The Fintech Challenge – How PSD2 will kickstart banks in their Digital Transformation
Fintechs are perceived as a threat to financial institutions. However, in reality they will be partners in the bank’s journey on their digital roadmap. Via PSD2, banks and fintechs can strengthen their collaboration.
The pressure to comply with PSD2 (the Second Directive on Payments Services) has placed huge demands on financial institutions. Banks across Europe need to provide open platforms and access to information to comply with the revised regulation. The revisions were introduced as a means to include fintechs within the regulatory space, while giving them access to the banks’ customer data. No wonder bankers are having sleepless nights.
The advent of fintechs must seem like a tsunami rolling in to many traditional institutions. These firms are often hamstrung by aging software that no-one understands anymore, because all the experts who were there when it was installed have retired, moved on, or even been retrenched. Most of the code that keeps banks running is written in Cobol, which no-self-respecting Java developer will maintain. What is more, most CIOs have to spend up to 80% of their budget on these Jurassic systems, which leaves no wiggle room for digital adoption. The situation is exacerbated by the massive infrastructure, staff complements and compliance costs that these banks must fund to provide the same services that a fintech can offer.
Fintechs – Poachers or Partners?
The perception that fintechs seek to steal bank’s clients with better, cheaper services is not totally incorrect. There is also a belief that banks have brought this upon themselves by their resistance to change and lack of focus on the customer’s needs.
However, the reality is that there are many types of fintechs, some of which do compete in the payments, lending, wealth management and personal finance space, but many others who actually provide services that banks themselves need. The larger banks try to be all things to all men and businesses. In some areas they are market leaders, in others, not so much; no company can excel in everything they do. Fintechs can be the answer in this regard. While the number of categories of fintechs expands on a daily basis, they can roughly be divided into competitors and suppliers, and there are different strategies for dealing with them.
Disruptors – Fintechs who speed up digital transformation
While startups like Kabbage, which lends to small businesses, or iZettle, which facilitates payments, attract new customers and are steadily growing, they are limited in their scaleability. This is where the opportunity lies for the traditional banks. They can either invest in a startup and see how it progresses, then acquire it as a subsidiary, build a partnership, or underwrite its offerings. Fintechs know how to innovate and bank how to scale. Santander saw the opportunity in iZettle and Kabbage, and ING also liked Kabbage’s operation.Then there is Atom, another fintech in the Spanish Bank’s stable, and surely not the last.
It takes a great deal of time for banks to go digital: BBVA took 10 years to get there, even with a computer boffin as CEO, Francisco Gonzalez. Although BBVA managed their transition internally, because they wanted full control and understanding of the transformation, they have not ignored the potential of fintechs. One of their investments is in Saveup, an interesting offering that rewards customers for paying off their debts. Points are scored for paying a debit order, for instance, and these points can be used to enter competitions to win prizes.
To speed up its digital strategy, Scotiabank snapped ING Direct up when ING divested in Canada. It was rebranded as Tangerine, which is now Canada’s leading digital bank. Tangerine bears the fruits of digital marketing and branding success. It runs autonomously, but obviously benefits from the backing of a large multinational bank. The benefit is mutual; Scotiabank acquired a ready-made digital platform, without the effort of building their own solution.
Partners – Fintechs who offer much-needed services
There is a growing trend in fintechs that provide services that banks need as part of their portfolio. Large banks launch their own accelerators such as KBC Start it to spot innovation. The hottest startups in this field are “regtechs”, who specialize in governance, risk and compliance. Non-compliant banks have attracted huge fines: between 2008 and 2016, banks have been fined a massive $321 billion, according to Boston Consulting Group (1). Some of this was fraudulent activity, but much of it was poor compliance. There are various flavors of regtechs, offering services from compliance monitoring to identity management. Droit manages compliance in the trading space for banks such as Goldman Sachs. European regtech Feedzai uses AI to manage payment risk and detect fraud and is used by Citibank.
Cybersecurity is another worry in the digital age. Here again, it makes sense to outsource to a fintech whose main focus is the early detection and prevention of onslaughts on precious data and clients’ funds. Israel is the place to look if you want a fintech that can secure you against hackers.
Not far behind the regtechs and security boffins are the data and analytics specialists. It has been estimated that there will be a need for some 80 000 data scientists and associated roles by 2020. An organization can budget for hiring these very scarce and expensive skills as part of their permanent set-up, or can partner with an analytics fintech like Kensho or Persado. Citibank and Goldman Sachs use the services of both these companies.
Banks that are Taking the Leap of Faith
While some banks may dabble in the shallows with a couple of fintech experiments, Goldman Sachs is one of the banks that has taken the plunge and is unbundling its current business model. In Europe, Santander has been exploring the possibilities, while the remaining European banks are more conservative.
In Asia, fintechs are definitely seen as an opportunity, rather than as a threat. Initially, there was resistance, and most Asian banks are cautious, but in Singapore momentum is gathering. The regulatory authority has created a “regulatory sandbox” where startups can test the robustness of their product, in the hopes that Singapore becomes the Fintech capital of the world.
What about Blockchain?
We have deliberately excluded blockchain here, because one of the aims of distributed ledger is to bypass banks in the transaction sequence. IMF managing director, Christine Lagarde, recently said that she foresees the end of banking and the triumph of cryptocurrency. This does not mean that banks have not been paying attention to blockchain, as this is the biggest disruptors to banking as we know it. Major banks have been investing much time and money in blockchain pilots, notably r3, which had twelve of the largest European banks and 5 of the largest US banks committed to getting it up and running. The product is called Corda, and is not actually a blockchain, nor a distributed ledger. Some of the original investors have left to invest in other chains, as it now has over 80 members and seems a bit crowded.
For those banks outside the EU who are reading this, there is no place for complacency. Regulators across the globe are watching the implementation of PSD2 with great interest, and the chances are that there will be wholesale adoption of the same approach in other markets. What is certain is that a digital platform is the first major hurdle in digital transformation, which is non-negotiable. This clears the way for unbundling the bank to form a leaner and more focused entity, with fintechs as partners.