Bank Vs Fintechs
“We need Banking but we don’t need Banks” – Bill Gates
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Can Fintechs win the battle against Banks?
The Guilty Banker
I feel guilty. Despite having spent most of my worklifewith banks,I still can’t defend them.It isn’t easy to shield an intermediary who runs on legacy processes,continues to err on regulations and still has a tantrum or two up its sleeve!
They can delay remittances, demandredundant details and when you call, make you hear long promos and contorted IVRs. And that’s not all!
The bank critics can share umpteen stories ofgullible old men, looking to park pension funds in a term deposit but ending up investing inriskyequity-linked insurance or the naïve Small Business owner signing up for currency Swaps. All this because thebank showed them the shining, bright light at the end of the tunnel.The line between a car salesman and banker may seemblurry at times.
However, while you enjoy the bank bashing, these are only the symptoms of a more fundamental flaw.Much of this inefficiency and opaqueness can be attributed to thelack of innovation in banking.Whether it’s a deliberate strategy or sheer laziness, they are guilty all the same.
There could be some respite in sight though.
The Fintech Redeemer
It was only a question of time beforehefty bank fees, complex documentation and unreasonable TATs (Turn-around Time) were challenged.
Payments was crying for simplification andthe likes of Paytm, Stripeand numerous otherscame to reducefriction.
Basic services like account balance enquiryor tracking expenses or investmentswere undesirably exclusive and the likes ofMTrakr orHappay or Movenstarted offering real-time analytics.
The obscenely high interests, cumbersome documentation and monopoly on loanswas painful and the likes ofKickstarter,Lendingclub, Sofi, LendingKartetcchallenged the premise of underwriting and pricing. As they become mainstream,loans and overdrafts may no longer require a ‘favour’ from your friendly banker.
Lack of innovation in bankingis precisely the opportunity Fintechs are encashing.They are disrupting the way things have been for decades with ideas ranging fromcommon-sensicalsimplification to big paradigm shifts.But,can they be our redeemer?
The answer isn’t an easy one.
Let’s get over with the bad news first
Banks generate and consumelarge amount of data. AI relishes data.While AI may not make us slaves, one problem is imminent.
- Repetitive jobs in back office operations like screening standardisedforms and processing routine transactionswould be automated.
- Contact centres and IVRs would no longer be dumb and you needn’t have to wait for a human John or Arvind to answer. John and Arvind would need to look for a new job.
- Analysis of parameterised retail products like credit cards (in whatever form) and small ticket loans, are low hanging fruits for automation. Analyst jobs, Risk and Credit Middle offices may all be automated and the lone human supervisor handling these functions may be more techie than a bankie!
- And Branch staff. What branch??Jobloss is inevitable in banking and many other sectors.
Another risk of AI,often articulated,is centralisation of power.Stephan Hawking and Elon Musk have been vocal about responsible use of AI. Would those who have access and controlof AI, become czars of the new world order?
If not already worrying about it, Government think tanks should start mulling over the socio-economic impact of AI, in not so distant future.
But these dark clouds may have some silver linings.
Not an easy battle
In this Fintech v/s Banks scrimmage, everyone seems to have a view and it’s strongly skewed towards “Good riddance banks!” However, a closer look gives a reality check.
Yes, fintechs might have won a few skirmishes but need more than an idea to win the battle. It’s a painful, long haul. While on the face of it the banks look vulnerable, in reality they do have enough arsenal to ward off the onslaught.
1. The shield of Central Banks
The concept of Central Banking has evolved through many trials and errors over the last century.In his book titled‘Lords of Finance’, LiaquatAhamednarrates howthe sensibilities and prejudices of a few central bankers defined the monetary policy templates after the World War Iand gathered pace around the Great Depression in 1930s. That evolution is far from over.
Balancing growth and inflation is still a challenge and the jury is still out onwhether volatility of exchange rates or the socio-economic variableslike unemployment ratehavea causal relationship or are a mere correlation with the monetary policy actions.
