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Why Banks And FinTech Need Each Other... And For How Long

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According to Sebastian Siemiatkowski, CEO of Klarna, which is one of the leading Swedish FinTech unicorns, banks need to be customer centric, not just talk about it. But in practice, we see little change in the banks’ approach. That’s why we often hear about developing alliances between banks and FinTech platforms. Will friends become enemies?

“Customer-centricity? Yeah, right” - this title of an article by Deloitte shows precisely what retail customers have to deal with when it comes to treating the client as a midpoint of traditional financial institutions. There are a few reasons why that is.

In banks we trust

First, traditional banks as financial institutions have developed a strong heritage of procedures Not only in terms of workflow, compliance, and products but also in their corporate culture. It is not easy to bring down the walls of tradition and create a climate of openness to novelty and innovation. It requires introducing a brand new set of beliefs executed by top management. Even these execution-driven visionaries, however, must face these decades-old walls because fiddling with these walls means gambling with a bank’s most valuable assets: trust and reputation.

Banks have worked for hundreds of years to gain this reputation, which remains at the center of their business models. The history of their products is often impressive, with accounts and saving deposits enjoying longer lives than individuals do. Moreover, banks leverage the credibility of other institutions by mastering a “regulatory tsunami” to receive licences, obey additional and separate regulations, and their deposits are guaranteed by the state.

All of this trust projected from the state makes banks appear credible and trustworthy to their consumers.  This is one of the economic laws of contract theory, called: “signalling theory”. It describes how trust between cooperative partners starts before they know each other very well. The approach can be applied to many situations in our lives, i.e. having a recruiter verify our experiences, degrees, networking, etc.if we want him or her to help us find employment. As she or he does not know us, there is a search for signals, like a highly rated educational institution or a company with a strong brand that we have studied at or worked for previously. Signalling theory indicates that potentially somebody else did their due-diligence on us, so we have to be good in case a strong brand has accepted our application.  When all of the candidates are brilliant, it still does not mean we are a perfect match for the company, but there is a high chance that we might be.

On the other hand, when we have a major career change and start doing something new, we run into more unexpected developments than when you were doing the job that you are the expert at. Banks and other traditional financial providers like Insurances or Structural funds are in the very same situation. If it is an employee suddenly out of their depth, you can simply say, “Oops, sorry!” and move on, but for banks, this is far from satisfactory.

Does it pay off?

Second, innovations in retail banking are not very profitable, at least when compared to ones introduced in other covering corporate accounts, wealth management, or mortgages. Middle-level managers often resist novelties, being opposed to changing something that worked or was at least reliable so far, as it is hard to believe that they would get promoted by putting the IT security and the trust & reputation of the bank at risk while working with FinTech companies In this, they have a very strong argument: is it worth it financially?

They are somehow right. The most lucrative products for banks are the following:

  • mortgages
  • servicing enterprises
  • international transactions
  • wealth management

Although margins are melting heavily in each of that areas, the retail banking vs effort needed to attract and maintain a new customer is still something that banks can hardly earn on.

Adapted from: Crédit Agricole. n.d. Breakdown of net income attributable to the Crédit Agricole Group in 2016, by sector* Statista. Accessed July 18, 2018.

Third, implementations of innovations are difficult to execute. Shifting a corporation from product-oriented to customer-oriented requires a tremendous amount of effort to map customer’s journeys. Everyone who has tried this knows that there is no such thing as a unified customer journey. It’s a complex patchwork of crisscrossing paths, which are not rigorously followed by clients.

Independently if individual customers might be hunters or vegans, they still see the same online banking interface as The users of  Facebook or Google on a daily basis and are used to having their platforms personalized. As it turns out, that’s a pretty hard hurdle for banking interfaces due to their technological heritage.  Banks can not follow due to their technological debt. The foundations for today’s European banking infrastructure were laid in the 1980’s. Layers have been added to the foundation like a skyscraper constructed on a weak basement and modified since then even though the core structure remains the same. Dig into your average banking system today, and you will still find elements written in Turbo Pascal, a programming language developed 35 years ago on a DOS operating system. With this in mind, it is no surprise they are struggling to integrate with trendy languages programmed in Swift, Node.js, and Elixir.

Nothing to lose, but a fortune to gain

FinTech companies do not share the limitations of their banking peers. They can default because they have mostly little to lose (say “oops” and then “bye”). Their earnings are much thinner than banks’ and they usually come from a single stream. Finally, their software is newly coded and maintaining a clever twitter feed is a bigger headache than navigating interoperability problems with generations-old technology. FinTech is agile, cool, customer-centric, and has the ability to solve customer problems in innovative ways. But, even with all of that, what they really lack is trust and reputation.  This is where traditional banks come in--with a bank’s reliability and FinTech’s innovation, the two can reinforce each other and become allies.

Currently, their businesses do not jeopardise each other. For instance, in the UK, if a bank refuses to give you a loan, it is obliged to point you to another financial provider, if any, that will (read more about this here). If a bank finds a customer with too high PD (probability of default), why not send them to a FinTech Crowdlending entity with different criteria (for example: Funding Circle), rather than another traditional bank? From the banks’ perspective, the segment could generate additional income and support the effort to close the credit circle in the national economy.

How the fairytale ends

As with most things, when the profits increase so does the potential for conflict. As long as FnTechs occupy a relatively low- or mid-margin niche, banks should be keen to use them as fig leaves of innovation. But when FinTechs step into more profitable areas and travel upwards in the value chain, the game may change.

Historically speaking, FinTech entities started as businesses subject to comparatively simple regulatory requirements, which is why so many innovative companies have jumped into the business of handling payments (e.g. Klarna).  However, the scene is evolving rapidly and there are already valuable FinTech companies focused on wealth management, RegTech and blockchain. You can bet there will be more of them soon, fighting for increasingly lucrative pieces of the financial cake.

On the other hand, the FinTech industry is not neglecting their credibility. Recently, Klarna, a payment solution provider, received a Swedish banking license. Some are already listed on stock exchanges, including the most prestigious like NYSE, NASDAQ, LSE, or FWB (Frankfurt Stock Exchange). The first InsurTech bought a traditional Insurance provider.  Representatives of the industry actively participate in setting the European Union’s agenda on FinTech, which has responded by issuing an ongoing consultation on the European FinTech Agenda.

The growing presence of customer-centric companies has just begun, but banks might consider cooperating with FinTech companies beyond the need for synching their IT systems while learning from each other’s strengths. FinTech companies now have a presence beyond retail customers.  Travelling up the value chain will accelerate the need for successful intraorganisational cooperation.

Following the signalling theory, teaming up with banks would provide FinTech companies increased credibility while allowing banks to create solutions for their customers without reflecting on historical turbo pascal IT luggage. With respect to last year, there was a shift in perception; not questioning “if” there is a need for cooperation, but rather how to facilitate such an exchange to each others’ benefit.

Read more my Forbes posts here.