Are banks finally getting an upgrade?

Consumer expectations of banking have changed a lot — but traditional banks haven’t. Fintechs have rushed to fill in the gap. Big Tech has also tip-toed into offering services previously considered part of ‘banking,’ such as consumer credit, money transfers, and payments. Is this staid industry finally getting a tech-fueled comeuppance? Or will regulations designed for the past give legacy banks time to fight back?

Banking has changed; banks have not

Our idea of what a bank does, and who can do what a bank does, has expanded dramatically. Banking has surreptitiously gotten an upgrade, via services we used to get from banks but are often getting from other players — we now make payments and transfers using Venmo and Paypal (and ApplePay and Google Wallet); we finance our purchases using Affirm; we refinance our student loans and mortgages with SoFi.

But banks have not changed much: most banks’ digital interfaces are still pretty creaky — certainly in terms of user experience, but also in terms of functionality (3-day ACH delays, anyone?) Since the financial crisis, the reputation of large banks has continued to decline, fueled by a suspicion that large corporations prioritize the bottom line over customers and ethics: the furor over large banks financing the Dakota Access Pipeline and private prisons like GEO Group, continued examples of barely-disguised racism, and mystifying products and fees. The streamlined digital interfaces and transparent fees offered by fintechs helped consumers question the necessity of the confusion.

According to the J.D. Power 2019 U.S. Retail Banking Satisfaction Study, “At the consumer level, the evolution of digital channels is creating a new set of demands and expectations that banks must understand and address. Customer loyalty within segments — critical for the future — is questionable.”

So while consumers don’t appear to be leaving their primary legacy banks en masse, it’s safe to assume that consumer expectations for services that can be provided digitally have changed dramatically over the last decade. Many aren’t hampered by whether the company helping them lock in a lower rate on their mortgage is technically a bank, and fintechs are incentivized to make the switch as easy as possible for consumers.

The Players:

• Neo-banks: Digital-only banks like Varo, Chime, N26, and Mercury are also known as challenger banks. These fintechs have rushed to fill the void opened up by consumer dissatisfaction with legacy banks. They’ve addressed consumers’ major pain points by doing away with overdraft fees and providing intuitive interfaces, higher-APY cash accounts, and instant transfers. Some differentiate by offering customers value alignment, like Good Money. [More on the promise of fintechs in Post 2]
• Non-bank fintechs: Some startups have taken a different approach, offering a single financial product to attract consumers and expanding out from there: SoFi initially focused on student loans; Wealthfront on investment management services; Aspiration on investment management for those looking for sustainable investing options. Fintechs like Plaid and SynapseFI have emerged as plug-and-play solutions for those focusing on customer acquisition. [More on the party in banking back-office in Post 4]
• Legacy banks: Traditional banks haven’t been watching idly, as demonstrated by legacy banks’ digital initiatives and acquisitions like Finn (JPMorgan), Marcus & Clarity Money (Goldman Sachs) and Greenhouse (Wells Fargo). Success has been mixed — Finn was shut down after just 1 year, but Marcus has grown tremendously. Legacy banks have the advantage of huge ‘install bases,’ but they have been somewhat left behind by changing customers tastes, including a growing awareness of banking’s role in funding controversial projects and companies. [More on incumbents’ forays into digital banking in post 7]
• Big Tech: In addition, lots of non-bank companies are tip-toeing into services that were traditionally part of banking: think ApplePay and Google Wallet, but also Wealthfront and Betterment’s high-APY cash accounts, as well as Affirm and Paypal credit. Even Garmin has a payment function, and Uber offers its drivers personal loans. [More on big tech in digital banking in Post 5]

A new banking world order?

So why haven’t neo-banks eviscerated traditional retail banks completely, as ridesharing companies have done with the taxi industry? Banks have a serious moat: bank charters. A bank charter gives a company the official permission to conduct banking operations. States can issue state bank charters, but the OCC has the exclusive authority to issue national bank charters. In order to provide banking services, neo-banks have all had to rent a traditional bank’s charter — the OCC hasn’t issued a new bank charter since 2009, so it’s not as if charters are available for the taking. Challenger banks could potentially pursue Industrial Loan Charters, or the OCC’s new, limited “fintech” charter, but each option is fraught in a different way. [More on the bank charter moat, & what fintechs are doing about it, in Post 3]

In order to grab market share, challenger banks need to cooperate with legacy banks by renting their charters. Consumers have gained with the proliferation of no- or low-fee digital options, though there are now so many that it’s hard to tell them apart. Will incumbents let these newcomers pull the rug out from under them or will they simply watch them burn through venture money until they realize that they can’t lower their CAC enough to build a reasonable business? It’s an odd dance, and the result is a dynamic digital banking landscape — not just in the US but also in other global financial hubs like the UK, Germany, and Hong Kong.

This post is the first in a series covering the revolution taking place in banking. Stay tuned for the rest of the series: Post 2 will delve into the promise of fintechs. Post 3 examines whether a bank charter is really necessary for banking. Post 4 takes a look at the fintech party happening in the banking back-office. In Post 5, I look at how Big Tech has crept into banking services. I analyze all of these new players’ tactics at getting into digital banking in Post 6, and take a close look at incumbent banks’ attempts to fight back in Post 7.

This series started with the research project I worked on in collaboration with Radicle Impact Partners while pursuing my MBA at Berkeley-Haas last year. The opinions and research in this post are my own and do not necessarily represent Radicle Impact Partners. I’m grateful to the Radicle team — especially Ami Naik at Radicle and Nick Egger-Bovet at Beneficial State Bank — for their support, encouragement, mentorship, and feedback.