Schlagwort-Archive: Fintech

How Banks Can Compete Against an Army of Fintech Startups

It’s been more than 25 years since Bill Gates dismissed retail banks as “dinosaurs,” but the statement may be as true today as it was then. Banking for small and medium-sized enterprises (SMEs) has been astonishingly unaffected by the rise of the Internet. To the extent that banks have digitized, they have focused on the most routine customer transactions, like online access to bank accounts and remote deposits. The marketing, underwriting, and servicing of SME loans have largely taken a backseat. Other sectors of retail lending have not fared much better. Recent analysis by Bain and SAP found that only 7% of bank credit products could be handled digitally from end to end.

The glacial pace at which banks have moved SME lending online has left them vulnerable. Gates’ original quote contended that the dinosaurs can be ”bypassed.” That hasn’t happened yet, but our research suggests the threat to retail banks from online lending is very real. If U.S. banks are going to survive the coming wave in financial technology (fintech), they’ll need to finally take digital transformation seriously. And our analysis suggests there are strategies that they can use to compete successfully online.

Lending to small and medium-sized businesses is ready to move online

Small businesses are starting to demand banking services that have engaging web and mobile user experiences, on par with the technologies they use in their personal lives. In a recent survey from Javelin Research, 56% of SMEs indicated a desire for better digital banking tools. In a separate, forthcoming survey conducted by Oliver Wyman and Fundera (where one of us works), over 60% of small business owners indicated that they would prefer to apply for loans entirely online.

In addition to improving the experience for business owners, digitization has the potential to substantially reduce the cost of lending at every stage of the process, making SME customers more profitable for lenders, and creating opportunities to serve a broader swath of SMEs. This is important because transaction costs in SME lending can be formidable and, as our research in a recent HBS Working Paper indicates, some small businesses are not being served. Transaction costs associated with making a $100,000 loan are roughly the same as making a $1,000,000 loan, but with less profit to the bank, which has led to banks prioritizing SMEs seeking higher loan amounts. The problem is that about 60% of small businesses want loans below $100,000. If digitization can decrease costs, it could help more of these small businesses get funded.

New digital entrants have spotted the market opportunity created by these dynamics, and the result is an explosion in online lending to SMEs from fintech startups. Last year, less than $10 billion in small-business loans was funded by online lenders, a fraction compared to the $300 billion in SME loans outstanding at U.S. banks. However, the current meager market share held by online lenders masks immense potential: Morgan Stanley estimates the total addressable market for online SME lenders is $280 billion and predicts the industry will grow at a 47% annualized rate through 2020. They estimate that online lenders will constitute nearly a fifth of the total SME lending market by then. This finding confirms what bankers fear: digitization upends business models, enabling greater competition that puts pressure on incumbents. Sometimes David can triumph over Goliath. As JPMorgan Chase’s CEO, Jamie Dimon, warned in a June 2015 letter to the bank’s shareholders, “Silicon Valley is coming.”

Can banks out-compete the disruptors?

Established banks have real advantages in serving the SME lending market, which should not be underestimated. Banks’ cost of capital is typically 50 basis points or less. These low-cost and reliable sources of funds are from taxpayer-insured deposits and the Federal Reserve’s discount window. By comparison, online lenders face capital costs that can be higher than 10%, sourced from potentially fickle institutional investors like hedge funds. Banks also have a built-in customer base, and access to proprietary data on depositors that can be used to find eligible borrowers who already have a relationship with the bank. Comparatively, online lenders have limited brand recognition, and acquiring small business customers online is expensive and competitive.

