Banks: the next frontier for disruptive technology
Are financial institutions and regulators prepared to weather the coming storm?
Fintechs are a disruptive technology threatening the very existence of one of the most stable industries in our nation. Are Canadian financial executives concerned? You bet they are. It’s time our policy makers are equally concerned.
Fintechs are financial service companies, mostly startups, that use software and the internet to provide services we traditionally associate with those of banks and credit unions. There are currently about 12,000 fintechs active worldwide.
From low- or no-cost stock trading apps like Robinhood, to digital wallets from Apple and Google, the financial services market is undergoing a digital revolution. To find a specific area that is coming under siege, one must look no further than the management and processing of payments. Despite its place as a core pillar of the earnings of Canadian banks, payments processing is at risk of disintermediation by new entrants using blockchain-based technology (e.g. cyber currencies such as Bitcoin).
Last month in its Global Banking Annual Review, McKinsey & Co predicted that banks could lose up to 60 percent of their retail profits to fintechs over the next 10 years. The numbers belie the enormous impact this could have on the global financial industry, with US $674 billion in bank revenue projected to shrink to less than $400 billion in a decade.
In general, fintechs are entering the most lucrative markets and offering consumer choice at lower prices. The formula is easy. They have neither the regulatory burden nor legacy systems of the big banks. As a result, they can target specific products and proceed to cherry pick.
Take Bitcoin. This digital currency system essentially facilitates the exchange of wealth without any intermediaries.
In contrast, since 2008, the regulatory requirements for banks and credit unions have been steadily rising with the implementation of reforms designed to protect the global economy from another banking crisis, like the Basel III framework that ensures banks have adequate capital reserves.
Clearly, the playing field is not level for established versus entrant firms. In many cases that would not require regulatory or policy change and could create benefits for the populace, but in this case further rules are required. Many of the restrictions hurting existing firms’ competitiveness–such as interest rate ceilings or deposit insurance requirements–exist specifically to protect consumers, but are not always applicable to the new entrants. Given this lack of rules, consumers are not protected in the Wild West of emerging financial services. The banks and regulators need to step up.
Policy makers should be doing two things. First, they should be reviewing the regulatory burden they place on established financial institutions and any unintended consequences that might be having in light of the coming fintech wave. Next, they must actively work to develop and implement an effective consumer protection framework.
At the same time, established financial institutions like the Big Six cannot leave their fortunes in the hands of regulators. It’s clear they are aware of these emerging and potentially disruptive technologies, just as they were aware of the online trading onslaught that they ultimately embraced—often buying out their disruptive competition.
In the case of fintech, financial institutions need to be even more proactive if they don’t want to lose precious market share.
Regulations aside, fintech is changing the way financial business is done. If established banks and credit unions don’t want to watch from the sidelines, they are going to have to understand these emerging technologies, examine where the market is going and develop strategies to use their experience and existing customer base to capitalize on it. As with the online trading platforms they gobbled up, they will also have to be prepared to invest.
If they don’t, it will be at their peril. Just ask the recording industry geniuses who ignored the potential of Napster and the MP3 player.