Is FinTech The Enemy Of Smaller Banks?

How Smaller Financial Institutions Should Engage With The Digital Revolution

We all know that digital change is transforming the banking industry. Today two main contenders lead this revolution. On one side we have the incumbent large banks – established players with deep pocket, lots of customers, huge legacy issues and out-dated ways of dealing with customers. On the other side we have the FinTech challengers with less money, fewer customers (for now) and great new ways of providing value. Both players are incentivised by same things: technological change, real process efficiencies, growing customer demand and increasingly demanding regulators.

Lately, we are seeing this confrontation morphing into a cautious collaboration. The two parties are slowly coming together: the incumbent are buying challengers (see BBVA buying Simple, Atom and Holvi and BPCE buying Fidor) – and sometimes even the reverse happens with challengers buying the incumbent (see Tandem buying Harrods Bank). When acquisitions are not viable, the big banks are creating funds to invest in the most promising FinTechs (see Santander Innoventures or Uncredit EVO). Lastly, the big banks are even helping to create challengers by backing accelerators, incubators and innovation labs (see Commerzbank Main Incubator or Barclays Techstars just to name a few).

All of this is very exciting - the incumbent and the FinTechs jointly building better banking future for all of us. The truth is that this approach is creating the premises for one group of financial services providers to be severely challenged: the smaller banks.

These firms are facing a perfect storm. Their customers and regulators are expecting deeper digital capabilities from them. VCs, PE firms, corporate investors and even individuals are pouring money into the FinTech start-ups foregoing investing in smaller banks. All the while, the bigger incumbents are investing in digital innovation at a scale the smaller banks could never compete at. All of this is making the costs of attracting and retaining scarce digital talent become unaffordable. For many smaller banks digital innovation is becoming an existential threat.

The paradox of digital innovation is that instead of driving change and competition, it could end up reducing it. As the big banks and challengers come together, the smaller independent financial institutions could be come an endangered species.

But what can a smaller financial institution do to deal with such bad odds? Here are a few ideas:

1. Make Size a Strength: Smaller banks often have built-in advantages: they are less complex and have less legacy issues than the big banks. This means that they can adapt and change more rapidly than their larger competitors. In an environment where it is not clear what will succeed, the ability to test and learn quickly is a fundamental advantage. Because of their agility, smaller banks can be a much more effective partner to a challenger. The larger banks are often slow, not only because their legacy IT and operational issues, but also because their complex internal organisation require buy-in from many more parties before change can happen. Smaller banks could make speed of execution a unique selling proposition when partnering with a FinTech. If a start-up can choose between launching a proposition in weeks by partnering with a smaller bank versus launching the same with a large bank in months (or even years), they will choose the smaller partner.
2. Count On Your Customers’ Support: Smaller Banks often have a much tighter relationship with their customers than their larger counterparts do. Used intelligently, this could allow them to get more collaboration from their customers in designing, testing and accepting digital propositions that are just right. From co-creating to simply being more accepting of trial and error, benevolent customers can be the secret weapon of the smaller banks. Most smaller banks have stronger brands, are more trusted and have more customers than the FinTech challengers do. Using these strengths effectively when launching a new digital proposition will allow the smaller banks to scale much more rapidly than a start-up could do - even a well-funded one.
3. Join Forces: Smaller banks can explore partnering with similar institutions that are not in direct competition with each other. Be it across geographies or across products or even customer segments, smaller banks can group with each other to gain the scale they need to be able to invest in new propositions and technologies. By leveraging their speed, brand and customers, smaller banks could collaborate with each other in specific areas like authentication, payments, cyber-security or blockchain technology, to rapidly build a competitive advantage on the big banks and the FinTechs, while sharing both opportunities and costs.
4. Engage with the Ecosystem: Smaller banks can benefit from the errors made by their bigger competitors and FinTechs by learning from them. By keeping an eye on what everyone else is doing and studying the reasons for their successes and failures, smaller banks can learn how to make the right choices. Smaller banks should see taking part in the FinTech ecosystem (conferences, events, newsletters etc) as an effective and inexpensive way of outsourcing R&D and good way to attract and retain talent. Once they identify the right opportunity, smaller banks can use their speed and customer bases to credibly challenge both the big banks and the FinTech start-up.

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Many smaller banks feel vulnerable to the onslaught of the FinTech revolution, as the costs and complexity of engaging seem daunting. The reality is that digital innovation can be the most effective way for the smaller banks to compete with their bigger rivals.

It would be great for the industry and for customers to see more smaller banks actively engaged in FinTech. Unfortunately many are keeping away from the digital challenge – this may be a decision that could be seen as prudent in the short-term but actually prove to be fatal in the longer-term.