Beware the Fintech Raptors
by Jack Milligan
What exactly is a bank nowadays?
Those of us who are closely connected to the banking industry might be tempted to say that a bank is an entity that has a charter from either its state of domicile, or in the case of a national bank, from the federal government. A bank also offers deposit insurance through the Federal Deposit Insurance Corp., and is supervised by a combination of state and federal bank regulatory agencies if it has a state charter, or by the feds if it has a national charter.
To many traditionalists, that is a bank. And yet I would argue that the distinction between a bank and a nonbank has become increasingly meaningless. This is not a new phenomenon. The financial service marketplace in the United States has been has crowded with nonbank companies that have competed fiercely with traditional banks for decades. But we seem to be in a particularly fecund period now. Empowered by advances in technology and data analysis, and funded by institutional investors who think they might offer a better play on growth in the U.S. economy than traditional banks, we’re seeing the emergence of a new class of financial technology – or fintech – companies that are taking dead aim at the consumer and small business lending markets that have been banking industry staples for decades.
I wrote about the larcenous designs that nonbank competitors like Apple, Google, Walmart (through a joint venture with American Express) and Amazon have on the payments system in the Fourth Quarter 2014 issue of Bank Director magazine. But that is only half of the story. The payment system is important to banks because it ties the customer at least nominally to the traditional banking system, and is still a source of revenue (albeit a declining source) for most banks. And yet the threat that an emerging array of fintech companies like the Lending Club and Kabbage pose to traditional bank lenders could end up being just as serious because lending is still the activity whereby most banks make most of their money.
Halle Benett, a managing director and head of diversified financials investment banking at Keefe, Bruyette & Woods Inc., did an excellent job at Bank Director’s recent Chair/CEO Peer Exchange event of describing how the market for fintech lenders has exploded in recent years. These companies generally have a significant pricing advantage over traditional lenders because their Internet-only distribution strategy allows them to operate at much lower costs, and also because like many private-equity funded startups in the technology space they are more concerned about revenue growth than profitability at this stage of their development.
Will the likes of the Lending Club and Kabbage put traditional banks out of business? I don’t think so, any more than Facebook or Apple is likely to with their personal payments initiatives. But traditional banks do face the risk of continued market share loss in the near term as fintech companies swoop in and pick off some of their best customers. I live in what might be best described as a rural suburb near the Blue Ridge Mountains in Virginia, and there is a breeding pair of Cooper’s Hawks that live in the neighborhood. Unlike the falcon at the top of this post, which dives upon its prey from great height at terrific speed, a Cooper’s Hawk hunts its prey (mostly other birds) by hiding amongst the trees and strikes quickly and stealthily. I know they have been hunting in my yard when I find a pile of feathers (and nothing else) on the ground. Regardless of how they hunt, all raptors have the same endgame in mind. And when fintech companies snatch a potential bank customer, they don’t even leave the feathers behind.
I think the emergence of these new fintech companies has greater significance than just their potential to steal market share from traditional banks. I see them as harbingers of things to come. For a growing number of borrowers, they are redefining the meaning of customer service. We have seen this trend play out in other aspects of retail financial services for decades now (think ATM, online and mobile distribution) and more recently in small business banking (think mobile-enabled remote deposit capture), where the definition of “good service” is a well-priced product delivered through efficient and reliable technology rather than a smiling face on the opposite side of the counter, or kiosk.
Traditional banks, and particularly community banks that have placed most of their chips on the small business customer, tend to think of face-to-face customer service as their killer app because people still want the opportunity to bank with other people, or so the argument goes. But the world is full of examples where technology-enabled user interfaces have gained traction even when a “people interface” is available (think self-checkout machines at the supermarket). Applying for a $50,000 small business loan should be more arduous than, say, buying a book on Amazon, but the growth of the fintech lenders suggests that many potential bank customers see the two processes (buying a business loan from Kabbage versus a book from Amazon) as roughly equivalent.
It seems to me that the trend towards greater acceptance of (and perhaps even a preference for) technology as the centerpiece of the customer service relationship will only continue, particularly as millennials – the first generation that we can truly say are cradle technologists – become a greater force in the U.S. economy. Face-to-face customer service will still have its place in the world of banking, but traditional banks had better wake up and realize just how fast technology is reshaping their industry.
Raptors are pitiless predators. I suspect that many fintech companies are, too.