Breaking the bank
Fintech and financial institutions square off in fight for relevancy
On one side of the room, a phalanx of technology-armed thirty-somethings has assembled, dead set on convincing the crowd that banks are a thing of the past. Facing off with them on the other side of the packed conference venue is a row of top bank executives, also keen on innovation but eager to shoot down the fintech fighters’ visions of grandeur.
Not often does the proverbial battle between fintech and banks play out as exquisitely as it did this month at Sibos, a payments conference put on by SWIFT that has become a frontline for the debate on the future of payments, lending and of credit itself.
The two sides gainfully negotiate ideas but at times also trade fire: “I heard a lot of talk about innovation coming from there. I didn’t hear anything innovative,” Alexander Graubner-Mueller, founder of Kreditech, shoots at the banks across the room. The Germany-based fintech outfit says its data-processing prowess allows it to enter markets and within a year become profitable on its small lending business. Who needs a bank?
Smugly taking the pummelling, the handful of chief innovation officers from the likes of Wells Fargo, Standard Chartered and BNY Mellon remind the kids that the bulk of the world’s capital still sits on the banks’ side of the room and that fintech lenders are merely scratching the surface of their business.
The surface of banking – that is, the value-added services such as payments and increasingly credit lending – might be meatier, more valuable and more amenable to innovation than some bankers would like to admit. Fintech has grabbed a 2 per cent market share in the global banking industry, according to a report from the Economist Intelligence Unit published last week.
With the application of new technologies such as distributive ledger and application programme interfaces (APIs), the value that fintech is unlocking in the traditional credit and payments universe has taken some banks by storm.
But the true argument to be hashed out is not who wins ultimate control over payments and credit but rather how badly fintech and banks need each other to distribute those products. Many startups argue that banks supply the crucial infrastructure on which their programmes will run; others say innovate with us or get out of the way.
For now, it is the banks’ share of the market to lose and some of the world’s biggest lenders are keenly aware of the risks. At a debate on the application of the internet of things at Sibos this month, Michael Gorriz, chief information officer for technology and operations at Standard Chartered said fintech was already “picking our cherries”. At the same debate, Patrick Maes, chief technology officer at ANZ, remarked coolly yet defensively that “no fintech has replaced a bank”, as if revealing the darkest fears in the hearts of bankers. Many tech firms would argue that they do not need to.
In fact, it is quite the contrary for Ripple Labs, a payment solutions fintech based in San Francisco, which has based the survival of its key protocol on cooperation with banks.
Ripple is at the forefront of the integration of technology into financial institutions. Its system can make nearly instantaneous secure transactions in any currency using a distributive ledger, the same technology that underlies the cryptocurrency bitcoin. Ripple is one of the first examples of how a distributive ledger is being used by banks.
Last year, Fidor Bank, Cross River Bank and CBW Bank all brought on the technology for cross-border payments. Leasing the Ripple technology to banks is at the heart of the company’s business strategy.
“The important thing is we don’t believe that this is going to replace banks,” said Nilesh Dusane, Ripple’s vice-president of sales and client relations.
That’s because the company, along with many other fintechs, sees banks as the irreplaceable custodians of the world’s assets and ones that people generally trust to hold those assets. Ripple simply reduces the players and the cost of making those transactions, something many banks should be keen to take up, if they can wrap their heads around the technology.
“Banks are always going to be in the middle and that’s why our strategy is to work with them,” Dusane said. “We don’t have a value proposition where a customer at a bank can use Ripple without going through the bank.”
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Distributive ledgers for payments are a major disruptor to the industry. In the past, a third party was required to clear payments for the sending and receiving parties. The technology allows the two sides to securely make transactions while cutting out the middleman.
The losers here are the clearing banks at the centre of the world’s global payments industry, one of banking’s most lucrative markets. Revenues in the global payments industry hit US$1.7 trillion last year, up 9 per cent year on year, according to a report released by Mckinsey this month. It accounted for a staggering 38 per cent of total bank industry revenues in 2014, demonstrating the sensitivity financial institutions would have to a major disruption.
The disruptors can get disrupted too, and it is often the banks that the fintech firms look to for help.
Banks are coughing up billions annually to enhance their compliance operations, all with the hope of avoiding the next big fine for money laundering or sanctions violations. By nature, fintechs invest far less in appeasing regulators, mainly because they deal in small sums involving simpler products. However, the further into the finance industry they push, the more regulatory hurdles the companies will need to leap over.
“Ultimately, hipsters and startups hit friction, and the capital cost of getting through regulatory issues becomes big,” said Lawrence Wintermeyer, the chief executive at Innovate Finance, a lobby group for fintech, sponsored by the City of London. “You’ll generally need regulatory staff. Then you’ll get the capital drag of ‘Oh my gosh, do you know how long it takes to transact in a regulatory system and to get through the approvals process?’ So that starts to slow things down for the disruptors.”
Out of 100 top bank executives polled by the Economist Intelligence Unit, 34 rated banks’ regulatory experience as “very important” in driving their competitive advantage over fintech. Thirty-three gave regulatory barriers to entry the same weight in staving off the tech firms.
Rather than fork over the regulatory cost, many fintech companies are designing products that banks can incorporate into their regulatory regimes. Ripple, for example, does not have anti-money-laundering checks. Instead, the banks that use it perform that task, just as they have in the past when using a clearing house.
Add regulatory strength to a long list of advantages that banks tout. They also have a comparably low cost of capital, vast customer bases and a near-government guarantee on their deposits, tough acts to compete with, says Christoph Rieche, the chief executive of London-based small lender iwoca.
The firm lends up to £100,000 to small companies in need of working capital and uses an array of data points to make lending decisions that take a few days.
While Rieche says banks will likely always have a place in finance, iwoca’s strategy is not reliant on the banks for its core lending products. Instead it is circumventing the banks and going directly to the customer with a recent partnership with Chinese e-commerce giant Alibaba. The company has integrated a lending option directly on to Alibaba’s website. British businesses that source from Alibaba can get a direct loan from iwoca to pay for materials or goods that they buy from a Chinese vendor. No fees, no underwriting costs, no banks in sight.
“The first place [for banks] to get disrupted might be on the user experience, on product offerings, the website experience,” Rieche said. “That’s what we’re doing right now ... the customer experience is beautiful.”
To be sure, banks are still at each end of the process. They hold capital for iwoca, for British customers, Chinese vendors and for Alibaba, which was itself awarded a banking licence in China last year.
But in iwoca’s vision, and despite all the advantages that banks have, they are a shadow of their former selves.
“They have all the capital,” Rieche said. “It should have been a bank that came up with this.”