Sarp Demiray, CEO of EMBank
Digitalisation has been transforming many sectors since the new millennium, finance included. World Bank research shows that the financial sectors of some countries have become almost 80% digitalised. Besides the digital transformation of legacy banks and banking systems, fintechs have also been a key driver in terms of digitalisation, innovation, and growth.
Once neglected and underserved by the banking sector at large, fintechs can no longer be denied the attention they’ve earned. But should banks be threatened by the rapidly growing fintech ecosystem or be enthusiastic about mutual opportunities? Are fintechs foes to fight off or friends to collaborate with?
How Did We Get Here?
I would like to address the digitalisation journey in finance first. In my opinion, the transformation took place in phases, which are neatly described in a recent BCG report: Global Fintech 2023. The initial phase began in the late 1990s as a period of ‘digital disruption,’ sparked by the rise of the Internet and the advent of online banking. In due time, this phase saw the initial scepticism around online transactions become widespread acceptance as digital services’ convenience became clear.
The second phase, around 2008, is defined by the proliferation of smartphones and the financial crisis, leading to the emergence of fintechs and mobile banking. This period marks the rise of fintechs and mobile banking, as more customers began valuing the ability to manage finances and conduct transactions on the go. As the crisis of 2008 led the banks to become more risk-averse, it left the ground open for fintechs to emerge and flourish.
The third phase, from 2015 to 2022, witnessed a surge in digital transformation driven by fintech innovations and the impacts of the COVID-19 pandemic. The pandemic made digital services essential, highlighting the importance of digital readiness for all financial institutions during global disruptions. These were the golden years for fintech investments.
The fourth phase is a pivotal era marked by the integration of AI and other advanced technologies, which are set to redefine banking services and customer experiences. AI adoption in banking is shifting service delivery from reactive to proactive, anticipating and meeting customer needs before they are expressed.
Fintechs have been growing stronger since phase two, and the AI era we’re in is likely to provide a surge in favour of tech-savvy setups, which, in financial services, are often fintechs.
Collaboration Over Competition
I will take an early stand in this discussion. I’m pro-collaboration for fintechs and banks.
Looking barely at market shares, it seems like fintechs have taken a big bite out of legacy banks’ pie, and they have. Bankers may feel hard done or threatened by the surge of fintechs, and they should. However, fintechs have also made the pie bigger as they set out to serve the unbanked and underbanked population. They were also wildly successful in attracting the younger, digitalised customer base that is not enthusiastic about old-school banking schemes.
Let me elaborate further on why I favour fintech-bank collaborations. First, let’s review how fintechs snatch market share from classical market players.
Bringing the unbanked and underbanked masses into the fold
Compared to technology-first fintech setups, legacy banks typically incur higher costs to attract new consumers. Thus, legacy banks have different criteria for who they try to take on, which led to large crowds of unbanked and underbanked people – until fintechs came along. With lower acquisition costs, a different outlook on risk and opportunity, and a big appetite to grow their customer bases rapidly, fintechs won over these large crowds.
Eliminating friction in process and communication
Fintechs challenge large institutions with easier processes and better user interfaces. Consider signing up for a fintech over their mobile app, completing the KYC process directly online, digitally signing documents and starting your transactions in a few minutes, if not less. Compare this to visiting a bank’s local branch, waiting in line, signing endless documents on paper and waiting for the back office approvals to be completed before you can do almost any transaction – that is, if you’re allowed to open an account with the bank.
I know that many traditional banks have digitalised and streamlined their processes, but the nature of fintechs allows them to be faster and more digital about their operations. Legacy systems, existing non-digital operations, and even old habits often prevent banks from offering more streamlined, more digitalised processes and hinder how they communicate with their customers.
A better digital user interface or a set of favourable functions can lead customers to migrate to fintechs. Customers with payroll accounts at traditional banks transferring the full content of their accounts to digital apps like Monzo are stories we hear about often.
