As we noted a couple of weeks prior in our post on the FinTech boom, startups are chipping away at this highest margin pieces of a traditional banking operation. And when you take a look at this graphic from a recent article by The Financial Brand, it is pretty easy to see why this is occurring.
Therein lies one of, if not the biggest problems, with traditional banks today. Few people working in positions of authority (Director to C-Suite) seem to have a holistic understanding of how the industry is evolving and have chosen to bury their collective heads in the sand waiting for the startup danger to pass. It won’t. For just 18% of executives to have an understand of what LendingClub – a public company with a market cap of over $5 billion – does is inexcusable and must be depressing for shareholders of the banks where these executives receive their paycheck (and of course, their bonus).
“The vast majority of the leadership of banks don’t understand exactly how digital works and are very worried about the digital bank. They have a subset of a subset of a subset of their employee base running large percentages of their business without the leadership knowing exactly what’s going on inside.” – Alessandro Hatami, Founder of Pacemakers and former Digital Payments and Innovation Director at Lloyds Bank
Venture investment into FinTech at all stages has been skyrocketing and the growth is expected to continue. Add to that the likelihood that, as evidenced above, innovation is unlikely to occur within the walls of incumbent players and it is clear that what happens in the next few years will have an outsize impact on the future the banking industry.
The race is on to see whether existing banks can fend off their complacency-driven decline by effectively acquiring and/or building meaningful partnerships with upstarts in the industry – rebundling, essentially – before those new entrants gain too much market traction and leave today’s large institutions doing nothing more than grasping onto their existing customer bases with little room to grow and no way to claw back lost business.
De Novo? Don’t Think So
“Tesla created a new car, we’ll create a new bank.” – everyone’s first thought when looking to disrupt banking
According to a late-2014 paper from The Federal Reserve Board, over 2,000 new banks were formed between 1990 to 2008, more than 100 per year. From 2009 to 2013 only 7 new banks were formed, fewer than 2 per year. In the regulatory environment that followed the financial crisis, the FDIC tightened its policy on de novo (new) banks, noting a higher degree of failure for these types of institutions.
A bank starting today would almost surely take after many of the current FinTech startups in the market and offer a customer-centric experience, remain capital-efficient (no brick and mortar banks, more efficient online marketing, etc.) and be more selective in growing its workforce. Stripe, not a bank but an example of a modern FinTech company that has scaled efficiently in the face of high security and regulatory burdens, has been valued at $5 billion and has only 250 employees.
This approach, it seems, would help mitigate some of the risks associated with starting a new bank. Acquiring an existing bank, according to the appendix of Standard Treasury’s recent Series A pitch deck is also likely a no go since regulators have heightened their scrutiny of both non-banks buying banks, especially ones back by venture or private equity investors, who they perceive as having “short term profit motives.”
Additionally, an acquisition would minimize many of the benefits of starting from scratch since the acquirer would need to service existing clients, deal with legacy technologies, and likely manage some physical locations.
Alas, with the regulatory environment remaining relatively unchanged and the costs associated with trying to enter the market unlikely to go down, the path to building a hugely successful company in the financial space will require companies to own specific verticals before branching out (call it “unbundling), into adjacent spaces.
The Personal Finance Stack
The regulatory environment (in the United States, at least) makes is almost certain that the banking landscape won’t be getting it’s own version Tesla – a fully integrated, soup to nuts banking firm – any time soon. So where does that leave the near term future of the banking industry, especially in the United States?
It is already becoming clear that the bank of the future will be of the mobile-first variety. According to research by UBS and KPMG, mobile banking is expected to more than double in the next four years to almost 2 billion people. Add to that the fact that new finance-focused apps run laps around their incumbent counterparts in terms of ease of use and integrations with other applications and it seems that the banking branch as we know it is being downsized to fit in a folder on our iPhone screen.
A la carte banking is nothing new as existing players have been offering it for years as a way to seem more customer-friendly and help people find the right solution to fit their needs. Unfortunately, this still sticks consumers with the same “jack of all trades, master of none” bank that they had before. The new a la carte approach – call it one’s “personal finance stack” – makes it possible for individuals to ensure they are using best in class product for each category.
For early-stage investors looking to capitalize on the unbundling, the trick lies in understanding which pieces of banking will come crumbling off the tower next and the best way to do that is to do the opposite of the head-in-the-sand executives we talked about earlier. Look and learn about what is out there, then try it out. Betterment to replace high-cost advisors (who likely don’t have an app), Digit (who has built an addictive SMS interface), Venmo (to make quick and easy mobile payments). Once you’ve built an understanding of the market landscape as it stands today, you start to gain a clearer picture of where things may be heading and can allocate your capital accordingly.