Not all banks are comfortable taking on the risks of partnerships with startup fintech companies. Mike Butler is the president and CEO of Radius Bank, a $1 billion asset, Boston-based bank with three offices, and a national customer base serviced through innovative online and mobile technology. He explains how he handles the risk of doing business with fintech companies.
Community banks that leverage innovation could have a competitive edge over other traditional financial institutions. In this video, Brandon Janosky of Detalus explains how fintech partnerships can benefit organizations that lack in-house expertise and how to identify the right provider.
Banks and fintech firms are increasingly working together to create new and innovative solutions-developing a new products and services, or generating efficiencies for the traditional banking industry. How will these relationships continue to take shape in the near future? In these short videos, three members of the FinXTech Advisory Group share their thoughts.
Sima Gandhi, Plaid
—Sima Gandhi of Plaid shares why the best way for community banks to proactively invest in technology for the new digital age starts with partnerships.
Jim Hale, FTV Capital
Jim Hale of FTV Capital discusses where the significant investments and advancements for innovation lie for the banking industry.
Tom Brown, Paul Hastings LLP
Tom Brown, partner at the Paul Hastings law firm, shares why many early stage fintech companies fail, and how they can set themselves up for success.
What type of fintech lending solution should your bank pursue? Mike Dillon of Akouba outlines what management teams and boards need to know about these lending models, and how each can benefit the bank.
I talk to a lot of bankers, and lately I have detected a shift in bankers’ attitudes towards fintech. Just a few years ago, a discussion of fintech with community bankers would have inspired a certain amount of fear. It was widely believed at the time that fintech startups would disrupt and replace traditional banks. Millennials would turn to new marketplace lenders for their credit needs and use the new payment services from the likes of Apple for all their financial needs, leaving the banks with an aging clientele that would eventually die off. As time has passed, bankers and fintech companies alike have come to understand that is simply not going to happen. Going forward, fintech companies need banks just as much, if not more, than banks need them.
I recently saw a presentation titled The Impact of FinTech on Community Banks: Deal Breaker or Money Maker, by Ronald Shevlin, director of research at the consulting firm Cornerstone Advisors. He pointed out that while the number of marketplace lenders has grown rapidly, they still account for just 1 percent of the total loan market. And while they may have seen some growth, it appears they have not done so by keeping their customers happy. According to a U.S. Treasury Department report, marketplace lenders received a customer satisfaction rate of just 15 percent, compared to community banks whose satisfaction rate hit 75 percent.
Shevlin also pointed out that as millennials age, their attitudes towards money is changing. When you are 22 with a couple of thousand dollars in the bank and a couple of credit cards with $2,000 limits, it is easy to choose the flashy and fastest. When we start adding some zeros to their account balances, safety and security begin to matter more than the latest technology. Because of strict regulatory oversight and FDIC insurance, banks have an enormous edge when it comes to consumer comfort with the safety of their funds.
Bankers are starting to realize that they do not need to be innovators. As Shevlin pointed out in his presentation, it is easier to innovate when you don’t have a large installed customer base. Community banks can treat fintech firms like any other vendor. They need to recognize and deploy those innovative processes that survive the birthing process and add value to the bank. Bankers looking at a new technology offered today are asking: Does this adds value to the bank? Does it make me more efficient? Are are my customers demanding it? If the answers to these questions are no, then there is no need to add the technology to their existing offerings. Fintech companies are no longer scary competitors, but instead are another class of vendors that banks may or may not choose to do business with based on their needs.
Community bankers are worried about the brave new digital world. I go to several conferences during the year and I have noted more than a few cybersecurity vendors in the exhibit hall. I have also noticed that more insurance companies are in attendance offering cyber insurance. One insurance vendor told me that they were seeing several dozen claims related to ransomware alone every day. The CEO of a $300 million bank out west said that cybersecurity was the only issue that kept her up and night.
