Why traditional banks still outcompete FinTechs

The retail bank­ing sec­tor seems to be more resi­li­ent than oth­ers in the face of new digit­al play­ers. Why is this?

Bank­ing has always been a tech­no­logy-driv­en industry and the sec­tor did not wait for the arrival neo-banks to chal­lenge itself. In retail bank­ing, the trans­form­a­tion star­ted more than 30 years ago with com­pu­ter­isa­tion and dema­ter­i­al­isa­tion. Cus­tom­ers were able to access basic oper­a­tions dir­ectly, such as trans­fers or cur­rent account con­sulta­tions. Digit­al tech­no­logy has also facil­it­ated access to fin­an­cial sav­ings and con­trib­uted to the demo­crat­isa­tion of the stock market.

Yet, this trans­form­a­tion has raised ques­tions like: do bank branches still have a pur­pose? At first, the explor­a­tion of digit­al tech­no­logy went hand in hand with an exten­sion of the branch net­work. They were not con­tra­dict­ory: in a busi­ness based on human rela­tions, the phys­ic­al net­work is import­ant, par­tic­u­larly for first con­tact. Branch net­works made it pos­sible to win over a cus­tom­er base and build up their loy­alty. It is a logic has not dis­ap­peared. And even if numer­ous ‘digit­al’ banks have appeared in the last ten or fif­teen years, none of them have really replaced a loc­al bank.

Non­ethe­less, this new autonomy of the cus­tom­er in daily oper­a­tions has led to the evol­u­tion of branches. The counter-pay­er was replaced by advisors, some of them spe­cial­ised, whose role was to accom­pany the cus­tom­er through­out his or her life.

Until the 2000s, banks were able to invest in both phys­ic­al and digit­al chan­nels. But in the wake of the 2008 fin­an­cial crisis there was a massive switch to digit­al. Why did this happen?

This shift in invest­ment cor­res­ponds to a very rap­id change in busi­ness mod­el. Before the fin­an­cial crisis, the bulk of pay­ment was based on the out­stand­ing amounts, which enabled cred­it to be gran­ted. The bank made its mar­gin on inter­me­di­ation, and its income there­fore depended mainly on the volume of out­stand­ing amounts and their rotation.

After 2008, with the col­lapse of interest rates, the remu­ner­a­tion of loans became very low. The inter­me­di­ation mar­gin fell sharply. To rebuild their mar­gins, banks played on two fronts: redu­cing costs through digit­al tech­no­logy (giv­en that the revenue/cost ratio was his­tor­ic­ally very low in this sec­tor) and selling products.

Retail banks have there­fore star­ted to sell dif­fer­en­ti­ated ser­vice pack­ages, espe­cially to a “mass afflu­ent” cli­en­tele that is not rich enough for private banks, but is will­ing to pay for premi­um ser­vices such as Gold or Premi­er cards. The banks are try­ing to sell advant­ages and priv­ileges: spe­cial­ised advisers, tick­et­ing. They are also think­ing about rewards: inform­a­tion, train­ing, events on fin­ance or sus­tain­able devel­op­ment, meet­ings between peers.

Is the wealth of data avail­able to them use­ful here?

Yes, data is cru­cial: but banks still exploit this wealth very little, even though they have data­bases that are both very large (mil­lions of cus­tom­ers) and very pre­cise (hun­dreds of trans­ac­tions for each one), much lar­ger than those of insur­ance com­pan­ies, for example.

Their his­tor­ic­al pos­i­tion­ing is that of a trus­ted third party, which has con­fid­en­tial inform­a­tion and keeps it. But this could change, under pres­sure from FinTechs (digit­al start-ups in the fin­an­cial sec­tor) which do not have these con­cerns. In par­tic­u­lar, banks could exploit this data to bet­ter serve their own cus­tom­ers, but also sell (anonymised) mar­ket­ing insights to oth­er industries.

They could also con­tract with their cus­tom­ers to pass on or exploit some of their data. This aspect is only just emer­ging and, con­trary to what one might think, the inter­ested cus­tom­ers are not those with the low­est incomes but people belong­ing to the CSP+, who expect more effi­ciency and per­son­al­isa­tion thanks to the exploit­a­tion of cus­tom­er know­ledge and there­fore of their data. These devel­op­ments are vis­ible in the United States. In Europe, where reg­u­la­tions are stricter, banks are test­ing and experimenting.

Anoth­er aspect is plat­form­isa­tion, which enables them to enter the eco­sys­tems of cus­tom­er needs, as banks have already done by provid­ing insur­ance or tele­com­mu­nic­a­tions ser­vices. Retail banks are par­tic­u­larly inter­ested in the eco­sys­tems of mobil­ity, health and enter­tain­ment. The for­ays into these eco­sys­tems are enabled by an enabling tech­no­logy, the API. But inter­con­nect­ing inform­a­tion sys­tems does not solve everything. They need to define the right stra­tegic pos­i­tion­ing in worlds that are already highly coveted and ensure suf­fi­cient sources of revenue.

The ques­tions a bank asks itself are which eco­sys­tems it can be an entry point into and, in the oth­ers, what are the right part­ner­ships to gain mar­ket share. It has a com­pet­it­ive advant­age that is not neg­li­gible: on the screen of your smart­phone today, you inev­it­ably have your bank’s application.

Aren’t FinTechs and neo­banks bet­ter equipped to enter these eco­sys­tem dynamics?

They are more agile, no doubt, and both their man­agers and their teams spon­tan­eously enter into this logic. In fact, we are now see­ing the rise of a myri­ad of play­ers, includ­ing not only digit­al pure play­ers: tele­com oper­at­ors and insurers are also very present.

How­ever, in retail bank­ing ser­vices, no major digit­al play­ers are emer­ging, and the sec­tor’s his­tor­ic­al play­ers are doing quite well. There are sev­er­al reas­ons for this. First of all, cus­tom­ers still express the need to have a bank that is well estab­lished, espe­cially as banks have con­tin­ued their digit­al trans­form­a­tion: cus­tom­er feed­back shows that there is no major dif­fer­ence between banks and neo­banks in terms of experience.

Secondly, we are not so much wit­ness­ing an upheav­al as a con­sol­id­a­tion: banks are buy­ing the right FinTechs, find­ing part­ners and integ­rat­ing them. This is in line with the mind­set of star­tups and the investors who back them: they are most often look­ing for an “exit”, which in effect means either an IPO or a buyout.

Neo­banks often remain sec­ond­ary banks, attract­ing their cus­tom­ers with tar­geted offers such as every­day bank­ing, for­eign oper­a­tions, micro-cred­it… Those that have sur­vived are often sub­si­di­ar­ies of tra­di­tion­al banks. Neo-banks such as N26 or Revolut have not taken a large share of the mar­ket: we are far from the expo­nen­tial growth observed in oth­er sec­tors that have been shaken up by digit­al pure play­ers. It should be noted in passing that the cus­tom­ers of neo­banks are often “multi-banked”: they have accounts in sev­er­al insti­tu­tions. But these cus­tom­ers are not easy to make prof­it­able. The prof­it­ab­il­ity of a bank is no longer related to the volume of its out­stand­ings, but size still counts for a lot.

How­ever, in this highly reg­u­lated busi­ness, the man­age­ment and indus­tri­al­isa­tion of core bank­ing are com­plex (core bank­ing refers to all the basic soft­ware com­pon­ents that man­age the ser­vices provided by a bank to its cus­tom­ers) if one wants to cov­er the dif­fer­ent cli­en­teles and the whole range of their needs. This is a for­mid­able bar­ri­er to entry for newcomers.

Interview by Richard Robert