Banks to beef up their collaboration with FinTechs for innovation

25 September 2018 Consultancy.uk

In the coming years, banks will even more closely work together with FinTechs. With agile new competitors eating into their market share, many banks do this mainly to gain speed in innovative technologies and combat this trend.

Traditional players in the banking industry are often able to trace their roots back centuries. These oldest institutions have weathered various storms, including a global financial crisis largely attributed to their policies, along with continued arrivals of new, innovative competitors in the sector – from credit unions to internet-only banks. However, rapid advances in the financial technology space mean that traditional banking institutions find themselves increasingly open to potentially disruptive competitive forces.

The FinTech sector, a new industry, which aims to compete with traditional financial methods in the delivery of financial services by leveraging technology to adapt with agility to a rapidly shifting market. Given the difficulty of market access, as well as regulatory requirements, however, both FinTechs are keen to collaborate with traditional banks.

To what extent have you engaged with FinTech companies in the last two years

On the other side of the divide, while nearly half of executives in financial services see FinTechs as a 'significant threat', a majority believe that they at the same time offer opportunities for partnerships / collaboration. A pathway to innovation is regarded as the main driver for joining forces with FinTech players. As a result, such collaborations are becoming ever more prevalent.

To this end, a new report from DLA Piper has shown just why digital transformation in the financial services sector is so important. When banks works with Fintech, they mostly do so for innovative technologies, with four trends in particular standing out from the rest. These are payments, blockchain, analytics, artificial intelligence (AI). 41 % of financial services executives polled by DLA Piper said they believed payments were the most important area to apply FinTech in. 27% of those surveyed said their second top priority was blockchain, while just under 20% said that data analytics and AI were their second or third priorities, respectively.

Key trends

The value of applying FinTech in the payment arena is evident. Banks facilitate billions of transactions globally every day, and so optimising that process is a major efficiency driver. 17% of participants said innovation been most prevalent in the payments sector in mobile wallets and payments within the payment sector, while almost as many participants (14%) consider that there has been most innovation in digital tokens and cryptocurrencies. At the same time, another 14% identified real-time payments as the area of the greatest innovation.

Which areas of FinTech, including technologies and applications, is your business prioritizing in the next three years

Elsewhere, open banking represents a seismic development in retail banking, because it allows third-party FinTech firms access, for the first time, to consenting bank customers’ data. Open banking was initially driven by the UK’s competition regulator, the Competition and Markets Authority, while similar initiatives are occurring in Germany by the Berlin Group, and in other EU countries – though these are currently progressing more slowly than in the UK. The key is that, armed with this data, authorised app developers can now offer innovative products and services to bank customers, such as account aggregation or payment initiation services. Rival banks can also potentially access other banks’ customers and offer innovative new solutions.

Martin Bartlam, International Group Head of Finance & Projects and Global Co-chair of FinTech at DLA Piper commented, "Payments technology is set for profound transformation in this new era for the financial services industry. This concentration of investment in payments tech makes sense in today’s digital era, as it represents the interface between financial services and its client base, so is likely to be highly impactful on a number of levels, from customer experience to transactional efficiency."

In terms of blockchain, when asked for which what applications, if any, respondents’ organisations were utilising blockchain/distributed ledger technology, either as a pilot or completed project, the most populous portion of 38% said administrative systems and processes, including back office processes. Following closely behind, distributed ledger technology was being used by 32% for payment and settlement. However, across the financial sector landscape, take-up remains generally low, with some detractors seeing blockchain technology as a solution in search of a problem which can often be fixed via other means.

Where in the payments industry has there been most innovation in the last two years

DLA Piper’s survey also revealed key strategic opportunities developing across the industry through the use of advanced data analytics and AI to better commercialise and monetise vast amounts of data which organisations hold. The analysis shows that banks, financial services companies and FinTechs all plan to undertake a range of data driven initiatives in the following two years, with 35% planning to better utilise and monetise data in the next two years. That figure rises to more than 40% when just factoring in banks, who have access to a glut of valuable customer insights through the large amounts of data they hold.

AI and machine learning are likewise a higher priority for retail banks, with 32% naming it as a top-three priority, with its potential applications limiting the amount of time smaller disruptive banks need to spend on low value adding activity and administrative procedures.

Retail banks versus investment banks

In this regard, there are of course a number of differences in priorities between retail banks and investment banks. DLA Piper’s study reveals that while blockchain is a core item on the agenda for both investment and retail banks, there is a significant gap as to how much of a priority it is, with 50% of investment banks and 32% of retail banks citing it as one of their top three issues. InsurTech, at the same time, ranks as investment banks’ second-highest priority, whereas retail banks do not see it as a priority. Investment banks meanwhile do not appear to be concerned with mobile tech, at a mere 10%, while 53% of retail banks regard it as a top-three matter.

For what applications, if any, is your organization utilizing blockchain/distributed ledger technology, either as a pilot or completed project

The authors in the study also looked at how exactly banks want to work with Fintechs, and vice versa. More than a quarter of financial services companies plan to engage with FinTechs through partnerships, collaborations or joint ventures. On top of this, 19% plan to invest in FinTechs, either directly or through their corporate venture capital (CVC) arm, and 13 percent plan to acquire FinTechs on an outright basis. Appetite to participate in FinTech programs such as accelerators and hackathons is more limited, however, even though it is prevalent in key cities/areas with strong technology hubs, such as London, New York or Silicon Valley.

Partially, this may be because banks and FinTechs can find it difficult to match their cultures, or to work together at all. Banks’ procurement and approval processes are the greatest challenge for 30% of retail banks trying to work with FinTechs – more than twice the percentage of the second most important obstacle. Similarly, FinTechs cite this as the second most significant hurdle to partnering with financial services companies. This is a major concern for FinTechs, as it is not uncommon for an early-stage FinTech to fail, as a result of being caught in a bank or financial institution’s procurement cycle, which may take a year or more to get final approvals from the appropriate decision-makers.

These problems are less of a factor with investment banks, however. Due to their more offensive approach to business, these entities appear to be far less worried about procurement, with only 8% of investment banks citing procurement as one of their top three obstacles to engaging with FinTechs – in contrast to 50% of retail banks.

Investment banks: What are the greatest challenges your business experiences when forming partnerships with FinTech companies

Regulatory and compliance obstacles banks and financial services organisations also face a number of regulatory obstacles when partnering with FinTechs. Banks highlight this as the joint-fifth greatest challenge to engaging with FinTechs, which in turn cite it as their fourth most important obstacle. Simultaneously, concerns about a FinTech partner’s potential insolvency is a large challenge for 23% of investment banks, making it their highest-ranked obstacle to forming partnerships. Meanwhile, cyber vulnerabilities mean 38% of investment banks and 25% of retail banks say FinTechs’ cyber vulnerabilities are a significant challenge. Despite these factors, however, as banks and financial institutions look increasingly to upgrade their customer experience and data handling times, FinTech partnership is likely to continue to grow.

Global Co-chair of FinTech and partner at DLA Piper, Anthony Day, said of the overall study, "There is no question that companies must continue to evolve their digital capabilities to survive. While there is strong evidence to suggest we are entering a period of unprecedented acceleration in the digitisation of financial services, there are a number of regulatory and procurement obstacles to navigate. And while it appears the will to collaborate is there, there is most definitely room to develop a clearer understanding of how financial services companies and FinTechs can more effectively work together in complex, regulated markets."

×

The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

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.