Don’t compete with Fintechs; Build your business on top of them

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The financial industry is not new to innovations. As the human civilizations became more and more sophisticated, there was a need to create new financial products to serve the ever-evolving requirements of these complex societies. Technology in the financial sector is also not new and is around for a few decades now. Machine readable cheques, automated data processing, automated teller machines and electronic payment systems made banking easier, accelerated innovations and gave rise to various new financial products in the second half of 20th century. But the proliferation of Fintechs in last decade or so has been driven mainly by the advancements in software and internet. Given that financial services are made up of non-tangible goods (unlike automobiles, oil, housing, pharmaceuticals etc.), the financial services industry is most vulnerable to the disruptions in information technologies.

A question that is heard quite often these days, in the banking corridors, is: “are Fintechts going to replace our traditional financial institutions?” In B2C space at least, this is a real threat. As technologies progress a lot of new services, that were not possible earlier, could be made available to the end customers. Take for instance P2P lending. Given technological limitations, it was not possible to process P2P or crowd funded loans 10-15 years back. Technology has now made this possible and has given rise to a completely new sector. Till now no established bank features in the list of top P2P platforms. So is it that the banks were too slow? No, not really. Clayton Christensen in his Disruptive Innovation Framework mentions that established organizations are normally engaged in ‘sustaining innovations,’ that help them succeed, in their existing market segments. ‘Disruptive innovations,’ on the other hand, serve altogether a different segment of the market when they are unveiled. But soon enough the trajectories of these two market segments cross each other. So yes, as markets progress and the growth trajectories of traditional financial institutions and new Fintechs converge, there is a real threat that the old established businesses will lose some ground.

However, we also need to realize that the main strength of existing financial institutions is their Risk Management capability. Whereas all industries, including Fintechs, are subject to certain risks such as operational or reputational, here the risks to be managed by financial institutions are credit risk (i.e. defaulting on debt payments or counterparty risk) and market risks (e.g. exchange rate and interest rate volatility) that they are most exposed to. Through years of experience, these established industry players have learned who would be a good customer and who would default or how the financial markets may move in the next months. Although in future, every company needs to be a technology company (given how fast technology is penetrating our lives), financial institutions should try to build a business model on their core strength of risk management and leverage the technological breakthroughs by integrating Fintech products in their offerings.

Let’s take an example. I work for an international bank in the credit cards business area. Our business is heavily dependent on two Fintechs: Mastercard and Visa. Yes, as surprising as it may sound but Mastercard and Visa are indeed Fintechs. They don’t issue credit cards directly. As the bank we do that. Mastercard and Visa provide infrastructure, channel and network to process payments. If a customer defaults, it’s the Bank who has to bear the most brunt. But the whole system is a win-win for all parties involved. Customers get the convenience and credits, Mastercard and Visa fees for processing payments, and the Banks charges issuing cards and interest on supplied credits.

Financial industry innovators need to build a business as an aggregator of various technology platforms provided by Fintechs. From big banks such as Unicredit planning to launch its ‘molecular’ Buddybank to startups such as N26 successfully testing the idea in Germany, we have ample examples. Today’s Fintech boom is neither a threat nor an opportunity. It’s just a logical next step as a result of advancements in software and information technologies. Will a financial institution survive or perish would depend on how prepared and open the organization is to adapt to changes and act as an integrator of available technologies.