Fintech: the revolution delayed
The ‘fintech revolution’ has been delayed for nearly a decade
The anticipated impact of fintech has not been as great as first anticipated.
In the heady beginnings around 2011, many banks worried about the prospect of nimble fintech firms ‘eating their lunch’.
Between 2011 and 2019, venture capital and others invested billions of dollars in funding into fintech firms. (e.g $51.3 billion in 2014 grew to $135.7 billion in 2019) [source: https://home.kpmg/xx/en/home/campaigns/2020/02/pulse-of-fintech-h2-19-global-trends.html ]
Over the same period, many of the biggest banks invested heavily. They created dedicated digital business units; distinct innovation teams; and corporate venture capital units (and sometimes combinations of all three).
While some of these new units and teams had success stories to tell, the net effect up to the end of 2019 was not revolutionary. Successful collaborations between fintech firms and banks have been rare.
There are complex reasons behind this, including differing technology stacks and different attitudes towards risk. Often banks and fintech firms have conflicting incentives - to either embrace innovation and change, or to shy away from it.
I have been fortunate in my career to have been on both sides of the ‘fintech divide’ - between banks and fintech firms. I spent a decade working on innovation and new ventures within banking. Followed by a further seven years working with fintech firms around the world. I have experienced first hand the subtle (and not so subtle) barriers to effective innovation in banking.
Despite the challenges, I have also seen the power and magic of getting it right, seeing new technologies adopted within a bank, and deployed into the wider market.
Done right, fintech and bank collaboration can combine the best from both worlds, and create better outcomes for bank customers, processes and people.
This note is intended to be the first in a series, where I will share my experience and the some of the things I’ve learned along the way about maximizing the odds for successful innovation in banking. And further, why I believe that we are reaching a ‘tipping point’ in banking, where we will see the tremendous potential for positive change from fintech finally become reality.
The 3 stages of banking innovation
Banking is a fascinating industry, with a great deal of complexity that is generally hidden from its customers. Banks are a key component of any country’s economy, and the largest banks around the world that operate in various geographies impact the global economy (as we all learned in 2008).
Underlying this complexity is the need to manage risk. This is of many kinds, from credit risk (will the people who the banks lends money to actually pay it back), to system/IT risks (will the bank’s records and systems be accurate at all times); and many others. The need to manage risk within the banking sector has led to a great deal of regulation, from governments and central banks. Regulatory compliance is one of the biggest cost drivers in banking, and has even led to the rise of sub-sector (‘regtech’).
This complexity and risk creates a great amount of ‘risk aversion’ within banks. Systems and processes are built up over many years to manage the inherent risks in banking. There is an understandable reluctance to make changes, especially in core areas. (See the great primer on risk management inside banks by Graham Seel here).
In this environment, generally the only people within a bank with the formal power to make changes are very senior - C-suite and their direct reports. Everyone else is expected to follow processes and rules laid out for them by others.
The risk-averse climate created by this reminds me of a great quote from Winston Churchill: “where you stand {on a given issue}, depends on where you sit”.
If you sit in the middle management of a bank, change is often to be feared and/or resisted; if you sit in the top levels of leadership, change is something you need to embrace, but also manage.
Leaders within banks are charged with responding to changes in their market, changes in technology, and even changes within the broader society. They need to be seen as responsive, and as having vision and direction for their organization. But they also need to be seen as managing change responsibly - they need to avoid bringing the core capabilities of the bank into question.
This can create tension between top management (who espouse change and using latest technologies) and middle management (who have to deal with any fallout if change does not go well).
The end result of the above tensions was summed up into a story I heard many years ago, describing the three typical stages of any innovation project within a bank:
Stage 1: “It will never work”;
Stage 2: “It might work, with a small group of customers, in a limited way, but it will not have a big impact”; and
Stage 3: “I supported it from the start”
Many bankers hearing this story respond with a wry chuckle. They have often seen and lived through similar experiences with new ideas during their banking careers. It may seem a bit cynical, but the 3 stages model reflects the reality that innovation within banking is difficult. Everyone wants to be associated with successful innovation (stage 3), but are cautious about any change at the start (stages 1 & 2).
Getting to Stage 3: how the evolution of the fintech industry is opening up a way forward for banking innovation
Fintech firms have evolved a lot over the past 7 years, moving from a sometimes exaggerated bravado (“banks just don’t get new tech, and fintech firms will disrupt them out of business”), to a more realistic understanding of the challenges within banks, and the constraints faced by those who work within them.
At the start, there were hundreds, then thousands, of fintech firms all offering solutions that seemed to solve a real problem faced by banks. But often on further engagement and deeper exploration, banks found that the proposed solutions did not always deliver as promised, and even when they did, they sometimes introduced new kinds of risk for the bank. Outside of the technology solutions themselves, another risk was that the fintech firm(s) they were working with could go out of business.
There has been a steep learning curve on both sides (banks and fintech firms). While this was happening, the expected fintech revolution was delayed. Much has been learned by all players over this period, and this is reflected in changes in the structure of the fintech industry:
While the total amount of funding to fintech firms continued to grow, since 2018 it was increasingly into larger, more established fintech firms - bigger investments into bigger firms, and less into pure startups;
Over the same period, there was consolidation within the fintech industry, with some larger firms buying out smaller ones; and
Growing collaboration between fintech firms, including new platform business models. These involve multiple fintech solutions working together, orchestrated by a leading player. The leading player behind such a platform could be a large fintech (e.g. Backbase); or a core banking system provider (e.g. Temenos, Mambu, etc.); or even a 3rd party with significant risk management and technical expertise.
The fintech industry has evolved, with both larger players and (more interestingly) technology platform providers. This has to some extent mitigated the risk for banks exploring and testing new technologies.
Leaders within banks today have a more defined set of options to explore, within a (generally) more robust risk-management framework. Banks have also become more sophisticated, linking their fintech projects and strategic agendas.
Together, these changes in the industry have increased the odds of successful innovation. This is where fintech solves meaningful problems for banks and/or their customers.
The promised fintech revolution is finally poised to become reality…if there is enough demand for change from customers. More on this topic to follow!