COVID-19 has indeed inflicted revolutionary change at a pace and scale to rival the political upheavals of the 20th century. No wonder so many have seen fit to wheel out Vladimir Lenin. And it is apposite: behind the pithiness Lenin was making the point much had been happening all along, just below the surface. Social pressure had been building.
"This future of banking has been one fintechs have been prophesising and – they hope – monetising.”
So too with this pandemic and what it has precipitated. COVID-19 itself is “Disease X”, a pandemic long forewarned of, indeed carefully mapped – albeit ignored by most governments. And the change it is accelerating, across geopolitics, industry, social structures, had already been occurring.
So it is with financial services and the future of banking.
What we are seeing - more urgent recognition of the shift to digitalisation, the necessity for better use of data and artificial intelligence, the importance of more sophisticated risk management, the shift away from physical assets like cash and branches – has been long coming.
This future of banking has been one fintechs have been prophesising and – they hope – monetising.
Yet even post-COVID, the future of banking will not be a rapid shift away from incumbents towards digital, revolutionary fintechs. And not because their technology is not iconoclastic but because market forces are still operating.
We have already seen the ground shift under fintechs. In the mid-teens fintechs were going to replace the banks. In more recent years the predominant model has been to partner with incumbents.
Fintechs bring innovation, cultural change and different world views but they lack the data, customer bases, capital and regulatory imprimatur held by the incumbents.
With COVID-19, many fintechs have indeed flourished – notably in payments where the acceleration in ecommerce and away from cash has been rapid. But others have foundered and indeed failed.
Fintechs need more than a good idea. They need funding. And they need to be able to survive a credit cycle. We’ve barely seen a credit downturn in more than a decade, since the global financial crisis (GFC) – and most fintechs weren’t even conceived then.
A credit cycle hits both the development of fintechs and the business model. Funding rounds have dried up. Meanwhile bad debts loom like a tsunami on the horizon.
It’s worth remembering the biggest disruption of retail banking in Australia in nearly 40 years, since deregulation, was the emergence in the early 90s of non-bank mortgage originators.
These revolutionaries, like Aussie Home Loans, Wizard, RAMS, used securitisation instead of balance sheets, brokers instead of branches and new processing technology not legacy systems.
They rapidly grabbed around a quarter of all new mortgage originations. The average price of a home loan plunged more than 2 percentage points. None of them are around today in their original form. They been taken over, dismantled, failed. The financial crisis was a final reckoning.
Thus does reality impinge.
CB Insights’ latest State of Fintech report found March quarter venture capital-backed fintech funding was the lowest since 2016. Seed and Series A deals were at a 13-quarter low.
“With forecasts of a recession, investors pulled back on early-stage bets to focus on fortifying portfolios,” CB Insights found.
“Asia saw a 69 per cent drop in funding (to $US883 million) and a 23 per cent drop in deals quarter-over-quarter. Europe was the only major region to see an increase in funding.”
Some fintechs, particularly in payments – for example AfterPay – are flourishing. Overall, the shift to more digital banking and online shopping should help fintechs in those sectors.
However, fintechs competing in the lending space face a double challenge: a terrible credit cycle is looming with wide-spread recessions. A steep rise in bad debts eats into capital and the large incumbents have bigger buffers.
Moreover, as we saw during the financial crisis, there is shift back to known brands in uncertain times. A recent survey by East & Partners found “corporates are allocating more of their business banking needs to well-established and well-known banks in response to COVID-19 related uncertainty, citing the shift as the best way to mitigate risks”.
“As businesses actively take steps to allocate more business to incumbent bank majors, fintechs will now need to use their niche specialities in financial services, low overheads and technology advantages, to regain their balance during turbulent times,” East said.
Alan Tsen, chairman of FinTech Australia, told members recently: “To say 2020 has been tough for the fintech industry would be an understatement. By now, many of you would have made difficult decisions that will define your business in the years ahead.”
Tsen noted the Australian government’s JobKeeper package had been essential in keeping many fintechs going.
Capgemini’s Sudhir Pai, Chief Technology & Innovation Officer, says the collapse in deals means many early stage and aggressive cash-burning start-ups may not survive the funding deficit.
“Fintechs need an urgent injection of cash, either through funding or through business growth,” he says.
“Having said that, the fintech world is gearing up to perform in the New Normal ways, be it through changing the value propositions to meet post COVID demands or focusing on areas that are of interests like Automation, Collaboration, Data (security and anonymisation), cyber (in the context of remote working) and in the new business areas like health, wellbeing, education etc.”
Digital banking meanwhile is taking off. Pai says digital channel adoption is off the charts as more and more consumers adopt digital channels for banking activities – yet banks remain underprepared amidst plunging profits.
- 58 per cent of digital journeys are still broken and require physical or offline efforts to complete banking interactions
- 36 per cent of consumers reported a better experience by switching to an alternative banking provider in the current environment and will continue using them post the crisis
- 82 per cent of consumers are reluctant to visit branches
- Use of digital mediums such as mobile apps and websites has seen a step increase from 47 per cent (pre-COVID) to 55 per cent (during COVID-19).
Regulators are also key to the future of banking. Afterpay, for example, is contesting how it should be regulated. Compared with existing credit and debit card schemes, merchants are required to pay a relatively high merchant services fee for buy now, pay later hire/purchase schemes but are unable to surcharge customers if they want to recover it. That, it has been argued, is not a level playing field. But allowing merchants to surcharge would hit the business model of buy now, pay later schemes.
As the Bank of England’s Christina Segal-Knowles noted in a recent address: “the changes in the way we pay and the challenges we’ve seen over the past several months pose two important and interrelated questions for central banks and regulators”.
“First, how do we ensure that we have legislative and supervisory frameworks in place to support development of safe private sector innovation that could respond to these challenges? Here, it is clear that we need to ensure that new ways to pay and new forms of electronic money offer equivalent protections to existing ones,” she said.
“And second, what is the right role for central banks in provision of the money we use to transact?”
None of this is to say the innovation fintechs promise is less important. As McKinsey & Co found, businesses can gain long-term advantages by understanding the shifts and opportunities crises present.