloomberg, but their use accounts for just 26% of physical point-of-sale payments. By 2024, WorldPay expects 33% of in-person payments globally to be made using digital wallets, while the use of cash is expected to fall to 13% from 21% in the next three to four years.

We are starting to see countries like China, Mexico and the United States strongly considering issuing digital currency, which could also drastically reduce the use of cash.

5. Regulators Catching Up to Fintechs
It’s no surprise that regulators have been playing catch up to fintech innovation for a few years now, but 2022 could be the year they make some headway. The Consumer Finance Protection Bureau, noting the rapid growth of “buy now, pay later” adoption, opened an inquiry into five companies late in 2021 and has signaled its intent to regulate the space.

Securities and Exchange Commission Chair Gary Gensler signaled the agency’s intent to regulate cryptocurrencies during an investor advisory committee meeting in 2021. The acting chair of the Federal Deposit Insurance Corp. has similarly prioritized regulating crypto assets in 2022, noting the risks they pose. And this January, the Acting Comptroller of the Currency, Michael Hsu, noted that crypto has gone mainstream and requires a “coordinated and collaborative regulatory approach.”

Other agencies have also begun evaluating the use of technologies like artificial intelligence and machine learning in financial services.

The Takeaway
There are other forces at play shaping the fintech space, including automation, artificial intelligence, growing attention on environmental, social and governance issues, and workforce challenges. But we’ll be watching these five major trends closely as the year continues.

5 Key Factors for Fintech Partnerships

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As banks explore ways to expand their products and services, many are choosing to partner with fintech companies to enhance their offerings. These partnerships are valuable opportunities for a bank that otherwise would not have the resources to develop the technology or expertise in-house to meet customer demand.

However, banks need to be cautious when partnering with fintech companies — they are subcontracting critical services and functions to a third-party provider. They should “dig in” when assessing their fintech partners to reduce the regulatory, operational and reputational risk exposure to the bank. There are a few things banks should consider to ensure they are partnering with third party that is safe and reputable to provide downstream services to their customers.

1. Look for fintech companies that have strong expertise and experience in complying with applicable banking regulations.

  • Consider the banking regulations that apply to support the product the fintech offers, and ask the provider how they meet these compliance standards.
  • Ask about the fintech’s policies, procedures, training and internal control that satisfy any legal and regulatory requirements.
  • Ensure contract terms clearly define legal and compliance duties, particularly for reporting, data privacy, customer complaints and recordkeeping requirements.

2. Data and cybersecurity should be a top priority.

  • Assess your provider’s information security controls to ensure they meet the bank’s standards.
  • Review the fintech’s policies and procedures to evaluate their incident management and response practices, compliance with applicable privacy laws and regulations and training requirements for staff.

3. Engage with fintechs that have customer focus in mind — even when the bank maintains the direct interaction with its customers.

  • Look for systems and providers that make recommendations for required agreements and disclosures for application use.
  • Select firms that can provide white-labeled services, allowing bank customer to use the product directly.
  • Work with fintechs that are open to tailoring and enhancing the end-user customer experience to further the continuity of the bank/customer relationship.

4. Look for a fintech that employs strong technology professionals who can provide a smooth integration process that allows information to easily flow into the bank’s systems and processes.

  • Using a company that employs talented technology staff can save time and money when solving technology issues or developing operational efficiencies.

5. Make sure your fintech has reliable operations with minimal risk of disruption.

  • Review your provider’s business continuity and disaster recovery plans to make sure there are appropriate incident response measures.
  • Make sure the provider’s service level agreements meet the needs of your banking operations; if you are providing a 24-hour service, make sure your fintech also supports those same hours.
  • Require insurance coverage from your provider, so the bank is covered if a serious incident occurs.

Establishing a relationship with a fintech can provide a bank with a faster go-to-market strategy for new product offerings while delivering a customer experience that would be challenging for a bank to recreate. However, the responsibility of choosing a reputable tech firm should not be taken lightly. By taking some of these factors into consideration, banks can continue to follow sound banking practices while providing a great customer experience and demonstrating a commitment to innovation.

Former Bank Disruptor, Turned Ally, Talks Innovation

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A career that began with upending traditional banks has given Alexander Sion perspective on what they can do to accelerate growth and innovation.

