Many pundits say the universal banking model is dead. They’ll tell you that just as department stores have been going out of business, the universal banks are about to be disrupted by a collection of emerging niche players who leverage the latest technology, the so called, “FinTechs”.
Most banks have product development departments dedicated to creating and launching new products, so why are they not as good at innovation as FinTechs ? The problem is culture rather than competence. A licensed and supervised bank is not going to launch the “minimum viable product” and then update on the fly – they have to get it right first time. Nor can a bank afford an uber-like gamble on the legality of an offering. What makes a good bank dooms them to be a poor innovator.
Banks have a strategic moat, and their future is bright – but only if they innovate.
Banks have customer data. Customer data gives them a competitive advantage over FinTechs who rely on publicly available data. To be blunt – instantly approving loans online is not so much genius, but more a mash-up of identity and publicly available credit score. Banks have much richer data. And the bank advantage is stronger still in emerging markets where publically available data is limited or unreliable. How much is data worth ? It’s hard to value customer data (since in many cases it’s not legal to sell it), but one useful reference point is the Caesars Palace bankruptcy. Filings show that Ceasar’s most valuable asset is their customer data.[i]
Banks have a strong balance sheet. Even with all the changes in regulatory environment, banks have better access to capital than most FinTechs. This gives them a tremendous advantage.
Banks have existing customer relationships that can be leveraged to sell new products. Even FinTechs with great products struggle to sell them because they cannot reach potential customers. FinTechs spending huge amounts of money on customer acquisition. One FinTech lender pays up to 7.5% of loan principle as a referral fee[ii] to agents who recruit borrowers. A Bank will not face such steep acquisition costs. Banks have a network of distribution channels, they have brands that attracts customers, and an existing customer base – FinTechs have none of these.
Banks have many advantages that FinTechs do not; but they need to drive innovation.
Can a bank drive innovation from within ? Some large companies sought to drive innovation by setting up a team outside the corporate mainstream, such as the IBM PC development team, or the Lockheed skunk works. However, it’s not so easy for banks. A plane can be test flown, but how do you test a financial product without brining it inside the regulatory framework ?
The Way Forward is for Banks to license technology from the FinTechs. Banks and FinTechs are a natural compliment – both have very specific strengths and weaknesses, which create great synergy when combined.
One approach is to place bets on promising start ups. Some banks are doing this. For example, the Development Bank of Singapore (DBS) has teamed with NEST (a VC firm) to set up an incubation lab in Hong Kong.[iii] It’s a good approach, but you risk backing the wrong horse.
Another approach is for Banks to license technology from proven FinTechs. A Bank can wait until the FinTech has proven the offering and technology, and then license it. The price may be higher, but the risk lower. A number of banks are taking this approach, and I believe it is the most effective approach.
In summary, the banking model is far from dead; banks have real strategic advantages, but they must co-opt innovations into their business model.
[i] http://www.wsj.com/articles/in-caesars-fight-data-on-players-is-real-prize-1426800166
[ii]http://www.nasdaq.com/markets/ipos/filing.ashx?filingid=9904732#D836749D424B4_HTM_ROM772825_8
[iii] https://www.dbs-accelerator.com/
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