FinTechs are growing concern for incumbent banks, collaboration is key

05 September 2016

Incumbent banks are concerned that FinTech startups will start to eat into their business, a new study finds. A loss of market share and pressure on margins are the two biggest areas of threat: well over 80% believe that up to 20% of their business might be lost to FinTech companies in the next five years. Working together is becoming an ever more exciting option, although IT security, regulatory uncertainty and cultural differences create barriers.

Financial technology (FinTech) pose a host of risks to incumbent retail financial services institutions, across a diverse field of products and services. A recent Capgemini study found that the tech giants and incumbent competitors posed the biggest risk to leveraging FinTech technology in a way unfavourable to incumbent, although FinTech startups too were found to pose risks for the industry.

In a new report, titled ‘Customers in the spotlight How FinTech is reshaping banking ‘, PwC considers the effects that FinTech startups are likely to have on consumer banking over the coming five years. The report is developed from the opinions of 544 financial service respondents, principally CEOs, Heads of Innovation, CIOs and top management, from 46 countries.

FinTech poses risks to incumbents

Rise of FinTech
The research suggests that respondents (73%) believe that disruption, to the traditional stability within the consumer banking segment, is likely to start to affect incumbent institutions over the coming years, particularly on the back of changing expectations from customers.

One area which respondents are particularly concerned about is customer relationships; FinTechs are often able to leverage agility and targeted solutions to meet the needs and expectations from customers, which make their respective propositions more attractive than those of incumbents. As it stands, while 75% of respondents says that increased focus on the customer is the most important area of impact, only 53% of respondents considers themselves to be customer-centric. 80% of FinTechs on the other hand, believe that they are able to deliver customer-centric products and services.

Threat to financial services from FinTech

In terms of the effects of FinTech companies on incumbent banks, a loss of market share is of greatest concern, cited by 70% of banking respondents vs. 50% of respondents from all financial sectors to a similar question. Pressure on margins came second, at around 67% of respondents, also slightly above that of all sectors. Information security/privacy threat came third, at around 60% of respondents concerned. Around 50% of respondents expects customer churn to increase from FinTech within their industry.

The percentage of incumbents’ business at risk from FinTech

In terms of the level of threat to bank incumbents’ business from standalone FinTech players, well over 80% of respondents rated it at between 1-20%, while around 40% said that a standalone FinTech player could take between 21-40% of their business. A smaller 20% thought that up to 41-60% of their business was at risk. A good 40% of respondents said that they do not know the full risks, with very few – around 10% – thinking that there is no risk at all to their current business model.

Trends in the banking industry ranked by importance

FinTech trends 
Respondents were also asked about how they were reacting to the various types of startups’ propositions (e.g., by investment, partnerships, etc), as well as their relative importance. Retail banks, seeking to streamline operations and reduce costs, placed ways of ‘improving and simplifying operations’ as the most important, while the rate of response to the trend came shared second – mitigations might include engaging with FinTech startups that offer open development and Software-as-a-Service (SaaS) solutions for banks. Banks also see the move to nonphysical and virtual channels as important, which also garners the most response from retails banks – responses include banks offering APIs that allows for the easy integration of third party apps and digital banking solutions.

'Reaching, retaining and engaging customers' came third, with retail banking respondents finding such solutions both important and response worthy. The simplification of product application processes was seen as the third most important trend in the industry. A number of other trends, including reaching the unbanked – which has considerable FinTech startup activity – as well as enhancing credit underwriting, are both seen as areas of relative importance to banks and are gaining at least some attention.

One area in which FinTech activity is very strong, but where incumbents are as of yet not responding, is the rise of peer-to-peer lending – which last year saw £2.4 billion in activity. Crowdfunding propositions, while not unimportant, has seen little activity from respondents.

What challenges did/do you face in dealing with FinTech companies/incumbent banks

The survey found that collaboration between FinTechs and incumbent banks is relatively robust, with banks already engaging in joint partnerships. A number of issues exist between the two parties, however. Incumbent banks have concerns (almost 60% of respondents) of the IT security of startups, while only 30% of FinTechs worry about the IT security of banks. Incumbent banks are also concerned (55%) about regulatory conditions related to what FinTechs are up to. FinTechs on the other hand, are the most concerned about differences in management & culture between them and their bank partner, as cited by more than 50% of respondents, while almost 50% are concerned about differences in operational processes.

Manoj Kashyap, PwC’s Global FinTech leader, says, “Customers want convenience, personalisation, accessibility and ease of use. To live up to these expectations, banks and FinTechs should focus on opportunities that leverage each other's strengths, whether in product design and development by start-ups, or distribution and infrastructure capabilities by banks. FinTechs are great at offering product simplicity and seamless integration, but they lack the proper IT security and regulatory certainty that banks have. We see both sides coming to the realisation of a new, mutually beneficial relationship and it’s ultimately the customer who will benefit the most from this.”



The business and operating models of digital-only banks

04 April 2019

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.