Sion is the director and co-head of Citibank’s D10X, which is part of Citigroup’s global consumer bank. Prior to that, he oversaw mobile banking and mobile channel governance for the consumer and community banking group as general manager of mobile at JPMorgan Chase & Co.

But before he worked at banks, he attacked them.

Sion co-founded “neobank” Moven in 2011 to focus on the financial wellness of consumers. The mobile bank disruptor has since become a vendor; in March, the company announced it would close retail accounts and pivot completely to enterprise software.

Bank Director recently spoke with Sion about how banks can create new models that generate growth, even as they face disruption and challenges. Below is a transcript that has been edited for clarity and length.

BD: How should banks think about innovation as it relates to their products, services, culture and infrastructure?

AS: Citi Ventures focuses on growth within a dynamic environment of change. It’s very difficult to achieve, and it’s very different from core growth with existing customers. But all innovation, particularly at incumbent firms, has to stem from a desire to grow.

Banks that struggle with growth, or even getting excited about innovation, need to ask themselves two sets of questions. No. 1: Do you have a deep desire to grow? Do you have aggressive ambitions to grow? No. 2: Is that growth going to be coming from new spaces, or spaces that are being disrupted? Or are you considering growth from existing customers?

If a bank is focused on existing customers, retention and efficiencies, it’s going to be hard to get excited about innovation.

BD: What’s the difference for banks between investing in tech and merely consuming it?

AS: They’re very different. If your bank is focused on growing within its core business, then you would lean more towards consuming tech. You’re building off of something that already exists and trying to make it better. You’ve got existing customers on existing platforms and you’re looking for more efficient ways to serve them, retain them or grow share.

If you’re interested in new growth and exploration — new segments, new products, new distribution channels — you might be more inclined to partner in those spaces. You have less to build from, less to leverage, and you’re naturally trying to figure things out, versus trying to optimize things that already exist.

BD: What kind of a talent or skills does a bank need for these types of endeavors? Do people with these skills already work at the bank?

AS: Existing bank employees know the product, they know the customer. At Citi, what we do at D10X and Citi Ventures is to try to expose bank employees to a different way of thinking, expand their mindset to possibilities outside the constraints of what or where the core model leans towards and think from a customer-centric view versus a product-centric view of the world.

The dynamics of customer behaviors are changing so much. There’s so much redefinition of how customers think about money, payments and their financial lives. Creating a more customer-centric view in existing employees that already have the deep knowledge and expertise of not only the product, but how the bank’s customers have evolved — that’s a very powerful combination.

BD: Why should a bank think about new markets or new customers if they found great success with their core?

AS: If most banks in the United States were honest with themselves, I think many would admit that they’re struggling with growth. America is a very banked place. The banking environment hasn’t changed all that much, and most banks are established. Their focus has been on existing customers, efficiency of the model and maybe deepening within that customer base.

But now, fintechs coming in. These commerce, payments and technology players are doing two things. No. 1: They are legitimately opening up new markets of growth and segments that weren’t reachable, or the traditional model wasn’t really addressing. No. 2, and maybe more important, is they are widening and changing the perspective on customer behavior. I don’t think any bank is immune from those two trajectories; your bank can be defensive or offensive to those two angles, but you’ve got to be one or the other.

BD: What are some lessons you or Citi has learned from its testing, refining and launching new solutions?

AS: Venture incubation has to be about learning. There’s a saying that every startup is a product, service or idea in search of a business model. The challenge that every existing incumbent bank will have is that we have existing business models.

Banks need to be able to test ideas very rapidly. It’s easy to test an idea and rapidly iterate when you’re in search of a business model. It’s much more difficult to test new ideas in an already-operating business model. A typical idea is debated internally, watered down significantly and will go through the wringer before the first customer gets to click on anything. In this kind of world, that’s a difficult strategy to win on.

