In previous posts, I introduced the concept of retail banks’ unbundling to particular services. Also, I outlined the reasons FinTech companies are successful. I stressed that banks could defend themselves by increasing their focus while simplifying the product range, looking at products from customer use case perspective, and ultimately driving down operating costs. In this post, I would like to elaborate on what is currently happening in the market and what are likely outcomes.

Firstly, despite all the media attention, the FinTech sector is still comparatively small in comparison to the overall financial sector. In 2014, all FinTech companies in the UK generated £20 billion in revenue, which is still nimble in comparison to £8 trillion of UK banks assets in 2013. Despite FinTech start-ups willingness to provide complex financial offering, they do not possess payments and account insurance infrastructure that incumbent banks have. Although, Fintech companies can unbundle bits and pieces from banks offering, they still play an only marginal role in the financial services value chain.

On the other hand, FinTech companies are often better in that particular service they provide than incumbent banks. Customers are increasingly switching to various FinTech user-friendly solutions that replace their bank’s products limiting their banks to regulated activities e.g. insured deposits.  

FinTech companies do not have access to the infrastructure associations of financial institutions built over the years. However, not having to maintain the banking infrastructure, they gained a significant operating cost advantage that they pass to their customers. Glaring examples are peer to peer lenders, whose costs over loan portfolio represent 2% vs. 5-7% of incumbent banks.

I see two likely scenarios of future developments that are not necessary excluding each other.

Scenario number one, the FinTech sector will build parallel payments and trust infrastructure. For instance, bitcoin could become a new transaction currency (think USD role in international payments) and Blockchain payment infrastructure (think SWIFT, SEPA, etc.). It is already happening, as 70 million bitcoin transactions were carried out until now and their volume is exponentially growing. Only in the last 12 months, about 30 million bitcoin transactions were performed across the world with $19 trillion of value exchanged. Although, the numbers seem impressive they are still negligible when compared to 18 billion transactions carried out in the UK in 2012. 

Scenario number two, consists of banks undergoing digital transformation either on their own or by swallowing some of FinTech start-ups while embedding their technology into their operating models creating synergy with assets unique to banks (e.g. insured deposits). From recent data, it seems that banks are already frequently courting FinTech sector as a chart below demonstrates.

I think that, to a certain extent, both scenarios will materialise. An alternative payment and trust infrastructure with an ecosystem of service providers and users will be built around Blockchain. The underbanked population in emerging economies will be early majority adopters of Blockchain based financial solutions. At the same time, banks will be exploiting new technologies to serve their customers better and drive down cost base. Over time, bank’s digital transformation will gradually move upstream the value chain from front office solutions to back office where the bulk of cost savings opportunities are. Therefore, we will witness and participate in interesting developments on both sides of the barricades.

Chart - Reactions of global banks to the development of Fintech companies as of February 2015, source Statista