The recent wave of market entrants in the financial services industry, from small fintechs to the world’s largest technology companies, is reshaping the space and incentivizing incumbent financial institutions to adapt.
New fintech players are getting ahead by moving quickly to address consumers’ specific needs. This puts banks in a position where their legacy solutions are not enough to drive sustained growth.
So, what is the way forward?
One way banks could innovate faster is essentially to copy what fintechs do and partner with companies that complement their services to broaden their customer reach. Many businesses are looking to add finance capabilities to their own platforms, including Big Tech companies -- Apple, Facebook, Google, Amazon and Microsoft.
Big Tech has a competitive advantage in terms of customer acquisition, creating great user experiences and innovative products that attract customers. In turn, banks are skilled at understanding compliance, treasury and credit risk management, which are difficult tasks for Big Tech companies.
However, from the banks’ perspective, the decision to partner with Big Tech companies is not really a straightforward one. There are pros and cons, and each bank will decide if and what partnership would make the most sense for its business model.
On one hand, by partnering with technology companies, banks gain access to a wider customer base, but risk being disintermediated from the end client. This is a real concern for banks, Kate Drew, director of research at CCG Catalyst Consulting, told Tearsheet.
“When we talk about partnering not only with big tech, but with any kind of fintech, this always comes up on the bank side. It is definitely something that they are concerned about,” she added.
But some argue that banks have already been disintermediated. “It's not unusual for Gen Z or millennials to have three or four checking accounts and use six or seven different mobile payment tools,” said Ron Shevlin, director of research at Cornerstone Advisors.
“If a bank can generate more revenue and profits by being a dumb pipe than as a smart provider, then why is the former an inferior strategy? What's the benefit of being the smart provider if you can't afford to do it and can't do it as well as everybody else?” Shevlin added.
There are also questions around customer loyalty, which typically lies with the company marketing the product, not with the supporting act in the background, adding to banks’ fears of turning into a utility. And Big Tech companies want to market the product as their own.
For example, when Apple launched the Apple Card in partnership with Goldman Sachs, the bank was only a footnote in the presentation Apple CEO Tim Cook gave to introduce the product to the world as the most “significant change in the credit card experience in 50 years.” It advertised the card as “Created by Apple, not a bank”, which ruffled some feathers at Goldman Sachs.
"I want to be really clear on this, notwithstanding whoever lays claim to the creation of the card. There's only one institution that's making underwriting decisions, and that's Goldman Sachs," Goldman Sachs’ CFO Stephen Scherr told analysts in a conference call.
But no matter how the product is marketed, such partnerships would push banks to see the tech provider as their client, as opposed to the end customer. While this requires a more progresssive mindset in a traditional industry, it can also be advantageous.
“It's pretty well known that the Apple Card is powered by Goldman Sachs. That's a branding opportunity for Goldman. It's all in how you approach it. But I don't think anybody would say that Goldman is the dumb pipes behind the Apple Card,” said Kate Drew.
“These banks are building their own brands as being able to partner well with technology companies, and I think there's a real opportunity to do that, too,” she added.
Moreover, the decision to partner with Big Tech platforms can also prove to be favorable if it helps strengthen a bank’s digital abilities and infrastructure. But this aspect could prove tricky to negotiate, as Big Tech companies may not be the friendliest when it comes to transferring knowledge and data.
“The bigger challenge these banks should be thinking about when partnering with a company like Amazon or Google is how to change their marketing and inner technology integration capabilities to best leverage this versus simply thinking that it’s just a distribution channel. It's a technology play -- they should be more worried about what capabilities they need to best leverage this,” said Shevlin.
And last but not least are regulatory matters, which banks would have to navigate carefully if they choose to associate with a Big Tech that’s already subject to government scrutiny.
“Banks require partners who are able to meet their compliance needs and evolve alongside new regulations, and with many of the Big Tech companies currently being scrutinized for potential privacy violations, certain partnerships might become an issue,” said Tony Glasby, SVP of banking and payments strategy at PPRO, a platform provider for local payment methods.
And privacy is not the only issue Big Tech has to deal with, as entering financial services even without a bank charter will mean increased pressure from government watchdogs. The CFPB’s director, Rohit Chopra, is laying the groundwork to investigate more of Big Tech’s practices as they move into consumer payments and other financial services.
“We cannot have a two-tier system where financial institutions have to play by the rules, [and] where Facebook and other tech companies using mysterious black-box algorithms get to skate off with no accountability,” Chopra said in his first testimony as CFPB director before the Senate Banking Committee this October.
Big Tech is not skirting any regulation by not becoming a bank, Ron Shevlin told Tearsheet.
“The CFPB is basically saying they don't care that you're not a regulated bank. Its purview isn't just regulated, licensed or chartered financial institutions -- it’s anything to do with financial services. And that could include the flow of data,” Shevlin added.
But at the end of the day, it’s the banks who offer such companies access to the financial system. And when it comes to partnerships, the most important thing is compliance, said Drew.
“In that sense, the compliance burden is always on the bank. There's no way really to shift the compliance burden to your partner. And the bigger your partner is, the more distribution they have, the bigger the risk that something will go wrong. So there is a real risk there that has to be managed,” she added.
But while some large banks might not see such a partnership as an attractive proposition, they might be more valuable for community banks. Smaller FIs can pair up with Big Tech to provide world-class customer experiences that help them acquire customers they don’t normally have access to. For example, Seattle Bank aimed to do this through its partnership with Google Plex, which also gave the bank new opportunities with digital first customers.
Just consider the rapid growth of the Banking-as-a-Service market, where many community banks act as the partner bank behind challenger fintechs. The Bancorp Bank works with Chime, Cross River with Affirm and Stripe, Evolve Bank & Trust with Dave. Such relationships can be direct, or involve third-party API providers like Galileo, Synapse and Marqeta.
“It's incumbent upon the banks to determine what new capabilities they need to be able to compete effectively. They figured out how to compete at branch level, and then figured out how to compete on search engines. Now they have to figure out how to compete when the platform is the point of competition,” Shevlin said.
In an increasingly crowded financial services market, it has become harder for incumbent players to compete. But one way today’s ecosystem can thrive is from the value that can be derived from meaningful partnerships.
Partnerships need to be a win-win for both the bank and Big Tech companies to truly broaden their service portfolio, cater to different needs, and draw a holistic customer journey through both their strengths. While change is never pleasant, it can also bring opportunity.