Why It’s Never Been Easier to Adopt a Fintech Solution

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innovation-4-9-18.pngFor many banks and financial services firms (incumbents), emerging financial technology firms (fintechs) were once viewed in two camps: flash-in-the pan, one-hit wonders or serious threats institutions should avoid. Perhaps the media was partially to blame for this “us vs. them” mentality with its prolific use of words like “disruption” or its positioning of fintechs as the only companies who embraced change or were capable of innovation. Beneath the exuberant headlines espousing the promise of these new technologies and the industries they would revolutionize, there was more than a hint of negativity, a healthy dose of fear mongering, and a pretty clear message, “Dear banks, you are not invited to the party. In fact, we are coming to crash yours.”

Although those of us who worked in banking and wealth management bristled at the tone and approach of these young companies, none of us could disagree with much of what they were saying: things were broken and radical change was afoot. Yet, there was something about the disruptor’s manifesto that seemed a little naïve, a bit misguided and certainly incomplete.

There was the assumption that financial institutions were resistant to change or opposed to innovation; neither of which, I would argue, were entirely true. For a myriad of reasons companies wanted change. The unspoken matter was how could they realize it in a cost effective and compliant way without disrupting any core processing or custodial technologies. Would these technologies integrate cleanly?

Fast forward to 2018
Much has changed. Many of the disruptive fintechs with their go-it-alone, direct-to-consumer business models have pivoted to business-to-business service models and now service the very companies and industries they set out to upend. Similarly, banks who either ignored the boisterous fintechs or chose to build internally are rethinking their strategies and engaging with start-ups.

What has changed?
The quick answer is everything. The disruptors have not only proven their technologies, but the market has begun demanding their services. Furthermore, the speed of innovation, adoption and deployment has quickened at such a rate that what was once deemed new or disruptive is suddenly table stakes.

Having experienced how difficult it is to create brand identity and how expensive it is to acquire clients, many fintechs have turned their focus to servicing institutional clients. Fintechs have a deeper understanding of the complex business activities and regulatory and compliance processes with which financial services must adhere and are designing their technologies accordingly. The technology is often preconfigured, ready to integrate into existing back-end processes, and deployable at a large scale.

Us vs. Them Becomes We
Fintechs are easier to partner with and their solutions have become easier to adopt. No longer is innovation limited to the banks or organizations with large IT budgets and staffs. FinTechs have made innovation available to all financial firms, with prices and engagement models that meet most budgets.

The nimble nature of fintechs has allowed them to adapt to changes and fine-tune their technology at a much quicker rate, bringing the most scalable solutions to the market. With an emphasis on engagement and a seamless experience for both clients and institutions, fintechs are no longer serious threats but rather trusted partners bringing a necessary business function to institutions.

Lastly, and equally important, the value proposition for incumbents to adopt digital solutions is clearer and far more comprehensive than previously articulated or understood. Fintechs make it easier for institutions to launch new business services such as wealth management or lending solutions to diversify product offerings, deepen client engagement, enhance client acquisition and strengthen loyalty. This not only helps grow the overall business, but many incumbents have realized significant cost savings through the automated processing solutions these new technologies offer and the elimination of manual back-end processes. As a result, businesses are seeing improved efficiency ratios and in some cases, higher valuations.

To conclude, a new breed of fintechs has emerged, many with the same face, most with a new sophistication and a deeper understanding of integration but all with the mission to empower. Transformation through collaboration is an impressive phenomenon, one that every firm should take advantage of and fintechs provide that opportunity.

Making Consumer Lending Profitable for Your Bank

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lending-2-12-18.pngThe economy has recovered significantly since the financial crisis in 2008. The stock market continues to thrive. The unemployment rate is the lowest it’s been in almost two decades, and there’s more demand for housing than ever before. Consumer lending has substantially increased in the past year, and now that the U.S. has returned to more prosperous times, it only makes sense for community banks to open their doors again to welcome consumer lending—and make a sizeable profit while they are at it.

The Great Recession brought a more restrictive regulatory environment and calls from legislators for revision and change in the banking industry. Facing heightened regulatory concerns, many community bankers abandoned potential revenue from consumer lending in the face of mounting costs. For example, total costs for originating a $30,000 unsecured consumer loan in a bank branch could be over $3,000, making the overhead and costs unattractive to many bankers. With an improving economy and a need for higher yielding assets, community banks are looking for ways to lower these costs and make consumer lending profitable again.

