A surge of new entrants in the financial services arena has forced incumbent providers to react. After the initial apprehension has dissipated, how are transaction banks engaging with this disruptive influence? Joy Macknight reports.

The financial technology (fintech) start-up story can best be told in numbers. More than $50bn has been invested in almost 2500 companies since 2010, according to an Accenture report, and in 2015 alone the value of global fintech investment grew by 75% to $22.3bn.

The report, Fintech and the Evolving Landscape, published in April, shows that the retail payments space has been the main recipient of investment over the past five years. But as the fintech sector matures, it also diversifies. Start-ups are now looking for other areas to disrupt along the financial services spectrum, including transaction banking.

Substantial impact

Julian Skan, a managing director in Accenture’s financial services practice and the executive sponsor of the Fintech Innovation Lab London, believes the impact of fintech innovation on this area of financial services will be substantial, but will also take some time to come about. “For a business model to work in transaction banking involves high-end relationships and often cross-border capability, which is more challenging for a fintech start-up to contend with,” he says. “However, it is an area where margins are still relatively high, so it is in their sights.”

In addition, the customer experience is a poor one, which opens up the opportunity for radical improvements, says Mr Skan. “Many transaction businesses, such as trade finance, are still in the 1980s in terms of STP [straight-through processing] and the processes are extremely paper-laden. Even sending a cross-border payment from a not particularly exotic country involves a bank counterparty relationship, takes days to arrive and involves guesswork as to the total cost.”

New cross-border payments players such as Currency Cloud and TransferWise have sprung up, successfully targeting the customer experience but also lowering the cost base – in so doing, making it more profitable.

“[Fintechs] have gone after the areas that are either easy to tackle from a technology perspective or [where it is] easy to change the business model and disintermediate the banks,” says Liz Oakes, leader in KPMG’s global payments practice. “The incumbent banks are in danger of being left to deal with the complex, paper-intensive parts of the business, as well as the regulatory burden such as anti-money laundering, sanctions screening and know your customer requirements.”

Shifting attitudes

Most banks’ initial reaction to fintech disruptors has been to treat them as competitors, according to Ms Oakes; as a consequence, banks attempted to build their own technology, set up innovation labs and revolutionise internal processes. However, she believes their approach is changing as the fintech ecosystem matures. “Banks are now interested in working with fintechs or even acquiring them because competing with them is not an effective strategy. Large organisations just aren’t that good at innovating. They aren’t designed for that,” she says.

Using cross-border payments as an example, she predicts more foreign exchange players will look to team up with transaction banks. “The latter aren’t good at giving good foreign exchange rates to businesses, mainly due to the complexity of how they built their businesses historically,” she says. “New players may find customer and geographic reach a challenge – something that large transaction banks can help them with.”

Currency Cloud, an international payments platform, substantiates her opinion. The new entrant is working with a number of financial institutions that are struggling to innovate and take new products to market quickly. “It is no longer possible for them to take three or four years to innovate. By partnering with Currency Cloud and using our infrastructure, banks can build an app or front-end service much quicker than before,” says Todd Latham, chief marketing officer and head of product at Currency Cloud.

Fabian Vandenreydt, Swift’s global head of securities and the head of Innotribe, Swift's service that identifies emerging trends in financial services innovation, has traced the collaboration evolution in this arena over the past seven years. “When Innotribe began in 2009, there was a big question mark over how combining these two groups would play out. The start-ups didn’t know what to expect from the banks and some profiled themselves as a replacement to the banks, whereas the banks didn’t know how to engage or communicate with the fintech community. But today, start-ups see the advantage of accessing the banks’ customer and distribution networks and many banks have reached the conclusion that they don’t have the attention span, time or resources to innovate at speed,” he says.

Similarly, Samantha Pelosi, senior vice-president, payments and innovation, at the Bankers Association for Finance and Trade, reports greater collaboration in the past few years. However, she stresses this trend goes beyond just start-ups to longer established technology companies. “I see active co-operation between banks and technology companies on developing new solutions, joint ventures or helping a bank to improve its internal services. I don’t view this as disruption but as a new level of collaboration,” she says.

The Accenture research charts the systematic shift from competition to collaboration. Whereas in 2014 investment in collaborative fintech ventures was 29% of the total investment pool, in 2015 it rose to 44% of the total. However, when broken down into regions, Europe and Asia lag far behind North America, with just 14% and 16% collaborative fintech investments, respectively, versus 60% in North America.

A win-win situation?

The banks’ extensive customer base is “an incredibly attractive prospect”, according to Ms Oakes, as customers are expensive to acquire. It is indicative that retail banks are willing to spend more than £100 to acquire a new client. Corporate and financial institution clients cost even more due to the regulatory and operational cost of onboarding new customers.

Fintechs can also use the banks to help them navigate regulatory processes, which can be an enormous obstacle for start-ups to overcome, and educate them as to the reasons behind such heavy regulation. “By the time fintechs have discovered all the things they have to do with regards to regulations, they are most likely halfway through building their business model or even onboarding customers,” says Ms Oakes.

Banks also benefit from collaboration as outlined previously, but she believes it can be difficult for large incumbents to admit they need to partner. “This requires emotional maturity to recognise the need to evolve, admit there is something wrong with the bank’s existing model and then move towards teaming up with a small organisation,” she adds.

Established banks may also find it difficult to understand the technology behind some new entrants. “When the incumbents look at new players, they can see new products and services but they can’t necessarily figure out what is it that they are doing that is better – all that is visible is the improved customer experience,” says Ms Oakes. “That leads many to think they can just change the front-end web design. But it is the end-to-end experience based on a modern infrastructure that is driving the digital experience, not just the user experience at the front end.”

Innovation strategy

Fundamentally it is critical for banks to have a focused approach to innovation, according to Mr Vandenreydt. “Banks are still placing bets when it comes to technology innovation because they don’t know which firm is going to win out. Many banks are doing proofs of concept involving several fintechs in the same innovation domain – such as blockchain, or distributed ledger technology – to develop a portfolio strategy and see what is possible without leaning too soon towards one particular start-up,” he says.

Mr Vandenreydt's view is that solutions to issues that specifically concern transaction banking will most likely be found by incumbent banks working with new entrants, rather than the latter providing a silver bullet. “The answer lies more in collaboration, with existing correspondent banks embracing new technology, rather than disruption from a new entrant,” he says.

He stresses the importance of the industry working closely together to prevent new silos developing. “My goal at Innotribe is to work with start-ups in a way that doesn’t create new silos, whether technology or standards, because silos won’t lead to the cost reduction that is needed for the industry in the longer term,” he adds.

Along with other industry pundits, Mr Vandenreydt believes that 'fintech' as a term has an expiration date. “The problem is that we also have ‘regtech’ and ‘instech’, which are conveying a silo approach, whereas the technology can be used in various areas, financial services, retail, etc. The true value of fintech for transaction banking is that it is exposing what areas need to be revamped and improved upon in terms of transparency, speed and fees,” he says.

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