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New Finance in 2016: Banks and Disruptors Are Better Together

At the start of 2015, there was a sense that Silicon Valley would soon rule the world of finance and that banks risked irrelevance. A year later, a more balanced picture has emerged.

In the January 2015 Ideas Issue of American Banker Magazine, we described in an article titled "'New Finance' Redefines What's Possible" how a combination of forces could potentially transform financial services in ways that are massively beneficial for customers.

These forces include: advances in analytics that have helped financial firms better track trends and understand consumer behavior; rapidly improving digital technology; increased emphasis on financial health and financial inclusion; and the expectation from consumers that their financial providers deliver much better experiences, on par with what they get from the likes of Apple and Uber. We also considered whether incumbent banks might be pushed toward the role of commoditized utility while innovation and high-value customer relationships were claimed by technology-enabled disruptors.

As it turned out, the overriding theme in 2015 was collaboration.

Technology companies continue to act as pioneers. They take advantage of their lower costs, decision-making and technological agility, higher risk tolerance, and access to talent to shape and respond to shifting customer needs. In turn, banks are proving to be effective engines of scale for New Finance through partnership, acquisition and replication. They are doing so by drawing on natural advantages — lower cost of capital, risk management capabilities, known (if not always loved) brands, and the reassurance of physical bank branches.

Indeed, some of the largest players in fintech are partnering with incumbent banks. Lending Club is helping Citigroup meet its Community Reinvestment Act obligations and has teamed with some 200 local community banks to help them get back into personal lending. JPMorgan Chase and OnDeck will partner on small-business lending in 2016. The new near-field communications payments offerings — Android Pay, Apple Pay, Samsung Pay — emphasize a similar theme of collaboration.

In other instances, financial institutions are scaling New Finance through acquisition. Northwestern Mutual bought LearnVest, whose mission is to replace traditional financial advice. In 2014, BBVA bought Simple, providing access to both a talented team and a mobile-first banking platform.

Tech companies are also pioneering ideas that are quickly becoming industry standards. For example, Charles Schwab introduced a version of the "robo-advisor" concept first brought to market by startups such as Betterment and Wealthfront. And the blockchain technology that underlies bitcoin is now being pulled into the mainstream by more than 40 leading banks in search of more effective clearing and settling.

What does this all mean for New Finance in 2016?

First, banks need to continue to improve the experiences they deliver. Today's leading banks will likely be the primary providers for some time to come, even as new entrants continue to push the frontier of innovation. Unfortunately, the top four U.S. banks are among the top 10 least-loved brands by millennials. Delivering the great experiences more commonly found among consumer tech, hospitality and retail brands requires change across culture, operations and strategy. Capital One is a good example of a bank that gets this, as evidenced by the products and services it now offers, such as digital checking and savings accounts and fractional share purchase for smaller investors. Its acquisitions of Bay Area design firms Adaptive Path and Monsoon show that the bank is dead serious about improving the look, feel and experience of its digital banking.

While some startups will achieve scale on their own, many more will only achieve meaningful reach once they find a way to work with incumbents.

Second, customers need more help in making good financial decisions. In McGraw Hill's latest Global Financial Literacy Survey, 48% of Americans did not answer the following question correctly: "Suppose you need to borrow $100. Which is the lower amount to pay back: $105 or $100 plus 3%?" That is concerning because a failure to understand basic math often leads to poor financial decisions. RevolutionCredit is tackling this problem head on through a series of capability-building videos aimed at low- to moderate-income customers who have limited experience with credit.

Third, we need new financial products to solve some of today's biggest challenges. Americans take too few good risks and manage bad risks badly. For example, Americans started 3% fewer small businesses in 2013 than in 1977, despite the fact that the population has grown by nearly 100 million people. And Americans' financial health is poor; the average family does not have enough liquid savings to cover one month of current spending. Several startups have emerged to help improve finance health. Digit offers automated savings, while LendStreet focuses on reducing personal debt.

Banks' embrace of New Finance means great ideas may reach millions, if not billions, of consumers more quickly. But it is highly unlikely that banks can realize New Finance's potential without working hand-in-hand with disruptors. Regulatory, efficiency and near-term growth pressures make it hard to ask banks to deliver boundary-pushing research and development completely on their own.

Paul Breloff is the managing director at Accion Venture Lab, which provides seed capital to startups that improve underserved consumers' access to financial services. Robert Schiff is a vice president and general manager at Medallia, the global SaaS-based customer experience technology company.

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