The spectacular success of Swedish payments provider, Klarna, which has gone from start-up to incumbent in less than 10 years, is a poignant reminder that financial technology companies – fintechs – can change the business landscape. Such shifts in the competitive landscape will almost certainly accelerate when the second Payment Services Directive (PSD2) becomes operational in 2018, mandating that European banks expose their accounts and payment systems to third parties. As they contemplate how to engage the ecosystem going forward, banks need to weigh their options carefully.
Putting an application programming interface (API) layer in place to satisfy compliance requirements is a good start, but it leaves banks wide open to competition if not accompanied by strategies to ensure customer retention. Most banks are quite clear that they want to have a more measured and strategic approach to working with fintechs, in the post-PSD2 financial services ecosystem. They believe the way to achieve that is by harnessing the power of fintechs in a series of commercial partnerships to create a controlled, almost captive ecosystem to ward off competition.
We are seeing the start of ‘development’ approaches to attract fintechs into partnerships. This is precisely what Deutsche Bank is aiming to do through its new dbAPI developer portal, which launched last month and allows external parties access to the bank’s proprietary development environment.
A win-win arrangement
This type of cooperation is likely to succeed because it is based on creating mutual advantage. Banks have primarily looked at technology as a means of support for business processes rather than a catalyst for innovation. For a traditional bank, stuck with decades of legacy processes and systems that are both hard and expensive to re-engineer, a fintech partnership means it can launch new innovations and enter new markets at a price point and speed it would never be able to match in its own environment; one example being ING’s tie-up with small business lending platform, Kabbage, marking its foray into the Spanish market.
For the fintech firm, rich in blue-sky thinking but short on customers, a bank tie-up promises a ready clientele. This is probably why three out of four respondents to the European Financial Management & Marketing Association (EFMA) – Infosys Finacle Innovation in Retail Banking 2016 study favored partnering with fintech as a way to access disruptive technologies.
In Europe, the Bank-fintech cooperation is also concentrated in banks’ core portfolios – those with the biggest impact on the balance sheet – and is aimed at reducing the friction in their business processes and models. One example is secured lending, whose onerous front and back office processes and extensive documentation make it a great candidate for digitisation: leverage mobile technology to scan and transmit documents without visiting the branch, use online real-time data sources to validate collateral and know-your-customer (KYC) credentials, and so on. In general, banks are looking at partnerships that will enable them to propose and service an offer in real-time. In some cases, they are also looking at white labelling the agile processes underlying the solutions arising from the partnerships, to open up a new revenue stream.
Clearly, striking a successful partnership with a fintech firm needs more than just open APIs; banks would have to implement some key changes within their organisations. For instance, banks need to establish an internal “startup” function, which ensures a measured and agile approach in ensuring that the select fintech or external partners plugs into their ecosystem from a technological and operational perspective, and that the banks actually derive adequate business benefits from the relationship. Again, Deutsche Bank, with its independently functioning innovation units, is a good example.
Key success factors
There are certain key success factors that will define the success of the partnerships between banks and fintechs.
Banks need to think about how to invest in the fintech community. Most are coming around to the view that it is better to invest in improving their own ability to incorporate the partner’s offerings than investing directly in the partner itself. Investment focus is therefore shifting towards upgrading the banking operational environment so it can engage and industrialise fintech offerings to the maximum.
Going forward, we expect banks will engage with fintech more for their business models than for acquiring some me-too capability. This will spark a need for internal “venture capitalists”, who will conduct detailed business model assessments to identify which fintech firms are a good fit for their respective banks.
In the long-term, banks might need to make even bigger changes, such as reclassifying their business and technology processes into those that should be outsourced for cost efficiency, those that should be re-imagined through fintech partnerships for differentiation, and those that must remain in-house. The time to begin this journey of process model maturity is now.
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