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.
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.
Today’s small businesses are empowered more than ever by technology. Start-ups and emerging technologies are colliding with established financial institutions to create a true Wild West for business and financial management in the small and medium business (SMB) sector. But what approaches are different finance and technology players taking—and how will they impact the way small businesses manage their finances?
There’s no doubt that business owners recognize the benefits of technology—one recent survey found that 29 percent of all SMBs say technology is critical to improving business outcomes. The result is a mad dash by incumbents to catch up, keep pace and partner with innovators in the right ways to earn the loyalty of business owners.
Here are four different ways that financial companies are battling it out to help small businesses manage their cash flow, start to finish.
Integrating POS with Financial Management
In a recent report by technology provider Wasp Barcode, a majority of small business owners said that their number one priority for technology investment this year is to replace hardware. For a great many SMBs, this includes front end equipment like cash registers and credit card processing devices. Square was the primary innovator of integrating credit card swiping with iPads, but today the bar is much higher in terms of payment hardware technology design, performance and accessibility.
Take Bank of America’s Clover Point-of-sale (POS) solution, for example. As opposed to Square, which only allows for card swiping, Clover is a fully integrated POS, cash drawer and receipt printer. BofA supplements the basic hardware and software with an app store, where businesses can add extra layers of functionality and customization based on their unique processes. The POS software is then able to communicate and send data back to financial management software, so that the two are seamlessly integrated.
Offering End-to-End Cash Flow Management
Other companies are approaching small business management technology with the goal of providing complete, end-to-end financial management. This means that everything from payments, checking, savings, credit, insurance and investments are all handled by one technology platform. This is the logic behind Capital One’s Spark Program for small business finance, that offers a different Capital One Spark product or service for each of those areas, all tailored towards entrepreneurs.
That isn’t to say businesses can pick and choose from different products within the Spark ecosystem (such as checking, corporate credit Cards and 401(k) account management), but the goal is to have everything tightly integrated so business owners can access everything in one place. The ancillary part of the pitch is that it makes customer service that much more convenient, as you only have one partner to contact if multiple issues arise. The challenge will be for a medium-sized mainstay like Capital One to innovate on a pace with both fintech start-ups and mega-bank competitors that acquire or partner with these new players.
Creating a Best of Breed Ecosystem
Having an all-in-one suite is great in theory, but there are certain small business tools that will always be known as being the best at what they do. Accounting and financial management is an area that Quickbooks has traditionally dominated; it still occupies 80 percent of total market share for SMB accounting. But rather than building additional features onto the Quickbooks product, companies like Intuit are building out tightly integrated ecosystems consisting of first-class applications across the breadth of business management needs.
Intuit is an interesting case also because it owns another hugely popular brand, TurboTax. It has been in Intuit’s best interest to keep these successful brands, and add others like the hugely successful personal finance app Mint.com. The intent is to not only make the business easier to manage, but to handle the business owner’s personal finances as well.
SalesForce.com’s strategy is another great illustration of building out a comprehensive ecosystem under one umbrella. Any business that uses SalesForce.com can purchase proprietary financial management apps on the firm’s cloud platform, and perform multiple functions without leaving the SalesForce interface. Businesses can utilize the Financial Force app for payroll, Accounting Seed for accounting and so forth. In these cases, SalesForce often provides resources and guidance to these start-ups to make the software on their platform as competitive as possible.
Innovating the right way
Fintech startups have the stated goal of disrupting a financial services sector that has become known as overly traditional and lacking in personalization. But as startup technologies for small business management begin to scale, like the example of Mint.com, these companies often face a crossroads in terms of how and where to expand. Some choose to be acquired, as in the case of Mint.com, while others seek partnerships with big banks to gain additional marketing exposure while retaining control of their product.
