The Ongoing Debate: Are FinTech Startups Really Disrupting Banks?

A research report by Goldman Sachs in 2015 estimated that a part of the traditional financial services’ revenue ($4.7 trillion out of $13.7 trillion) is at risk of being displaced by new technology-enabled entrants, which include FinTech players from lending, wealth management, payments, and others. But we have a debate wherein some entities (basically big media houses agreeing with each other) think this disruption is exaggerated, and some think it is more real than it looks. And in this debate about "breaking banks," some players are old-timers—such as Brett King. He said in an interview recently, "I just don’t see any scenario where we don’t lose the vast majority of banks globally under $1 billion in assets unless they’re a pure-play digital bank. Certainly, we’ll see massive consolidation in community banking in the US. All because of digital disruption."

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I think the threat of FinTech is more real than ever before for banks. And the reason for that is not only what FinTech startups are building (as a threat), and consumers are loving, but the fact that banks have ignored consumer demands for too long, and their legacy infrastructure needs tremendous work to be fixed. A handful of banks in each FinTech hub have responded to the Fintech challenge by doing one of the following: work with startups by having some sort of an engagement model (startup contests, hackathons, incubators, accelerators, and investments), but the work on core transformation, reimagining banking services and competing truly on the digital front is slow or not enough. Consumer finance, mortgages, small-business lending, retail payments, fund transfer, and wealth management are the critical subsegments expected to face a big attack from the innovators. This article looks at the key highlight areas which FinTech is disrupting.

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Retail Banking

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The effect of disruption is very high across the banking sub-sectors. However, retail banking has been hit the worst by the emergence of FinTech. Retail banking segments such as lending, remittances, and payments have undergone disruptions. Thanks to the millennials’ habit of using mobile devices, the infrastructure supporting retail banking such as bank branches and ATMs is also transforming. It is considered just a matter of time till the rising cost of operating branches and improving online sales will lead to the closure of more and more bank branches. ATM and mobile devices are expected to become the critical channels for consumer engagement. Banks that are not digital are also at the risk of losing customer relationships.

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Furthermore, on the products side, emerging FinTechs such as Lending Club, Prosper, Abra, Apple Pay, Android Pay, among others, are expected to eat a significant portion of revenues. According to an estimate, close to 20 to 30% of the retail banking revenues will be at risk from FinTech disruptors by 2020. Over 1,500 and 2,300 investment deals in the retail banking/lending and payments segments, respectively, have occurred for the last 10 years. About $17 billion in loans were provided in the US through P2P platforms in 2015, while the mobile payments in the US were worth $60 billion in 2015.

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Corporate Banking

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Though some banks have established a digital presence, the banks are underinvested when it comes to corporate banking. The disintermediation of corporate banking seems to have a lasting effect on the bank. When it comes to working capital management and SME loans, firms such as CAN Capital, On-deck, MarketInvoice, Fundbox, PayPal, Square, etc., have gained significant traction. Together, these firms lent more than US$ 12 billion in SME credit in 2015. Business payments are another significant disruption in this space. Last year, KeyCorp Bank invested in several payments-related startups, understanding that commercial clients wanted their payments process streamlined. Blockchain and IoT solutions to improve trade finance have also gained some traction in the market. Recently, Barclays partnered with Wave, a blockchain-based trade finance startup, to help business clients reduce costs associated with supply chain management. Over $12 billion in loans were financed through online lending platforms in the US in 2015. A study by BCG on shadow banking suggested that various shadow banking players are now providing roughly 25% of US middle-market lending.

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Investment Banking

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The investment banking sector has undergone a sea change in the last couple of years primarily because of the advent of FinTech such as robo-advisors, social trading platforms, market funding platforms, and market data and sentimental analysis service providers. In the social trading space, startups such as ZuluTrade and Stocktwits have seen good traction. These platforms act as a communication platform for the investing community, which uses information from tweets as cues for trading. The market-funding platforms are occupied by small and large crowdfunding firms such as Kabbage, EquityNet, Crowdcube, Fundable, Kickstarter, etc. The market data platforms are occupied by firms that mostly use sentimental analysis and big data analytics to track the market movement. Some of these firms are B2B firms, while others provide direct services to end customers. Companies such as Heckyl Technologies, SumZero, Contix, and Kensho offer services such as the ones listed above. Assets managed by robo-advisors are estimated to increase by 68% annually and about $2.2 trillion in five years. The robo-advisor space includes online platforms such as Wealthfront, Betterment, AssetBuilder, Financial Guard, FutureAdvisor, Jemstep, Personal Capital, and SigFig. These firms develop automated investment portfolios and recommendations for their individual clients. Market penetration of robo-advisors has been estimated at $20 billion in 2015. More than 1,600 investment deals in the securities/capital market and wealth management space have taken place in the last 10 years, while roughly 8–10% of the deals in the US by value happen in this segment.

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Insurance

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InsurTech could happen fast because of the rising consumer demand. The sector is witnessing tremendous support from global investors. Around $4.1 billion has been invested in InsurTech in the last five years. There are around 700–800 InsurTech firms globally that are addressing the requirements of the $4.5-trillion insurance industry, but the state of InsurTech is at a stage of infancy. There were 184 deals in the InsurTech segment in 2014, and 2015 with the value of the deals was totaling $3,391 million. Average deal values in 2014 and 2015 were $9.9 million and $24.3 million, respectively.

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The use of data analytics is a critical differentiating factor between the incumbents and the disruptors. Big data analytics play a significant role in getting 360-degree insights of the customer, forecasting their needs, providing educational training, and assessing their risk parameters to get the best quotes. For example, Shift Technology leverages data science to detect networks of fraudsters in insurance and e-commerce automatically. The solution is integrated into the big data platform and is provided in a SaaS model. Likewise, smart contracts powered by blockchain could provide customers and insurers with the means to manage claims in a transparent, responsive, and irrefutable manner. Startups such as Everledger, Blockstream, and Tierion are working in this direction. For example, Everledger provides an immutable ledger for diamond identification and transaction verification for various stakeholders, from insurance companies to claimants and law enforcement agencies.

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