The tools used by central bankers are,in essence, a hit and trial experimentation of controlling money supply.Byrationing bank licenses, they didend up creating‘systemically risky’institutions but presumably seem satisfied to have got better controlof money flows. The fintechs on the other hand are an untamed animal.
The very nature of a startup is to break traditionand put consumer needs, instead of the institutional constraints, at the forefront. Cryptocurrencies likeBitcoin, for example, can potentially make the money flow lassiez faire, making the monetary policytools irrelevant.
While there is some let up with licensing of Payments Banks in India or digital banks like Atom, Tandem and Number 26 or the PSD2 guidelines in Europe, Central Bankers are still a divided lot on how to manage fintechs. The regulatory views on P2P lending, Crowdfunding and Cryptocurrencies is still inconsistent and patchy. The regime is still to ‘regulate’.They may not be partisan, but till such time we don’thave new methods, the musical chairs of money supply with handpicked players would continue.
Adding to the fears are episodes of misuse, like the Dark web marketplace SilkRoad (now banned) where drugs were sold using Bitcoin or the exit of LendingClub CEO, following the poor governance and influence in loan approvals. The repercussions of unbridled access of financial technologies in wrong hands are real and serious.
It may, therefore, be too much of a perceived riskfor the traditionally trained central banker to junk their ‘stable’ templates, so painstakingly built over decades, despite the evident flaws.
Put shortly, for now, the blessings of ‘Lords’ is no less than a divine energy-shield protecting the Banks
2. The mine-field of Compliance and AML
As covered in my previous article, 9/11 and 2008 financial crisis led to a new paradigm of regulatory compliance and Anti-money laundering practices for banks.It’s no surprise that Governments wantclosemonitoring of money trails and corporate governance. AMLcompliance havebecome non-negotiable. The world continues to be insecure and in the current world dynamics, increased regulation clearly overshadows call forliberalisation.
This hasa twin impact- first, the costs of compliance havespiraled andsecond, bank documentation and reporting have become increasingly complex. Despite the growth in digital infrastructure, bank TATs continue to be unpredictable. In India, for example, banks still struggle to open business accounts in less than a week and that’s being optimist.
The legal and procedural compliance costs continue to rise as more and more geographies across the globe bring out new regulations. JP Morgan, for example, expanded its compliance team from 23,000 in 2011 to 43,000 in 2015.Atemplated business run froma centralized office in California or London or Bangalore would necessarily falter without a strong legal and compliance understanding of the local market.
Even with best of intentions, it is some task for a technology startup to build efficient business in such a dynamic compliance environment, with the bar moving higher every day. If USD320 Billion compliance related penalties paid by banks is any indication, the road ahead for a fintech with a slightest compliance slip, may end in a cliff.
3. The Vantage point: Branches
Bank Branch is dead and the data coming from Europe seems to corroborate it very strongly.Major Banks in the UK have closed 1700 branches in last 5 years.In Spain,Banco Santanderclosed 450 branches last year while in the US, Bank of America alone closed 1400+ branches since financial crisis.The story is similar for many others.
This shouldn’t surprise us though. Considering digital screens are the window to the world for millennials and Gen Y, the face of financial intermediation is bound to change. But it may be wrong to infer that brick and mortar is an anti-thesis of digital.
If opening of Amazon Go Store, increasing number of Apple Stores and many players in Indian startup space augmenting their online presence with experience stores, is any indication, there is still much value in a physical distribution setup.
While Branch may largely become redundant to distribute standardised services, these may still be a competitive advantage for enhancing customer experience, confidence building and deeper reach.The branch closures are, therefore, only a recalibration of distribution.The branch will stay.
A large section of the socio-economic pyramid- senior citizens, less educated and disabled, may still depend onsome physical network in the medium term, especially in the emerging markets. It’s also a reassurance for the High NetworthIndividuals to have face to face interaction before they put their money in someone’s hands. Infact, all products that require subjective vetting, deviations or expert advisory would still need human presence.
The development of machine learning and Robo-advisorsis still some distance from reaching the level of human intelligence to vet creditdecisions, structure loans and complex derivatives and handle stressed assets.