Jared Hamilton, senior manager of cybersecurity at the consulting firm Crowe Horwath, gave a talk recently on cybersecurity issues where he told the bankers that they needed to pay greater attention to this critical area going forward. There needs to be someone handling cybersecurity for the bank on a full-time basis and not just as part of the administrative or IT functions. He also suggested that the purchase of cybersecurity insurance was not optional. In today’s world, your bank must have this coverage. Judging by the furrowed brows and slumped shoulders I saw in the room at one conference recently, the costs of cybersecurity will become as big a concern for community banks as climbing regulatory costs have been over the past several years.
One of the most underserved areas in financial technology is construction lending, which exposes banks and non-bank lenders to unnecessary risk, costs shareholders money and negatively impacts the client experience for borrowers. For an asset class that is finally gaining steam after punishing many lenders during the Great Recession, this is an area that can’t be ignored.
The problem? Once a construction loan closes, it’s booked into a loan servicing system. But to be properly serviced, that requires paper files, spreadsheets, emails and phone calls between lender staff, borrowers, builders, draw inspectors (people who go out to the job site and validate that the work is being done before a bank can release loan funds from a draw request) and title companies throughout the construction period. This coordination between parties is critical for lenders to mitigate risk and ensure that every dollar is actually going into their collateral. However, this reactive rather than proactive process is not only slow and costly, but it prevents even the most sophisticated internal systems from providing lenders with real-time visibility into what’s going on, much less their clients.
The concept of applying technology to a problem within lending in order to greatly reduce risk, increase transparency, eliminate friction, improve the customer experience and drive cost savings did not make its way into construction lending until recently. Most lenders don’t realize there is a better way.
This is the perfect example of how fintech can help solve a problem faced by banks and non-bank lenders alike.
Where Fintech Can Help
Risk: Construction loans are often perceived as the riskiest loans in a bank’s portfolio. As such, they garner significant attention from regulatory agencies that want to ensure risk is being properly managed. Technology applied to construction lending allows key information to be transparent and consumable in real-time. This reduces the opportunity for human error, ensures loans aren’t being overfunded and helps a lender maintain a first lien position throughout the life of a construction project. And perhaps the most exciting byproduct of bringing these loans into the digital world is the data. Analytics can now be used to help lenders make better decisions about the loans they make as well as proactively manage risk in their active portfolio. For instance, imagine proactive notifications to alert appropriate lender personnel that a construction project has gone stale or that a borrower has materially changed their behavior based on historical data.
Efficiency: Construction loans require more post-closing support and ongoing administration effort to be properly serviced than any other type of lending. While critical, this effort costs lenders more money than they likely realize. By bringing collaboration and automation into construction lending, lenders can now connect with their borrowers, builders, draw inspectors, and others in real-time, allowing each party to push things forward while knowing where (and with whom) things stand in the process. This eliminates countless steps and saves everyone significant time. Not only does this improve a lender’s efficiency, but it also gets borrowers their money safer and faster–creating happier builders and allowing lenders to accrue more interest.
Customer Experience: Today, the customer experience for a borrower managing a construction loan is sadly lacking. If a borrower or builder wants to make a draw on their loan, or wants to know where a loan currently stands, it requires a phone call or an email to their lender. This triggers a domino effect of events that usually results in stale information and disrupts the lender’s workflow. Through technology, borrowers and builders have full transparency into what’s going on, and can often self-serve from their phone or computer. That ends up being a better customer experience even though there is no human-to-human contact. Technology also means faster access to draws, which means that projects can be pushed forward faster.
The best part is that with the right technology solution, lenders don’t have to choose which of these three areas is most important because they can have their cake and eat it too. As with most areas of the financial services industry, fintech’s introduction to construction lending is changing everything for the better.
FinTech startups were originally perceived as a significant threat to banks of all sizes. Today, we’re talking about “coopetition” between banks and fintechs. Why is that? Let’s start by winding back the clock just two years.
