Fintech start-ups struggle to compete with incumbent banks but the entrance of BigTech companies into consumer banking could spell radical change, Ouida Taaffe reports.
Back in 2000, tech stocks imploded. Many investments that, only a few months earlier, looked viable sank fast. The list of expensive failures is long but there are some stand-outs. The fashion site Boo.com, for example, made headlines as dotcom royalty. It had backing from Bernard Arnault, chair of LVMH; from the Benetton family; from Goldman Sachs; and from JPMorgan, among others. It folded after 18 months, having burned through a reported US$135m.
The Covid-19 crisis has led to a similar shake-out in fintechs. It is not as dramatic as the dotcom crash, but some big names have been tarnished – among them high-profile neobanks. Monzo, for example, announced in its 2020 annual report in August that the pandemic crisis had cast “significant doubt” over its ability to continue as a going concern.
Although Monzo has a big profile, it is a small company. Its annual report said that it had 3.9m customers, revenues of £47.5m and deposits of £1.39bn. To compare, the UK’s largest incumbent retail bank – Lloyds – reported 17m active digital account customers in the first half of 2020 and overall retail net interest income of £4.2bn.
Because competing against the deep pockets and large installed base of incumbents such as Lloyds is an uphill battle for neobanks, the UK financial regulator has done its best to encourage competition from fintechs. (Richard Tomlinson discusses this on p 14 of the magazine.) But the incumbents are not standing still and they are willing to invest – perhaps more so than their challengers – because the stakes are high.
“For an incumbent bank, there is no one answer on tech return on investment,” says Rakefet Russak-Aminoach, the former chief executive of Bank Leumi, an Israeli incumbent, and now managing partner of Team8, a venture capital firm. “Usually, if you don’t make those investments, your chance of surviving is limited. It is not a question of counting when you will get the investment back.”
Who’s afraid of BigTech?
If fintechs are struggling to compete with incumbents and a shake-out in that segment is under way, what poses the more immediate threat to big banks?
BigTech has already disrupted some industries that looked unassailable, including music and publishing. The day when it enters front-end, retail financial services has long been feared in banking. And that day is getting closer. Google is working with eight US banks to launch mobile-first bank accounts within the Google Pay app in 2021. The new accounts will reportedly offer “financial insights” and “budgeting tools”.
In addition, earlier in 2020, the head of Google Finance in the UK placed an ad on his LinkedIn feed looking for someone with “deep industry experience to develop partnerships with the biggest banks in Europe, the Middle East and Africa (EMEA)”.
What does BigTech want?
Google has both the technological know-how and the balance sheet to compete vigorously in many industries. But does it want to compete with banks? And is it the disruptive threat to retail financial services that people fear?
“I think incumbent banks are facing huge disruptions, but I don’t think those will come mainly from BigTech,” says Russak-Aminoach. “The reason for that is that financial services has a lot of very local components, not just currencies and financial governance, but also rules on regulation and compliance that vary from one geography to another. At the end of the day, the regulator in each and every region wants to own the destiny of its financial system.”
But she doesn’t discount BigTech as a coming force in financial services. “I think BigTech will embed fintech into their services as much as possible, as long as they don’t have to deal with financial regulation,” she says. “Financial services is one of the world’s biggest sectors, so there is enormous potential for revenues and for increasing customer stickiness.”
What retail banks face
BigTech, then, has good reason to be a visible presence in financial services – as long as it can avoid the snares of financial regulation. If nothing else, regulation could turn out to be a major headache much closer to home if the recent US Congress report on Investigation of Competition in the Digital Marketplace starts to develop teeth. The report found a “clear and compelling need to strengthen antitrust enforcement and consider a range of forceful options”.
But regulation is not just a burden. The challenges that come with being a regulated financial services provider, particularly working across multiple jurisdictions, provide incumbent banks with a moat. Even when the regulator is on their side, newcomers struggle to compete. Small, new banks, for example, face higher capital risk weighting than incumbents do. The high level of regulation also means that consumers tend to trust banks. However, even if that regulatory, and reputational, moat is formidable, the castle behind it may not be.
“Retail banks face two main trends, both accelerated by the Covid-19 lockdown,” says Antony Jenkins, former chief executive of Barclays and now executive chairman and founder of 10x Future Technologies, a fintech start-up. “First, customers want a beautiful digital user experience. Second, there are cost pressures from low interest rates and rising credit losses.”
Those two together, alongside a generational change at the top of banks, are making the industry “look much more seriously at radical solutions”, says Jenkins. “They see that the only solution is to massively automate the bank.”
Large-scale automation and radical technological solutions are required at incumbents because of their legacy technology. “Even when incumbent banks have a great front-end digital experience, it is a skin over a pile of software patches built up over many years,” says Russak-Aminoach. “That is why it is so difficult for them to innovate.”
