How Banks Need To Be Using Fintech Post-Pandemic

By Leonardo Mattiazzi

Thanks to COVID-19, companies are facing tough decisions about how to operate and what they want to become. For banks, this means looking closely at the relationship they have with fintech and considering what kinds of integrations or partnerships make sense. To continue offering the most value to both investors and customers, banks will likely need to embrace open banking and marketplace operations far more than they currently have.

The evolution of the bank-fintech relationship

Over the past 10 years, the bank-fintech relationship has been based on fear, curiosity, or pragmatism, at various points in time. The main concern banks had at first was that fintech would offer the same services banks do, which would lead customers to turn to fintech businesses instead of banks. A good illustration of that is the famous chart that visualized the "unbundling of a bank." The illustration, which has been rehashed by many organizations, showed a big bank homepage and how each one of the services on the page could be obtained from a different fintech -- arguably with better speed, experience, and/or lower cost.

To some degree, this fear has proven to be warranted. Fintech businesses can compete with banks in many service areas. Globally, they have also consistently attracted $10B+ per quarter in VC-backed funding throughout the pandemic, and IPOs, such as that of Affirm AFRM and Robinhood, have been highly anticipated in 2021. 

In response to the initial fears banks had about fintech, banks that had sufficient capital started to partner with accelerators (e.g., Techstars, Plug, and Play), create their own incubators, do demo days, and make investments in early fintech startups. The hope was that they would learn from these nimble, young companies and start transforming themselves. For the most part, however, these initiatives have been completely apart from the bank's mainstream business and have yielded little results other than satisfying top executives' curiosity. They wanted to understand how fintech companies worked so they could operate more like them.

But observing or financially investing in digital players alone doesn’t transform anything. At the end of the day, a more traditional, mid-to large-size financial institution still operates much the same way it always has. As Julia Kagan notes for Investopedia, “industry watchers warn that keeping apace of fintech-inspired innovations requires more than just ramped up tech spend. Rather, competing with lighter-on-their-feet startups requires a significant change in thinking, processes, decision-making, and even overall corporate structure.”

So, some banks started to pragmatically go beyond simple observation and establish better levels of integration, which allowed them to leverage their fintech acquisitions or resources beyond the financial investments. Those who first invested in their own transformation -- e.g., by challenging internal processes, adopting agile at a large scale and beyond the IT realm, and embracing human-centric design and modern architecture practices -- are definitely better positioned to realize the benefits of such integrations. Otherwise, it's like trying to blend water and oil.

But fintech companies are conquering banks, as well. In February 2021, for example, LendingClub, a mature fintech, completed its acquisition of Radius Bank. These kinds of interactions set a precedent and highlight an interesting question about whether the trend of fintech becoming more like banks -- something that has been called "rebundling" -- will grow or become more normalized. Some forward-thinking professionals, such as Chris Skinner, are actively conjecturing about what the future of the financial industry will look like in 2030 based on what current companies are doing. Others are more directly asserting that “banks should be nervous” as fintech get closer to bank charters. And here we are, full circle again at fear.

The challenge of proper valuation

Banks that want to acquire fintechs face a challenge in swallowing market valuations, with the uncertainties from the COVID-19 pandemic only aggravating the problem. Banks are used to M&A discussions involving other banks, but fintechs -- both those which are just starting and those that already are at the growth stage -- are valued with very different parameters. It's their ability to grow, not revenue or profitability, that is the most important variable. Putting a price on that is, by definition, far from being an exact science. Valuations may sound unrealistic, and coming through a deal requires nothing short of a leap of faith. This faith literally becomes "goodwill" on the balance sheet, and it goes against both regulatory capital requirements and the conservative nature of banks.

And if banks do not accept the higher value that growth-stage fintechs have compared to traditional M&A operations, then other companies will outbid them. Big technology companies or larger, well-established fintechs usually have plenty of money to make good offers. Those funds come either from their own operations (as is the case with BigTech) or successive rounds of funding (as is the case with fintech). The reach of these groups into the fintech space is also already evident. We all use digital wallets such as Apple Pay, Google Pay, Facebook Pay, Amazon Pay, Alipay, or WeChat Pay, for example. These wallets have surpassed traditional credit cards globally as the main payment method, according to the FIS Global Payments Report. We're getting used to making payments within everyday activities, such as sending a message through social media and messaging apps. On top of that, Google announced its intention to offer checking accounts some time ago. And although so far all of these rely on some traditional credit card, debit card, or bank account on the back-end, innovation will continue to expand beyond payments, either organically or through M&A. Their pockets have only deepened throughout the pandemic, as the tech industry has fared well through the crisis. 

