Banks and Fintech Finally Pull Together

Young fintech firms started out hoping to eat the banks’ lunch. Now, they’re taking a seat at the table and breaking bread together.

The “digital revolution” has been famously disruptive, with online e-tailers, for example, killing off long-standing brick-and-mortar operations.

Financial technology—fintech—seems to promise similar upheavals in the finance world, and savvy banks, as well as their corporate clients, are actively engaged in seeking new solutions. At EuroFinance 2016 in Vienna, Austria—one of the biggest events on the corporate treasury calendar—in between sessions on payment factories, multibank environments and managing volatile cash were tech labs filling treasurers’ heads with all they could digest concerning “blockchain for dummies” and payments and supply chain disruption by fintechs.

 “If you’re not a software company, you’re going to be disrupted by a software company,” says Microsoft developer turned futurist and author Ramez Naam. Companies need to understand that change is coming, says Marcus Treacher, global head of strategic accounts at payments technology provider Ripple. He told attendees at EuroFinance’s Treasury Lab: “Technology is now a key source of competitive advantage, and you cannot afford to be at the back of the queue.”

But lately, that warning doesn’t sound as much like a death knell for established institutions as it once did. After all, most of the fintech pin-ups—Betterment, TransferWise, Funding Circle—have not been around as long as the banks, who have survived wars, depressions and the first incarnation of the Internet.

The fintech battlefield is being reshaped as a playing field, defined as much by collaboration as by competition. “Compared to a year or so ago when a lot of fintech investment was in companies that were going to eat the bank’s lunch,” observes Warren Mead, global partner and co-leader of KPMG’s fintech practice, “that type of investment has fallen away and been replaced by investment in companies that want to collaborate with incumbent financial services firms to either build blockchain-type projects, experiment with artificial intelligence (AI) or improve the front-end customer experience.”  

As was the case with the dot-com Gold Rush, a lot of fintechs are propped up by venture capital (VC) money. According to “The Pulse of Fintech”, a quarterly report by KPMG Enterprise’s Global Network for Innovative Startup and research firm CB Insights, VC-backed fintech companies raised a total of $13.8 billion in 2015. The year 2015’s VC-backed total topped 2014’s by 106%, with deal activity growing 11% in 2015, compared with 2014’s, and 119% compared with 2011. “Without venture-capital funding, not a lot of the fintechs have the business models to be profitable,” says Bill Sullivan, head of global financial services market intelligence at Capgemini.

Since Q4 2015, VC-backed fintech funding has cooled significantly, falling by 64% on the previous quarter. Q3 2016’s “Pulse of Fintech” report saw global fintech financing “megarounds” (over $100 million) falling to a new low and VC-backed fintech funding falling 17% to $2.4 billion, its lowest level since Q2 2014. “The euphoria for megadeals that we saw into the latter half of 2015 has waned,” states Anand Sanwal, CEO of CB Insights. “Total investments to key areas like marketplace lending and blockchain technology have both seen declines heading into the tail-end of 2016.”

Fintechs recognize that if they are to scale successfully and gain critical mass, they cannot disregard the “dinosaurs” altogether. “In financial services, customer acquisition is incredibly difficult, even if you are a fintech with a low-cost product,” observes Mead. Even billion-dollar fintech companies like Funding Circle, a peer-to-peer lending marketplace for small and midsize businesses, and money transfer platform TransferWise are still small in comparison with the banks, he notes.

“Banks have a customer base that fintechs can only dream of,” Ed Budd, chief digital officer of global transaction banking for Deutsche Bank, remarked at EuroFinance’s Treasury Lab. In corporate banking, customer acquisition is likely to prove even trickier for fintechs. Multinational corporations with a $100 million payroll are unlikely to want to risk giving that business to a fintech, says Mead. The tech giants—Amazon and Google—by contrast, could potentially make inroads into corporate banking. “They are likely to appeal more to corporates as they already have customers,” says Mead, adding that Amazon already provides inventory or asset-based financing to suppliers on its marketplace.

WHO NEEDS WHOM?

The fintechs may need the banks in order to scale and grow their business, but equally, the banks need the fintechs to drive innovation. Fintechs are seen as “young, cool and wild,” all the things a bank is not. They even attract former bankers frustrated by the lack of progress within their own organizations. Anne Boden, former COO of Allied Irish Banks and former head of EMEA, global transaction banking, for RBS and ABN Amro, is now the CEO of mobile UK challenger bank Starling. It wants “to build the best bank account in the world,” according to its website. Why did she have to leave the world of banking to offer something more innovative? On Starling’s website she explains that while working at Allied Irish Banks, she was “frustrated by the restrictions still imposed by outdated technology.”

“Not a lot of banks and insurance companies have the courage to start something new,” says Christina Kehl, managing director, board member and co-founder of Swiss Finance Startups and co-founder of Knip, a mobile-based insurance broker. “In the insurance industry, it is difficult to integrate new technology onto old legacy platforms,” she says. “A lot of the customer-facing stuff sparkles on the front end, but on the back end it is still very manual.”

Most banks are unlikely to be able to afford to rip out and replace their 20- or 30-year-old legacy systems, which might not be smart but are still efficient. However, fintechs could provide smarter and more elegant payment, trade finance and cash management solutions that sit on top of the banks’ legacy systems.