David Gibbons, managing director at Alvarez & Marshal financial consulting, recently told CNBC that “Banks are partnering to keep in the game and keep relevant. I think they’ve caught up fairly well.” On Deck Capital is one of the foremost innovators in small business lending, using technology to gauge creditworthiness based on the performance of an entrepreneur’s business instead of personal credit score. But rather than be acquired, On Deck has partnered with JP Morgan Chase to build a new lending product for small businesses, under the Chase brand. This is a great example of some “quick win” technology partnerships taking place in the small business space that combine the benefits of innovation with the security and scalability of big banking to better serve SMBs.
And these are just a few of the innovations, technologies and trends that are constantly emerging in the small business sector. The bottom line is big banks now realize that adopting new technologies is critical to retaining SMB clients. With so many startups and established players evolving to offer more services with less hassle, it’s a pretty good time to be a tech-savvy small business owner.
You’re a community bank and your customers love you, right? So why do bankers worry that customers–and deposits–will flee to high-yield online accounts when rates rise? Or maybe it’s the possibility of disruptive technologies that has so many bankers nervous. In this session from Bank Director’s 2016 Growing the Bank Conference, Joe Bartolotta, executive vice president and director of strategic partnerships at Eastern Bank, headquartered in Boston, explains the activities that undermine customer loyalty and expose banks to startups and other institutions that could threaten their bottom line.
When looking at the new competition arising from fintech companies, many bankers understandably feel that they are at an unfair disadvantage. Banks must deal with a constricting regulatory environment, but regulators don’t always apply the same standards to fintech companies. So bankers have lobbied regulators to take a more aggressive stance towards their new competitors. [Editor’s note: The Consumer Financial Protection Bureau recently fined payment startup Dwolla $100,000 for “deceiving” customers about its security practices.]
Bankers are right to push regulators on this issue. Regulators must take a closer look at the growing fintech sector, create new standards and coordinate their efforts across multiple enforcement agencies.
The purpose of these oversight efforts should not be leveling the playing field between banks and new entrants. Instead, the purpose should be protecting customer data and keeping customers informed about how their information is used. Regulation that properly incentivizes innovation and benefits consumers needs to focus on security, privacy and transparency.
The Clearing House, which processes payments for banks, correctly pointed this out last year in a white paper that detailed some of the security lapses by alternative payments providers. For example, reports surfaced last spring that Venmo allows changes to important account information without notifying the user. This is a basic security blunder, and banks can be left on the hook for fraudulent transactions when new providers make such mistakes.
Setting Standards Based on Size, Access to Customer Information To help fix this situation, regulators need to implement security standards for fintech companies based on their size and the type of customer information they touch. That means some fintech companies should be held to the same standards as banks—particularly those that offer account products—but others should not, depending on the sensitivity of the customer data they handle.
It also means that early stage startups shouldn’t be held to the same standards as larger, more mature fintech companies. An early stage startup with a minimum staff is not likely to have a security professional or the funds to hire one. So holding small startups to the same security standards as a large mobile wallet provider that processes billions of transactions per year will only strangle innovation.
Banks can play a key part in helping these early stage startups while also improving their own offerings. Many of these startups hope to partner with or be acquired by banks. As millennials grow up, those banks will increasingly compete with their peers based on their digital offerings. The ability to effectively partner with small, agile startups while ensuring security and compliance will be a competitive advantage for these institutions.
A bank that wants to partner with a promising startup can share some of its knowledge, staff and resources in security and compliance with the startup. Banks are usually cautious in launching new products in conjunction with startups anyway, typically starting with a small trial with a limited number of users before a full launch. That approach helps banks ensure security and compliance with the product and partner before a full launch with customers.
Effective Security Standards While giving early-stage startups leeway on security makes sense, fintech companies with a threshold of customers using their products should face appropriate scrutiny and regular security audits because of their increased value and attack surface for hackers.
That means regulators will need to be more specific about their security guidance than they’ve been in the past. Regulators often shy away from mandating specific security measures, instead favoring general guidelines and benchmarking against industry peers. As the cyber threat grows bigger, regulators will need to require measures like tokenization and encryption for fintech companies handling sensitive customer information. Those fintech companies that offer account products or a direct connection to users’ existing bank accounts should be required to monitor and analyze user activity to prevent unauthorized logins and transactions.