It may be difficult for Fintechs to comprehend the need to build a physical presence and replicate it. The smarter lot amongst the banks, like BBVA and closer home HDFC Bank may ultimately build a significant digital presence while also leveraging the existing, albeit pruned, branch network.
Branches, though bashed and declared dead, still offer banks a vantage point to see much deeper than the fintechs.
4. The Productarmoury
It’s exciting to see how fintechs have unbundled the bank products. But on closer look, many seems to have simplyleveraged the existing infrastructure, layeringtheir solutions over the availablebank products.Many of these are minor increments or transitional offerings, where the banks are catching up easily.
Take Wallets, for example. They still require a Bank account or Credit card and convenience they offer is only a temporary competitive advantage before new modes of authentication like biometrics become mainstream.
The lending startups are still experimental and the resilience of their portfolios and analytics is yet to be vetted over a longer economic cycle.It isstill a long way before the fintech products become comprehensive and proven for scalability.
While the banks have faltered on delivery, there is no denying that they have had a long head-start to refine their offerings. Bank products have evolved over time to cover the needs over the customer lifecycle. Many of these- Checking accounts, deposits, Cards, Retail Loans et al, are interlinked and supported by a whole ecosystem. This wide product suite, though not necessarily the most efficient, is still essentialfor customer stickiness.
Interestingly, the smarter banks are building platforms and Open APIs, while simultaneously leveraging theirarmoury of traditional offerings.
The challenger fintechs may ultimately need to offera comprehensive product suite comprising of Payments, Investments, Loans and Forex to address all needs of the customers. Some are already trying to re-bundle products through bank tie-ups(like Number26, a digital bank in Europe,has attempted or Moven, a US based finserv, has tried by tying with CBW Bank) but theyare in danger of becoming a selling agent or service providers for banks.
This may be exact opposite of the premise they started with- reduce and streamline intermediation.
5. Regulatory advisory and legal
Banks operate in a increasingly dynamic regulatory environment. The constant fear of being on wrong side of the law is one reason why bankers have become over-prudent and avoid taking even logical calls. There is a whole ocean of circulars, statutes, laws and guidance that a bank and its customers need to be navigate.It’s even more relevant in a developing economy like India where both complexity of transactions and regulator’s response are evolving.
In my career as a banker, there have been numerous occasions where customers seek clarity on FDI (Foreign Direct Investment)or ODI (Overseas Direct Investment) norms, requiring approval, condonation or clarity from RBI (Reserve Bank of India). The moment such a grey area is encountered, the transactions are put on hold till the time regulators respond.
But AI would catch up in these complex use-cases as well. Ross Intelligence is an AI augmented legal advisor that makes it easy to search through legal literature. It is built using IBM Watson and can answer legal queries. Scanning banking laws and regulations may just be a simpler use for Ross.
The End Game
Fintechs have demonstrated the use-cases where machine learning, algorithms, robo-advisors can vastly improve efficiency. Even the success ofmPesa in Kenya and Micro Finance Institutions in India have shown that financial inclusion can happen without the tantrums of banks.Whether the individual start-ups succeed or not, they have fundamentally changedfinancial intermediation.And till the time banks continue to pride in their legacy, fintechs will continue to find chinks in theirarmour.
But not all banks are sleeping. Some have learned the lessons the hard way and the smarter amongst them are emerging stronger and battle ready. Yes, there still are dumb ones (and there are many!) who would perish. But this may be their opportunity to convince their aging Boards to consider technology as an investment and not expense.
However, it’s the Regulators who walk the double-edged sword. The new age financial services require a ‘facilitator’ in central banks.Innovation cannot thrive with a tight clutch on experimentation and zero risk but technology can be dangerous in wrong hands. While I fear their ‘regulate’ mindset may just turn some fintechs into ‘banks’ too, I’mmore sanguine seeing some banks starting to behave like Fintechs.
Ultimately this is a battle against inefficiency, complacency and too much centralisation.
No matter who wins, it’s the customerwho wins the war anyways.