The consumer lending landscape has changed drastically in the past decade. The space has gone through a digital transformation led by marketplace lenders focused on disrupting traditional brick and mortar banks. These marketplace lenders are not yet as highly regulated as banks, enabling their online lending platforms to thrive in the current economy with little to no legislation working against them.

Many community banks lack the internal expertise, infrastructure and resources to quickly build their own digital lending platforms. Those that do build their own platforms face the challenge of keeping the platform current and fully compliant while still delivering an exceptional experience that meets the needs of today’s digital banking customer. This creates significant costs in capital expenditures for the platform’s infrastructure, and lofty operating expenses for the institution to continue to competitively offer these products and maintain regulatory compliance.

Banks can dramatically decrease both the cost and time-to-market for a digital lending platform by partnering with technology providers. Implementing and launching a digital lending platform can take as little as six weeks by partnering with an outside provider, and these partnerships provide the necessary infrastructure banks are looking for without having to build and staff internally. In contrast to the high costs of originating loans in a traditional branch, the digital platforms provided through technology partnerships can lower total costs to originate that same $30,000 unsecured consumer loan down to roughly $750, making it significantly more profitable for the bank. The reduced costs and reduced risks in creating these platforms is resulting in an increase in technology partnerships.

Choosing a digital lending platform provider that understands the regulatory and compliance complexities facing the banking industry, and focuses on a higher standard of customer service, should be a top priority for community bankers in 2018. The boards and management teams of these institutions should seek partnerships with endorsed technology providers that demonstrate a keen eye for ever-evolving regulations, exceptional customer experiences and lucrative lending opportunities for the future.

Not All Innovations Are Disruptive, But This One Could Be

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I was listening to a financier talking about fintech companies the other day, and he claimed that their work products are all sustaining innovations and not disruptive. He was referring to Clayton Christensen, a Harvard Business School professor and an expert on disruption. In his research and writings, Christensen has pointed to various markets that were disrupted by outsiders, including the American car industry, disrupted by cheaper Japanese car manufacturing; fixed line telephone firms, disrupted by cell phone makers; and the mainframe computer industry, disrupted by PC manufacturers.

Rubbish.

There is a flaw in Christensen’s work, which is that incumbents often fail to respond when challenged by outsiders, which makes their situation worse. That was true of Kodak and Nokia, where the change was fast and the management teams were weak. American car firms—Ford, General Motors and Chrysler—have not disappeared because of competition from Toyota and Honda; instead, they responded proactively and survived. AT&T, with $168 billion revenues in 2016, is hardly dead either. And IBM, with $80 billion revenues, is still going pretty strong.

Equally, Christensen points to industries that produce commodity products such as phones, cars and computers, where there may be giants, but the giants are not protected by layers of law and regulations like banks are. That is why banking has not been disrupted to date, and is unlikely to be in the future.

Christensen does make an important point, although it’s not as radical as those who refer to his work believe. If a weak competitor enters the bottom-end of the market, he argues, they may have the opportunity to disrupt the market if the incumbent does not respond. That is true, and that was the case with Kodak and Nokia. Ford, AT&T and IBM did respond and survived the change.

That is the case with any change however. As Charles Darwin noted: “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.”

How true.

We really need to understand the difference between sustainable innovation and disruptive innovation in order to see if there is any disruptive change in banking. According to Matt West:

Sustaining innovation comes from listening to the needs of customers in the existing market and creating products that satisfy their predicted needs for the future. Disruptive innovation creates new markets separate to the mainstream; markets that are unknowable at the time of the technologies conception.

Sustaining innovation improves what is there today; disruptive innovation replaces what is there today. Hmmm. I blogged about this over on The Next Web, stating that there are three streams of fintech innovations:

  • Those that serve markets that banks don’t serve
  • Those that improve the customer journey by removing friction
  • Those that work with banks to eradicate inefficiencies, for example, in customer onboarding

Obviously, the latter two categories are sustaining innovations, as they improve what is there today. The first category is interesting though, as it is creating and serving new markets. In my blog, I pointed to SME financing and crowdfunding, but that’s not a true example of disruption. That is an extension of what’s occurring today.

However, I do see one example of disruptive innovation out there. I think about this one often. It is clearly disruptive, but is it noticed by the incumbents? Have they responded?

Not yet.

What is it?