So, what's the alternative?

The rise of open banking

One trending financial practice that is seeing widespread adoption around the world is open banking (or, in its broader perspective, open finance). This practice allows banks and other financial institutions to share financial data (as authorized by customers) with third parties through standardized application programming interfaces (APIs), and ultimately, realize transactions safely. It can dramatically influence the services and products available and how users access them. Embedding financial services in apps like Facebook and WeChat (or any other) is made a lot easier with a set of standard APIs. In other words: embedded finance is possible without open banking, but it's a lot easier and simpler with it.

Some geographical areas, such as Europe, India, Australia, and Brazil, have already embraced open banking through regulatory demands. In the United States, open banking isn’t formally mandated, and fear of increased competition from fintechs has again delayed the market’s adoption of the practice for many years. Nevertheless, be it from regulatory, customer experience, or competitor pressures, getting out of the cocoon and connecting with third parties is becoming more imperative day by day. In fact, it’s becoming so important that the U.S. financial industry is organizing its own "open banking" standards, and progress is evident through the growth of supporting members of the Financial Data Exchange (FDX).

A key open banking advantage -- platformification

Adopting open banking as a strategy -- or, to avoid the confusion with regulatory-mandated open banking, simply embracing an API-driven strategy -- would allow banks to work more collaboratively and team up with fintechs to provide more services to their customers, rather than remaining as direct competitors. This is where I see more pragmatism getting into the scene. By leveraging standardized APIs to connect with partners, banks can more quickly establish 1:1 relationships with companies that can provide specialized services to their customers, such as a niche product for a specific segment of their clientele. Or they can go the other way around and offer banking services to their partner’s customers without having to bear the burden of customer acquisition/customer experience development through Banking as a Service (BaaS). In BaaS, a company which might not be able to obtain a required banking license on their own partners with a bank. The bank, which does have the proper license, can then provide white-labeled services to the partner’s customers through its APIs.   

Embraced more radically, open banking also allows for platformification. Traditional businesses can be seen as "pipeline" businesses, with a clear and linear path from demand to supply of products and services. Platform businesses, by contrast, connect producers and consumers and create a value exchange, benefiting all participants and allowing them to take advantage of the larger network. A good example is Amazon, which started out as a traditional pipeline business with books but became a platform when it created its marketplace. Financial services marketplaces (e.g., Starling Bank marketplace), where clients shop for multiple services from different providers, can function much the same way. These types of marketplaces don’t have to be simply a brokerage of services. It all depends on how the platform is designed and the value it provides. 

To their credit, banks are currently asking fair questions of themselves, such as who owns the data, who owns the customer experience, and who gets the brand loyalty. But these questions are still oriented to pipeline thinking and strategy. Because platforms have already demonstrated that they can exert more power in the market than pipeline businesses, due to network effects, it’s to banks’ advantage to shift their thinking into a platformification mindset. A good example of that is Brazilian bank Inter. They created a marketplace not of financial services, but of retail goods. This marketplace has around 100 participating retailers. It is amassing a large number of clients (upwards of 10 million), as well as great revenue while positioning the bank for global expansion.  

Adopting open banking and platformification is the best bet for banks to take advantage of fintech

As banks look forward past the pandemic and think about fintech, they have to figure out whether they will ignore or adopt the open finance and platformification trends. They must figure out what new role they can play for investors and consumers. Some might decide to participate in somebody else's platform, as providers of services. Some might want to play a central role and be the platform, creating a reason for other financial institutions and fintechs to offer services through it and having the banks' customers as the other side of that market. Others might prefer to continue creating bi-lateral partnerships with fintechs, hopefully leveraging standard APIs to make it less painful. And still, some others might decide to keep operating as stand-alone operations, with very limited room for partnerships -- at their own peril.

Banks will likely have more success if they move to an API-based, platform approach where the most important question is how to create a value exchange that makes the company indispensable. 

It’s unlikely that any bank will occupy a role similar to Amazon AMZN's in retail in the short term. But the elements for progress are already in place. Those banks that can look beyond the traditional moats they have entrenched through compliance, charters, and regulation, and that can transform themselves into platforms that everyone trusts and benefits from, will have outstanding strength for the future.

Photo Via Unsplash