Fintech Threatens Small Banks More than Crisis Ever Did

I have witnessed two banking crises, the passage of numerous banking laws and significant industry consolidation. But the rapid growth of competition from financial technology firms may be the greatest threat to the traditional banking industry that I have seen in my career.

Success in navigating our on-demand economy, which uses technology to deliver goods and services in a speedy fashion, will determine whether community banking thrives or goes the way of the local bookstore or video rental shop. All banks should be thinking hard about who their customers are today and who they are going to be in the next five to 10 years.

Sure, change and innovation have been constants throughout the history of U.S. banking. This has ranged from new products such as “negotiable order of withdrawal” — or NOW — accounts and variable-rate mortgages, to new protections such as deposit insurance and privacy provisions, to new delivery systems such as online banking and mobile payments. 

However, the pace of evolution and customer demand for change is growing at an unprecedented rate. And a community bank’s innovation strategy is further complicated by competition from nonbank firms and regulatory uncertainty.

Fintech firms attract billions of dollars in venture capital investments. These nonbank entities have some significant advantages over traditional banks. First, they are not saddled with an extensive branch network or legacy IT systems, resulting in substantially lower operating costs.

Second, they are leveraging this generation’s distrust of the banking industry instilled by memories of the financial crisis, which hit home for many families in the form of foreclosures and lost jobs.

Third, nonbanks are actively using technology and big data to design superior customer-centric products. When those are products are combined with mobile delivery channels and automated credit decisions, they provide an efficient and high-speed experience for the on-demand generation.

Fourth, there is little or no regulation for many of these nonbanks, further driving down costs and freeing them to test new products.

Regulators, who heavily monitor the banking industry, are not risk takers. They are familiar with operating within the confines of statutes and procedures and are charged to ensure banks remain safe and sound and compliant with consumer protection laws and regulations. Regulators typically have very little incentive to allow the entities they supervise to engage in innovative or, as they may perceive, risker practices. Banks and regulators wanting to keep pace with the technological change must hire and retain staff proficient in emerging technologies. Compounding the challenge is the fact that banks’ governing laws cannot keep pace with the current speed of innovation.

Nevertheless, many regulators have attempted to work proactively in this space. The Consumer Financial Protection Bureau has embraced the concept of financial innovation through its Project Catalyst program. The bureau has also announced a policy that it will issue “no action” letters stating it will withhold enforcement actions for certain innovative products. Additional examples of regulators supporting innovation include: the creation of the Federal Reserve’s Faster Payments Task Force, the Conference of State Bank Supervisors’ model regulatory framework for virtual currencies, and Comptroller of the Currency Thomas Curry’s recent remarks regarding the potential risks and benefits of new banking products.

But a fundamentally risk-averse mind-set among regulators largely continues to persist. Accordingly, banks would be wise to proactively engage with their regulator as they refine their innovation strategies.

To be sure, there are important advantages that banks hold over fintech firms. The first is their existing customer base and the fact that, at least for now, checking accounts are sticky. The second advantage is the rich source of customer data banks hold. The third advantage is existing barriers to entry for companies into the banking system; nonbanks may not want to enter due to the difficulty of the chartering process for de novos and the higher degree of scrutiny a charter brings. Lastly, being a bank ensures a lower cost of funds, access to the Federal Reserve discount window and payment system, and federal deposit insurance.

Yet the challenge is that all of these advantages may be fleeting, so having a strategy for keeping pace with fintech is crucial for smaller banks. Bank management could choose to invest accordingly and hire or contract with the experts necessary to disrupt their own bank. Banks could buy fintech platforms or products from other banks and nonbank providers.  Or, banks could engage in some type of partnership with third-party providers. All of these options come with different risks and rewards. The only choice community banks seemingly do not have is to do nothing.

Steven L. Antonakes is the senior vice president and chief compliance officer at Eastern Bank in Boston, the largest and oldest mutual bank in the United States. He previously served as the deputy director of the Consumer Financial Protection Bureau and as the commissioner of the Massachusetts Division of Banks.