Are Banks Doomed To Disappear?
We are entering an era of increased competition between incumbents’ banks, insurance companies and fintechs. While banking and insurance business models haven’t evolved significantly over the past few decades, the services proposed by FinTech firms have a relatively high potential for revolutionizing the industry. This comparison holds for several reasons.
The first reason is that FinTechs are more recently developed, fewer and less regulated. This makes them more agile, with a greater ability to propose innovative services. A typical FinTech example is Transferwise which proposes cross-country/currency transfer solutions. By comparison, banking and insurance companies have a long history. They’re large and highly regulated. Thus, they are more difficult to reform.
The second reason is that FinTechs tend to have a singular service focus (e.g. lending, payment or equity investment). As such, they can offer more efficient client-facing solutions. That said, FinTech’s value-adding potential could be diversified to include a more user-friendly interface, lower pricing or a faster solution.
The third reason is that Fintechs can broaden financial horizon and remove barriers, allowing them to reach are wider consumer base. They are able to demystify complex financial solutions, making services more accessible to a larger proportion of the population. Robo-advisors, for instance, remove the traditional minimum thresholds imposed by asset managers. This significantly reduces investment costs, enabling greater access to high quality investment services.
The fourth reason is that Fintechs are very well informed about their clients. Greater client visibility gives companies the ability to act discriminately and make better pricing decisions. Consider Ant Financial, which rates consumers through Sesame Credit. App users report Ant Financial as offering much more cost-effective loans relative to traditional institutions. Similarly, some insurance companies provide their fitness trackers to clients. This allows them to monitor exercise habits, and reward insurance premium discounts to their more active clients.
The fifth reasons is that Fintech firms are digitally-based. The technologies used help them provide better, more cost-effective client services. As such, their cost base is likely to be lower than that of traditional players. More importantly, client acquisition and servicing costs are lower. Furthermore, instead of using their own capital, leading companies like Lending Club and Prosper use investor capital to fund client loans.
Although digital-only "challenger banks" like Starling, Fidor and Monzo are gaining momentum, particularly in the United Kingdom, it is too early to assume that these financial technology (fintech) challengers will create “existential crises" amongst brick-and-mortar banks.
The financial services industry may follow in the footstep of the car industry. Over time, the car dealers selling cars became independent from the car manufacturers building cars, some sell only one brand while others are multi-brand. As a result, the industry has split between sellers and distributor on one side and manufacturers on the other. Financial services will likely follow a similar path, with fintech taking an increasing share of distribution and sales while regulated banks are expected to act as the engine factory that builds and administers financial products. As a result, FinTech start-ups and banks are likely to assume complementary roles in the medium term. Banks have a long history, and will continue benefiting from their established reputation as solid and trustworthy customers relationship builders.
We see the number of alliances between FinTech and traditional players to continue to rise, with several large institutions announcing their strategic alliances. For instance, in February of 2018, Bank of America and Amazon announced a joint venture that offers loans to Amazon marketplace merchants. It would not be surprising if banks continued along this path, by regulating similar mortgage and loan activities. However, distribution and front office work is expected to be conducted online. To capitalize on this overlap of data collection and decision-making capabilities, banks may continue purchasing fintech companies to better sort through data and create decision-optimizing blockchain.
Marion Laboure is an Associate of the Department of Economics at Harvard University.
Image credit: Drew Stephens via Flickr (CC BY-SA 2.0)