Can Traditional Banks Stop Fintechs from Eating Their Lunch?

By Greg Cohen, CEO & chairman of Fortis

For decades, banks fulfilled a vital role in the economy, lending money, providing credit, handling deposits and facilitating withdrawals for consumers and businesses. Financial institutions, especially larger ones, have profitable investment banks too, but receivables, payables and ultimately serving as a treasury department in business and consumer cash management processes has been smaller banks’ bread and butter.

Over the past few years, fintechs have positioned themselves to disrupt the traditional banks’ role. As fintechs like Square, Stripe, PayPal and others experience explosive growth and amass assets, they’re diversifying activities and expanding capabilities. After carving out a role as embedded payments leaders, fintechs started expanding their value proposition to include a myriad of other banking services for small businesses.

And because the fintechs enable a hassle-free way to pay for small business goods and services, they changed expectations for the consumers, too, by establishing bank-like relationships one transaction at a time. Venmo, owned by PayPal, and Square Cash are great examples as fintechs literally creating bank accounts by transforming digital wallets into virtual deposit accounts for consumers who purchase goods and services through these providers. Additionally, these fintechs have the ability to issue credit and debit cards to these consumers, offer traditional banking services and even enhanced services like crypto-exchange capabilities, further establishing the bank-like relationship and appeal to the everyday consumer.

Banking for consumers isn’t the only area seeing a shift from a rise in fintech innovations.

Fintechs Expand Business Services, Cutting Traditional Bank Revenue Streams

Traditionally, merchants looking for capital and other financial services would approach their bank for a loan. Today, fintechs often get the first look as product expansions like Square Capital, which offers business loans, are an existential threat. For businesses, fintech innovations like Stripe Treasury often attach embedded commerce through business software or platform integrations, becoming a powerful draw to businesses since it can create a better client experience and increase sales through a more seamless offering than those offered by banks.

A merchant who uses Square commented on the integration between seller and payer transaction ecosystems and said he was “stunned by how easy and intuitive” transactions had become for staff and buyers alike. He remarked, “Our customers love the ability to scan a QR code and quickly pay right from their phone, which has simplified and sped up our checkout process.”

“Buy Now, Pay Later” (BNPL) offerings from Affirm, AfterPay (now owned by Square) and many others are making further inroads into what was traditional banking turf. BNPL offerings extend credit to a consumer at check-out, allowing businesses to collect cash immediately while purchasers pay over a period of time. This method of financing is hugely popular with younger consumers as Gen Z and millennials comprise nearly 75% of users. This means instead of using credit from banks, these buyers are getting credit from fintechs.

Factors That Hold Traditional Banks Back

Fintechs will continue to diversify and innovate, cutting into traditional bank revenue. Smaller banks are most at risk since the financial services they offer to smaller businesses is a crucial revenue stream, but big banks can’t ignore the fintech revolution either. As JPMorgan Chase CEO Jamie Dimon said of fintech and big tech innovation on a 2021 analyst call, “Absolutely, we should be scared s—less about that.”

The playing field isn’t exactly level. Traditional banks have a valuation disadvantage because fintechs are rewarded for growth, so they can plow profits back into development. Banks are valued on profit, dividends and return on assets, so they don’t have the same internal investment options. Banks are also hemmed in by a regulatory environment that fintechs operate outside of, and that’s unlikely to change in a major way.

Organizational culture is another potential obstacle to traditional banks’ competing effectively with fintechs. The banking industry is inherently risk averse, so traditional banks aren’t as nimble in their reaction to marketplace changes. All of these factors explain why many banks find themselves at a crossroad now, with companies like Square, Stripe, Affirm and others, carving out larger slices of the pie and smaller fintechs picking off vulnerabilities from the side.

Here’s How Banks Can Fight Back

The path banks choose now will make all the difference. Banks will need to overcome a risk-averse infrastructure and create a digital strategy that leverages existing assets and advantages to fight back effectively. Overcoming legacy obstacles and operating more nimbly will require elevating decision-making about the digital strategy beyond a subcommittee within the organization. Chief digital officers and the retail or small business side of the house need to make the business case for change at the top.

Creating the right solution and digital strategy will require holistic thinking. Banks should evaluate what is truly core to their business and then work to build, buy and/or partner to meet the business needs and various objectives of this platform strategy. It will be critical to think in terms of a holistic offering and delivering a myriad of solutions to maintain relevance in a rapidly changing sector. The key, though, will be the execution – and now is a crucial time to implement and ensure the right infrastructure and strategy are ready in place.

Banks are already rethinking distribution, and that’s important. But when addressing the fintech threat, they need to methodically create a strategy centered on goals like attracting more deposits with alternative channels, as well as capitalizing on the assets they have that fintechs don’t, like personal relationships and physical locations in the communities in which they operate.

The good news is banks have opportunities to partner with companies designed to support the incumbents and build many of these infrastructure services that are an internal challenge to establish and will help banks compete in the long run. Some partners are fairly simple to work with and even allow an opportunity for banks to test their solutions before they buy or build. Often entering a partnership is a great way to understand what pieces of the digital infrastructure it makes sense to own.

Traditional banks can stay relevant and compete effectively with fintechs, but they’ll need to evolve quickly to make up for lost time. They’ll need to create a strategy, bring in resources to formulate a roadmap, and then effectively execute it. Banks that take these actions now can not only stop fintechs from eating their lunch — they can create new opportunities to evolve, grow and deepen relationships essential for remaining competitive as “traditional banking” becomes a novelty of the past.