But banks’ ability to use these strengths to build real competitive advantage is not a forgone conclusion. The new online lenders have made the loan application process much more customer-friendly. Instead of walking into a branch on Main Street and spending hours filling out paperwork, borrowers can complete online applications with lenders like Lending Club and Kabbage in minutes and from their laptop or phone at any hour of the day. Approval times are cut to days or, in some cases, a few minutes, fueled by data-driven algorithms that quickly pre-qualify borrowers based on a handful of data points such as personal credit scores, Demand Deposit Account (DDA) data, tax returns, and three months of bank statements. Moreover, in instances where borrowers want to shop and compare myriad options in one place, they turn to online credit brokers like Fundera or Intuit’s QuickBooks Financing for a one-stop shopping experience. By contrast, banks — particularly regional and smaller banks — have traditionally relied on manual, paper-intensive underwriting processes, which draw out approval times to as much as 20 days.

The questions banks should ask themselves

We see four broad strategies that traditional banks could pursue to compete or collaborate with emerging online players—and in some cases do both simultaneously. The choice of strategy depends on how much investment of time and money the bank is willing to make to enter the new marketplace, and the level of integration the bank wants between the new digital activities and their traditional operations.

Two of the four options are low-integration strategies in which banks contract for new digital activities in arms-length agreements, or pursue long-term corporate investments in separate emerging companies. This amounts to putting a toe in the water, while keeping current operations relatively separate and pristine.

On the other end of the spectrum, banks choose higher-integration strategies, like investing in partnership arrangements, where the new technologies are integrated into the bank’s loan application and decision making apparatus, sometimes in the form of a “white label” arrangement. The recent partnership between OnDeck and JPMorgan Chase is such an example. Some large and even regional banks have made even more significant investment to build their own digital front ends (e.g. Eastern Bank). And as more of the new fintech companies become possible acquisition targets, banks may look to a “build or buy” strategy to gain these new digital capabilities.

For banks that choose to develop their own systems to compete head-on with new players, significant investment is required to automate routine aspects of underwriting, to better integrate their own proprietary account data, and to create a better customer experience through truly customer-friendly design. The design and user experience aspect is especially out of sync with bank culture, and many banks struggle with internal resistance.

Alternatively, banks can partner with online lenders in a range ways – from having an online lender power the bank’s online loan application, to using an online lender’s credit model to better underwrite and service bank loan applications. In these options, the critical question is whether the bank wants to keep its own underwriting criteria or use new algorithms developed by its digital partner. Though the new underwriting is fast and uses intriguing new data, such as current bank transaction and cash flows, it’s still early days for these new credit scoring methods, and they have largely not been tested through an economic downturn.

Another large downside of partnering with online lenders is the significant level of resources required for compliance with federal “third party” oversight, which makes banks responsible for the activities of their vendors and partners. In the U.S., at least three federal regulators have overlapping requirements in this area, creating a dampening effect that regulatory reform in Washington could serve to mitigate.

Banks that prefer a more “arm’s-length” arrangement have the option to buy loans originated on an alternative lender’s platform. This allows a bank to increase their exposure to SME loans and pick the credits they wish to hold, while freeing up capital for online lenders. This type of partnership is among the most prolific in the online small business lending world, with banks such as JPMorgan Chase, Bank of America, and SunTrust buying assets from leading online lenders.

The familiar David vs. Goliath script of the scrappy, internet-fueled startup vanquishing the clunky, brick-and-mortar-laden incumbent is repeated so often in startup circles that it is sometimes treated as inevitable. But in the real world, sometimes David wins, other times Goliath wins, and sometimes the right solution involves a combination of both. SME lending can remain a big business for banks, but only with deliberate choices about where to play and how to win. Banks must focus on areas where they can build a distinct competitive advantage, and find ways to partner with or learn from the new innovators.


China’s booming fintech sector

The fast and furious growth of the country’s Internet finance industry will inevitably slow. Companies need to begin positioning themselves for sustainable success.

Download the full report here: Disruption-and-connection-cracking-the-myths-of-China-internet-finance-innovation

China’s Internet finance industry has boomed in recent years. The country leads the world when it comes to total users and market size; financial-technology (or fintech) start-ups are mushrooming, as are company valuations; capital markets are aggressively pursuing the Internet finance industry; and consumer behavior is altering dramatically. By the end of 2015, the market size of the country’s Internet finance sector was more than 12 trillion renminbi ($1.8 trillion), dominated by the payments sector (exhibit).