I’m tempted not to say, but that would be rude. It’s financial inclusion.

There’s loads of discussions about financial inclusion and the use of mobile wallets in Sub-Saharan Africa to provide cheap and simple money transfers between people without bank accounts. This is serving the bottom end of the market, and Christensen defines disruptive innovation as: “A process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves up market, eventually displacing established competitors.”

Oooh. We have one. Are the banks noticing?

New Index Tracks Fintech Stock Performance

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Nasdaq and investment bank Keefe, Bruyette & Woods recently announced the formation of the KBW Nasdaq Financial Technology Index to track fintech companies. KBW describes it as an equal weighted index designed to track the stock performance of U.S. companies that leverage technology to deliver financial products and services, and earn most of their income from fee-based sources instead of interest payments. This is an index, not an exchange traded fund (EFT), so for now it is useful only for tacking the performance of fintech stocks, and investors cannot yet buy the index as an ETF. I won’t be shocked if that changes before too much time passes. For now, the index can be tracked under the symbol KFTX.

I find the development of the index significant for two reasons. First, fintech is one of the more investable concepts that I have run across in the past few years. In 1972, Thomas Phelps wrote a book titled “100 to 1 in the Stock Market” in which he talked about the powerful returns that can be earned by identifying companies that would benefit from a changing world and hanging onto them for a very long time. One of my favorite intellectual exercises is to sit and think of those industries that offer the potential for decades-long periods of growth that could deliver 100-to-1 returns. Fintech is pretty high on the list.

While my primary focus as an investor is and always will be on community bank stocks, I find with increasing frequency that while in the process of researching banks and talking to bankers I run across companies that focus on product areas like cybersecurity, payment processing, loan underwriting algorithms and other technology areas that help bankers make more money with greater efficiently as well as increase their safety and security factors. A few of them have made their way into my portfolio and a bunch more have made it onto my watch list in hopes that I can buy them at more favorable valuations at some point in the future.

When the new index was announced, Fred Cannon, KBW’s global director of research, highlighted something about the fintech sector that’s not widely understood. “Some people see fintech as disrupters who are going to kill the big bad banks, but we feel it’s not quite that,” he said. “We feel that there are some big companies that are already providing financial services [companies with] technology.” There is a perception of many fintech entrepreneurs as Steve Jobs-type garage cowboys who are running around disrupting the banking industry. The real story is that many of the leading edge fintech products are being developed or sold by old line companies like First Data, Fiserv, Alliance Data Systems, VeriFone Systems and Fair Isaac. All of these are included in the KFTX.

There are some new cutting edge fintech companies in the index as well, including Green Dot, Global Payments and Square. Most of the newer companies in the index appear to be those involved in payments, and they deal directly with un-banked or under-banked consumers. They are not really a threat to traditional banks.

Those fintech companies that sell directly to banks tend to be older, more established players. There a key lesson here for younger fintech companies hoping to sell technology services directly to banks. Most banks are not going to be willing to take on the early adopter risk of doing business with new and untested technology companies no matter how exciting their products might be. Younger fintech firms are going to need to partner with older, more established companies that have been doing business for decades and have a large installed user base. The makeup of the new index acknowledges the reality that very few bankers will be willing to take on the reputation and career risk needed to deal with start up vendors.

How Financial Institutions Can Meet the Marketplace Lending Challenge

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What makes a bank a bank? When it comes to the commercial lending space, in a world of seemingly commoditized products and services, the true differentiation is defined by how a bank decides who they will lend to and who they won’t. It’s each individual bank’s unique credit policy that, however subtly, makes one bank different from another. All banks use many of the same metrics and scoring data to determine credit quality, and there is generally no secret sauce that one bank has and the rest don’t. Instead, it is often the nuances within those metrics and the interpretation and prioritization of the data that makes one bank different from another—and potentially, enables a business owner to get capital from one bank and not from the other.

Banks have spent a long time fine tuning their credit policies to match their risk appetite and even the history and culture of the bank. Their risk profile is integral to who they are. It is integrated into their brand, their mission statements and their core values. The bank’s credit policy is exclusive to that bank and helps define it as a lender.

