"Coopetition" with fintechs may be the key to thriving in tomorrow's financial services industry
For several years now, the banking industry has been inundated with warnings about how financial technology (fintech) startup companies will disrupt the industry to the point where traditional depository banks—especially smaller community banks—become irrelevant. As it turns out, the rumors of banking's imminent demise were greatly exaggerated, according to Lee Wetherington, director of strategic insight at Jack Henry & Associates. "We're beyond the point where everyone thinks fintechs will destroy banks," he said, explaining that fintechs discovered they couldn't establish user bases large enough and quickly enough to sustain their business models and compete directly with banks. In addition, efforts by some of the nation's largest banks to emulate fintechs (or outright acquire them) helped to neutralize the competitive threat.
According to an August 2017 World Economic Forum report, banks shouldn't fear fintechs; they should fear other financial institutions who leverage fintechs in the right way.
Rather than direct competition, banks and fintechs find themselves in a competitive, yet co-dependent standoff; each has something the other needs, but since the other is a competitor, partnerships between the two are far from routine. A recent Forbes article described this dynamic as "coopetition," "a term used to describe unconventional collaboration and cooperation within an otherwise competitive field of players." Stacy Grafenauer, vice president/director of deposit operations and electronic solutions at First Bank Financial Centre, Oconomowoc and a member of the 2017-2018 WBA Technology and Operations Committee described the process of banks partnering with fintechs as "building an alliance without compromising sound practices."
Establishing a partnership in order to access technology solutions provided by fintech companies can be a powerful strategy for delivering top-notch products and services to customers. Determining whether partnering is the correct strategy, choosing the most appropriate type of partnership structure, and identifying potential obstacles are three critical steps bank leadership must take when considering fintech solutions.
The determination of whether partnering with a fintech is a good tactic for keeping up with the pace of technological growth will be different at every institution. "It depends on the bank's strategy," said Fiserv Chief Operating Officer Mark Ernst. "Having clarity about where technology-enabled delivery fits in the overall strategy of the institution is the earliest question that needs to be answered." The key for bank management is to maintain alignment with the bank's strategic goals, particularly goals related to how the bank wants to differentiate itself from the competition for its specific market and customer base. "Banks choose a fintech because it offers a feature or function that will help them differentiate their bank from the competition," said Wetherington. "The key is figuring out how to leverage fintechs of choice in ways that matter strategically." Of course, size is also a factor that management must consider. A bank's ability to keep up with technology is dependent on its infrastructure, which is driven by asset size, according to Grafenauer. "If you have the infrastructure and the budget to support building those integrations, it is a good strategy because it's a differentiator," she said. Institutions that find ways to blend the community bank feel with a great digital experience will set themselves apart, Grafenauer predicts. "I think this will be the differentiator between community banks," she said. "Fintech companies will play an important role in that."
Types of Partnership Structures
Banks of all sizes have several options for partnership structures when it comes to fintechs, so each institution should determine the most appropriate strategy for its size and capabilities as well as its current and future needs. One option is a one-to-one partnership with—or outright acquisition of—a fintech, though for most institutions, forming a one-to-one partnership is "practically difficult," Wetherington explained. "Most mid-tier and smaller banks don't have the capacity or resources to negotiate one-to-one partnerships with major fintechs," he said. The majority of fintechs need to scale as quickly as possible (before they exhaust their venture capital) so they are looking for the largest financial institution partner they can find. However, there are some fintechs seeking to capitalize on the power of local partnerships. "There are some local fintechs who look to partner with local financial institutions, but that can also be challenging because smaller fintechs may not have an appreciation for the regulatory compliance concerns of banks and the difficulty of connecting with all the other areas the bank needs them to," said Ernst.
Another type of partnership is the one-to-many relationship, that is, bank access via a platform or industry consortium. "The rise of platforms [such as Akouba, Avoka, and LendKey] could be the technological way in which smaller institutions connect to fintechs of choice," said Wetherington. According to Ernst, most banks' current technology providers will seek out new technology as it becomes available and tailor it to local financial institutions. "Another way this happens is through large industry consortiums," he explained.
