By Jim Neckopulos
As FinTech companies look to disrupt and change how we conduct business across all facets of financial services, how should banks view these entities? While it is difficult to measure the disruptive impact these firms will have on traditional financial services companies, the EY FinTech Adoption Index, a recently completed EY study that captured respondents’ FinTech awareness and usage, suggested a few emerging trends:
- FinTechs are increasing the competition for customers and demonstrating the value of advanced analytic capabilities.
- Digital technology-enabled business models are pushing the economics of most traditional bank and financial services providers in an economic environment of squeezed margins.
- New, more agile business models are providing increased flexibility that better facilitates and aligns with both customer and employee preferences.
As a result, banks are now looking at FinTechs through three lenses: as competitors, as partners or as acquisition targets – each role has implications though they are not mutually exclusive.
Competitors
According to the study, FinTechs have demonstrated that the barriers to entry into financial services have been fundamentally lowered. FinTechs are looking at the entire value chain of these businesses to understand what customers want and need and how they can create business models not dependent on legacy thinking and technology.
As a result, FinTechs are not looking to merely improve or enhance these businesses; rather, some are looking to reinvent them altogether. In most cases, FinTech companies are currently able to operate in less-regulated environments than those of traditional financial services providers.
While there have clearly been innovative successes amongst the FinTechs, some are beginning to experience key challenges, which will affect their ability to effectively compete in the long term unless properly addressed. Some of these challenges include having an appropriately experienced and managed team and a well-developed growth strategy as well as the ability to address regulatory compliance considerations to which they are subject today or in the future.
These questions, and others, will continue to have a significant impact on the strength of these companies and their ability to be true long-term threats to banks and other legacy financial services providers.
Partners
Many banks have used the emergence of FinTechs to find “partners” that allow them to benefit from new business models. These arrangements have taken several forms to include understanding new ways of leveraging technology, changing business processes to be more efficient and responsive, creating new channels to be more relevant to certain segments and expanding geographic reach. These relationships have mutual benefits, the most significant of which is helping both traditional providers and FinTechs learn about each other’s strengths and capabilities.
The result has been to build collaborative working relationships and alliances that benefit these providers and their end customers. Banks and other legacy providers learn new ways to think about their businesses, while FinTechs gain an appreciation for some of the considerations and challenges they may face as they grow or begin to face more regulatory supervision.
Acquisitions
The first two ways that banks and other legacy providers interact with FinTechs logically lead to a third option – acquisition. Today, this typically means bank acquisition of smaller FinTechs, which, in many cases, is the exit strategy of the FinTechs and their investors. A recent Wall Street Journal article suggested that some FinTechs have reached valuation levels of 29 times (or more) of forward earnings.
As a result, these entities potentially have the currency for some significant transactions. While a few FinTechs have already acquired other FinTechs, at some point in the not too distant future, we will likely see a FinTech acquire a traditional bank or another legacy provider.
In current relationships where banks and FinTechs are partners or in alliance relationships, both entities have an opportunity to evaluate each other and the feasibility and attractiveness of working together more closely. With that said, there are a number of factors that would have to be evaluated beyond the financial impact of transactions for these acquisitions to be successful, which include the benefit to the entity’s overall strategy, competitive positioning and, perhaps most importantly, culture and fit.
Conclusion
According to EY’s Horizon Scanner database, which actively tracks FinTechs globally, more than 5,000 FinTechs currently offer products and services. Clearly, given the number of these competitors and their innovations, other traditional financial services providers must determine how best to respond. The newly developed FinTech business models provide significant flexibility. Moreover, FinTechs are creating platforms to achieve significant change – even true transformation.
In contrast, many legacy providers struggle to change as they have focused much of their recent attention toward continuing margin pressure. And FinTechs offer new and more flexible ways to interact with customers to meet their needs and objectives, and the Millennial generation has eagerly accepted these changes.
Conversely, banks and other financial services providers have strengths that FinTechs must also understand and value to be successful, including long-standing customer relationships; deep expertise and capabilities to instill trust around cyber, privacy, risk, compliance and regulatory mandates; and a well-developed understanding of the regulatory environment.
Therefore, while the potential disruption of the financial services industry is certainly a possibility as FinTechs compete, coexist and/or are acquired, it is very likely the changes they bring will strengthen and benefit the banking and financial services industry overall. Perhaps more importantly, the best of these innovations will result in better ways to serve and meet the financial needs of all customers.
Jim Neckopulos, is an Executive Director in Ernst & Young’s (EY) Financial Services Strategy Practice and is based in San Francisco.
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