Older Financial Institutions Are “Losing Their Shine” To Nimble and Smarter FinTech Startups

Introduction

The financial services industry is a highly regulated, highly technical, and highly traditional industry where ancient companies reign supreme and new entrants do not have good odds of survival. The Internet and the rise of the digital age have disrupted the old order in the financial services industry and now, FinTech is threatening the existence of traditional financial institutions.

FinTech broadly refers to the act of exploiting digital technology to provide products and services that traditional banks typically offer. FinTech companies are able to offer the financial services with innovations, a faster processing time (sometimes in real time) and at a cheaper cost than traditional financial institutions.

An overview of the performance of bank stocks

Bank stocks have started to face strong headwinds since UK voted to leave the EU. Now, investors are worried that the decline in bank stocks bears an uncanny resemblance to the collapses of traditional financial institutions in the eve of the 2008 global economic meltdown

Christopher Whalen, senior managing director with Kroll Bond Rating Agency in a report covered by CNN observed that “The disruption to commercial and legal structures caused by the extraordinary legal process that looms ahead will… cause systemic contagion à la Lehman Brothers as some analysts have worried.”  Whalen also observes that one of the pitfalls of Brexit is “a slowdown in economic activity that could materially impact volumes and earnings in the global banking industry.”

In fact, the traditional finance industry has been suffering in the last couple of years due to macroeconomic concerns occasioned by the low interest rates environment. More so, the fact that regulators are tightening the reins on banks in order to avoid a repeat of 2008 is also forcing traditional financial institutions to record falling returns because they can’t take big risks.

Rupert Hargreaves, an analyst with Motley Fool notes that “the banking sector is facing a very hostile operating environment and while many European bank shares may now be trading for less than book value, unless there’s a sudden improvement in the operating environment, these banks could be value traps.” The charts below shows the performance of U.S., UK, and Australian banking stocks since the Brexit vote was cast on June 23.

UK Bank Stocks

U.S Bank Stocks

Australian Bank Stocks

However, the weakness being recorded in bank stocks cannot be blamed entirely on the doorstep of the Brexit vote. The fact remains that the traditional finance industry has been struggling for years. Ancient banks, old-school investment firms, old-school lenders, and traditional insurers have all being struggling behind the façade of magnificent buildings and impressive corporate speak. The Brexit vote and the uncertainties that it triggers only served as a catalyst to expose the weak fundamentals of the traditional finance industry.

The main problem with banks is “tradition”

However, the problems with traditional financial institutions go beyond declining share price, Brexit, and low interest rates. The main cause of the woes facing old-school financial institutions is the drastic change to their business fundamentals occasioned by the rise of the FinTech industry.

To start with, banks typically invest customer deposits into government bonds in order to make higher returns in the spread between the bond yield and the interest rates paid to the customer on deposits. Now, customers can access a wide range of digital financial instruments that pay better returns than the interest on savings accounts. More so, traditional finance institutions now have to contend with modern FinTech startups and many old-school finances houses are slashing rates on loans in order to lure customers. The reduction in rates and customer –friendly terms is eating into the profitability of the banks.

As discussed above, bank stocks have become a sort of value trap for investors and smart investors are already moving their funds out of the stocks of traditional financial institutions. This outflow of funds in the financial services industry is the main driver of the weakness in the stocks of financial institutions. In contrast, investors have been moving huge amounts of money as investments into FinTech companies and startups.

In a Pwc report, analysts observed that funding of FinTech start-ups more than doubled in 2015 reaching $12.2bn, up from $5.6bn in 2014. Steve Davies, PwC EMEA Fintech Leader observes that “Fintech is changing the FS industry from the outside. PwC estimates within the next 3-5 years, cumulative investment in fintech globally could well exceed $150bn, and financial institutions and tech companies are a stepping over one another for a chance to get into the game”

In another report, analysts at Accenture Consulting observed that “Investment in financial-technology (fintech) companies grew by 201% globally in 2014, compared to 63% growth in overall venture-capital investments”

FinTech is disrupting the financial services industry

Below are some critical areas in which FinTech companies have been threatening the profitability and existence of traditional financial institutions.

