Three challenges for financial institutions as they compete with new market entrants

The accelerating pace of technological advancement and the applications in financial services are creating opportunities to serve customers in new ways; the situation is giving rise to new entrants who are achieving real scale and experimenting with innovative models. 

Incumbents see potential to apply their own innovative approaches, but the rapid changes make it difficult to predict how different businesses will be impacted and what investments and strategies will be most effective. Financial institutions hold a strong position, with massive customer bases, strong balance sheets and substantial amounts of capital to invest. 

But pressure is building on them to innovate as new technologies are changing the shape of the markets. New technologies and growing competition are putting pressure on incumbents:

• More agile, and magnets for talent, fintech firms are growing, with investment on pace to reach $100 billion globally in 2018. Today, fintechs make up 12 percent of all ‘unicorns’ (startup companies valued at over $1 billion) globally.
• Big technology companies could be the most disruptive if they increasingly move toward direct competition with financial services institutions.
• While much of the growth has been focused on retail consumer businesses, like payments and lending, new technologies have the potential to drive unprecedented transformations and competitive shifts in commercial and wholesale markets as well. The same technologies that enable new entrants to compete with established incumbents are also changing how incumbents themselves operate, manage information, and engage with customers. 

“They all want to eat our lunch … Every single one of them is going to try,” warned JPMorgan Chase CEO, Jamie Dimon in his annual letter to shareholders in 2014.

Customers increasingly expect flexible, personalized services. They expect them at times and in places of their choice and to have products specifically tailored to their needs. And they want full services on their mobile phones.

FinTech firms make this kind of relevancy their take-off point. Many are focused on the consumer space, where technology has enabled them to reach and acquire customers more easily. Some of the greatest inroads from new competitors have come in retail consumer banking. 

The $100 trillion payments market has long been dominated by major banks, credit card companies, and other financial firms. But new entrants are emerging, offering cheaper and more flexible ways of processing payments, and they now have most of the online market, as an article in The Banker, “Chinese Banks’ Big Tech Threat”  shows. Some challenger banks now have over now have over 2 million customers, according to CB Insights’ The Challenger Bank Playbook: How 6 Digital Banking Startups Are Taking On Retail Banking.

The largest InsurTech companies have collectively raised nearly $1 billion, with total valuations approaching $9 billion.

Many of these FinTech firms are targeting younger customers—their average age is currently 34—and are marked by agility in organizational design as well as in deploying technology.  The continued scaling up of these startups poses growing competitive threats to the incumbents.

“Product by product, if someone figures out how to do it cheaper, and better, it will crush the margins in each,” as one director observed at the summit.

Peer-to-peer and online lending represent a major market for growth outside of traditional incumbents. In 2016, online platforms provided approximately 15% of all SME loans in the United Kingdom. In the United States, FinTech companies account for about a third of this lending, up from less than 1% in 2010. New models are emerging as well, which could have a significant effect on financial services in the future. One new model is the “bank-as-a-marketplace,” which allows customers to easily move money into multiple providers. 

“That’s the opportunity. It’s about finding a way to feed customers content and get time on their mobile device,” according to one participant at the summit. Innovative business models are also emerging from InsurTechs, creating innovation in response to changing customer needs, although few have reached the scale seen in banking. 

“This is how insurance started: getting together to solve problems and reduce risks,” commented one director at the summit. 

Incumbents face the additional threat of major entry into financial services by the large-scale technology platforms. It is easy for these huge service providers to offer banking and insurance across their networks, which comprise billions of consumers. 

Incumbents struggle to respond to the pace of change in financial services, yet they have to adopt some of the best aspects of FinTech startups and tech companies if they are to remain competitive. FinTechs are winning market share by providing ease of access, and cheaper, more flexible services. For incumbents to do those things, they need to make organizational changes to culture and operations. 

Yet, while financial institutions are renovating their business models, they still have to maintain profitability and share price. 

“And they recognize they don’t have all the capabilities to do that — they need to shift their workforce and people, do more joint ventures, outsource more and bring more partnerships into the organization,” one banker at the summit warned.

Some incumbents are changing the way they think about their organizations, including adopting methods common in tech companies and startups, such as agile project management, DevOps or “sprints.” Though they cannot embrace the “move fast and break things” culture of the technology sector, incumbents are changing internal structures so that things get done more quickly, creating separate organizations or brands that offer more flexibility, and making an effort to change organizational culture to make it more flexible and open to innovation.