These measures are likely to become industry standards in time anyway, but regulators shouldn’t hesitate to take a hand in speeding up that process. Regulators might prefer to wait and let the fintech market determine industry standards. Security is already a competitive advantage for fintech companies. Apple set the bar when it introduced Apple Pay and emphasized the security built into it. The fintech companies that don’t meet industry expectations for security won’t succeed in the long run. But regulators shouldn’t wait for fintech winners and losers to shake out to take action that could help protect customers’ information now.
Today, numerous financial technology (fintech) companies are developing new strategies, practices and products that will dramatically influence the future of banking. Within this period of transformation, where considerable market share is up for grabs, ambitious banks can leapfrog both traditional and new rivals. Personally, I find the narrative that relates to banks and fintech companies has changed from the confrontational talk that existed just a year or two ago. As we found at this year’s FinTech Day in New York City on Tuesday, far more fintech players are expressing their enthusiasm to partner and collaborate with banking institutions who count their strengths and advantages as strong adherence to regulations, brand visibility, size, scale, trust and security.
With more than 125 attendees at Nasdaq’s MarketSite on Times Square, we explored the fundamental role financial technology firms will play in changing the dynamics of banking. While we heard about interesting upstarts, here are three questions that underpinned the event that I feel a bank’s CEO needs to sit down with his/her team and discuss right now:
1. Are We Exceeding Our Customer’s Digital Experience Expectations? Chances are, you’re not. But you can re-set the bar to make clear to your team that while customer expectations have shifted in pronounced ways, this is an area that a bank of any size can compete, especially with the help and support of a fintech company. If you are looking for inspiration, take a look at these examples of successful partnerships that we highlighted at FinTech Day:
City National Bank in Los Angeles and MineralTree in Cambridge, Massachusetts, developed an online business-to-business, invoice-to-pay solution that enabled the bank to differentiate itself from its competitors and attract new corporate customers. (In June 2015, City National was acquired by Royal Bank of Canada.)
USAA in San Antonio, Texas, and Daon in Reston, Virginia, collaborated to roll out a facial, voice and fingerprint recognition platform for mobile biometric authentication that enhances security while enhancing customer satisfaction.
Metro Bank teamed up with Zopa, both in the United Kingdom, on a deal which allows Metro Bank to lend money through the peer-to-peer platform the fintech company developed.
Any good experience starts with great data. Many presenters remarked that fintech companies’ appetite to leverage analytics (which in turn, allows a business to tailor its customer experience) will continue to expand. However, humans, not machines, still play critical roles in relationship management. Having someone on your team that is well versed in using data analytics to uncover what consumer needs are will become a prized part of any team.
2. How Do We Know If We’re Staying Relevant? How can new players show us whether the end is near? That is, what part of our business could be considered a profit center today but is seriously threatened in the future? As you contemplate where growth isn’t, here are three companies that came up in discussions at FinTech Day that could potentially help grow one’s business:
Nymbus, a Miami, Florida-based company which provides a cloud-based core processing system, web site design, marketing and other services to help community banks compete with bigger players.
Ripple, a venture-backed startup, whose distributed financial technology allows for banks around the world to directly transact with each other without the need for a central counterparty or correspondent.
nCino, based in Wilmington, North Carolina, which developed a cloud-based, end-to-end small business loan origination system that enables banks to compete with alternative lenders with quick processing and approval of loans.
3. Do We Have a “Department of No” Mindset? Kudos to Michael Tang, a partner at Deloitte Consulting LLP, for surfacing this idea. As he shared at FinTech Day, banks need structure, and when one introduces change or innovation, it creates departments of “no.”
For instance, what would have happened if Amazon’s print book business was able to jettison the idea of selling electronic books? If you refuse to change with your customers, they will find someone else who does. Operationally, banks struggle to make change, but several speakers opined that forward-thinking banks need to hire to a new level to think differently and change.