1)    Investments

• Online stock investing systems

FinTech is already changing how people invest and how people manage their investments. In the years past, investors had to meet with an investment bank before they could buy or sell stocks, ETFs, or other paper assets. Now, high-volume traders can go online to use online stock investment programs and apps to manage their investments.

For instance, ProRealTime is an intuitive market analysis tool that investors can use for stock charting, technical analysis, and stock trading. VectorVest is another FinTech product that combines fundamental valuation with technical analysis on more than 6500 stocks.  E*TRADE, and Etoro are other online tools that investors can use to track their investments.

More so, investors don’t even need the services of financial advisors because the Internet is littered with thousands of training programs for beginners, intermediate, and advanced investors.

• Investment profiling products

Interestingly, the FinTech industry is adopting a multifaceted approach to provide custom services for investors irrespective of their net worth and risk-taking quotient.  Conservative investors can use services such as Betterment to invest in low-cost index funds without having to pay hefty cuts to brokers and money managers. Passive investors can also use Wealthfront as a perfect most tax-efficient, low-cost, and hassle-free way to invest. Wealthfront prides itself on its PortfolioReview feature, which will analyze your current portfolio to recommendations on how to balance risk in your investments and on how to make your portfolio tax efficient.

Let’s also not forget the new Bitcoin IRA or Digital Currency IRA. It is an Individual Retirement Account in which Bitcoin or other approved digital currencies are held in custody for the benefit of the IRA account owner. It functions the same as a regular IRA, only instead of holding paper assets, it holds the popular digital currency, bitcoin, in custodian managed wallets. Bitcoin IRAs are usually self-directed IRAs, a type of IRA where the custodian allows more diverse investments to be held in the account.

2)   Savings Accounts

Savings account used to be a risk-free way to invest because the money was FDIC insured and you’ll be paid an interest on your deposits. The prevailing low-interest rate environment has removed the shine from savings account; your savings won’t keep up with inflation and the ultra-low yield doesn’t justify the opportunity cost of savings over other low-risk investments.

However, the FinTech industry is making the savings account fun and profitable once again. The rise of digital banks with online savings and checking accounts has provided investors with fee-free savings that yield higher interests over traditional savings accounts. For instance, Synchrony offers a high yield online savings account with 1.05% APY. The savings account doesn’t have a monthly service fee and there’s no minimum balance requirement. More so, you are eligible to perks such as $5 per month on out-of-network ATM fees, theme park discounts, and free checks.

3)   Loans

Giving out loans used to be the exclusive business of banks but FinTech has peeled away that veil of exclusivity. Now, Peer to Peer platforms makes it easy for borrowers to connect with lenders to work out mutually beneficial loan and repayment terms. Peer to Peer lending often meets the needs of borrowers who are unserved and underserved by traditional financial institutions. More so, Peer-to-peer lending eliminates the desperation that pushed borrowers to take loans from loan sharks and payday loan operators.

In a typical P2P lending network, borrowers apply for loans and their creditworthiness determines the amount of interest that they’ll attract on their loans. Lenders can look through the profile of the borrowers and buy loan notes commensurate with their risk-to-reward expectations. The lenders are also able to invest relatively smaller amounts of money to give out loans that pay a tidy income in the form of monthly repayment and interest.

LendingClub is the world’s largest online marketplace for connecting borrowers with investors and you can access both personal and business loans. Prosper is another P2P platform where borrowers could get a wide range of loans for debt consolidation, home improvement, small business and special occasions.

 4)   International money transfers

FinTech has invaded the world of international money transfers and people have fewer reasons to use wire transfer or traditional services such as Western Union to move money across borders. The arrival of cheaper non-bank services makes it easy to transfer funds from your bank account, credit card, or debit card directly to a recipient in any part of the world right from the comfort of your home. The best part is that the transfer is often concluded within minutes as opposed to the typical wire transfer processing which can take multiple business days.

