By Barbara Boccia, CRCMIt’s difficult to open any media device these days without seeing or hearing something brilliant about the fintech revolution, often followed by doom and gloom predictions about retail banks becoming obsolete. Bill Gates once dismissed retail banks as “dinosaurs.” However, many of those same banks are still here more than 25 years after that remark was made! But while many banks may have been too indecisive to venture into fintech in the past, perhaps now is the time to make an affirmative decision about the future. After all, not making a choice is actually a choice itself.
Millennials are here
A funny thing happened in that time since Gates’ remark—a whole new generation arrived on the scene (who perhaps might ask, who is Bill Gates?) The millennial generation includes those born between the 1980s and early 2000s, and they have already surpassed the baby boom generation as the largest age cohort in the U.S. By 2020, millennials will account for about one-third of the adult population. Millennials are right now coming into their peak home-buying years, making this a good time for more traditional brick-and-mortar financial institutions to capitalize on emerging fintech opportunities to be better prepared to meet the needs of this group.
While retail banks traditionally have focused on relationships, millennials primarily focus on transactions, according to fintech expert Brett King. They consider the ease, speed and simplicity of transactions to be a very important driver in their choices. Therefore, it’s time for every financial institution to answer the question: “Are you aligned with how your customer base is changing?”
Additionally, in order to stay competitive over the next 25 years, it is essential that every financial institution consider what choices it needs to make in order to provide customers with the ability to perform transactions when and where they want. Fintech solutions can enable a banking experience that is more intuitive, seamless and digitally engaging. The Federal Reserve recently issued a report showing that about a quarter of community banks plan to start offering online loan applications in the near future. This raises another question: “Are you keeping up with your competitors?”
Strategies for implementing fintech
The type of financial technology solutions that are best suited for any particular institution vary tremendously. Some institutions may be looking to digitize or modernize processes from within, others may be looking to add-on a single solution such as mobile payments. Fintech solutions could also involve data aggregation or lead generation activities as well as arrangements to buy assets, such as small business loans, from leading online lenders.
Once the fintech solution is identified, each institution needs to identify the best strategy for itself to either compete or collaborate with emerging players—and capitalize on trends and capabilities to position itself with the most competitive advantage going forward. There are generally two broad strategies that financial institutions can pursue: invest in or build emerging technologies on your own, or buy, partner or network with fintech companies.
Invest/build. Consider investing directly in early-stage fintech if your goal is to optimize internal centers of excellence to access innovation. Consider building in-house if there are sufficient internal resources, expertise and scale to innovate and customize unique capabilities. These strategies may be more appropriate for regional or larger banks than smaller community banks.
Buy/partner/network. If the technology you want already exists, consider opportunities to buy, partner or network to get it. It is essential to at least stay current with your competitors, and this approach is best if you have insufficient resources, expertise or scale to optimize this technology in-house.
A recent example of this approach is the Zelle network. Launched in 2017, Zelle is the result of the collaboration of many large and regional banks, payment processors and card networks to create an easy-to-use platform for peer-to-peer payments. This network has directly taken on PayPal’s Venmo, Square Cash and Google Pay Send (formerly Google Wallet), among others. In 2018, Zelle members moved $122 billion, more than double the $62 billion by PayPal’s Venmo in the same period.
This instant success of Zelle illustrates that, compared to fintech firms, traditional banks currently enjoy some competitive advantages. These include a reliable, low cost of capital; a built-in regulatory compliance structure; a dedicated customer base; and an established brand. New startup online institutions may face inconsistent and higher priced sources of capital, limited brand recognition and expensive customer acquisition costs, as well as a steep learning curve to address regulatory compliance concerns. So now may be an opportune time for banks to act, before their advantages dissipate, and while fintech companies are still looking to gain a foothold in this space.
Considerations for buying, partnering or joining a network
Many considerations for buying, partnering or networking to develop fintech capabilities are the same as in any merger, acquisition, or third-party vendor decision—and involve careful due diligence for all compliance and reputation risks. Notwithstanding the number of name brands involved in Zelle, there have recently been reports of vulnerabilities, fraud and outages that suggest the network may need to increase security measures to protect consumers and educate the public about how real-time payments work.
In addition to cybersecurity concerns, consider whether the fintech company has a management team that includes a regulatory compliance officer and compliance management system. The operational infrastructure should have a familiar, defined system of processes and controls as part of a regulatory risk framework for the evolving and increasingly complex compliance and regulatory reporting requirements.
Also consider contractual protections if regulators require remediation and ensure that their intellectual property considerations do not cloud transparency for your compliance monitoring or root-cause analysis. Finally, be sure that you consider the system infrastructure carefully—for example, screen scraping has been associated with increased loads on servers at peak times—and you likely want to be sure to integrate data security escalation procedures.
It is critical that you consider changing demographics, the competitive landscape, and evolving technologies in making a deliberate choice about where to play and how to win. Otherwise, those fossil predictions might yet come true.
Barbara Boccia, CRCM, is a senior director on the Wolters Kluwer Advisory Services team, helping financial institutions through the maze of regulatory compliance issues they encounter day-to-day, pre- and post-exams, or due to organizational and regulatory change.