The European Commission’s Payment Services Directive II requires banks to open their back-end systems to application programming interfaces, or APIs, developed by third parties such as fintechs. Some predict that the implications of PSD II for incumbent firms could be even bigger than fintech. “With open-banking APIs, banks will become more of a platform that fintechs can plug into,” says Sullivan of Capgemini. But the banks may not be comfortable handing over sensitive customer data to API providers. And if something goes wrong—a transaction is incorrectly processed or fails to settle who is liable, the bank or API developer?

Corporates may complain about the speed, user-friendliness or efficiency of traditional banking applications, but the quid pro quo between them and the banks is that in return for a line of credit, companies award transaction banks their treasury and cash management business. In the credit stakes, at least, fintechs appear unlikely to steal a march on the banks. “We always go for a relationship bank,” stated Mike Cassidy, treasury manager for hotels and resorts group Wyndham Worldwide. “Fintech providers aren’t going to provide us with finance. They won’t supplant our banks.”

However, Roland Plan, head of Western European corporate coverage for RBS, says fintech will have more of an impact than corporates think. “I don’t think corporates will say, ‘I won’t work with fintechs because they won’t give me a credit line,’” says Plan. There is a new generation of younger more tech-savvy corporate treasurers emerging—Johan Bergqvist, head of corporate development and treasury at digital music streaming site Spotify, for instance. With no legacy systems to speak of, Bergqvist uses Cloud-based tools for real-time monitoring of bank accounts and performs a number of treasury functions on his mobile. He is, perhaps, the exception—at least for now—when it comes to corporates embracing the value of fintech.

WHO IS GOING TO EAT WHOSE LUNCH?

Fintechs and banks are currently in an exploratory phase, trying to develop proofs of concept and determine how they can work and move forward together. “The next hurdle for fintechs is getting adoption,” says Uwe Erdtmann, director, global product marketing, finance, at enterprise software vendor SAP. “Everything will start to be measured as to whether there are tangible outcomes.”

FINTECH UNICORNS
Privately held financial technology firms valued at $1 billion or more
COMPANY Country Valuation (US$ billions)	FOCUS
Lu.com	Online lending platform for small and midsize enterprises and individuals, Lu.com
China
$18.5
Stripe	Internet commerce company that enables businesses to accept Internet payments
United States
$9.2
Zhong An Insurance	Internet insurance company
China
$8
One97 Communications	Mobile Internet and payment solutions for e-commerce companies
India
$4.8
Social Finance	A lending pool and social community for students and alumni
United States
$4
Credit Karma	Provides free access to credit scores, monitoring of credit and financial accounts
United States
$3.5
Mozido	White-labeled mobile financial transaction services
United States
$2.4
Adyen	Internet payments for merchants
Netherlands
$2.3
Klarna	Payment solutions for e-stores
Sweden
$2.3
Zenefits	Cloud-based HR platform that connects with payroll
United States
$2
GreenSky	Consumer finance marketplace
United States
$2
Avant	Uses machine learning and advanced algorithms to extend personal loans
United States
$2
Prosper Marketplace	P2P lending
United States
$1.9
TransferWise	P2P money transfer service
United Kingdom
$1.1
Funding Circle	P2P lending for SMEs
United Kingdom
$1
China Rapid Finance	Online consumer lending marketplace
China
$1
Kabbage	Uses machine learning to provide automated funding to small businesses
United States
$1
Gusto	Web-enabled payroll for businesses
United States
$1
Rong360	Small loan services to small businesses and microenterprises
China
$1
51Xinyongka	Online financial services and mobile app for credit cards, loans and wealth management
China
$1

Source: CB Insights

 Sullivan says a lot of fintechs are looking to be acquired, but given their valuations, the cost may be tough for incumbent firms. “Banks will gobble up some of them,” says Mead of KPMG, “but when I talk to banks, they recognize that gobbling up fintechs could destroy what they want to buy in terms of people, culture and agility.” Mead believes areas such as AI and blockchain will remain more collaborative, while digital-only banks and P2P platforms could potentially be acquired by the banks. “There are 150 P2P platforms in the UK,” he explains. “My view is that there is only room for five to 10 scale players, so I wouldn’t expect half of these to really make it in the next couple of years.”

“In three to five years, we won’t be talking about fintech,” says Sullivan. “It will just be part of banking. Some will be able to find a unique value proposition; others are going to find their niches in terms of partnering with incumbents; but there will be many that end up failing or will struggle to have a viable business.” 

But even if fintech darlings like Betterment and TransferWise are not around in 10 or 15 years, their legacy in terms of raising customers’ expectations is likely to endure. “Fintech is about digitization,” says Kehl of Swiss Finance Startups. “Every single industry is being impacted by digitization. It is a form of democratization. Customers can now dictate how they want to do business.”

If a company were to come along tomorrow promising you cross-border payments in seconds, cheaper and more efficient trade finance instruments powered by proven blockchain technologies, or more transparent and affordable FX pricing, could you as a corporate afford to disregard them, knowing that these features were not provided by your trusted relationship bank?