PayPal allows you to send and receive money using your email address alone without having to worry about revealing your financial details. Xoom allows you to transfer money from a bank account, credit card, or debit card directly into the bank account of your recipient. The best part is that you’ll know the prevailing exchange rate and you’ll know how much your recipient will receive.

5)   Insurances

The insurance industry is one the hardest industries to break into and the U.S. health insurance industry might be the most regulated industry in the world. The regulations are numerous and navigating them could be costly and time-consuming. The worst part is that most policyholders distrust existing insurance companies and a startup insurance firm does not have any reputation with which it could gain the trust of potential policyholders.

Nonetheless, the FinTech industry is deploying a consistent assault on the impregnable armor of the insurance industry and it is only a matter of time before FinTech startups overrun traditional finance firms in the insurance industry. FinTech insurance startups are coming to the market with improved transparency, better data analysis, impeccable customer service and fair premiums.

For instance, Metromile offers an affordable pay-per-mile insurance for low-mileage drivers to ensure that they are not paying more than necessary in auto insurance premiums. Oscar is offering smart, simple, and cheaper health insurance powered by technology, data, and design. Lemonade is the first P2P insurance carrier in the world and it seeks to redesign insurance by making it honest, instant, and stress free.

6)   Payments

The Fintech industry has pushed banks to the background in the world of payment processing. Now, small business owners do not have to jump through the hoops of traditional payment processors such as Visa and MasterCard because of the proliferation of digital payment products. The digital payments industry also offers more convenience, security, and cheaper transaction costs than the traditional payment systems.

Products such as Stripe, Apple Pay, Samsung Pay, and Google Pay allow people to pay for products and services directly from their smartphones. The great thing about digital payment systems is that eliminates the necessity of sharing your financial information with third parties. The rise of these payment services is leading to the emergence of a cashless economy where people do not need to hold cash or their wallets before they can perform financial transactions.

7)   Personal finance

In the years past, traditional financial institutions offer one-size-fits-all services to all customers – only the high net worth individuals are offered personalized financial services in the form of wealth management services. However, the personal finance industry has witnessed explosive growth with the emergence of tools created by the fintech industry. Everybody can now access and use personalized tools for investment advisory, savings, budgeting, and other important money decisions.

Mint helps users to create budgets, stick to the budget, and manage their money more effectively. Pocketsmith is a product that helps people to see where their money is going so that they can control their spending habits with simulations of what-if scenarios. Money Dashboard is another personal finance product that provides a realistic view of your finances by showing exactly where your money goes across all your online financial accounts.

Digit is another smart personal finance tool for saving money easily without much fuss. With Digit, you don’t have to do anything to save money, the AI system goes through you account every few days, examines your spending habits, and moves any spare change into a savings account for you. Of course, you can withdraw the money whenever you are ready.

Conclusion

From the foregoing, it is obvious that the FinTech industry will leave no stone unturned in its quest to wrest market share from the control for old school finance houses. Old school banks, insurers, lenders, and investment managers must acknowledge the need to wake up from their traditional complacency and know that the impending doom cannot be wished away.

A cataclysmal wave of disruption is flowing through the financial services industry and the ability to navigate regulations while waiting for interest rates to rise will not be enough to save banks from being swept off by the flood. The only way forward for traditional financial firms is to start thinking up ways to disrupt their business models before they are overrun by nimble and smarter startups.

Some traditional financial institutions have started to embrace the change and some of them have started offering parallel digital products to compete with the offerings from the fintech industry. However, the fact that traditional finance institutions are wary of taking big risks suggests that they’ll only make halfhearted attempts to adopt fintech products. Traditional financial houses are not likely to be trailblazers in the ongoing FinTech revolution and they’ll likely by on the sidelines reminiscing over the glory days while a new order of tech-savvy FinTech firms arise out of obscurity.