A 2015 Goldman Sachs research report estimated that $4.7 trillion out of $13.7 trillionin traditional financial services revenue was at risk due to new fintech entrants in the lending, wealth management and payments space. Similarly, a McKinsey report, The Fight for the Customer: Global Banking Annual Review 2015, suggested that as much as 40 percent of revenues and up to 60 percent of the profits in retail banking businesses (consumer finance, mortgages, small-business lending, retail payments and wealth management) were at risk due to dwindling margins and competition from fintech startups targeting origination and sales, the customer-facing side of the bank.
Early fintech success led to thousands of promising ventures gradually crowding the space and attracting the attention of industry stakeholders. In the last two years, financial services professionals, with decades of experience, have flipped fintech startups’ perceived threat into an opportunity, which kick-started the phase of collaborative initiatives.
Despite tremendous financial success of the fintech industry globally, startups find it difficult to succeed on their own. Matthaeus Sielecki, head of working capital advisory, financial technology at Deutsche Bank, noted in his article for LTP that despite having developed customer-focused, innovative solutions, startups lacked crucial ingredients to scale their product into a viable product or service. Startups lacked access to processing infrastructure, global industry reach and regulatory expertise, and many came without understanding customer behavior in the financial service sector.
Traditionally, community banks have not had many choices for technology innovation outside of their core banking provider. A March 2016 article on theCNBC.com website suggestedthat economic growth and predictions regarding interest rates are felt acutely by smaller institutions. Since smaller banks focus more on interest-sensitive products such as mortgages, prolonged low rates by the Federal Reserve hurt them disproportionately. Working cooperatively with fintech startups present community banks with an opportunity to achieve rapid gains in cost-efficiency, operational efficiency and new product offerings.
All of these factors combined led to the understanding between banks and fintech companies about the value of mutually beneficial work that would bring together the strengths of each party. As a result, banks have contributed significantly to the establishment of accelerators, incubators, innovation labs and other collaborative initiatives with fintech startups. In addition, forward-thinking governments have invested resources and efforts to launch Regulatory Sandboxes to facilitate a relationship between the traditional sector and fintech startups.
In a 2016 survey, more than half of regional and community bank respondents (54 percent) and fintech respondents (58 percent) indicated that they see each other as potential partners. Moreover, the same survey suggests that 86 percent of community and regional banks believe it to be absolutely essential to partner with a fintech company.
CNBC noted that the ability to outsource functions, such as customer acquisition, to startups means smaller banks have more clients to pursue. This enables smaller banks to tap into revenue that previously would have been inaccessible due to distribution, geographic or technical limitations. Advances like cloud technology, APIs, blockchain, InsurTech, RegTech and partnerships with online lending companies are in focus right now as they offer the most return on investment for all banks, large and small. For example, community banks can lower their costs by integrating a RegTech solution for compliance rather than hiring consulting firms or employing whole departments.
Examples of partnerships include Cross River Bank in Teaneck, New Jersey, which works closely with marketplace lenders to originate loans for borrowers who apply via online platforms. CBW Bank in Weir, Kansas, is another notable example. According to an August 2016 article on the Fortune.com website, over the last few years, the 124-year-old bank has become a secret weapon for fintech companies, which rely on both its technology and status as a state-chartered bank to build their own businesses.
For regional and community banks, enhanced mobile capabilities and lower capital and operating costs are seen as the benefits of collaborating with fintechs. For fintechs, market credibility and access to customers are seen as the main benefits to partnering with banks. The unlikely journey of fintech startups going from foe to friend will make the financial services sector one of the most interesting businesses to be a part of in the next decade.
As noted throughout our 2017 Acquire or Be Acquired Conference, partnerships between a bank and a tech company can take on many forms — largely based on an institution’s available capital, risk appetite and lending goals. With fintech solutions gaining momentum, many advisors at this year’s event encouraged banks to look at viable alternatives to meet consumer demands, maintain and expand their lending revenue and give formidable competition to those looking to take that market share.
Fintech lending has grown from $12 billion in 2014 to $23.2 billion in 2015 and is expected to reach $36.7 billion in 2016, a year-over-year growth of 93 percent and 58 percent in 2015 and 2016. This market, according to Morgan Stanley Research, is expected to grow further and reach $122 billion by 2020.
