A version of this piece first appeared on Chris Skinner’s blog, The Finanser.
There is an old joke about a guy who is lost while driving in the countryside. When he stops to ask a pedestrian how to get to the city, the pedestrian replies: “Oh, if you want to get there, I wouldn’t start from here.” The joke highlights the very real sentiment banks are feeling today: Institutions want to get to the nirvana of new technologies, but they are stuck in a bowl of spaghetti of old systems. Some call these systems legacy, others call them handcuffs. Whatever the nickname, the antiquated core systems are challenging banks’ ability to progress in a digital banking world — a big weakness that fintech startups believe they can exploit.
New fintech companies have been launching capabilities built upon the latest internet-enabled technologies, such as easy-to-use apps for customers, simple payment checkouts for merchants and open systems to allow anyone to work with them. It is almost like banking in a mobile app store: Hundreds of companies are offering thousands of services that are simple and easy for sending and receiving money. These companies include firms like Stripe, a six-year-old startup that is the preferred code for building online checkout services. Stripe, which is really easy to work with, is the chosen system for many other innovative companies including Kickstarter and Apple Pay and was valued at almost $10 billion by the end of 2016. Not bad for a six-year-old startup. Stripe has gained such a valuation because it has taken something that banks make difficult — setting up online payment services — and made it incredibly easy for customers.
There are companies that do similar things in lending, savings, investments and other specific areas of financial services based upon internet technologies. These companies have names like Zopa, SmartyPig, Nutmeg and eToro, and have fun branding and cool offices. They are very different from banks. They all share many of the same attributes, in terms of being young, aspirational, visionary and capable. This is why, collectively, they have seen investments from venture capital and other funds averaging $25 billion for the last four years, according to figures published by KPMG.
However, there is a possible impasse here. The most successful fintech firms are not replacing banks, or at least not yet. They are serving markets that were underserved. But none of them have replaced a bank. Rather, the companies are succeeding by addressing areas that banks find difficult to serve due to cost or risk, such as lending to small businesses.
Certainly, some startups appear interested in supplanting big banks. It is interesting to see almost 50 new banks launching recently in the U.K., many of which are fintech banks. Atom, Starling, Monzo and more young companies have bank licenses from the U.K. regulator and they have considerable funding. However, they are up against the biggest U.K. banks that have millions of customers, billions of funding and centuries of history. For new players, fighting the large banks is going to be a challenge and they will need a lot of funding to succeed. These challenges do not mean they will fail; however, they will need real differentiation and exceptional digital services to succeed. And even then, will customers switch? It will be interesting to find out.
But the one thing the new players have from the start is fresh technologies, no legacy and unconstrained thinking. Equally important, they have relatively no cost overhead, and therefore, they can compete more effectively on interest rates. After all, big banks have an awful lot of branches despite the rapid shift toward mobile services. It may not be attractive to shut down these branches in the minds of the media or their customers; however, if banks do not do so, they will fail to compete with these new digital startups, even with their millions of customers.
Therefore, the fight for the future of banking is going to be between a host of new digital players and a few large banks that find it hard to change, but are adapting as fast as they can. Interesting times, indeed.