Throughout FinTech Day, it struck me as important to distinguish between improvements to the status quo and where financial institutions actually try to reimagine their core business. Starting at the customer layer, there appears massive opportunities for collaboration and partnerships between established and emerging companies. The banks that joined us are investing more heavily in innovation; meanwhile, fintechs need to navigate complex regulations, which isn’t easy for anyone. The end result is an equation for fruitful conversations and mutually beneficial relationships.
It’s no secret that what has been happening in the fintech space is attracting more attention from the world of banking. It’s hard to ignore the fact that venture capital invested $10 billion in fintech startups in 2014, compared to just $3 billion in 2013, according to an Accenture analysis of CB Insights data.
But watching M&A in the fintech space shows that these startups are much more likely to pair with others or get acquired by incumbents than they are to go public with an initial public offering, as noted by bank analyst Tai DiMaio in a KBW podcast recently.
“Together, through partnerships, acquisitions or direct investments, you can really have a situation where both parties benefit [the fintech company and the established player],’’ he says.
That may lend credence to my initial suspicions that there are more opportunities in fintech for banks than threats to established players and that these startups really need to pair up to be successful.
Take BlackRock’s announcement in August that it will acquire FutureAdvisor, a leading digital wealth management platform with technology-enabled investment advice capabilities (a so-called “robo advisor.”) With some $4.7 trillion in assets under management, BlackRock offers investment management, risk management and advisory services to institutional and retail clients worldwide—so this deal certainly caught my attention.
According to FT Partners, the investment bank that served as exclusive advisor to BlackRock, the combination of FutureAdvisor’s tech-enabled advice capabilities with Blackrock’s investment and risk management solutions “empowers partners to meet the growing demand among consumers to engage with technology to gain insights on their investment portfolios.” This should be seen as a competitive move to traditional institutions, as demand for such information “is particularly strong among the mass-affluent, who account for ~30 percent of investable assets in the U.S.”
Likewise, I am constantly impressed with Capital One Financial Corp., an institution that has very publicly shared its goal of being more of a technology company than a bank. To leapfrog the competition, Capital One is quite upfront in their desire to to deliver new tech-based features faster then any other bank. As our industry changes, the chief financial officer, Rob Alexander, opines that the winners will be the ones that become technology-focused businesses—and not remain old school banking companies. This attitude explains why Capital One was the top performing bank in Bank Director’s Bank Performance Scorecard this year.
Case-in-point, Capital One acquired money management app Level Money earlier this year to help consumers keep track of their spendable cash and savings. Prior to that, it acquired San Francisco-based design firm Adaptive Path “to further improve its user experience with digital.” Over the past three years, the company has also added e-commerce platform AmeriCommerce, digital marketing agency PushPoint, spending tracker Bundle and mobile startup BankOns. Heck, just last summer, one of Google’s “Wildest Designers” left the tech giant to join the bank.
When they aren’t being bought by banks, some tech companies are combining forces instead. Envestnet, a Chicago-based provider of online investment tools, acquired a provider of personal finance tools to banks, Yodlee, in a cash-and-stock transaction that valued Yodlee at about $590 million. By combining wealth management products with personal financial management tools, you see how non-banks are taking steps to stay competitive and gain scale.
Against this backdrop, Prosper Marketplace’s tie up with BillGuard really struck me as compelling. As a leading online marketplace for consumer credit that connects borrowers with investors, Prosper’s acquisition of BillGuard marked the first time an alternative lender is merging with a personal financial management service provider. While the combination of strong lending and financial management services by a non-bank institution is rare, I suspect we will see more deals like this one struck between non-traditional financial players.
There is a pattern I’m seeing when it comes to M&A in the financial space. Banks may get bought for potential earnings and cost savings, in addition to their contributions to the scale of a business. Fintech companies also are bought for scale, but they are mostly bringing in new and innovative ways to meet customers’ needs, as well as top-notch technology platforms. They often offer a more simple and intuitive approach to customer problems. And that is why it’s important to keep an eye on M&A in the fintech space. There may be more opportunity there than threat.