Ronny Lavie, Managing Editor at The Fintech Times.
When someone says fintech, the image in many people’s minds is of three 22 year-olds seating in an office that should really be a broom cupboard in Shoreditch, probably with a designer dog napping under one of the desks, all drinking espressos out of a coffee machine that costs more than their rent and saying words like ‘synergy’ and ‘dynamic’ a lot. But does that image have anything to do with reality? The short answer is no.
The fintech industry has been growing at a dizzying rate in the last few years, with billions of dollars of investment streaming in. Perhaps as a result, it seems more and more challenger banks, peer-to-peer lending apps, innovative payment systems and exciting new ways to save money are popping up on a near daily basis. But where is all of this innovation coming from? Is it really young mavericks in their hipster offices, or is it actually established players within the industry that are driving change?
Like our headline suggests, it’s a bit of a David and Goliath situation – one is agile, young and fast, whereas the other is big and powerful, but slow. In the biblical story, as we all know, David came out triumphant. In the battle for the financial industry, however, the outcome may not be as straightforward.
While there is no shortage of startups founded and operated by graduates with a vision, it is actually people with a long history in traditional finance that are launching the most successful and interesting companies. The CEOs of Starling, Atom and Revolut have all held key positions in top old-world financial institutions (RBA, Lehman Brothers, AIB and HSBC, to give a few examples). In the case of some, like Revolut’s Nik Storonsky, his experience of the shortfalls of traditional banking is what drove him to create an alternative. He’s been quoted as saying that traditional banks are “living in the past” and, when asked why he chose to base his new company at Level39, positioned at the centre of London’s banking and finance world, he replied simply – “eat what you kill”.
While safety and security are still important to customers, efficiency, ease and speed of access and, crucially, transparency and choice are now arguably more of a deciding factor. A recent study by Network Research found that 7 out of 10 UK consumers are open to trying new financial brands, while a third would consider a disruptor brand.
These changing priorities are driving the change in the way people use financial services and the way in which banks will have to adapt in order to survive. In future, banks will no longer be monoliths, jealously guarding their core systems and insisting on doing everything themselves. Whether they like it or not, traditional banks will have to open the doors to their sacred inner sanctum and work with a system built on the principle of open-source and API sharing. They will eventually become a marketplace of third-party apps, where customers can choose the services best suited to their needs from a range of third-party providers (otherwise known as plug-and-play), gaining access to innovative, bespoke services, while safe in the knowledge they are backed by the bank’s security and trust.
Chris Skinner explains this best in his book Digital Human – “A growing number of financial marketplaces are appearing: lending marketplaces, credit marketplaces, payments marketplaces and more. Consider a marketplace to be the bazaar. Market stallholders gather to meet with prospective clients, and the digital version of the marketplace is the focal point for many FinTech start-ups because they can create stalls here that become major technology businesses like Stripe and Square. Banks have to think differently. Banks have the regulatory licence to be marketplace owners, enabling them to create the spaces for the new players and startups to move into. As a marketplace owner, the bank does not provide all the products and does not run the stalls. It just owns the space where a stallholder offers their goods and services and they can charge the market stallholder a fee to be in their space. It’s a good space to be.”
Unsurprisingly perhaps, the first bank to enter this arena is a challenger bank – Starling. Founded in 2014, Starling recently launched the first Banking-as-a-Platform venture in the UK. This move allows businesses to offer their own unique retail banking payments services, including card issuing, as an API through the Starling system. Anne Boden, CEO of Starling Bank, said: “Platform strategies have taken off in many other industries, with Airbnb, Uber and Apple becoming major players in the markets for accommodation, transport and music and yet owning no properties, vehicles or content themselves. As a new generation digital bank, Starling is now bringing the model to UK banking, enabling other businesses to build banking services on top of its own-label banking infrastructure.”
Of course, this is not as straightforward as it sounds. The reason Starling beat all of the old institutions to the punch is likely because it is not sitting on a 50-year-old core operating system, which has been added to over the years and is now essentially a maze of interlinked functions, where the failure of one part can bring the entire system crashing. Most traditional financial institutions use COBOL as their core operating system – in fact, according to Reuters and the International COBOL Survey Report, 43 percent of banking systems are built on this language, 95 percent of ATM swipes rely on COBOL code and 220b lines of it are in use today.
Unfortunately, COBOL is an ancient system (in tech terms) that simply cannot withstand the level of digitisation required for optimal operations within financial services today. Over the years, rather than upgrade the system, most banks have simply been adding elements to it, to supports things like ATM transactions and credit and debit card payments. The result is a bunch of siloed code pockets that do not support AI and machine learning intelligence and that will be very difficult, if not impossible, to take apart and rebuild. We’re talking billions of dollars and years of work. Is it any wonder banks are not raring to go? It works, so why change it? The likely scenario is that they will be forced to, however, not just by the customers’ changing needs, but by regulators, who will required them to provide real-time data using APIs and third-party connectivity.
But it’s not just the technical challenge that presents a barrier to banks adopting shifting priorities. Mindsets would also need to be changed. As mentioned, banks loath ceding control of their systems and, naturally, are averse to taking risks. “I think most bankers were stuck in the vacuum of not being able to change the bank and not being able to replace core systems. Instead they were just twiddling their thumbs while watching all these startup marketplaces and saying, ‘Oh look! There’s a FinTech start-up that does what we do. Let’s watch it.’
Fast-forward a few years and they are still watching it and saying, ‘Oh look! That start-up has got quite big. Interesting!’ Then they go back to doing what they’ve always done, whinging about legacy systems and wondering why the regulator is always on their case.
Then they look around again and say, ‘Oh! That start-up is now a bit of a threat. Let’s go buy it.’ To which the start-up replies, ‘Get lost! I’m too big to mess with now!’” Chris Skinner writes.
That said, the incumbent banks will not really need to reinvent the wheel in their attempt to modernise. Crucially, they have quite a few important elements that startups don’t, like an existing customer base and extensive capital. Rather than try to compete with the agile and fast-thinking startups, they need to join forces with them. Of course, this is already starting to happen now, with new incumbent-startup collaborations announced regularly, such as the recent partnership between Barclays and online invoice financing platform, MarketInvoice. This is the key to the big banks surviving the coming age of digitisation and open source banking, and the way in which they will become the financial services bazaars discussed above. The management of this will be done through AI and machine learning, with the banks using analytics to learn the customer’s financial history and behaviour and, through that, predict future financial needs.
Ultimately, the core solution to the standoff is actually for traditional financial institutions to not look at the space as a battle, but rather to work together with startups to create a better service for customers, which, really, is the most important thing. When the customers leave, that’s when the house of cards crumbles. While their income will have to come from different sources than it does now, banks will still do better than if they insist on doing everything themselves. For this, core operating systems and, crucially, attitudes will need to be worked on, but some banks are already making steps in this direction.
As for us, the consumers, the future of banking looks to be full of fast, efficient processes and an exciting choice of bespoke services to cater to our every whim. We, for one, definitely like the sound of that!