Similarly, shared services companies offer smaller banks the benefits of a platform or consortium partnership with the added advantage of more control. "It's a viable way for smaller banks to get enough scale to be able to partner with a particular fintech of choice at a better price," said Wetherington, pointing out that a shared services company could also potentially acquire a fintech. "Those are the kinds of options you have when you pool resources," he said. However, this smaller-scale many-to-one partnership structure requires the participating banks to overcome their own technological challenges, particularly relating to sharing data. "You'd have a lot of hurdles to get around," said Grafenauer. "If you had other banks on the same core and your processes were generally the same, it could work," she continued. "But I'd look to your core for a viable solution first."
Perhaps the most efficient and effective way for smaller institutions to access fintech products is via their legacy vendors/core providers. "Most core providers are aware of what the fintechs are doing and are buying what they have to offer and selling it to banks," Grafenauer explained. This arrangement smooths out many of the wrinkles banks experience when establishing partnerships individually or on a smaller scale. "The reason it's more effective is we've done the pre-integration of all the fintech's capabilities," Ernst explained. "By the time we're bringing it to market, the fintech has proven to some degree to be viable for market." For example, Fiserv developed the INV Accelerator in early 2016 as a way to connect high-potential startups to the real world in which financial institutions operate, assist with compliance concerns, and integrate with core processing technology. "From our perspective, that's the way you can take an interesting idea and make it available to a number of smaller institutions in a way that integrates with what they're already doing," said Ernst. For those institutions who would like more control over their fintech solutions, Wetherington recommends engaging with legacy providers in order to amplify your voice, for example by sitting on an advisory board. "Be the squeakiest wheel," he said. "Develop relationships with decision-makers inside your existing vendors."
The two primary components to a bank's integration with a fintech are regulatory compliance and technology. Thorough understanding of the risks inherent in each is critical in order for bank management to mitigate that risk.
With compliance, one of the biggest risk factors is simple ignorance on the part of the fintech. "As a banker, you have regulatory compliance top-of-mind," said Grafenauer. "The fintech is trying to help you meet the customer where they want to be, but they typically have no idea what the regulations are that bankers are faced with when they're creating solutions." One example is data security. Fintechs tend to be smaller and younger companies, so regulators are likely to focus on how sensitive information is transferred and stored in terms of security and compliance. "You have to do really diligent vetting up front of how the fintech vendor stores and secures its data," said Wetherington. Another regulatory concern is the fintech company's sustainability. "Regulators are very concerned about the stability of anyone's technology provider," said Ernst. "Before you introduce your customers to someone else's capabilities, you want to know that entity will be around and viable. While there's a lot of talk about fintech startups, the reality is that very few of them ever make it."
On the technology side, the largest hurdle is the sheer complexity of integrating the data necessary to deliver the fintech's product or service to the bank's customers. "Most banks think about the compliance side first, but the technical side is far more complicated than most people realize, both with scale and with how the data flows," Ernst explained.
The solution to these challenges is to treat a partnership with a fintech company with the same care and due diligence as any other third-party provider. "Fintechs are just another third-party vendor, so all of those checkboxes still apply," said Wetherington. As with so many other external relationships, selecting the most appropriate partner is essential for success. "Picking the right partner is the most important step in this process," said Grafenauer. "Invest time in doing a really thorough job of reviewing your contracts and agreements."
Ultimately, the biggest obstacle getting in the way of lucrative partnerships between banks and fintechs may be the lingering perception of fintech companies as threats. However, the reality is that banks have firmly maintained secure relationships with their customers. "You'll always be able to find someone to talk about how fintech is putting banking at risk, but what we see is fintechs trying to tap into the trust that exists between banks and their customers," said Ernst. That trust is the secret ingredient to traditional banking's persistence in the face of disruptors. "Our customers aren't going to trust whoever developed the latest and greatest app with their financial security; they look to us," said Grafenauer. "Fintechs are not competitors. They're solution-providers."
Fiserv is a WBA Associate Member.
Jack Henry & Associates is a WBA Associate Member.
By, Amber Seitz