What funding bubble? Banks, VC firms pour more money into fintechs

Predictions of a fintech funding bubble have been made repeatedly over the last several years, yet investment in the sector remains strong.

Venture capital investment in U.S. fintech companies reached a quarterly high of $3 billion in the second quarter, according to KPMG’s latest Pulse of Fintech report. Traditional banks are pumping more money into, and forming partnerships with, fintechs as banks seek to launch digital-only services.

American Banker recently spoke with Safwan Zaheer, head of fintech and digital banking for KPMG U.S., about the banking industry's contribution to the flow of money to startups. Certain sectors are particular favorites of banks, Zaheer said.

What follows is the interview, which has been edited for length and clarity.

Despite concerns about a bubble, investment in fintech doesn’t seem to be slowing down.

SAFWAN ZAHEER: It is not showing signs of slowing down at all. The investment in fintech for the first half of 2018 is already double the total annual amount from 2017, and we see that continuing across different types of fintech solutions. Areas where there’s a lot of investment right now include blockchain, artificial intelligence and regtech. We also see the launch of the OCC fintech charter as accelerating further activity and investment in this space.

Venture capitalists providing funding. Are traditional banks also investing more in the fintech space?

Traditional banks are not only investing but also partnering with fintechs more than ever before. We are seeing three main areas of investment banks are making in fintech. The first is around customer experience; banks are continuing to enhance and transform the experience that they are currently delivering to customers to make it more digital and seamless between channels. The second is they are looking at investments to enable them to automate and enhance middle- and back-office platforms and technology. This is to make manual tasks more efficient and automated and reduce paper-based processes. Third, a few banks have already started to look at creating new digital solutions that run outside their core platform. So banks are looking at agile, nimble digital solutions that are typically provided by fintech firms.

Why do you think we’re seeing more partnerships and investment between banks and fintechs?

One reason banks are working more with fintech startups is to collaborate to refine or enhance a specific product. Then they can integrate that product or service into their organization. They are also working with startups to essentially integrate and take whatever solution they are already offering and have in the market and white label it. In some cases banks have a significant investment in a fintech startup where they are actively shaping new products and using that [relationship] as a way to stand up new digital-centric products. The larger banks have been active in the space for a number of the past years.

Is there a gap in investment in fintech between larger and small banks?

For one thing, you’ve seen a few big banks launch their own digital-only banks recently and are now in the market testing those virtual and digital banks. At the same time they’re also continuing to make investments to enhance their current products and improve on the customer experience. On the super-regional and regional side it is a mixed bag, but we see some regionals that are very, very active in the fintech space, having announced partnerships and investments. With community banks we are seeing some activity, but not a whole lot compared with the larger banks.

You mentioned there were some areas seeing especially high investment. Can you elaborate on those?

Blockchain was one area where we witnessed an increase in interest and investment — almost double that of 2017. When it comes to blockchain, banks are starting to move away from use-case qualifications and brainstorming to active experimentation and proof-of-concept development.

There’s also a lot going on in AI. It is a broad term, but where we see a lot of the investment going is in AI technology that helps makes sense out of large amounts of data, as well as reducing manual, repetitive tasks that a human would currently do.

When it comes to regtech, we are also seeing investment in solutions that are leveraging AI for process automation. Banks are looking at technology to not only help them comply with regulation but also improve efficiency and reduce cost when it comes to regulatory processes.