The banking industry has bought into the negative narrative that, in order to survive, traditional banks need to replicate the experience offered by fintechs
By Eric Bierry
The banking industry has bought into the negative narrative that, in order to survive, traditional banks need to either replicate the experience offered by fintechs or launch neobanks of their own. These aren’t the only–or even the best–options, however.
To be clear: Fintechs will outpace traditional banks. By reimagining the banking experience, these companies are increasingly becoming the main point of contact for end-customers, for everything from lending money, opening bank accounts and making payments.
They’re able to appeal to and engage consumers with easy-to-use digital interfaces and social media savvy. They’ve tapped into consumers’ need for increased transparency and informed decision making. And they often offer a compelling mix of low interest borrowing and high interest savings options (perhaps as a loss leader to encourage new account creation).
On top of all of this, they’re innovating faster than incumbent banks, as they’re not legacy IT systems or regulatory requirements.
But this strength is also their weakness. And it’s where traditional banks can step in and redefine themselves. Rather than scrambling to introduce digitally savvy user interfaces that help them appear more like fintechs, banks can solve a massive problem for their competition: Fintechs lack the backend infrastructure and industry experience necessary to replicate what traditional banks do.
The real opportunity for banks and fintechs is to each do what they’re good at. For banks, this means transforming the aspects of banking that fintechs can’t offer into new revenue streams and a new business model: Banking as a Service (BaaS).
What fintechs lack and how banks can fill those gaps.
The vast majority of fintechs and neobanks are in no position (now, nor in the near future) to offer a full set of traditional banking services. They’re in the customer service and technology business. Banks, on the other hand, are in the funding, lending and regulation business.
Issues arise when these technology companies seek to offer traditional retail banking services, such as mortgages, personal loans and credit cards. Doing so requires a banking license in each country of operation, and sometimes even at the state level in the U.S. While a fintech can apply for its own banking licenses, the process is timely and expensive.
There are also issues around capital and regulatory requirements, cybersecurity infrastructure, a lack of brick-and-mortar presences, and other critical infrastructure that banks built during their 100+-year head start.
Through a Banking as a Service model, incumbent banks would provide fintechs with what they need to be fully functioning banks, including their banking licenses, infrastructure and expertise. This would free up fintechs and neobanks to focus on consumer experience and innovation, rather than navigating funding, lending and regulations.
The challenges–and opportunities–for banks if they take on the role of middleman.
Of course, this approach begs the questions: As the rate of fintechs engaging with end customers rises (with the help of BaaS), will banks be disintermediated from the financial services value chain? And will they ultimately cease directly communicating with customers?
The answer to both questions could be a resounding yes, particularly for smaller regional banks already struggling to compete in the market. For these incumbents, their future may rely on BaaS in order to survive.
BaaS is incredibly scalable and profitable for banks if the right infrastructure is in place. According to some estimates, by 2025, European revenues for BaaS would amount to $60-$80 billion, reaching $300-$350 billion by 2030. This equates to between 20% and 25% of the total banking income in Europe. Essentially, huge profits can be earned by those banks able to offer BaaS services.
To transform their models, banks will need to transform their systems.
While the BaaS model is a viable one, offering BaaS services will not be without its challenges, considering that traditional banks’ core systems are often outdated and incompatible with third-party integrations.
Banks will have to accelerate their digital transformation strategies and modernize their existing architecture in order to profit from a BaaS service model. Many are already investing heavily in technology, but many of their current investments are geared toward competing with fintechs and neobanks. Their technology ambitions will need to change with their business models.
There is little confusion over the decision to enter the digital ecosystem, however. Most banks realize that digitally transforming is key to opening new revenue streams. According to the Forrester and Sopra Steria report “Master Ecosystems: To Be Future-Ready In Banking,” 82% of banks claimed to have plans to invest in business APIs to better connect to partners digitally. And an additional 32% said that improving business and technology integrations with their partners was actually their number one priority.
Banks will fuel the “bankification” of other industries.
Supporting fintechs and neobanks is the first and most obvious stop for banks, but as soon as they’re set up to offer Banking as a Service, banks will fuel the banking ambitions of other industries, too.
Banks are already working with manufacturers and companies across traditional industries such as automotive and real estate to offer direct lending, financing and other services. Imagine, for instance, an auto manufacturer providing lending and subscription options directly to consumers. Or even financing the loans their dealers need to purchase their fleets, all through a DIY interface that integrates with their inventory, supply chain and back office. This reality is here.
As banks narrow their focus on BaaS, other industries will embrace the new customer experiences and revenue opportunities these new banking services open.
Contrary to the current narrative, traditional banks have the power to dictate the trajectory of a growing sector of the financial services industry, and many other industries to follow.
Shifting their focus from competing with fintechs to supporting them will set new and old banks down a path to redefining banking together.