It is difficult to conceive a reality where banks stand redundant and, while the probability of such a happening is highly unlikely, a large number of individuals globally are adopting a new set of expectations for the infrastructure that supports their pecuniary activities on a p2p, p2b level, e-commerce, or for cross border transactions.
Consumers are also becoming noticeably more independent when it comes to their financial decisions. Even in terms of advice from financial services firms, they don’t want to talk face to face with an advisor but they want to feel special & have the ability to switch seamlessly between personal and hands-off options. These are no meager demands to place on a traditional bank whose entire infrastructure requires significant investment in data and analytics capabilities (McKinsey) to support these demands. As Eli Broverman, Co-Founder and CEO of Betterment explained “In some cases, investors want to self serve, but they want to self serve in a different way than they have traditionally self served. They want that advice in a digital format.”
While the focus seems to be on convenience, professionals in the sector indicate that the fundamental driver in consumer behavior is, in fact, cost. Jandir Matos, Founder of Gooseberry MX, a business lending platform based in Mexico, says that, “speed and ease of transaction is not a priority over cost. Transferring money, for example, from one friend to another will not go through PayPal if there is a possibility to do it at a lower cost; i.e. other technologies.” Matos further argues that, “users’ expectations are increasing in terms of speed of attention, ease of transaction and pricing; while maintaining security issues. Faster payment processing will be accepted as long as it does not translate into a higher fee or lower quality. Speed in service will not be a priority over quality of service.”
It is in this quality and security that Matos sees the continuity of the physical bank: “People do recognize, as a setback, the time it takes to go to the branch or to use traditional banking channels, however many of them still think that’s the more secure way to do it.”
Digitalization of channels has increased the demand for quality services. A few years ago anything could be solved through a visit to the branch; now that people have a choice in doing so by telephone, chat, mobile banking, so on and so forth, the demand for quality at a lower price is skyrocketing. The financial consumers’ habits have radically switched from a fiduciary relationship with their financial intermediaries to transparency-based engagement. This change has deep implications for the financial sector, as individuals are more in control of their financial decisions and favor highly-specialized, fully transparent service providers.
For the traditional banking institutions, these services continue to be high margin, low efficiency services which create a space for innovative fintech companies to make greater headway in establishing themselves as alternate, credible and cheaper alternatives. And due to their specialized infrastructure and innovative technology, have the ability to provide these services in real time at more affordable prices.
Irfan Khan, CEO of UK based real estate investing portal, Yielders, talks about how it’s no longer about ‘Fin’ but about ‘Fintech’ in addressing how Yielders addresses the demands of clients and partners on providing fast, secure and transparent transacting infrastructure: “Historically there would need to be a settlement office to deal with transactions, not to mention the audit team who would be called in to find any anomalies in the transfers. As the years pass by, the demands from clients increase; the demand for faster, more reliable and secure payments is increasing. Traditional operations of money transfer will not cut it in the new age of FinTech.” Khan points towards three core aspects that they needed to address to stay in the now and relevant: Security, Automation and Reliability.
In fact, today’s consumers increasingly expect their financial firms to offer innovative products, be readily accessible via social media, and deliver a multi-platform experience that measures up. It’s no wonder young financial technology trailblazers are expected to impact over 80% of the traditional firm’s customer base as they democratize finance and provide new investment and advisory solutions. As Bill Sullivan, Head of Global Financial Services Market Intelligence at Capgemini shared, “The challenge is the acceleration of disruption is happening at a faster pace. [Disruptors] are setting expectations higher and they continue to raise the bar day in and day out.”
Essentially, the traditional banking channels are finding it difficult to keep up with the current pace of disruption. It’s a constant race to lower margins and achieve efficiency but a path that requires a degree of risk taking that these institutions are not traditionally accustomed to taking. Fintechs, on the other hand, thrive on this high risk model because that is their ticket to the party, in the absence of scale and brand name. This is exemplified by Swedish player Klarna, who enables online merchants to receive payment guarantees in real-time with an email and zip code from a consumer. In all cases, Klarna pays the merchant and assumes the full risk (McKinsey).