As part of the cultural change, incumbents may also need to increase their tolerance for risk and encourage innovative thinking.

Incumbents do have some advantages in their competition with FinTech firms. Large financial institutions are viewed by consumers as safe places for personal data. An American Banker Association report found that 59% of consumers trust banks to safeguard their payments more than they trust alternative payment providers, retailers, or telecommunications companies. 

And the size and stability of incumbent institutions and their balance sheets have substantial value and are a competitive advantage against smaller FinTechs. 

Another participant said of large banks, “Scale attracts. We have millions of users and a scale of investment that cannot be matched by small FinTechs.”    

Incumbents react…but too slowly?

Financial institutions are reacting to all this, upgrading legacy systems, exploring new business models, expanding use of partnerships and acquisitions — all in an effort to become more flexible and agile to focus on the customer. 

But the pace continues to be slow, with incumbents struggling to decide which models to adopt. There has been a debate about what approach to take. Some participants expect that some banks may end up being utilities, providing the “pipes” and the balance sheet. Others expect banks to effectively capture the value in marketing their own products and services to customers, protecting the customer relationship and the data that comes with it by using new technology. Some participants advocated a “mobile-first” strategy—particularly for younger customers—with dedicated communications and product via these devices.

Some insurers, for example, are bundling risk prevention and mitigation services with their protection products. But insurers are also struggling to adapt, as changing relationships with intermediaries, distribution strategies and simplifying the complexity of insurance products are all fraught questions in the industry.

Some participants expect these models could mean that the lines between financial services sectors—banking, insurance and asset management—will be blurred. “There will be creative models: people who ride on top of the platform providing new ways to connect with customers, attracting more consumer wallet spend, apps running on top of the financial services offering,” as one participant put it.

Unless regulation and supervision evolve, incumbents will remain at a disadvantage to agile startups unencumbered by the same degree of regulatory scrutiny. Innovation within incumbents is also challenging regulators. While innovations can bring considerable benefits — to consumers, individual financial institutions and the financial system as a whole — they may also pose new risks. Regulators at the summit say they are focused on encouraging innovation that serves the interests of customers without creating unacceptable prudential risks.

New business models make it feasible to bring financial services to customers previously seen as commercially unreachable. In particular, the widespread adoption of smartphones has opened up new distribution channels, bringing hundreds of millions of previously unbanked and uninsured consumers into the formal financial system. Advances in technology have significantly lowered the cost to reach these customers, meaning that financial inclusion can be a source of growth for both traditional and new players.

Large populations remain unbanked. A World Bank survey, Global Findex Database 2017: Measuring Financial Inclusion and the Fintech Revolution, found that 37% of adults in developing economies have no bank account, compared with just 6% in high-income economies. 

Research indicates that digital innovations—digital bank branches, real-time payments and the like—could reduce net expenses for global banks by up to $60 billion (3% of total expenses) by 2022. Smartphone proliferation and fast internet access have enabled banks and insurers to launch digital-only products and services, slashing the number of costly branches and field agents.

Advances in digital identity combined with supportive regulatory environments in some markets provide a pathway to reach the underserved and fulfill know-your-customer (KYC) requirements. And the availability of data from a growing universe of sources allows firms to explore alternative data sets to try to understand the wants, needs, and behaviors of the underserved and create new approaches to underwriting in credit and insurance. 

Financial services firms, including FinTechs and incumbents, are now partnering with entities ranging from banks to microfinance institutions, FinTechs, and telecom companies. Global banks and insurers have been providing capital to support FinTechs. And some institutions are forming consortia to scale more rapidly. 

But financial exclusion also exists in the developed world. Techniques developed for inclusion in emerging markets may help to enfranchise these marginalized consumers in the developed ones. Still, the flipside of this is that while technology can expand access, digital technologies aren’t available to many who depend on banking branches. As products and services are increasingly digitized, those customers could be excluded further from the financial system.

Conclusion

The need for incumbents to determine strategies to adapt to the accelerating pace of change is critical. 

The changes are coming so rapidly that leaders are both careful not to make imprudent bets but also endeavoring to move quickly enough to ensure they don’t get left behind. They must manage these risks and manage their legacy businesses and legacy systems even as they work to transform for the future.

This article is based on the Viewpoints from the Financial Services Summit annual meeting, and aims to capture the essence of the Governance Leadership Network discussions and associated research.