Customer service is another arena of change. Both fintechs and banks can make a difference by effectively enabling voice or text-based online channels and integrating AI-driven software. Even FAQ sections have taken a turn; we can observe some fintechs set up and monitor their own P2P platforms, such as user forums, where they leave the task of addressing customer questions to other customers. All these schemes bring down service costs and increase scalability for customer retention.
The ‘maturing’ of fintechs
I recall a scene from a favourite TV show of mine, ‘How I Met Your Mother’, where Marshall (Jason Segel) talks to Robin (Cobie Smulders) about his marriage to Lily (Alyson Hannigan): ‘Robin, Robin, like I said, as we mature, our relationship matures with us’. There is a parallel here to bank-fintech relationships.
The increasing interest in fintechs and the investment frenzy largely led by the ‘fear of missing out’ led to a surge in fintech startups, many of which did not have a solid plan for profitability. The majority of B2C fintech startups had their business plans around rapid growth and new investment rounds. This was the scenery until 2022, when the tide started turning, and investors started asking about profitability.
In 2022, only 20 of 453 challenger neo-banks were profitable. In 2023, 33 of the biggest 70 public fintechs are profitable. Focusing on increasing the profit margin and keeping costs low as fintechs seek to attain scale is more important for their strategic sale, merger or initial public offering in the near future. In other words, they have ‘matured’.
Even though the global funding for fintech has come down 71% from 2021 to 2023 to USD 41 billion, and the revenue multipliers (a fintech’s valuation figure compared to its annual turnover) have now stabilised at X4 in 2023 from its X20 heyday in 2021, fintech’s global revenue is still growing pretty strongly at 14% during these years. It is expected to reach USD 1.5 trillion by 2030 from its current level of USD 320 billion. As such, fintech income is expected to make up nearly 7% of global banking revenue (from its current level of 2%) and penetrate 13% of banking activities.
Legacy banks have also become more digitalised and fintech-friendly. They pay closer attention to fintechs and their business models, listen, and are more willing to work together. In the earlier days, their attitude was better described as ‘I don’t know, I don’t want to know, I don’t care’. Banks, in turn, have also matured.
Regulations are also ‘maturing’
The third component of this maturing process is regulations. Regulators are moving in more hands-on. The initial regulatory leeway is a thing of the past. In this period, the influence of rule-makers will become even more important for the development of the ecosystem. A key phrase for fintechs is compliance by design.
The European Parliament has approved the Digital Operational Resilience Act, DORA, which will come into force in 2025. Its purpose is to prevent cyber threats by detecting them in advance and to minimise their effects on the critical functions of institutions and the financial sector while ensuring protection for end users in the EU. Another important directive is PSD3 and the first Payment Services Regulation (PSR1), which includes important rules on data privacy and security on top of PSD2, which paved the way for fintechs thanks to its open banking framework in 2015.
In April 2024, Synapse Financial Technologies, a leading Banking-as-a-Service (BaaS) provider, filed for Chapter 11 bankruptcy. This filing involved USD 85 million in unaccounted-for consumer funds, triggering a significant financial crisis affecting over 100,000 customers across the US. Synapse, known for its middleware that connects fintech companies with traditional banks, faced insurmountable issues that led to a substantial shortfall.
The Synapse incident sparked widespread criticism, especially in the US, about the robustness of fintech-bank partnerships. Critics argued that the case underscored the risks of heavy reliance on third-party fintech providers and gaps in regulatory oversight. Regulators demand clearer consumer protections and transparency in how fintech products are insured and managed. In short, sponsor banks will be asked to know exactly what their fintech partners are up to, ensure the books add up, so to speak. Those banks that invest in attaining the necessary data and tech muscles would surely benefit more.
Further pressure points ahead
Technology enables the establishment of service models that could not be formed before. Transaction and service costs come down. Ways of working need to change, and when legacy institutions fail to keep up with developments, others rapidly fill the void.
One quick example is how legacy banks and institutions stayed away from blockchain technology and digital currencies for the longest time, which led to the emergence of crypto-friendly investment platforms, some of which have become gigantic over time.
