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Michael Baxter

Can traditional banks survive the Fintech and challenger bank threat?

Written by: Michael Baxter on April 20th 2017

Category: Thought for the day

Banks, they are a staple part of many investor’s portfolio, but can they survive the new threat? Mark Carney and a report from PwC casts doubt on whether they can.


The threat

The lesson of history is that nothing lasts forever.  The lesson from academia is that successful companies are usually pretty good at dealing with an evolving market or evolving technology. But they are lousy when a market changes rapidly. They are no good at allowing for an attack that comes from the metaphorical left-hand side of midfield.

The Giggs of business

If you like football you will know that the English football team has been haunted by a lack of talent on the left-hand side of midfield, probably since John Barnes retired.  What a pity that Ryan Giggs, one of the greatest football players in the world to grace that side of the pitch for decades, could not play for England – or that there could have been no English/Welsh team, because such a side may have been good enough to win the World Cup.

But the left-hand side of midfield has another meaning. It is shorthand for surprise.

And it is surprise that businesses are not so good at dealing with.  This is the essence of Innovator’s dilemma, the theory of disruptive technology advanced by Clayton Christensen.  Dominant companies continue to dominate for as long as the market they operate in, and the technology it uses, merely evolves. But if a technology is developed in another area, becoming ever more sophisticated, until it reaches a level that gives it wider appeal, then the result can be a business earthquake that can have devastating effect on incumbent companies.

The financial left

But these days, if you apply the idea of the left-hand side of midfield to banking, you find it is a busy place.  I list some examples:

  • The internet lowering barriers to entry
  • IT legacy haunting existing banks
  • Electronic payment systems such as Apple Pay
  • Peer to peer payments in which users can make electronic transfers without a bank account
  • Peer to peer lending and crowd sourced funding, in which the lender or investor goes direct to the recipient, bypassing the middle man – the bank
  • Blockchain technologies

The rise of challenger banks has been enabled by these left-hand side of midfield developments.

Carney enters the debate

Recently the Bank of England governor, Mark Carney, warned that new financial technology poses a threat to the business model of existing banks.

Mr Carney was of course, focusing on the regulatory implications.

He said: “If this happens, the Bank of England would need to ensure prudential standards and resolution regimes for the affected banks are sufficiently robust to these risks.”  He added “The challenge for policymakers is to ensure that fintech develops in a way that maximises the opportunities and minimises the risks for society.”

Reading between the lines, the implication is clear. Traditional banks face a major threat.

Cyber security

There is another threat to banks – cyber security.  In particular quantum computers. If, or when, they finally reach the market, they will be a hacker’s dream, making it possible to bypass just about any security system. The answer to the cyber security threat posed by quantum computers on banks comes in two forms. Either quantum computing itself, leading to a kind of quantum arms race, between hackers and those trying to ensure security. Or Blockchain, which uses a distributed ledger so that the record of all money transactions using a blockchain currency system is held on every computer that uses it. To hack into such a system, you would need to hack into every computer simultaneously.

With this in mind, the Bank of England has been promoting an Accelerator scheme to support fintech companies in the development of a blockchain system that would meet the bank’s objectives.

In an environment, in which there is a quantum computers arms race, and we see a move to blockchain, it is not hard to see how traditional banks may struggle to keep up.

I would say the odds that at least some banks will go the way of Kodak, or the Nokia phone, or Blockbusters, is pretty high.

What is a challenger bank?

Meanwhile, PwC has been looking at challenger banks.  And it has concluded that the make-up of such banks is so varied that actually there may be no such thing. ‘The catch-all idea of a challenger bank masks the very significant differences between many of the banks it purports to describe,’ it says.

It then goes on to lump different challenger banks into four categories:

  • Mid-sized full service banks, which apply digital technology but ‘believe that physical presence remains important and serve customers with a physical network of up to 600 branches.’ It gives as examples, the Co-operative bank, TSB and CYBG.
  • Specialist banks, in which the bank specialises in an area of lending or saving, such as mortgages or small businesses. Examples:  Secure Trust, Aldermore and Shawbrook.
  • Digital-only banks which aim to serve ‘both digital natives and converts.’ PwC says these banks ‘pride themselves on innovative technology platforms that promise exceptional customer experience and engagement, primarily through mobile apps.’  Examples include Starling, Monzo and Tandem.
  • Non-bank brands, in which parent companies are ‘strong players in other industries.’ Examples include Tesco bank, Sainsbury’s bank and Virgin Money.

I would add to that list two other categories.

The giant techs, such as Apple, Facebook and Amazon, and start-up fintechs currently working on ideas that not many people have even considered.

What to do?

I would say treat banks as an investment class with caution, and be aware of the threat that is emerging. I am not saying that all the existing major bank brands will fail, and many may survive by buying out challenger banks or fintechs.

Then again, not even the biggest bank in the world can afford to buy the giant techs, and if there is one thing that the rise of these techs has taught us, it is that it can occur very quickly. I wonder what surprises lurk in the world of fintech!

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Tags: banking sector, Fintech, challenger banks, innovators dilemma, blockchain

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