Enter the fintech revolution, which has spawned a long list of marketplace lenders that have disrupted the business lending universe by essentially disregarding credit policies that took banks and credit unions decades to develop. Marketplace lenders like Lending Club, OnDeck and Kabbage are telling the business borrowing universe that they have a better solution than financial institutions when it comes to measuring a borrower’s credit worthiness.

Banks and credit unions are being driven to offer an online business lending solution by the need to improve the customer experience, increase customer acquisition and raise their profitability, while at the same time decreasing costs, streamlining workflow and reducing end-to-end time. As marketplace lenders aggressively court the business borrower, financial institutions need to do something in the online space just to remain competitive!

To replicate the technology that the disruptors have created would cost banks millions of dollars and years of development time and energy. The great news is, with innovation and evolution there is always the exploitation of every niche and iteration of a solution or model resulting in alternative means to attain the same outcomes.

There is a technological revolution within the fintech phenomenon that is being created by businesses that have the vision and mission to work with banks—not against them. Companies are hitting the marketplace with technology-only solutions that help banks help their business customers succeed. These “disruptors of the disruptors” are essentially selling financial institutions the technology needed to deliver loans easier, faster and more profitably, without forcing them to give up their credit policies, risk profile, relationships or control over the customer experience.

Banks and credit unions need to find these partners, and find them quickly, because they represent a way for those institutions to accelerate their entry into the online business lending space. Choose a partner that best meets your needs. Are you looking for an online application only, or an application and decisioning technology? Or, are you looking for an end-to-end solution that provides an omni-channel experience from application, through underwriting, docs and due diligence and even closing and funding? The type of partner you select depends on what’s driving your financial institution, whether that be increasing profitability, new customer acquisition, streamlining workflow, reducing end to end time or simply creating an enhanced customer experience for the businesses you serve. Explore all your options!

What Banks Need to Do to Address Technological Change

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In the past few years the fintech industry has grown exponentially. According to a recent Forbes article, the existing number of fintech start-ups globally are between 5,000 and 6,000, all seeking to take a slice of the financial services marketplace. The fintech industry broadly includes any new technology that touches the financial world, and in many ways, this industry redefines forever the notion of traditional banking. More specifically, fintech includes new payment systems and currencies such as bitcoin, service aggregators such as robo advisors, as well as mobile applications, data analytics and online lending platforms. The fintech industry can also be divided into collaborators and disruptors, those businesses that provide services to banks and those that are competitors for services and looking to displace banks. As new technologies and approaches to delivering financial services are adopted, community banks will be challenged to meet the future expectations of their customers as well as to assess the additional risks, costs, resources and supervisory concerns associated with providing new financial services and products in a highly regulated environment.

The largest commercial banks have recognized the future competitive impact on their business as fintech companies create new and efficient ways to deliver services to their customers. Bank of America, for example, recently announced a fintech initiative and plans to target the start-up market for potential acquisitions. The large banks have the advantage of scale, deep pockets and the luxury of making bets on new technologies. If not by acquisition, other banks are partnering with new players that have unique capabilities to offer products outside of traditional banking. While community banks are not new to the benefits of fintech, the advancement and number of new technologies and potential competitors have been difficult to keep up with and integrate into a traditional bank’s business model. On top of that, the fintech industry remains largely unregulated at the federal level, at least for now.

Competition, compliance and cost are the three critical factors that bank management and board members must assess in adopting new technologies or fending them off by trying to stick with traditional banking values. Good, old-fashioned service based on long-term banking relationships may become a thing of the past as the millennial generation grows older. Contactless banking by the end of this decade or sooner could rule the financial services industry. While in some small community banking markets, the traditional relationship model may survive, it is far from certain as the number of brick-and-mortar bank branches in the United States continues to decline.

Also falling under the fintech umbrella is the rapidly escalating online marketplace lending industry. While most banks may rationalize that these new alternative lending sources do not meet prudent credit standards in a regulated environment, the industry provides sources of consumer, business and real estate credit serving a diverse market in the billions. While the grass roots banking lobby has been around forever, longtime banks should take note that the fintech industry is also gaining support on Capitol Hill, as a group of Republicans are now preparing legislation coined the “Innovation Initiative” to facilitate the advancement and growth of fintech within the financial services industry.

