Customer Development
As FinTech funding rises to new record levels – $131.5 billion globally in 2021 – banks and credit unions are losing their status as the primary financial services providers to American consumers.
According to a 2022 report by Cornerstone Advisors, the percentage of Gen Z, Millennial, and Gen X consumers in the U.S. who consider a digital bank (like Chime, Cash App, or PayPal) to be their primary checking account provider has more than doubled since 2020.
Today, more Gen Zers and Millennials consider their primary checking account provider to be a digital bank than those who consider their primary checking account provider to be a traditional bank or credit union – combined.
Taking the FinTech Threat Seriously: What Should Banks Be Doing to Compete?
While financial institutions are rightly concerned with the competitive threat posed by FinTech companies, far too many banks’ strategies are either backward-looking (focused on protecting legacy products and business models) or dependent on vaguely-defined digital transformation goals.
Fighting back against the FinTech disruption isn’t an exercise in total war – it’s about carefully picking one’s battles. After all, FinTech isn’t some monolithic force consuming banking (though it’s sometimes discussed that way). FinTech is thousands of companies, each individually trying to disrupt banks across hundreds of different products and customer segments.
Here are five specific competitive threats – areas where FinTech companies are gaining traction in the banking market – and what banks should be doing to counter them.
1. Overdraft
Thanks to neobanks, fee-free overdraft protection has become a central and highly visible product feature. This has provided neobanks with substantial competitive differentiation in the market, considering that U.S. banks collected $15.47 billion in overdraft and non-sufficient funds (NSF) fees in 2019.
It is now competitively and regulatorily unsustainable for banks to generate significant revenue from overdraft and NSF fees. Forward-thinking financial institutions recognize this and are making proactive adjustments, such as eliminating excessive overdraft fees and designing features to help customers avoid accidental overdrafts.
While this is a good start, banks cannot lose sight of the value that intentionally used overdraft protection (or similar short-term lending products) can have for customers with cash flow imbalances. Solving for customers’ short-term liquidity needs without benefitting from overdraft fee income will be challenging, however, this shift presents opportunities for banks that are ready for it.
2. Saving and Investing
This area consists of two jobs:
- Helping consumers set more money aside for saving, and
- Helping consumers earn the best possible yield on that money (within their risk tolerances).
For both of these jobs, consumers are increasingly turning to FinTech companies. In fact, only 12% of consumers are using an automated savings tool from their bank or credit union, based on a Q1 2022 Cornerstone survey.
The threat posed by FinTech savings and investment apps (especially apps that combine these functions) lies in their potential to wrest control over the allocation decisions that fund those products. By automating the actual money movement process and providing consumers with a variety of high-yield investment options, FinTech apps can significantly reduce the need for consumers to log in to their primary banks’ mobile apps.
Banks need to sharpen their strategic responses to this competitive threat on two fronts:
- Refine the experience and insights provided by savings tools.
- Blend savings and investing together. (In a low-rate environment, banks should also be offering a variety of different yield-generating investment opportunities across a wide spectrum of risks.)
3. Buy Now, Pay Later
Buy now, pay later (BNPL) has exploded in popularity over the last few years. According to Cornerstone Advisors consumer surveys, the percentage of Gen Zers making purchases with BNPL plans grew six-fold between 2019 and 2021.
This makes BNPL a dangerous competitor to banks’ payment and unsecured lending products. A recent estimate from McKinsey shows that FinTech companies providing BNPL products have already siphoned $8 billion to $10 billion in annual revenues from banks.
While retroactively attaching BNPL capabilities to credit cards is an appealing approach for banks – it preserves existing interest and interchange revenue streams and doesn’t require building direct partnerships with individual merchants – it’s a shortsighted approach.
Emerging evidence suggests that some consumers will struggle to use BNPL responsibly, especially across multiple providers. There is opportunity for banks to help these consumers more effectively manage these loans. If banks care about acquiring younger customers or helping consumers manage their financial health, they cannot sit BNPL out.
4. Niche Neobanks
There’s been an emergence of a robust set of FinTech infrastructure companies – including banking as a service (BaaS) platforms as well as modern card issuing, processing, and servicing systems. This has led to a significant decrease in the upfront time and cost to launch a new consumer or small business neobank, which has spurred the creation of an entirely new category of financial services providers: niche neobanks.
The niche banking strategy finds a specific segment of consumers that share a common set of functional and emotional needs when it comes to money management. The neobank designs differentiated financial products and leverages existing groups and communities to market and distribute products.
By intensely focusing on specific customer segments, niche neobanks gain an advantage over most traditional banks because they understand the pain points of their target customers at a very granular level. Differentiated products enable niche neobanks to “pick out” small portions of banks’ customer bases, which is a threat that can seem minor on an individual level but becomes far more serious in the aggregate.
In order to compete, financial institutions must dramatically reduce the time and cost it takes to launch new products. Banks should also seek out specific customer segments with financial needs that are either unmet or inadequately addressed, and build personalized products and experiences for them.
5. Open Banking
Open banking – which we’ll define as the ability for consumers to share data from their financial accounts and providers in order to enable other products or experiences – is a core function of many FinTech apps on the market today.
A natural consequence of this growing use of open banking is that more consumers have come to view such capabilities as critically important. According to research commissioned by Plaid, 80% of U.S. consumers agreed that, “It is important to be able to connect my bank account to the digital finance apps and services I choose.” Regulators like the CFPB (which is currently reviewing rulemaking on open banking through Section 1033 of the Dodd-Frank Act) also see open banking as a critical tool for leveling the competitive landscape.
Open banking is going to happen, whether banks want it to or not – so they might as well benefit from it. Many banks are now working with data aggregators to replace screen scraping with more secure and performant APIs. Building common standards and streamlining technical integrations is a necessary first step. The second step is to leverage these APIs (and consumers’ willingness to permit access to their data) to build new products and services.
Banks should use open banking to build new financial management capabilities that pull data together from disparate FinTech providers and deliver unified insights to their customers, which can help people protect and improve their financial health.
The Bottom Line
Consumers have never had more choices or higher expectations than they do today. There are a number of challenges that banks will need to overcome if they want to effectively respond to the threats posed by FinTech companies.
The disruptions introduced by FinTech should be viewed as opportunities to innovate and improve your bank’s competitive position in the market. If you don’t, the market will pass you by.
Read the full report by FICO and Cornerstone Advisors here – Counterattack: Banks’ Field Guide to FinTech Disruption.