Four factors are driving this rapid growth. First, China has an open, supportive regulatory environment. In fact, in 2013 the People’s Bank of China explicitly expressed support for tech companies to promote Internet finance. Second, China has a highly developed e-commerce sector, with more than 30 percent of the Chinese population already using Internet payment systems. Third, there is enormous latent demand for inclusive finance. Due to historical protection and strict regulation, traditional players are moving slowly to meet underserved customer segments, opening the door to disruptors. And finally, the strong profitability of traditional banks has underwritten a strong trial-and-effort culture, facilitating aggressive investments in innovative digital services.

The Internet finance sector’s torrid growth will inevitably slow. This will present challenges and opportunities for companies, especially as more mature regulations are imposed and a degree of consolidation takes place. As outlined in our new report Disruption and connection: Cracking the myths of China Internet finance intervention, surviving and thriving in this changing environment requires companies to take steps now. That means understanding not just the trends likely to shape the sector but also the kind of companies that have evolved in recent years.

China’s three types of fintech players

Numerous players from various industries have rushed to stake a claim to China’s Internet finance sector. We’ve identified three distinct types of companies that are taking the lead, each with distinctive value propositions:

  • Internet attackers, or ‘barbarians from the outside.’ China has a uniquely competitive digital landscape dominated by a few digital companies that have established comprehensive multilicensed financial ecosystems. They differ from each other by core businesses or target groups. As one of the largest e-commerce companies globally, for example, Alibaba used its e-commerce business as a foundation of its financial empire, first entering into the payments sector before expanding into financing and wealth management, with an emphasis on hundreds of millions of individual and small- to medium-enterprise (SME) customers. Tencent took another route, expanding beyond the powerful social nature of its WeChat platform to build a consumer-oriented financial network that taps into its huge user base. These entrepreneurial attackers form the largest group and the most prolifically and wildly innovative, offering local products and expanding aggressively by taking full advantage of the customer insights at their disposal.
  • Traditional financial institutions. Incumbent financial institutions are accelerating their push into the Internet finance sector. They don’t want to just witness this wave—they want to ride it. Yet strict regulations and relatively conservative mind-sets mean they are typically followers rather than leaders, at least compared with Internet attackers. That said, institutions such as Ping An Insurance Group are strategically entering the sector through subsidiaries including Lufax, Pinganfang, and Ping An Puhui. In addition, large commercial banks are acting: for example, China Construction Bank and Industrial and Commercial Bank of China are now building their own e-commerce platforms. Others will inevitably follow. Traditional players also have several strengths that should not be underestimated: a legacy of strategic partnerships, comprehensive product offerings, professional risk-management expertise, and physical branches.
  • Nonfinance companies. Although small in number, companies with no experience in either finance or the Internet are joining the sector. Examples include retail companies Gome and Suning, and real-estate group Wanda Group, which are marrying extensive offline resources such as customer leads with data mining to design new financial products. In doing so, they threaten to undermine banks’ control over key business customers.

Six emerging fintech trends

In the near future, we believe China’s Internet finance players will enter a “warring stage” that results in consolidation. Regulations will be updated to account for new companies and products, and growth will become more orderly. In next five years, we see the enormous potential of six developing trends being gradually unleashed. Players should act quickly and firmly, strengthening skills and capabilities to take advantage of fintech’s global emergence.

Mobile payment and wealth management

Payment is the most mature sector in Internet finance, but growth in the payments industry is far from slowing. Consumer engagement and affinity are increasing, and online-to-offline mobile payment via smartphones has become a new battlefield where companies are already starting to compete fiercely for market share. Traditional financial institutions, in cooperation with mobile-hardware manufacturers, are also starting to adopt near-field communication payment. At the same time, China’s capital market is opening up. As they accumulate more wealth, Chinese consumers are hunting for higher investment returns—meaning that all investment products, except savings, are expected to maintain rapid growth. That provides opportunities for Internet-based wealth-management businesses.