In terms of making the most noise at the ‘party’, it’s the payments sector that continues to lead the way in terms of attracting competition from alternative financial service providers. To a large extent, this has been an area marked by high costs and user experiences characterized by complex and inefficient processes.(Deloitte) The challenge is that most of the global payments infrastructure (e.g., clearing houses) leveraged by incumbent players (mostly banks) still operates on systems designed to accommodate the demands of the pre-digital era (McKinsey). PayPal was one of the original pioneers (disruptors) in this sphere and now boasts 188 million active accounts worldwide. Kenya’s M-Pesa is a prime example of disruption highlighting how strong consumer sentiment is for cheaper higher quality service. This mobile payment method was introduced in 2007 by a leading mobile operator, offering a simple process where anyone using basic cell phones can transfer money nationally via text message and can redeem that transfer via franchise based network of Pesa agents. M-Pesa has gained so much popularity and traction that 43% of Kenya’s $US 40 Billion GPD is processed through M-Pesa as of 2013, 6 years after launch (Deloitte). Now, that’s what I call disruptive.
While banks have always faced attackers, history is a testament to the idea that most startups will never gain solid footing. During the dot.com boom of 1997 to 2000, fewer than 10 of more than 450 payments startups survived, with PayPal being the most notable. However, both McKinsey and Deloitte suggest that this time is different; traditional banks are competing against the world’s largest and most valuable tech and social media titans: such as Apple, Google, Facebook, Amazon, Microsoft, Tencent and Alibaba, that already have loyal and highly engaged user bases, are integrated into many aspects of their customers’ lives, and have vast cash reserves. This is complemented by being the era of the ‘digital native’ (i.e. consumers born in the digital era, post 80’s) hence, posing a new challenge for banks looking to tackle the challenge of disruption. Consumers are quicker to take notice and evaluate these newer options as credible avenues for transactions while these institutions are able to reap value from the existing payments value chain and upend pricing models by providing payments services either free or for significantly below-market prices (McKinsey). This enables them to gain market traction in the payments sphere a lot faster than a purely transactional entity.
The digital natives that are facilitating this disruption no longer consider traditional financial service providers at the front of their minds for solutions to their financial needs. This sentiment is echoed by consumer brands as well who become the sounding board for consumer sentiment due to their middleman status in facilitating consumer expenditure. According to Jordan Lampe, Director of Communications at Dwolla, “Consumer Brands are just starting to realize as they wade into the FinServ space is that they're just as handcuffed to the outdated infrastructure as the banks and credit unions are. These constraints limit the Brand's ability to continue consuming aspects of the financial service space while delivering the expectations they've set with the consumer. That's why FinTech is so special right now. We're either bridging the helping modernize today's infrastructure, like what Dwolla is doing with bank transfers, or collaborating with stakeholders to create new ones."
To succeed, financial institutions will need to dramatically increase their customer insights and understanding allowing for a tailored and unique experience for each customer interaction. As customers grow accustomed to faster and more convenient payments on the retail side, they will soon demand similar conveniences and service levels in transaction banking as well (McKinsey). As consumers grow accustomed to the benefits of using technology in their daily lives, their expectations also grow. Nonbank digital entrants have used superior design and user interface to build solutions that often surpass consumer and merchant expectations in terms of end-to-end customer experience. By integrating payments into commerce, nonbank attackers have created more seamless, personalized and interactive experiences, contributing to increased conversion rates (McKinsey).
The one aspect that the traditional banks have in their favor is the vast amounts of data being collected and stored, which banks can use to develop insights on consumer behavior and maybe even get ahead of the curve. As of now though, it’s a catch up game; Banks’ core platforms will need to be updatable in real time, fraud platforms and processes will need to be very near real time, and clearing systems must be capable of handling exchange of information, posting of transactions to the customer and funds availability all in real time. Or face being left behind in this new form of disruption the industry is facing.
Further information on this disruption can be found at:
McKinsey & Company. Global Payments 2015: A Healthy Industry Confronts Disruption.2015
Deloitte. Digital Disruption: Threats And Opportunities For Retail Financial Services. 2014.
Adit Vaddi is a business development associate with a Bachelor of Arts in Economics from Vassar College, New York. He has a background in Economics, Accounting, Political Science and Operations (Event Management). He is from Hyderabad, India. Prior to Crowd Valley, Adit has worked as a research analyst for Baring's Private Equity Partners in Mumbai and for the IdeaSpace Foundation in Manila as well as a risk analyst for Fincare in Bangalore. On the operations side, Adit has organized and run over 30 large scale events that cater primarily to a college community. He is currently based in New York City.