(This story originally appeared in New Jersey Business Magazine.)
By Rob Milrod
Traditional banks must actively plan for change as the digital divide grows.
The marketplace has evolved, and traditional, legacy-driven banks need to follow suit by upgrading technology through partnerships.
One in 10 banks are in the process of developing a banking-as-a-service (BaaS) strategy and another 20% are considering one. Why? Embedded finance, which is essentially interconnected, integrated, automated, online banking services, is projected to generate $230 billion in revenue in 2025, which is a 10x increase since 2020. Banks who can ‘rent’ their charter to a fintech to enable embedded finance apps will add a substantial new source of revenue.
As a result, banks are spending more dollars and effort on application programming interfaces (APIs), which drive BaaS. In fact, the percentage of banks and credit unions that have invested in APIs will increase 25% this year. The number had already increased 47% from 2019 to 2021.
And banks are partnering with Fintech’s to improve their own infrastructure and better compete. Banks that can compete with a digital forward approach will also lose fewer customers to fintechs, as the environment impacting retentions continue to change. Last year, one of President Biden’s executive orders encouraged one of the nation’s financial guardians, the Consumer Financial Protection Bureau, to prioritize Dodd-Frank regulations that would make it easier for consumers to access their data and transfer it to other banks and fintechs. In 2021, banks invested $80 billion in technology while fintechs raised $140 billion to disrupt the industry, according to the Financial Times.
CFO Consulting Partners has recently spoken at several industry events, including the Financial Managers Society of Philadelphia and Northern New Jersey Community Bankers, about the merge between banks and fintechs.
Here is how this new relationship can work in both directions:
Banking On Hi-Tech
The ongoing partnership between fintechs and banks will be a marriage of necessity for most financial institutions—now that the trend has begun.
For traditional banks, partnering with fintechs could result in a temporary cost disadvantage due to the cost of replacing internal technology, such as core operating systems. Investing in new technology can be substantial, according to Cornerstone research. Banks pursuing BaaS increased non-interest expenses above the industry median of 18%, as part of the short-term investment.
However, the shift toward integrated banking can create new opportunities for revenue. During the last five years, BaaS-partnered banks grew non-interest income by 67%, compared to the industry median of 31%. Banks can realize $25 billion in BaaS revenue in the next five years through relationships with fintechs. Banks can also, while they’re at it, benefit from applying the new technology to many internal banking functions, including onboarding customers, ID verification, as well as payment applications and financial applications that aggregate data across institutions to provide finance management guidance.
Banks that ‘‘rent’’ their charter to fintechs can grow their customer bases and balances at a rate much higher than normal expectations. BaaS banks are able to better leverage their operating systems and infrastructure, which allows them to process fee-generating transactions at higher volumes for more revenue.
Fintechs can’t win the game if they’re not playing. And gaining entre to financial services isn’t quick and easy. Regulators don’t often approve new banking licenses, so fintechs will need to piggyback on an existing bank’s charter to access the financial system so their neo-bank products can function.
In many cases, however, fintechs will be looking at banks not only to enable their BaaS, but also as a source of investment.
But if tech companies really want to cross the moat, they will have to make accommodations. First, the Fintech team might have to dress up a little bit to get with the program. Jeans and t-shirts don’t fit in a community bank culture.
Fintechs should also be prepared to answer a lot of questions in the process, since banks will need to handle compliance requirements and volumes could grow at a much faster rate than banks are used to seeing.
If you are going to provide technology to a bank, you should expect to deliver a lot of integration support. Be prepared to help the bank make the investment case to drive a go-decision. And consider having an implementation team available to problem solve on the spot for quick and effective outcomes.
Banks also need to weigh the cost of fitting in with or getting out of the usually long-term contract with their core operating system provider. Banks must prepare their IT team to integrate any selected fintech apps, assuming it will take longer than expected. And finance and operations teams should be prepared for any impact on close and reconciliation activities, as well as transaction flows.
Banks should be prepared for customer and balance growth that might exceed historical trends by quite a bit, which would impact the financial forecasting process, a high-class problem.
Remaining Relevant Amid Uncertainty
While the new world of banking is being built, there are a few trends that should not be overlooked. Relevance and survival are always paramount during times of change.
Early-adopter banks have made it clear that serving particular customer segments will be crucial. Once conservative banks are now implementing crypto savings, payments, and lending.
All the while, staple consumer banking strategies such as high-rate credit cards, overdraft fees, and accounts that pay near-nothing in interest will be targeted for disruption.
Banks must start planning today to keep pace. While banks are being heavily disrupted on the consumer side, they are less so on the commercial side—so far.
Fast-moving, automated processes and easy access to digital applications and customer service are table stakes. Consider applying technology to key components of the process that are pain points for customers, such as loan origination.
CFO Consulting Partners is comprised of a team of senior financial executives. We provide a broad range of financial management services to public and private companies. We work for CEOs, CFOs, as well as audit committees and boards. Our mission is to apply our consultants’ considerable collective experience to resolve client issues in a professional and efficient manner.
Rob Milrod of CFO Consulting Partners is a senior finance leader with more than 25 years of experience, including audit experience at a Big 4 public accounting firm. Recently, he has provided firsthand fractional CFO support to build financial infrastructure and operating discipline at e-commerce, fintech, nonprofits and private equity portfolio companies.