The Art of Transformation: Will Banks Keep Up?

The Future of Financial Technology

Fleur van Nes, Roy Koning, Ruben Jan Rietman

February 2017

In the 1990’s, people used checks and money order to transfer funds from bank account to bank account. But then came PayPal[1], perhaps the best known financial technology (Fintech) [2] firm in the world, and set a completely new trend. Now people are able to transfer large sums of money online at a fraction of the cost. However, it has not always been like this, in Ancient history, as far back as the Medicis, Fuggers, Welsers and Rothschilds, banks performed a central role in borrowing and lending. Banks, as we are familiar with these days, stem from the Renaissance in Northern cities of Italy such as Florence, Siena, and Genoa. They have evolved from small rooms with makeshift green tablecloth desks to large financial institutions with thousands of employees. We feel that banks have stood the test of time (Great Depression, Japanese Crisis, Subprime Mortgage Crisis) and will be around in the future. But the question remains what does the banks’ future entail? How will this notion of Fintech unfold? We will guide you through challenges faced by Fintech and provide you the views shared by bank CEOs, as well as our own.

The development of Fintech

It’s becoming ever rarer for people to live without the latest technology. Most people hear “Fintech”, short for financial technology, and think about the newest application for the mobile phone or the newest payment method to shop the latest trend. But the Fintech revolution already arose decades ago. Technology people never seem to think about but use almost every day, like credit cards or ATMs, have been developed since the 1950s.

Now you might think why exactly is this such a big deal for banks in recent times? This is because it was not a threat to the banking sector in the past, quite the opposite even; banks used it and grew thanks to this. However, due to the financial crisis, people lost faith in the financial sector. According to 2014 Edelman Trust Barometer[3], the financial services and banking were even the least trusted industries in the world. At the same time, technology is the most trusted sector worldwide. In response to this, new companies have begun to provide automated and digitized services; the Fintech start-ups. The Fintech developments of the start-ups are hard to implement and improve for traditional banks which could lead to the replacement of banking service completely. So, the big threat nowadays is the start-ups with the newest consumer-facing Fintech services. These interesting Fintech start-ups are chipping away key parts of the banking franchise and fundamentally disrupt the biggest players in finance.

Numbers published by Accenture[4] displays that the digital revolution has arrived in the financial services sector. Global investment in financial technology ventures grew by 201% in 2014 compared to a 63% growth rate in overall venture-capital investments.

Why exactly is the Fintech industry growing faster than other industries? The answer is mainly because the provision of financial services is the world’s largest industry. Fintech changes the user experience of the financial services industry, and people become less reliant on the providers of traditional financial services.

The Fintech start-ups disrupt the banking sector through different channels like investment banking, payments, and lending. In 2015, investors discharge $19 billion into the Fintech market. The figure below shows the best-funded Fintech start-ups of 2015 obtained from Fortune.

According to Accenture[4], the global Fintech investment will on track grow up to $8 billion by 2018, see next figure. So, the digital revolution in financial services is well under way.

A threat for traditional banks?

The penetration of Fintech start-ups in the financial services market is a benefit for companies and customers but also has negative consequences for the traditional banks. The banks run the risk of disruption due to their inefficient workings such as slow processes and high fixed costs. Especially compared to the potential improvements[5] Fintech start-ups could offer, such as faster innovation implementation, better rates, and improved services.

On the one hand, an additional drawback is, if the start-ups succeed in their financial technology development, that the current manual processing will be automated and related jobs will be lost. According to Citigroup[6], 60 to 70 percent of all retail banking employees, which are 800,000 people, will lose their jobs at financial services companies to new software in the coming decade. On the other hand, banks could also take advantage of the upcoming Fintech start-ups. The start-ups can help banks to create better, faster and cheaper services. But are banks doing this to date? Do they generally view the start-ups as a threat or an opportunity?

How do banks respond to date?

As of 2017, banking institutions are already embroiled in an industry rife with continuous technological development. As mentioned before, while this process possibly advantageous, these changes could possibly impose risks and constraints on current banks. A survey[7] held by PwC in 2015 concluded that 68% of bank CEOs identified the speed of technological change as a primary threat to growth, and 79% of CEOs viewed cyber threats including a lack of data security as a primary threat. Jim Marous explains in The Financial Brand[8] that CEOs currently identify three general methods to try to guarantee success in the future.

The first opportunity to be grasped is for banks not to resist the digital transformation. According to the PwC survey as summarized in The Financial Brand, CEOs perceive the development of mobile consumer technologies, as well as developments in cyber security and data mining as the most important factors for future success. The notable second opportunity becoming more popular among banking institutions is the engagement in more collaborations and alliances. Banking CEOs believe these collaborations will help their banks to gain more access to new and emerging technologies.

The third and final approach banking CEOs employ is related to the increasingly regulated environment after the financial crisis. While 89% of CEOs believe regulation to be a hindrance to future growth for established banks, it could also function as a barrier to Fintech firms preventing them from entering the market. In order to maximize the possible advantages to be reaped from regulation, interviewed CEOs prefer to take a proactive approach to regulation compliance. In short, contemporary banking institutions in general employ simplification processes; cultural reform; collaborations with other banks, and general investment in technology geared for consumer friendliness, cyber security, and data mining in order to maintain their profitability in a possibly radically different future.

“Adapt or die” – Additional strategies

We provide banks with additional strategies to outperform Fintech firms. These strategies are related to the three main opportunities identified by bank CEOs, according to EY[9]. The first strategy, adapting their traditional strengths, could yield a benefit for a bank in the field of credit decisions or regulatory compliance. Considering that Fintech firms generally have issues[10] in these fields, traditional banks could possibly create value by protecting their financial interests; offering advice; connecting with customers, or improving access.

Secondly, banks should develop market-facing innovations to stay ahead of the competition, possibly in collaboration with other firms or banks. A recent example[11] is a collaboration of Woori Bank in South Korea with South Korean mobile carrier KT to track vehicles and machinery. These movable assets could be used as collateral. The last strategy involves more innovation at the company level itself. As mentioned before, these innovations should generally focus on consumer accessibility, data mining and cyber security. An example of bank-specific innovation, potentially providing additional benefits, is to improve engagement between different company-units. Next to this, Fintech start-ups and banks could also host[10] IT-oriented events to pair bank staff to start-up employees. The main objective of these bank-specific innovation and IT-oriented event is to exchange knowledge and discover joint-venture-possibilities.

Conclusively, in a world that stands on the brink of the first technological revolution that poses a serious threat to the business model of banking institutions, it’s “adapt or die”. The question whether banks will be able to keep up can only be met by a general answer; banks clinging to old business models and cultural paradigms will probably not fare well in the future. The banks currently most involved in long-term proactive regulatory compliance, data and security innovation, as well as simplification processes, will have the best odds of keeping up with the unpredictable future of financial technology development.






Fleur van Nes

MSc Finance at Vrije Universiteit Amsterdam

Roy Koning

MSc Finance at Vrije Universiteit Amsterdam

Ruben Jan Rietman

MSc Finance at Vrije Universiteit Amsterdam