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This article was published on May 20, 2018

Fintech is disrupting big banks, but here’s what it still needs to learn from them

There's a reason why big banks are, you know... big.

Fintech is disrupting big banks, but here’s what it still needs to learn from them
James Hickson
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James Hickson

James Hickson is Group CEO of Mash, one of the fastest growing fintech companies in Europe. He previously led fintech at Morgan Stanley. James Hickson is Group CEO of Mash, one of the fastest growing fintech companies in Europe. He previously led fintech at Morgan Stanley.

Much of the hype around fintech focuses on what traditional banks do wrong: they’re slow to adopt new technology; they don’t center the customer; they’re too big to respond nimbly to change. This narrative is part of why fintech continues to attract massive investment, with $31 billion total flowing into the sector last year, according to KPMG.

The truth is that there’s actually a lot that banks do right — things that fintech startups can struggle to replicate. I mean, there’s a reason why they’ve been successful.

For example, banks have large customer bases, capital, resources, strong brands, and deep expertise managing risk and navigating regulations. Meanwhile, fintech startups that don’t partner with established incumbents often struggle to scale. While startups are still poised to disrupt big banks, it’s likely that they’ll do so by imitating them as much as differentiating from them.

Here are the three areas where I feel fintech’s needs and banks’ expertise overlap.

1. Deal proactively with regulation

As fintechs scale up, complying with financial regulations can be an enormous challenge. In the US, for example, even where upstart companies don’t pursue full banking charters, they must often apply for other types of licensing on a state-by-state basis. The same is true in Europe, where in many cases countries interpret European regulations locally, creating an increasingly complex business environment for larger players, as well as regulation risk as governments look to modify regulations as the market matures.

Mistakes in navigating this complex landscape can be costly. For example, early in its tenure in the US, UK-based remittance service TransferWise repaid more than $16,000 in customer fees after a citation from regulators in New Hampshire, according to the Wall Street Journal. That wasn’t enough to hobble TransferWise, which is now worth over $1 billion, but for younger, smaller startups such penalties can sting — or even close a company’s doors.

At this point, however, there’s no excuse for fintechs to enter this landscape unprepared. Even early-stage startups should be able to show investors a proactive plan for navigating the web of regulations relevant to their business, a sensitivity analysis should regulation change, and a financial model that incorporates capital requirements, fees, and other compliance costs.

The reality is that in most cases, the easiest path through the regulatory minefield will be for fintechs to partner with the very institutions they’re supposedly vying to replace. By working with banks, fintech startups gain the wisdom of a more experienced partner, as well as access to “dumb pipes” for money transfer and the like that are already compliant with regulations.

It’s worth noting that these relationships will likely transform traditional banking in the long run as well — it’s possible that banks could one day build an entire business around providing fintech infrastructure, the way Amazon Web Services provides infrastructure for tech.

2. Approach risk holistically

As a general rule, fintech’s priorities lean more toward customer convenience than risk management. The sector’s value proposition is based largely on its ability to say yes where traditional finance would say no, allowing more people to take out loans, open credit cards, and open checking accounts than ever before. Just like tech startups that are funded by venture capital, fintechs also place a premium on growth, which makes turning down a potential customer due to credit risk (or any other factor) painful, but essential for sustainable growth.

Though it’s definitely possible to grow while managing risk intelligently, it’s also true that pressure to match the “hockey-stick” growth curves of pure tech startups can lead fintechs down a dangerous path. Startups should avoid the example of Renaud Laplanche, former CEO of peer-to-peer lender Lending Club, who was forced to resign in 2016 after selling loans to an investor that violated that investor’s business practices, among other accusations of malfeasance.

It’s not just financial risk that they may manage badly: the sexual harassment scandal that recently rocked fintech unicorn SoFi shows that other types of risky behavior can impact bottom lines, too. While it might be common for pure tech startups to ask forgiveness, not permission, when it comes to the tactics they use to expand, fintechs should be aware that they’re playing in a different, more risk-sensitive space.

Here again, they can learn from banks — who will also, coincidentally, look for sound risk management practices in all their partners. Since the 2008 crisis, financial institutions have increasingly taken a more holistic approach to risk as the role of the chief risk officer (CRO) has broadened. Fintechs would do well to evaluate risk the same way — and not wait until after they scale, or after a major scandal has damaged their reputation. Regulation, when managed effectively, can be a competitive advantage.

3. Partner to acquire customers

Though fintech startups might offer customers more convenience and lower fees, they won’t necessarily find it easy to acquire customers. Consumers are significantly more risk-averse when it comes to financial products than they are about social media or ride-sharing apps, and being the newest kids on the block doesn’t always work to a fintech’s advantage.

Plus, though trust may have eroded since the financial crisis, established banks are already meeting the challenge of digital convenience, and have strong brand recognition which gives them an advantage when acquiring customers. All this adds up to high customer acquisition costs for new players looking to scale.

A study released in October 2017 by Blumberg Capital found that American consumers are ambivalent when it comes to big banks versus fintechs. Among the findings, 57 percent of consumers have a positive view of fintech startups, but 24 percent prefer a traditional bank and want to avoid the risk of fintech solutions entirely. 68 percent believe that banks are trustworthy and serve a customer’s best interests, while 76 percent worry about security with online banking and payment services.  

In many ways, it’s simply a question of numbers: even the most successful fintech startups see their user bases dwarfed by those of banks. As of last year, for instance, TransferWise had 1 million users, an impressive figure for a young company. But JPMorgan Chase had almost 50 million digital users, and Bank of America almost 35 million, according to Tearsheet. For most fintech startups, partnering with banks and other players is simply going to be the fastest and most efficient way to scale up.

Technological disruption in most industries is inevitable, and there’s little doubt in my mind that fintech has a bright future. However, that future doesn’t have to come at the expense of traditional banks, which have their own resources and expertise to offer up-and-comers. By learning from each other, fintech firms and banks can work together to help the finance ecosystem evolve.