The promise of fintech in banking

  • Distribution: Before the coronavirus crisis hit, pushing business to shift online almost instantly, legacy banks relied on brick and mortar branches, direct mail, and product cross-selling. We’ve all gotten credit card applications in the mail and seen ads for other services on our paper statements. Traditional banks are working on building a digital marketing footprint to replace — or at least complement — their former reliance on a physical catchment area around their branches.
    Fintechs are often digital-only and focused on a niche demographic, say: parents (Current), folks with an uneven banking history (Varo), people in recovery (True Link), seniors (also True Link), freelancers (Azlo, Lili, Oxygen, and several others). They often rely on generous referral programs, based on the hypothesis that their business can grow with significantly lower customer acquisition costs (CAC) — after all, they don’t need to bear the overhead of physical branches, a serious advantage over legacy banks. The challenger bank playbook is predicated on a better ratio between CAC and lifetime value (LTV.)
  • Products: Traditional banking products have long been both indistinguishable and opaquely priced. If you’ve tried to get a mortgage, you’re familiar with the struggle: ARM or 30-year fixed? What about points and PMI? Do these even make a difference, and is it worth shopping around? Challenger banks are speaking directly to consumer frustration with fees on services that seem like they should be standard, e.g. payments and transfers. Many are doing away with these fees completely, refusing to charge overdraft fees, transfer fees, or minimum balance requirements. For example, Robinhood was a pioneer in offering zero commission trading to its clients in 2013. By late 2019, legacy brokerage firms Schwab, ETrade, TD, and others all followed suit. [More on incumbents in Post 7.]
  • Processes: Some legacy banking operations are still paper-based, and many banks still operate in an environment restricted by internal and external regulation. Fintechs can build processes from scratch, resulting in digital-first, automated, and/or AI-powered processes that often use new or different types of data. This is what Lending Club, Prosper, and other P2P loan providers did for personal and business lending, and many others have done with all-digital account opening.
  • Legal & Compliance: Similarly, legal & compliance often limits incumbent banks. After the excesses of the financial crisis, legacy banks’ compliance teams may still be cautious about offering services that aren’t clearly covered by existing regulation. Challenger banks may be less gun-shy in forging forward — as mentioned in post 1, most challenger banks are effectively renting another bank’s charter in order to operate at all. This can provide an opportunity for fintechs to build compliance programs that address products or markets that banks aren’t nimble enough to tackle. Fintechs have the compelling chance to be able to carefully build their compliance program in order to address their real risk in response to a defined risk appetite, unencumbered by historical inefficiencies and outdated compliance systems. For business-minded compliance leaders, this also provides the opportunity to leverage technology in order to avoid the cumbersome customer experience that is often unavoidable at legacy banks. Fintechs that see legal and compliance as a strategic advantage get to create companies that will leap over their competitors when regulators inevitably engage deeply in the industry. [More on bank charters in post 3, and on L&C as an opportunity for fintech in post 4]
  • Technology: Underpinning all of this is technology. According to Quartz, “Common Business-Oriented Language — the ancient computer code better known as COBOL — was developed in 1959 as a business-focused standard programming language, and is still relied upon by banks around the world. It’s responsible for $3 trillion in commerce in the US every day. As of 2014, 92 of the top 100 banks, as well as 71% of the companies in the Fortune 500, were still running COBOL programs on mainframe computers.” Reuters has a some striking numbers on the continued prevalence of COBOL:

Fintechs, unencumbered by legacy systems and massive operations that require round-the-clock support, can build in a way that is optimized for rapid product development and deployment, new use cases, security, transparency, information aggregation, and smoother customer referrals.

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