Let me elaborate further. Consider how legacy banks’ investment departments or investment firms work. They’re typically after the top of the pyramid and provide consultancy services to investors above a certain threshold. There would be tiers. Top investors would get more frequent phone calls, in-person meetings, and tailored advice. Mid-tier customers would hear what everyone else in their tier would hear, and investors in lower tiers would be expected to take care of themselves without generating service costs for the company. What you can invest in is limited, and service fees are considerable.
Today, any investor can easily set up an account with a retail broker and access stocks worldwide, commodities, FX, or digital currencies. The barriers to entry are very low, service fees are minimal, and one can enjoy the benefits of AI, algorithmic trading, or social trading. With technology, what was once impossible is now possible, and what was costly and unrealistic is now attainable.
Despite the new players and schemes, most businesses and individuals initially stay with legacy institutions. Thus, the pressure is not apparent at first. However, failure to tune in to the new practices and catch up will eventually lead to significant business loss over time.
Is it possible to catch up?
In order for a service idea to turn into a viable “business model” worth any legacy bank’s while, it must offer volume and scalability. There are major shifts in the viable business scenarios thanks to technological developments. But there are difficulties around benefiting from these changes.
Banks and the unbanked/underbanked masses are virtually strangers; there’s no love lost between them. And winning back a customer base that migrated to fintechs is not easy or cheap. Traditional banks’ vertical and horizontal integration advantages disappear, and retaining consumers thanks to barriers or easy cross-selling is over. Individuals don’t need bank accounts or bank-issued cards to make payments. Merchants are not dependent on their banks to attain a virtual POS.
Fintech disruptions benefit consumers: A US-based study reports that the average Net Promoter Score (NPS) of the country’s largest banks is around 23 (with the best of them near 50), while the NPS of the largest fintechs is around 80. However, neither technology nor greater digitalisation through its use is the be-all and end-all. People are at the centre of financial solutions. Unless this mindset is present in fintech communications, the benefits created will remain limited.
Another human factor that will directly affect the extent to which existing banks can compete or cooperate with fintechs is talent: Where is the “talent” for the bank of the future, and how do they want to work? Can the suit-and-tie, highly structured and predictable working environment of legacy banks attract tech-savvy people who want to work remotely? On the scales of compensation, career track and fulfilment, which financial institutions offer a better future for people who can best compete and cooperate with fintechs in this transformation, and what must legacy banks do to invest in their talent pool attaining capabilities?
Why and how to collaborate with fintechs
The reason behind my advocacy in collaboration with fintechs is short and simple: There’s money to be made and benefits to offer to businesses and individuals via collaboration.
B2C fintechs have a strong affinity with individuals, especially in payment and investment services. By collaborating with fintechs, banks can offer products and services such as shopping loans, cash withdrawals, and money transfers to a large client base they do not have, which would be too costly to acquire or retain.
The B2B side offers even more opportunities. B2B relates to the transactions between businesses, such as a fintech company providing payment processing solutions to a retailer. According to BCG’s 2023 global fintech report, the US will account for a projected 32% of global fintech revenue growth through 2030, supported largely by the proliferation of B2B2X and B2b (Business to small businesses) by monoline fintechs going into additional products and services. B2B2X (Business-to-Business-to-X) is a chain where a business sells to another business, which then provides products or services to an end user, who could be another business, a consumer, or any other entity. For example, a fintech firm might provide a platform to a bank (B2B), which then offers digital financial services to consumers (B2X).
So far, B2C models have been the fastest-growing companies and have reached the highest figures in valuation and turnover. However, by 2030, fintechs focusing specifically on the B2B field are expected to take the lead and grow 11 times. B2B2B and B2B2C companies that establish embedded finance and as-a-service models are expected to grow nearly eight times, almost two times faster than B2C models. Renovation of focus and technology is a must if banks would also like a more significant share of embedded finance, which is only set to grow in the next phase.
Embedded finance has become a household name in the finance industry over the last couple of years, with solid implementations in retail, travel, insurance, etc. Banking-as-a-Service (BaaS) fintechs do a great job at bridging the gap between banks and B2C fintechs. Banks that work with fintechs to help provide these services are enjoying the benefits these collaborations bring.
