Ben Walker, Partner & CTO, Airwalk Reply
Traditionally, the only genuine threats to the incumbent banking giants were macroeconomic instability and direct competition from other industry leaders. However, over the past decade, their market dominance has been challenged by the rise of digitally native fintechs. Their innate agility, niche offerings, technical superiority and customer-centricity have allowed them to bypass the astonishingly high barriers to entry that have previously deterred new entrants.
As a result, the fintech venture ecosystem grew fast in the past decade, putting a new pressure on the incumbent banks. Yet, perhaps surprisingly, that growth has slowed in the past few years. It may now be that the widespread financial volatility caused by the pandemic, Brexit and other political events has allowed the incumbents to wrestle back market power from the tenacious challengers that have been nipping at their heels.
So, has uncertainty encouraged people to revert to their trusted banking practices? Or should banks take this opportunity to finally invest in those long-needed digital transformation programmes or look to partner with and build alliances with their fintech competitors?
Covid – a catalyst for change
Banks are highly aware of the technical debt they have accrued with their legacy software and systems, but, prior to Covid-19, many felt that the costs didn’t warrant the investment that a digital transformation would require. Despite the triple digit growth of fintechs, the number of customers actively engaged with them was still a small subset, so instead of embracing digital transformation, incumbents opted for patches and incremental improvements to their systems.
Then along came the pandemic – and more specifically lockdowns – which dictated a different way of working for most; consequently, small technical developments are no longer sufficient. A full technological overhaul is now inevitable.
The next generation customer base has different needs. They are more geographically mobile and driven by ease of access and digital interaction rather than human interaction. They don’t operate from 9-to-5. They want to consume services when it suits them. Banks have reacted to this by shutting 48% (4,735) of all of Britain’s bank branches since 2015. Digital start-ups tapped into the mobile culture early. They generally offer more convenience and better data-driven experiences. Customers can open a bank account and use their digital wallet within minutes, not days. Rapid innovation via microservice architecture and APIs gives digital banks great flexibility. By contrast, legacy banking platforms are complex, less agile, and more costly to run.
If legacy banks wish to compete with the digital-only banks properly they now know that they need to invest in modernising and integrating their back-end systems; not just focusing on the front-end, customer experiences.
Despite fintechs’ convenience and clear understanding of their customer base’s needs, there is still uncertainty around whether they can offer enough to fully convince people to turn their backs on traditional banks. Incumbents are able to tap into far superior resources to offer free overdrafts, mortgages, loans etc. As such, fintechs have broadly stayed in the ‘holiday spending’ space.
Partnerships – a lifeline for fintechs as well as traditional banks?
For banks, digital transformation requires an entirely different technology stack and a different type of architecture. It is more about building a full ecosystem than a platform. As a result, much of the narrative in the past few years has explored the potential benefits that incumbents could gain from partnering with digital-first start-ups due to their expertise with new technologies.
However, there is really nothing stopping banks from undergoing this transformation alone. So as changing consumer habits force the banks’ hands, now is the time for fintechs to seriously pursue forming partnerships with large banks. The window of opportunity for fintechs to form partnerships may be narrowing. Their previously attractive offer to help banks leapfrog to their expertise level is less enticing as incumbents proceed alone with their own digital transformations.
The pressure may indeed be transitioning back on fintech, so why should they seek out partnerships before the opportunity fades? Firstly, challenger banks, while nimbler, face a much higher chance of failure. They don’t have the luxury of government protectionism that is provided to incumbents that are vital to the economic health and prosperity of a nation. Fintechs also are more likely to operate with significant losses, opting to aggressively grow their platforms at the expense of profits. This has led to rapid customer gain, but this business model lacks a sustainable future.
Essentially, challenger banks have built some impressive digital experiences and have demonstrated that they capable of doing very well in retail banking, e.g., Starling. But this is not where the big opportunities lie. The cross-sell of other banking products (loans, mortgages, savings etc.) is the truly lucrative segment of the industry. On this front, fintechs, who often operate as single product shops, are unable to compete with the varied portfolio of incumbents. Furthermore, whilst challenger banks have shown a desire to scale up, they lack the knowledge of how to successfully do so. Incumbents, however, have ample experience in international expansion and dealing with regulatory authorities and jurisdictional challenges.
For now, the banking industry is at a crossroads for both fintechs and the big banks, with partnerships offering one solution to the problems that both sides face. However, in the wake of the pandemic, the ‘sleeping giants’ of the industry may begin to awaken and, if so, fintech will need to make their move sooner rather than later. Whatever happens, while banks and fintechs battle it out, the real competition lies in wait. Tech giants, the likes of Google and Apple in particular, are poised to majorly disrupt the whole industry. So perhaps it’s time that the banking competitors dropped their shields and worked together to win in this brave new world.
