In conversation with bankers and start-up executives, it is clear that there is a differing view of the world. It is not as clear-cut as nimble innovator versus dinosaur incumbent, which is how many portray this chasm of difference in thinking, but there is a difference in thinking. In fact, it’s a radical difference in thinking, perhaps best summed up by one banker who said to me recently, “Surely this is Techfin rather than Fintech.”
I thought about what he meant and realized that this is the subtle difference between the innovator and the incumbent. An innovator thinks of financial innovation as Fintech: taking financial processes and applying technology. Incumbents think of this as Techfin: taking technology to work with financial processes. This difference in thinking, although subtle, does create a very different thought process and output in terms of the way in which technology is used, and so I thought I would delve a little deeper, as this is a key to seeing how the world differs between the innovators and incumbents.
First, the start-up Fintech firm, which looks at the world through the eyes of a technologist. This means that the start point is technology. Apps, APIs, analytics and more are the foundations of their thinking. Open source, open operations and open thinking lie at the heart of their culture. Embracing diversity, working globally and no reference offices or structure are the tools of their skillset. And seeking a mentor, an angel and an investor represent the base capital requirements to get them started.
The start-up starts with thinking about how technology could transform financial processes. This means that they take something that exists – loans, savings, investments, payments and trading – and think about how they could reinvent these processes. Peer-to-peer (P2P) lending is a good example. When Zopa started in business in April 2005, they told me about their business model and it sounded weird, to be honest. “We’re an eBay for loans,” they said. “You give us your money and we lend it out on your behalf. You get better interest on your money than you would with a savings company, and people pay less for their loans. Want to invest £10,000?”
No way, as it sounded crazy. An untested, unproven business that would take my investment and manage the risk of lending that investment to borrowers? An eBay for loans? That’s start-up thinking. A decade later, that start-up is taking over £1.2 billion in funds from over 53,000 consumers to lend at the most competitive rates in the UK. In fact, the start-up P2P model is so popular that it’s been copied worldwide, with the U.S. being one of the fastest growing markets, where over $8 billion has been lent, doubling year-on-year. It is why Lending Club had one of the hottest initial public offerings of 2014, followed up by SoFi receiving more than $1 billion in investment in their latest funding round.
These are significant numbers, but nowhere near as significant as the forecasts being made by banks like Goldman Sachs and Morgan Stanley. Goldman Sachs predicts that almost $11 billion of bank profits from lending will move to the new start-up social economy by 2020 – about 5% of the current market – while Morgan Stanley estimates that global marketplace lending should reach $290 billion by 2020, with a compound annual growth rate of 51% from 2014-2020, with China and America being the two largest markets.
And this is the key to the Fintech thinking of the innovators: how can we take an existing market with a middleman and replace the middleman with a technology intermediary? That is what Bitcoin is focused upon – replacing the bank with the internet for value transfer; it is what new trading schemes like T0.com focus upon – replacing the stock market with the blockchain; and it is what firms like TransferWise and Currency Cloud believe – replace foreign exchange markets with P2P connectivity to enable money to move.
There are many more examples; the rapidly growing and disruptive Fintech scene is hot because it is all about using technology to transform financial processes. The incumbent thinking of the Techfin is very different.
Fintech start-ups begin with thinking: how can I transform this financial process using technology? Banks begin with thinking: how can I apply technology to this financial process? The core difference is that banks think Techfin rather than Fintech. They begin with their existing operations and wonder how to improve those operations with technology. It’s a very different mindset, and works differently in different markets.
For example, an investment operation in the capital markets space or a prime broker are far less fearful of ditching existing technologies and reinventing their operations than a large retail bank. This is not surprising, as an investment bank is competing in an ultra-cut-throat marketplace, where technology has been the competitive differentiator for some years. Take the rise of high frequency trading using low latency technologies, and you can see a completely restructured capital market that has been transformed by technology in the last decade. Compare this with a large retail bank with millions of customers whose primary focus is safety, reliability and stability, and you can soon see why retail banks are stuck with legacy technologies while their investment bank counterparts are running at light-speed.
So, you cannot view the banking marketplace as some homogenous structure. However, at a high level, it is certainly the case that investment banks think far more like Fintech firms than retail or commercial banks. The majority of the large retail commercial banks have a challenge that is very different to the Fintech firms and their investment counterparts, and that is how do you transform a business where the customer expects no risk and minimal change?
This was well illustrated to me by a conversation with a digital bank leader who explained that each time they change their mobile app, they get more complaints from customers than compliments. Customers don’t like change, especially in their bank. Change implies risk, and general banking should avoid risk in the eyes of both the bank and their customer. As a result, customers are generally reluctant to switch banks and do not expect their banks to switch the systems they use. Change the website design, add more mobile functionality, restructure the operations and, if any of this is visible to the customer, they scream “Foul!”
This is why so many retail and commercial banks find they are exposed to negative publicity if they close a branch, charge a fee for improved service or upgrade their systems. Any fault, glitch or failure gains headlines of gloom. Any downtime, lost transaction or missed payment results in regulatory review.
Hence, the Techfin firm has to focus upon technology improvement rather than total transformation. Techfin firms cannot think like Fintech firms because their customers don’t want them to. This is why Techfin firms – the incumbent banks – are not dinosaurs or technology deniers, but purely pragmatists who are improving their operations with technology rather than trying to disrupt and transform them.
Mr. Skinner is chairman of the Financial Services Club, comments on the financial markets through his blog the Finanser, and is the author of Digital Bank and the upcoming ValueWeb. He can be reached at firstname.lastname@example.org.