In the section above, I mentioned a number of difficulties in catching up with fintechs. But the list goes on. Many legacy banks need to modernise their core banking systems and adopt a more agile work culture. They would still require a certain level of modernisation to collaborate with fintechs, but the extent of change would be limited, and they could start generating revenue sooner.
Observations from the Field
There is a well-established result-oriented perspective, especially in countries that have proven themselves in finance and fintechs, such as the UK, where the innovation proposal and the business model come together. I notice that they focus primarily on the business model and the market need, not investing in innovation per se more than necessary. As they focus on innovation as the main solution to attain higher efficiency at less cost, it enables them to obtain clearer results in investment tours and partnership negotiations.
Partners, investors, and sometimes even good ideas can come from places and contacts you least expect, perhaps partly due to the fact that there are managers with more tech experience in the fintech field. It is a good idea to reflect more on your experience in terms of the human aspects of your business.
More and more companies focus on niche areas, specialising only in limited venues, and are emerging as more successful and profitable. Fintech’s main claim is to decentralise those financial services with low entry barriers. While the Fintech investment share is set to increase, I think this is where the real growth will come from.
Knowledge of regulation is becoming critical for companies’ globalisation. I do not mean only to fulfil compliance requirements. It has implications under two key headings:
- Fintechs who look at compliance at the beginning of the process end-to-end and then proactively take steps to meet it in industrial grade levels will benefit as they try to grow. For example, even if a fintech’s country of origin legislation is generally compatible with an economic area it aims to penetrate, it is likely not the equivalent. Even the tiniest differences can be crucial when expanding abroad and affect your bottom line and adaptation ability.
- The serious legislative changes underway open up opportunities. If companies can evaluate this in a visionary, agile, and intelligent way, their global stakes may well improve simply because other foreign companies are struggling in this aspect.
Legacy banks can wield their expertise and mighty infrastructure in regulation compliance and risk assessment to cooperate with fintechs and reap the returns in new consumer segments. Indeed, banks are critical to deepening and widening the digital financial offers in different geographies.
Customer orientation is not only for fintechs. Legacy banks can do better, too. Legacy banks have historically been profitable under any weather; that is perhaps why they have not utilised the consumer data they have access to as eagerly as a fintech could if it had the same depth and breadth of information at their fingertips. But this is poised to change. Legacy banks already put their marketing chops to consumers’ better use. For example, “connected commerce” involves making your own consumers aware of the services of merchants using granular customer data, showing them hyper-tailored ads, and merchants then paying the bank based on either attributable sales or traffic. The customer is rewarded and likely more loyal, merchants generate new sales, and banks have a new income stream.
To give an example from EMBank, we target those corporate segments that are not adequately served in the classical banking system but have a high potential for development, namely SMEs and fintechs. The first things that come to mind in their digital transformation are digital platforms, access to real-time electronic payment systems, and a rich API function set. Yet what distinguishes us is the personal contact we provide, how we familiarise ourselves closely with the business model of each fintech and make improvements so that we can grow together as partners, and how we stay capable of innovating for alternative solutions in the payment world accordingly. Even in the fully automated service models, the main differences at some point are our qualified human contact and expertise in offering customer-centric new solutions. It’s how we aim to grow profitably by retaining customers and increasing their lifetime value.
Conclusion
Was it a mistake or a missed opportunity for banks that they’ve left or lost such a large number of customers to fintechs? Maybe. However, their bigger mistake would be to remain oblivious to today’s realities and miss out on the opportunities that fintech collaborations would bring. Cooperating with fintechs would allow banks to tap into new segments.
Fintechs worldwide are expected to grow five times, their share of the entire banking world increasing from 4% to 13% over the next decade. At this point, the valuations of Fintechs will have reached more than a quarter of the system from its current 9%. Both innovation experience and qualified human resources are very important starting points in finance. The size and integration of economies and populations enable successful business models to scale up and remain profitable. Fintech disruptions directly impact legacy banks, but adaptation is inevitable either by competing or cooperating, and there is ample room for both.