With this in mind, we invite you to take a look at our new Fintech Intelligence Report on Marketplace Lending. The research paper, developed by FinXTech, a division of Bank Director, and MEDICI, a subscription-based offering from LetsTalkPayments.com, explores current market dynamics along with technology and partnership models. As noted in this report, the gains of new fintech companies were widely thought to be at the expense of banks; however, many banks recognize the potential value from collaboration and have built relationships with fintechs.
Tell us what you think! As we work to provide you the latest information and research as it pertains to the financial services industry, we would appreciate your feedback on the Fintech Intelligence Report. Please email us your comments and/or suggestions at firstname.lastname@example.org.
In 2009, a former Google engineer and his wife decided to buy a little bank in tiny Weir, Kansas. At the time, the bank had less than $10 million in assets. Why would a tech guy want to get into banking, with all its regulation and red tape—and do so by buying the textbook definition of a traditional community bank?
“Money is a very fundamental invention,” says Suresh Ramamurthi, the ex-Google engineer who is now chairman and chief technology officer at CBW Bank. (His wife, Suchitra Padmanabhan, is president.) “The best way to understand the [changing] nature of money is to be within a bank.” So Ramamurthi learned how to run every facet of the bank, and then set about fixing what he says was a broken system. The bank’s new-and-improved core technology platform was built by Yantra Financial Technologies, a company co-owned by Ramamurthi.
Ramamurthi and his team “recoded the bank,” says Gareth Lodge, a senior analyst at the research firm Celent. Many banks rely on their core providers for their technology needs, but CBW, with Yantra, wrote the software themselves. The bank’s base technology platform allows it to make changes as needed, through the use of APIs. (API stands for application programming interface, and controls software interactions.) “What they’ve created is the ability to have lots of different components across the bank, which they can then rapidly configure and create completely new services,” says Lodge.
The bank has used this ability to create custom payment solutions for its clients. One client can pay employees in real time, so funds are received immediately on a Friday night rather than Tuesday, for example, decreasing employee reliance on payday loans. Another client, a healthcare company, can now make payments to health care providers in real time and omit paper statements; by doing so, it cuts costs significantly, from $4 to $10 per claim to less than 60 cents, according to Celent.
The bank created a way to detect fraud instantly, which enables real-time payments through its existing debit networks for clients in the U.S., at little cost to the bank, says Lodge. CBW also makes real-time payments to and from India.
Today, CBW is larger and more profitable, though it’s still small, with just $26 million in assets, and still has just one branch office in Weir. The bank now boasts a 5.01 percent return on assets as of June 2016, according to the Federal Deposit Insurance Corp., and a 26.24 percent return on equity. Its efficiency ratio is 56 percent. In 2009, those numbers were in the negative with a 140 percent efficiency ratio.
Not only has its profitability substantially changed, but its business model has too. Loans and leases comprise just 9 percent of assets today, compared to 46 percent in 2009, as CBW increasingly relies on noninterest income from debit cards and other deposit-related activities. CBW found opportunities in partnerships with fintech firms, long before the rest of the industry caught on. CBW provides the FDIC-insured backing for the mobile deposit accounts of the New York City-based fintech firm Moven, and also issues the company’s debit cards. “Every one of these opportunities is a learning opportunity,” says Ramamurthi.
Is it possible to duplicate CBW’s approach to innovation? The bank’s model and leadership is extremely unique. A large bank may have the technology expertise in-house, but completely changing a complex organization is difficult. On the other hand, while it’s easier to make changes to a small, less complex bank, these institutions often can’t attract the necessary talent to facilitate a transformation. To further complicate matters, many banks are working off older core technology, and their partnerships with major core providers limit their ability to integrate innovative solutions, according to Bank Director’s 2016 Technology Survey.
CBW, on the other hand, is nimble enough to transform seamlessly, due both to its size and its custom core technology. It also has leadership with the ability and the interest to implement technology that can help better meet clients’ needs. “They’re providing things that nobody else can do,” says Lodge. “It’s not just the technology that distinguishes them. It’s the thinking.”