But the industry has been talking about the need for banks to get away from clunky legacy systems for a long time. Has it finally reached a tipping point when old systems will be discontinued? It may have. Thought Machine, a company that provides core banking software, announced an £83m
funding round in March 2020. It is increasing its headcount and said recently that the former chief operating officer of HSBC, Andy Maguire, would be joining it as president.
Meanwhile,10x Future Technologies has “only seen the number of inquiries” from banks increase during the recent lockdown, Jenkins says. “That is pretty much from everywhere, with slightly less demand from continental Europe.”
What BigTech can do?
BigTech companies do not have legacy back-end technology to overcome and they are, in any case, agile innovators. So, if Google were to enter the EMEA retail banking market with a Google-branded current account, what would that mean for EMEA retail banks? One argument has it that banks will become back-end utilities providing regulated banking functions behind a Google app.
“Will banks become utilities behind the financing offers of big tech platforms?” asks Paul Gordon, managing director SME and mid corporates within the commercial banking division of Lloyds Banking Group. “I think the way forward is for banks to do what they do really well, which, at its core, is to provide liquidity and payments. Banks can build a network with fintech partners who can help them do that brilliantly. Similarly, big tech companies should do what they do best and they probably won’t want to expand their brands into many areas of retail and commercial banking, such as supporting customers in financial difficulty, or arrears, or debt collection.”
Jenkins says: “The business that banks will be able to hang onto is balance sheet business, which is capital intensive and highly regulated. The danger is that they get stuck with maintaining the rest of the infrastructure they used to need, such as branches.”
How much of a drag on profits a branch network can be is suggested by the symbolic €1 offer that investment firm Cerberus is reported to have recently made for the French retail arm of HSBC. The firm is also said to have asked HSBC to invest €500m into the 270-branch business. Banks did not bid for the retail network.
BigTech companies, then, will likely cherry-pick the services that can be digitalised and offload anything that requires more intensive, and potentially contentious, customer engagement. But can BigTech do anything that banks cannot?
Jenkins points out that the fundamental products in banking are as old as time. “The biggest driver [for a new entrant] is how to make the customer experience materially better.” He adds that the banking industry over the years has not been deeply focused on the customer.
“It was much more on the manufacture and sale of products,” says Jenkins. “And most of what they do is just providing data – for example, how much money is in a current account. It is possible that BigTech could create a layer of value to the end-customer by placing themselves between the bank and the consumer.” That is not a new approach, he adds. “PayPal was set up to sit on top of the banking system.”
Many banks – both the incumbents and their fintech challengers – already offer a slick front end. How much of an inroad can a new current account app make, however good?
“If you can see a person’s entire financial life, you could provide them with optimisation for many services, offering to switch to better deals in other sectors,” says Jenkins.
And banks do have important factors going for them. “Financial data is an enormous advantage for banks,” says Russak-Aminoach. But they need to be able to use it to offer a personalised product, she adds.
BigTech, in contrast, lacks direct access to financial data, but can offer very personalised service, based on many different data feeds from one consumer and on a deep insight into the market overall. Google, for example, owns Google Nest which offers “smart home products”, including thermostats, speakers, doorbells, cameras and locks. All of those devices gather data – data that could be used to optimise other services, including financial offers.
But banks, too, can access a range of consumer data and the use of so-called “alternative data” is rising. How useful that “alternative” view can be has been shown by the Covid-19 crisis. Reuters reports that UK banks are using trends in internet searches, alongside traditional credit and payments analysis, to help them update their credit models. Online searches and social media feeds give the banks real-time and potentially forward-looking information on consumer sentiment. Their historical financial data, in contrast, is very detailed, but it only gives them a view of how things were before the crisis.
But getting to a point where banks utilise data as well as the BigTechs do could be a long road. “Mastering the technology is not beyond the ability of most banks,” says Jenkins. “The problems are much more about culture, about the fear of the unknown and about the ability to move forward.”
At the same time, consumers associate BigTech with excellent service – partly because it is constantly innovating. They do not tend to have a positive view of dealing with their bank. “For most people, managing their money is a challenging, somewhat tedious, activity,” says Jenkins.
He believes people will want financial apps to make life as easy as possible for themselves. That, potentially, could mean they only use one banking app, if they are willing to feed the app with all the necessary data via open banking. “Open banking is predicated on the idea of consolidating data,” says Jenkins. “It all comes down to ‘does it make the customer’s life easier?’.”
So, could a BigTech such as Google become the go-to front end for most retail financial services, or will the digital experience remain fragmented? I’m not sure I know the answer,” says Russak-Aminoach. “I think it will be fragmented, but not as fragmented as today. Acquiring customers is very expensive, so a one-product offer makes little sense.”