17 September 2014

Brett King

Brett King - Moven

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Innovation in Financial Services

A discussion of trends in innovation management within financial institutions, and the key processes, technology and cultural shifts driving innovation.

The Total Disruption of Retail Banking - Part 3

12 July 2011  |  8434 views  |  4

Massive spend on innovation at the front-end of retail financial services

Putting aside conjecture of whether or not we are in a bubble at the moment around tech, social media, and mobile services (which I believe we very well could be), the reality is we are seeing a flurry of massive investment in new distribution models and organizations acting as either technology or behavioral enablers. We’re used to seeing big numbers for M&A activity in banking, but we’re not used to seeing such a flood of start-ups and non-traditional competitors facing off against traditional players at the retail side of the business.

To date, there has been more than $7Bn in private equity, venture capital and private investment made into non-traditional financial services start-ups that challenge existing models. This is the first time globally that there has been this scale of challenge to the traditional retail financial services space from start-ups in the technology arena. To illustrate the level of activity, here are just a few recent investments in the New York fintech space alone (source: Quora):

SecondMarket ($15mm)- marketplace for illiquid financial instruments; secondmarket.com
Kapitall ($7.3mm)- discount brokerage with gaming elements; kapitall.com
Betterment ($3mm)- online brokerage for small investors; betterment.com
Plastyc ($2mm)- mobile based banking for the underbanked; plastyc.com
AxialMarket ($2mm)-
 online middle market i-bank; axialmarket.com
BankSimple ($3mm)- online/mobile banking interface; banksimple.com
Covestor ($11mm)- platform to find SMA providers and invest with amateur traders; covestor.com
Hedgeable- next generation investment management firm; hedgeable.com

However, in addition to these plays you have very some serious initiatives now doing major business in the space that used to be considered the sole domain of ‘banks’. Here are four examples:

Personal Financial Management

Mint was acquired by Intuit in September of 2009 for $170m. Mint has experienced meteoric growth in customer base. Today Mint has more than 5m customers willingly giving their personal financial data, bank account and spending information to receive the benefits of fine tuned recommendations for financial services investments and credit products.

Businesses like SmartyPig, which has a collaborative play with the industry, are very successful at stimulating simple behaviors like savings for specific goals. SmartyPig has raised over $1.2Bn in deposits for the partners banks it works with such as Citi, West Bank, BBVA, ANZ, etc. They utilize social media to encourage your friends and family to assist you in your savings goals. For example, my kids were able to use SmartyPig to solicit assistance from their grandparents, uncles, aunties, etc to help with their savings goal.

Admittedly, we also seen Blippy and Wesabe crash and burn in recent times. However, the readiness of the investment community to experiment in the space of services that are complimentary or competing directly with traditional FIs is clearly increasing.

P2P Lending

Lending Club, Prosper and Zopa are just three examples of recent successes in the P2P lending space. Lending Club is lending around $20m a month in loans, and have lent more than $300m, with an average loan size around US$10,000. In France, FriendsClear has recently announced that Crédit Agricole will be joining their efforts in a collaboration of sorts; exactly how this will work is still under wraps.

Zopa has lent more than £150m which means they are now approaching a 2% market share of the total UK retail lending market. Zopa’s average loan size is around GBP 5,000, but what is more significant is their Non-Performing Loans (NPL) ratio. Major U.K. banks typically recorded NPL ratios in the 2%-3% range from the mid-1990s through to 2007, but by the end of 2009 Lloyd TSB’s gross NPL was as up to 8.9% and HSBC’s hovering around 3% (source: Standard and Poors). So how did Zopa perform in this environment? Zopa’s NPL ratio sits at around .9%. That’s 10% of Lloyds and 1/3rd of the best bank in the UK HSBC!

So how is it that a social network that lends money between its participants is better at managing loan risk than banks that have been at this for hundreds of years?

The key here is the positive psychology of social networks versus banks. If I lend money off a bank and I’m having difficulty paying that back due to loss of income, or just having a hard time making ends meet, I’m likely to let the loan slip and wait for the bank to chase me. P2P networks like Zopa, on the other hand, are finding customers proactively contacting them to make payment arrangements when they can’t meet their monthly commitment. Why?

Firstly, there are people at the end of the loan – not a big bad bank who “can afford the loss”. Secondly, the fact that there are people at the end of the loan versus a bank means that people are more inclined to prioritize paying back their loan to other people, over that of a large institution. This positive peer pressure is producing astounding results. I also asked Giles Andrews from Zopa about why he thought Zopa was better at managing lending risk than banks...