Fortunately, the banking regulators are also supportive of innovation and the adoption of new technologies. The Comptroller of the Currency in March released a statement on its perspective on responsible innovation. As Comptroller Thomas Curry noted, “At the OCC, we are making certain that institutions with federal charters have a regulatory framework that is receptive to responsible innovation along with the supervision that supports it.” In an April speech, he confirmed the OCC’s commitment to innovation and acceptance of new technologies adopted by banks, provided safety and soundness standards are adhered to. The operative words here are responsible and supervision.

Innovation will come with a price, particularly for small and midsize community banks. Compliance costs as banks adopt new technologies will increase, with greater risk management responsibilities, effective corporate governance and advanced internal controls being required. Banks may find it necessary to hire dedicated in-house staff with Silicon Valley-type expertise, hire chief technology officers and perhaps even change the board’s composition to include members that have strong technology backgrounds. In the end, banks need to step up their technology learning curve, find ways to be competitive and choose new technologies that serve the banking needs and expectations of their customers as banking and fintech continues to converge.

This article was originally featured on BankDirector.com.

How Fintech Is Co-opting the Banking Industry’s Directors and What to Do About It

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directors-7-8-16.pngOver the last several years, companies which can be broadly grouped under the umbrella of “fintech,” or financial technology, have been making notable additions to their boards of directors by acquiring talent from traditional financial institutions and regulatory agencies. These additions include Sheila Bair, former chair of the Federal Deposit Insurance Corporation joining the board of directors of Avant, which specializes in digital lending to subprime customers, and Anshu Jain, former co-CEO of Deutsche Bank, joining online lender SOFI. This effort is certainly not unprecedented.

Many industries undergoing transformation often reach out to individuals in the industry they are attempting to disrupt to create an air of legitimacy to their efforts and facilitate communication and transparency with the primary regulatory organizations. In the case of financial services, banks should take this opportunity to turn the model around and cast their nets in the opposite direction. By reaching out to technology-based companies and sophisticated technology professionals, banks can enhance their ability to meet the challenges associated with delivery of financial services and be better equipped to assess the risks associated with an increasingly technological environment.

Directors are broadly responsible for the management of business and affairs of a corporation and the proverbial “buck” ultimately stops with the board. Directors must fulfill their fiduciary duties with due care and always be properly informed about the critical matters facing their respective institutions. This means that directors need to be able to understand the challenges posed by technological innovation and how technology can successfully be incorporated into a bank’s existing platform. Most directors, however, do not come to a bank board with the technological expertise or sophistication to truly understand how technology works and the risks posed through the use of that technology.

By the same token, at their nascent stage, fintech companies typically do not have boards of directors comprised of individuals who are well-versed in the panoply of regulations which affect the financial services industry or anti-money laundering compliance. Realistically, most fintech companies, even at a more mature level, are often populated with smart technologists, founders and the venture capital representatives who have funded them. But as they grow and move closer to significant liquidity events, whether they be initial public offerings, mergers or acquisitions, fintech companies are leveraging the expertise of establishment bankers and regulators who understand the risks and rewards posed by various business models. Traditional banks should do the same.

How should traditional banks approach this challenge? Of course, by thinking outside of the box. The characteristics that make for a director who understands net interest margin and the ins and outs of loan origination and credit risk are not necessarily the same ones that make for a cutting-edge technology expert who grew up with a computer in hand and who appreciates the cybersecurity and data privacy risks posed when financial information travels from point A to point B. That means that boards must expand their search profile and look for individuals who may not have horizontal breadth of understanding in a wide array of bank operations, but rather, have deep technology experience and can learn the other areas of bank operations while educating their board colleagues on the risks inherent in a technological world.

In addition, banks should inform retained search firms and internal cross-reference sources that the characteristics of leadership they are looking for are probably not sitting on existing bank boards, but instead, may be overseeing the operations of code-laden start-ups located in Silicon Valley. To that end, banks must rethink the manner in which they envision leadership. They must recognize that leadership does not always involve a horizontal breadth of knowledge across a wide spectrum of subjects, but rather, leadership can be articulated through a more narrow, vertical expertise which fills a critical niche in enabling financial service businesses to meet the challenges of today….and tomorrow.