How much ground have banks ceded to fintechs?
The Economist conducted an analysis recently that showed
The publication didn’t specify which companies it included in its calculations, but said it used the estimated valuations of the top 500 global bank, payment and fintech firms from sources that include Bloomberg, CB Insights, CNBC, Finextra Research, Reuters, Economic Times of India and The Wall Street Journal.
On social media, industry observers offered a mix of reactions from gleeful ("Yipee! Bye-bye banks") to skeptical ("This is bonkers").
Matt Harris, partner at Bain Capital Ventures in New York, pointed out that fintechs' market valuations are forward-looking.
“If you were to look at the value per dollar of revenue, the so-called revenue multiple, a fintech company might get valued at 10 or 20 times revenue, but no one thinks about banks in terms of multiples of revenue,” Harris said. “Skeptics could say that’s a function of inflated valuations that don't have a bearing on user behavior, revenue or profits.”
Harris looks at market valuations as predictions, rather than a view of what’s happening now.
“It's investors voting with their money about who is going to be the dominant set of players in the future,” he said. "[Those numbers] tell me that investors are incredibly optimistic about the future of fintech companies and quite pessimistic about the future of banks.”
Revenue or number of users might be better ways to measure the current impact fintechs are having, he suggested.
Hans Morris, managing partner at Nyca Partners, a New York venture capital firm, agreed that investors are strongly interested in fintech companies with good financial models and capital efficiency.
“The valuation differences between fintech companies and banks is unprecedented right now,” he said.
Alexandre Lazarow, investment director at the San Francisco venture captial firm Cathay Innovation, offered a different reason why market share numbers could be misleading: Fintechs are helping to enlarge the overall financial services industry pie with new services for previously underbanked people.
"The whole reason I entered fintech was a fundamental belief that technology allowed us to not just reinvent the experience of a financial product, but to also re-approach how we reach customers and offer them products and services,” he said. “It isn’t just that fintech is chipping away at the market — it's actually creating a bigger market.”
The reason there are 60 million Americans and 2 billion to 3 billion people globally who are underbanked, Lazarow argued, is not because banks don't want to serve them, but it's unprofitable for a traditional bank to serve them. That’s why the overdraft fee business model exists, he said.
Chime, for one, has low costs and charges no overdraft fees. It lives mainly off the interchange income it receives when customers use their Chime debit cards. Some have questioned whether this business model will prove to be profitable as the company grows.
Assuming banks have lost some market share to fintechs, is this trend going to continue?
Harris noted that though investors are increasingly betting on fintechs, their supremacy is not a foregone conclusion.
“If I were a bank executive looking at this, it would be a call to action,” he said. “It would not be a sign that the race has already been lost. There's time for the incumbents to rally and make that prediction false. But it's going to take more aggressive, energetic effort than we're seeing today.”
Banks are starting to offer some products fintechs made popular: online lending, virtual cards, online onboarding, early access to wages, automated savings and cash-flow forecasting, for instance.
“Some of the new experiences some fintechs have provided have raised the bar for the industry and pointed us in the right direction in terms of what we needed to do with our user design, [and] how we needed to rethink our products to better meet customers’ needs,” said Braden More, head of strategic partnerships at Wells Fargo. “They helped prove out customer demand or customer interest in certain areas. Fintechs have helped push legacy businesses to rethink, how long should it take to underwrite a customer? Can we get somebody digitally set up in a matter of minutes versus a classical underwriting process for a merchant that might've taken a couple of days or a week?”
Such technology-driven innovations are necessary to banks’ survival, Morris said.
“Technology is now the essential variable in determining competitive advantage in financial services,” he said. “If you're a financial services company, you have to have very good technology in order to maintain your competitive advantage."
And the COVID-19 pandemic has accelerated the increased adoption of mobile and digital payments and changes in the role of the bank branch, according to Morris.
“Many banks have been spending a lot on improving processes, building their own tech and in some cases incorporating new tech,” he said.
The importance of modernizing customer experiences has come to the top of the list for CEOs, executive teams, board members and regulators, Morris said.
Harris pointed out that banks trying to compete with fintechs face the risk of cannibalization.
“Banks have robust fee streams from things like overdraft and credit products,” he said. Adding access to earned wages can get in the way of this.
“It's a classic innovator's dilemma where they might understand on some level that customers want this stuff, but it's hard organizationally to kill the golden goose,” Harris said. “They need a more of a no-sacred-cows approach to distilling down what the consumer or business customer needs and then providing that.”
KeyCorp's purchase of the online lender Laurel Road is an example of a banking company putting more energy into competing, he said. Marcus by Goldman is another example of a bank moving more aggressively.
“It's a very clever approach because you can take a lot more risks and be a lot more aggressive when you're not cannibalizing your existing profit pool,” Harris said.
