The FinTech industry attracted over US$13.1 billion in venture capital-backed investments in 2016, about five times more than investments four years earlier. The growth of the industry has strengthened the belief that FinTech will disrupt banking.
However, collaboration — not competition — will be the primary driver of disruption. The biggest near-term threat to most banks comes not from FinTechs but from traditional competitors better leveraging those FinTechs.
Building better partnerships
Our analysis of 45 major global banks reveals that while all banks are engaged with FinTechs one way or another, only around 25% are extensively engaged due to barriers to collaboration with FinTechs.
Unless banks and FinTech firms get better at working together, neither will reap the full benefits of innovation (see Figure 1).
Figure 1 – The partnership imperatives and opportunities for banks and FinTechs
Actions for banks
We see four steps to success for banks seeking to unleash the potential of FinTech in their organizations:
1. Develop a FinTech framework that rewards innovation: An innovation adoption framework with clear accountabilities, decision-making frameworks and criteria for success is needed. We recommend that banks define their innovation framework and process clearly, then share relevant aspects with the firms they seek to engage with.
Watch this video on how banks can become leading innovators (36 seconds).
2. Choose an innovation operating model that connects new ideas to business needs: Banks typically employ one of three types of innovation operating models:
- Centralized: a chief innovation (or digital) officer oversees a central innovation team to develop business solutions
- Decentralized: each business unit runs its own governance processes, enabling those familiar with the business to identify real problems, and innovators with real solutions, far more quickly
- Hybrid: a defined, distinct innovation team helps to set the right tone and message, and clear leadership champions the cause
In our view, the hybrid model is the ideal solution.
3. Assess the pros and cons of your FinTech engagement strategies: Where banks turn to FinTechs to help drive innovation, our research shows that collaboration is the preferred engagement strategy (see Figure 2).
Figure 2 – Engagement model by region
Banks should carefully evaluate various engagement models and choose a mix that supports their innovation model and long-term growth strategy.
4. Carefully manage talent and architectural change: We believe that a component-based architecture, resembling a set of interoperable building blocks, will drive innovation and next-generation efficiency.
The composition of talent will also need to change. The stars of the future might well be internal entrepreneurs as opposed to those who excel at in-house development. This has implications for talent acquisition strategies at all levels of the organization.
Actions for FinTechs
FinTechs need to know how to approach and navigate their way through banking organizations. The following areas are of key importance:
1. Articulate a value proposition: FinTechs need to determine what they are, what they intend to be and what problem they solve. Are they disruptive, incremental or significant? (see Figure 3)
Figure 3 – Innovation approach framework
While banks are receptive to the various types of innovation, FinTechs need to communicate and explain the value proposition in a language that the buyer understands
2. Differentiate yourself with regulatory prowess: Even though some FinTech firms may not be regulated, they must understand regulations, conduct business in accordance with local laws and maintain the highest standards of integrity.
Regulators play an important role in fostering collaboration between FinTechs and banks, and are setting a positive example by introducing regulatory sandboxes. These allow financial organizations to test new ideas for a limited period with live consumers and loosened regulatory restrictions.
3. Be prepared and well-networked: Consulting firms, system integrators and venture capitalists have relationships with banks and a commercial interest in brokering introductions. FinTechs need to understand who the preferred advisors are in the domain in which they are operating. They can also approach business sponsors directly.
Once business sponsorship has been secured, the final hurdles to adoption typically involve the procurement, vendor risk management and information security functions.
Demonstrating a level of preparedness with regard to corporate history, funding, information security, data privacy, resiliency, scalability, architecture, processes and key people can help mitigate banks’ concerns about working with younger organizations.
4. Avoid overreaching yourself by building a robust business case: Business cases commonly fall short due to unrealistic assumptions, underestimates of integration costs and other dependencies, failure to recognize evidence relating to risk reduction, and failure to consider what bank resources are needed.
In the current climate, return on investment must be demonstrable, and payback periods need to be short. FinTech firms need to be crystal clear about their pricing strategy, which needs to reflect the value to both parties. In addition, they need to protect intellectual property through nondisclosure agreements and by sharing cautiously.
Embedding FinTech in the banking ecosystem
The most successful banks will be those that improve agility and reduce cost by using collaboration to bring various components together and build the strongest ecosystem.
Their retained organization will be stronger and leaner, augmented through external collaboration with FinTech firms, market utilities and managed service providers.
To achieve this future state, banks will need to unleash the potential of FinTech in their own organizations (see Figure 4).
Figure 4 – FinTech is a core part of the banking ecosystem
Success for banks will be based on building a better ecosystem, not a bigger bank. Our experience working with FinTechs and banks suggests that both need to get better at working with each other to successfully drive innovation.