Why bank-fintech partnerships go sour and how to prevent the hug of death
- Fintechs perform best when they can move fast and focus on growth, but when partnering up with big banks, some fintechs can experience the "hug of death".
- This hug keeps the fintech from focusing on its own priorities and instead diverts its attentions to what the banks needs and locks it in a cycle of meetings and bureaucracy. Fintechs that want to avoid getting over indexed need to focus on establishing clear boundaries from the start and keeping the scope of the partnership in check.
Coined by MIT Researcher Alan Thorogood, the phrase ‘hug of death’ refers to a situation where the mismatch between the bank’s and fintech’s priorities and their relative speeds results in the fintech’s resources being over indexed and a failure to achieve the fintech’s strategic goals.
Fintechs thrive when they move fast and through “consistent growth in customers, funds and transactions, which in turn facilitates capital raising and scaling of their products and businesses,” says Scott Simari, Principal of Sendero Consulting.
Banks however move slowly because they have to maintain compliance, manage risk and prevent product cannibalization, said Simari.
“It’s the endless committees, meetings, tollgates and reviews – often a lot of activity and strain on the fintech’s resources without meaningful productivity. From the fintech’s perspective, it’s an opportunity cost problem; the time and resources spent on supporting the financial institution could be better utilized to achieve their own strategic goals,” he said.
There is much to be said about the boons of bank-fintech partnerships and how they can push the financial industry towards innovation. There is a lot that can go wrong, too.
Much talk, no money
For banks, one of the worst things that can happen with partnerships is investing into a relationship with a fintech company that bears little fruit. For example, loan productivity and loan volume are primary priorities for banks to seek a partnership with fintechs, but only 28% of banks report seeing 5% or more improvement in these areas, according to research.
Partnering effectively is difficult: Banks have to spend a lot of time vetting potential partners and then integrating their tech in their core and ancillary systems. Beyond the technical issues, the bureaucracy inside banks can also delay market times.
This barge-like movement may mean delayed or diminished results for the bank, but for the fintech it can be akin to a death sentence.
The partnership processes to watch out for
1) The compliance labyrinth: For banks compliance is a little loved but necessary part of their operations, which means a fintech can find much of its time being spent on ensuring they meet the standards and conversely, less time spent on activities that will help the fintech grow. “Capital raising is intense; eighty percent of my time is spent on it,” a fintech founder told Thorogood during his research.
2) The regulatory rigmarole: “The large institution’s rigorous regulatory requirements and risk management protocols can disproportionately consume the fintech’s resources, leaving them with limited bandwidth to innovate and iterate on their platform,” said Simari.
Not only do these processes take away time from capital raising abilities, they also leave fintechs with limited resources to spend on the betterment of their own offering. This stagnation can be dangerous especially if the fintech is partnering with a very big and well recognized bank. “A fintech can risk its identity being overshadowed by the financial institution, resulting in a loss of autonomy and strategic direction,” he said.
How to avoid the hug of death
The hug of death isn’t good for either partner. While the bank may benefit initially from the fintech dedicating a large chunk of its resources to the relationship, the stagnation that the fintech may experience due to this, impacts what benefits a bank can reap down the line. Avoidance of an over-exerting partnership like this is the best policy:
- Launch independently first: Partners can consider standalone launches rather than diving headfirst and integrating products with business platforms. “This approach facilitates swift market entry, enables easy evaluation of value and allows for straightforward separation if necessary,” said Simari.
- Keep your scopes in check: The hug of death is more likely to occur if the partnership’s scope increases very quickly, which leads to “dependency on various business functions,” he said. The expanding remit of the partnership can cause delays and internal conflicts, as well as more costs for the FI. So partnerships should start small and with clear objectives from day one.
- Set boundaries: Fintechs should clearly define the relationship, distinguishing whether they are a strategic or transactional partner, according to Simari. This allows both partners to start the value matching process early in the deal and mitigates any risk of the relationship becoming too much to bear for any partner.
“Fintechs’ transparency about their current capabilities is essential, avoiding the temptation to oversell future product developments,” said Simari.