“I think our low defaults aren’t just because of P2P but because we built a better credit model, taking more account of over-indebtedness and affordability than banks”

Giles Andrews, CEO, Zopa.co.uk

 

Who would have thought that social networks would be better, safer, and more efficient at lending than retail banks?

In fact, P2P lending has been so successful that in recent times both Umpqua Bank and Fidor Bank (a start-up online, direct bank in Germany) have incorporated some P2P as a component of their bank platforms. Why take all the risk yourself as a bank, when some customers are willing to cover the risk themselves? But don’t think that P2P is just easy money. Wall Street Journal reported in June of this year that 90% of Lending Club’s applications were refused.

Maybe that’s why P2P is good business – because they actually take fewer risks than banks?

Pre-paid debit cards, E-Money Licenses and Payments

Amex, Greendot, NetSpend and Walmart are just three organizations that have recently made big pushes into the prepaid debit card arena in the US alone. Significantly, the US now has 40-60 million underbanked consumers (source: FDIC, Financial Times), half of whom have college degrees, and 25% of whom are prime credit rated. Many of these are opting out of the traditional banking system, but carry a pre-paid debit card. The pre-paid debit card industry will account for more than $200 Billion in funds by the end of 2011 along (source: Packaged Facts).

The financial crisis has accelerated the increase in those whom no longer participate in the formal banking system. Since the financial crisis 60% of new mobile phone users in the United States have been no-contract, pre-paid phone users.

 

“As an economy becomes richer and incomes rise, the normal expectation is that the proportion of the unbanked population falls and does not rise as is now happening in the United States...”
Washington Post, December, 2009

 

Combined with increased account fees from big banks recently affected by reduction in interchange revenue, and modality changes, I think we can expect that increasingly customers who don’t need complex banking relationships will opt out of the banking system by using prepaid debit cards and in the future prepaid wallets enabled via NFC and mobile Apps.

In the UK Google, O2, BT and others are looking seriously at the combination of prepaid debit cards type functionality into a wallet. Google already launched their Google Wallet earlier this year, and we can only see more and more of this action in the coming months.

The raft of P2P payments, mobile payments and mobile enablement are bewildering at the moment. Undoubtedly, we’ll see many variations of mobile payments in the near future. With PayPal predicting $3 Billion in mobile payments in 2011 alone, the future of mobile-based prepaid debit cards looks very healthy.

Conclusions

We’ve never had such a concerted, technology-led explosion of retail financial services solutions that are directly in competition with the traditional players in the space. While some of these initiatives are complementary, increasingly we’re seeing startups that realize you don’t need a banking license to play on the fringes of the banking system. When you only know one way of running your business you will be increasingly challenged by customers who don’t relate to the questions you ask, the processes you have in place, and the insistance on using outdated physical artifacts and networks.

This is the first time we’ve seen a global attempt at reinventing the way banking fits into our lives on a day-to-day basis, and it is bound to create massive friction for a sector known to be very attached to traditional modes and models. One thing is clear, increasingly banks will be competing with new businesses that are faster, better, more relevant and aggressive than the long-held bastions of traditional savings and loans.

These businesses will embrace and exploit changing modality. These businesses will love disruptive customer behavior, they’ll encourage it!

Zopa's NPL ratio is .9pc - Lloyds is 8.9pc TagsCardsOnline banking

Comments: (6)

Colin Henderson - Bankwatch Consulting - Canada | 12 July, 2011, 13:57

This is a great series of articles and provides excellent context for what is happening in the financial services space.  

I would take issue though that we are perhaps not yet seeing the 'disruption of banking'.  As both a long time observer and market participant (disclosure - I am involved with CommunityLend in Canada) I see these startups carving a useful niche, sometimes profitable, sometimes not.  These niches are small and paricular.  I believe Giles when he states he has a better credit model and he is also particular in what he allows on the books.  Not to defend banks, but they have been under politial pressure for decades to provide banking services to all.  It is also true they have been driven by quarterly targets to maintain stock market returns ( and employee bonuses).

This targetted versus generalist customer model view goes some way to explaining what we see in todays startups.  It might also go some way to describing waht the future of financial services might look like;  a much more divided, niche, targetted set of providers numbering in the hundreds or throusands could well be an outome.