Online consumer and SME finance

As China’s economy seeks to evolve from investment led to consumer led, demand for financial services among Chinese households will only increase. Younger Chinese consumers are early adopters and keen drivers of innovation, more open to online personal-finance products, and have both a higher propensity to spend and a higher tolerance for financial risk. Indeed, as more advanced application of data enables quick and remote decision making, the full range of conventional consumer-financing products—such as credit cards and consumer loans—can be offered online, further broadening the industry’s potential scope. In addition, there remains a large gap between the needs of SMEs and traditional banking products. SMEs in China contribute a significant share of GDP and employment (nearly 80 percent and 60 percent respectively), yet their development has been beset by a shortage of funds. As the country’s economy slows, banks are becoming more reluctant to address this issue—presenting a huge opportunity for the highly efficient, low-cost fintech sector.

B2B Internet finance

In the next five years, companies will still contribute the majority of banking revenue in China—and the long business-to-business value chain will generate both opportunities and innovation. Chinese companies are shifting from simply borrowing to having more complicated needs, such as transaction banking and asset management. In transaction banking, Internet finance can provide time-effective supply-chain financing solutions and digitized cash-management systems to support high-quality management of corporate finance and capital for large companies. In asset management, Internet finance can better address increasingly complex customer needs by providing quick, customized, and differentiated product matching, especially when high-quality assets are difficult to find. Internet channels are also well suited to marketing and customer expansion.

Financial cloud and infrastructure

Unlike the traditional model, where financial institutions operate their own data and IT centers, cloud-based services allow customers to be served remotely based on demand, paying for that usage. Cost effectiveness is a major advantage, with the cloud allowing customers to easily access information with minimal up-front and overhead spending. It also allows customers to retain flexible infrastructure that can be quickly scaled up or down. That’s especially important for small players who need to rapidly build IT capabilities to serve explosively growing user bases and fluctuating volumes. Many IT companies such as Alibaba, Huawei, and IBM are already providing cloud solutions and platforms. We believe cloud-enabled innovation in the Internet finance sector will only increase.

Big data application

Big data allows financial institutions to collect and analyze customer data, providing more tailored products and services through a personalized marketing experience. In risk management, big data allows players to use advanced statistical models to better understand the correlation between factors and risks, based on both internal and external data. Combining this with cloud services facilitates real-time credit investigation and decision making at a low cost. Financial institutions that master these data-driven advantages will enjoy increased operational efficiency and business performance. It’s perhaps no wonder that there’s a huge unmet need forbig data analytics in China—and more and more companies are emerging to serve financial institutions unable build this capability in-house.

Disruptive technology

Blockchain and related disruptive technologies have drawn close attention in the financial industry. Blockchain, the technological base of Bitcoin, is characterized as being safe, transparent, and unmodifiable—however, blockchain has much greater potential than digital currencyalone. It enables point-to-point transactions without a clearing intermediary, substantially reducing transaction time and cost. Further, if combined with smart contracts, blockchain makes it possible to automatically issue digital securities and trade financial derivatives. More broadly, the insurance sector will also provide new opportunities for the application of blockchain.

All of this isn’t to suggest there aren’t nonexposed risks, uncertainties, and challenges associated with China’s booming Internet finance industry. These include consumer irrationality, product defects, and even fraudulent activity, and require careful maneuvering. Players also should cautiously deal with the implicit credit risk and liquidity risk, and be aware that regulators are determined to strengthen the management of Internet finance.

Yet we believe China’s fintech sector will inevitably embrace fiercer competition and further industry integration, with true winners emerging through selection and elimination as they navigate the developing trends we have identified. No matter which element of the Internet finance industry they are in, and whatever their business models are, players must keep evolving to survive and realize a sustainable stake in the sector’s future growth.