We are yet to see a model that scales up the way a large bank scales however.  It is wonderful to see the start up activity that we see and I am happy to be part of that, but I include our own efforts in recognising that we are only nipping at the ramparts of the big banks, but we are hardly threatening to tear down those walls yet.

As a side note, in that future world of many strtups providing financial services, I wonder how the regulators will act and what the impact will be of the first major catastrophe that affects thjousands or millions of customers somewhere - a reality that will undoubtedly and unfortunately occur.

Thanks for listening to my musings.

PS ...Good luck on Movenbank btw.

Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune | 13 July, 2011, 19:13

I agree with Colin H's views that much of what we're seeing from the new startups is really fringe activity that has very low chances of threatening traditional banks. Besides, traditional banks have deep pockets, made deeper by government bailouts that unfortunately don't rain down on the Blippys and WeSabes of the world. With their huge resources, they (i.e. traditional banks) have the luxury of waiting and watching and letting the startups do all the evangelizing and then cherry-picking the promising ones. Citi-eCount (prepaid card), AmEx-Revolution Money (alternative payment), and, most recently, CapitalOne-INGDirect (digital channel), are cases in point. The recent actions of Reserve Bank of India and Dodd-Frank-Durbin in the context of bringing PayPal under some level of regulation in India and the USA respectively prove that regulators might start overseeing non-bank financial services providers well before a catastrophe strikes thousands or millions of their customers. 

Brett King - Moven - New York | 13 July, 2011, 19:28

All,

The objective is not to completely or effectively circumvent the banking system, although we're seeing that happening in Kenya with M-PESA and in the US with Prepaid Debit Cards. However, to say that non-traditional competitors have no impact is also niave. 

Today banks have to seek the permission of Google and Apple to have access to their own customers through App stores. In the near future, phones will carry wallets undoubtedly owned by non-banks. Does this mean banks are totally disintermediated, no...but it does mean they are once removed from their customers.

Would a regulator stop Google Wallet from operating because of risk to customers? Ketharaman - this is purely wishful thinking. In my view, Google is just as capable as executing a NFC-enabled wallet as a bank, in fact they have much more power to do so in a sensible, secure manner, than a collection of disparate banks fighting over who will own the wallet. Will regulators stop PayPal from their mobile payments play? Not a chance. Believing regulators will save you from your duty to improve the way channels and payments technologies work for your customers is foolhardy.

The fact is, increasingly banks are already competing in fringe areas against non-banks who lead with customer experience. In the case of Google and PayPal, they have banking licenses, but not because they want to be banks, but because it was easier than doing what they're doing without banking licenses.

The future is not as clear cut as it has been. A banking license doesn't offer the barrier to entry it once did.

BK

Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune | 13 July, 2011, 20:03

Google Wallet and the like are mere wallets and not payment methods. They store information of products issued by, well, banks - no bank issued credit card, no use of Google Wallet for the consumer. The question of regulators entering the picture doesn't arise. Banks don't have to seek the permission of Apple / Google to access their own customers. They can always opt for SMS or mobile web applications instead of native apps as many of them have already done. In India, the regulator has already created a framework that excludes a solo mobile money play by PayPal. When the non-bank financial services providers start learning banking and feeling the compliance pressures that banks have been subjected to for ages, I for one strongly believe - based on my experience with PayPal and a couple of others - that their customer experience will fare far worse than banks'.

While giving due credit to nonbank players for their innovations, it's too far-fetched to believe that they can make a significant dent on banks in the foreseeable future. If and when they do, banks can use their deep pockets to mitigate the impact by buying them out, as they've already done with Revolution Money and in the other cases I've pointed out. 

Brett King - Moven - New York | 13 July, 2011, 20:42

Ketharaman,

And that's why I'll eat your lunch as an innovator. Because you think it's far fetched that I can compete with you.

I bet bookstores thought the same of Amazon, and I'm sure record stores and video rental outlets thought the same about iTunes.

BK

Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune | 14 July, 2011, 10:10

Yeah, right. That's probably what WebVan thought of conventional grocery stores, INGDirect USA thought of conventional banks having branches, and digital pundits thought of conventional cheques. The first one crashed and burned after $$M in VC funding; the second one is just another channel of a conventional bank; as ilustrated by banks' recent decision on the third in the UK, I'm confident that banks know to place consumer preference and customer experience - cheque trumps ePayments on both - ahead of anything else while deciding the right mix of products / instruments / channels.

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