The FINTECH Moment
Silicon Valley is coming. There are hundreds of start-ups with a lot of brains and money working on various alternatives to traditional banking. – Jamie Dimon
Banking has historically been one of the business sectors most resistant to disruption by technology. Since the first mortgage was issued in England in the 11th century, banks have built robust businesses with multiple moats: ubiquitous distribution through branches, unique expertise such as credit underwriting underpinned both by data and judgment, even the special status of being regulated institutions that supply credit, the lifeblood of economic growth, and have sovereign insurance for their liabilities (deposits). Moreover, consumer inertia in financial services is high. Consumers have generally been slow to change financial services providers. Particularly in developed markets, consumers have historically gravitated toward the established and enduring brands in banking and insurance that were seen as bulwarks of stability even in times of turbulence.
The result has been a banking industry with defensible economics and a resilient business model. In recent decades, banks were also helped by the twin tailwinds of deregulation, a period ushered in by the Depository Institutions Deregulation Act of 1980 (DIDRA), and demographics (e.g., the baby boom generation coming of age and entering their peak earning years). In the period between 1984 and 2007, U.S. banks posted average returns on equity (ROE) of 13%. The last period of significant technological disruption, which was driven by the advent of commercial Internet and the dotcom boom, provided further evidence of the resilience of incumbent banks. In the eight-year period between the Netscape IPO and the acquisition of PayPal (one of the winners of this era) by eBay, more than 450 attackers – new digital currencies, wallets, networks, etc. – attempted to challenge incumbents. Fewer than five of these survive as stand-alone entities today. In many ways, PayPal is the exception that proves the rule: it is tough to disrupt banks.
History does not repeat itself; but it often rhymes. – Mark Twain
This may now be changing. McKinsey’s proprietary Panorama FINTECH Database tracks the launch of new FINTECH companies – i.e., start-ups and other companies that use technology to conduct the fundamental functions provided by financial services, impacting how consumers store, save, borrow, invest, move, pay and protect money. In April 2015, this database included approximately 800 FINTECH startups globally; now that number stands at more than 2,000. FINTECH companies are undoubtedly having a moment.
Globally, nearly $23 billion of venture capital and growth equity has been deployed to FINTECH over the last five years, and this number is growing quickly ($12.2 billion was deployed in 2014 alone).
So we now ask the same question we asked during the height of the dot-com boom: is this time different? In many ways, the answer is no. But in some fundamental ways, the answer is yes. History is not repeating itself, but it is rhyming.
The historical moats surrounding banks are not different. Banks remain uniquely and systemically important to the economy; they are highly regulated institutions; they largely hold a monopoly on credit issuance and risk-taking; they are the major repository for deposits which customers largely identify with their primary financial relationship; they continue to be the gateways to the world’s largest payment systems; and they still attract the bulk of requests for credit.
Some things have changed, however.
First, the financial crisis had a negative impact on trust in the banking system. Secondly, the ubiquity of mobile devices has begun to undercut the advantages of physical distribution that banks previously enjoyed. Smartphones enable a new payment paradigm as well as fully personalized customer services. In addition, there has been a massive increase in the availability of widely accessible globally transparent data, coupled with a significant decrease in the cost of computing power. Two iPhone 6s have more memory capacity than the International Space Station. As one FINTECH entrepreneur said, “In 1998, the first thing I did when I started up a FINTECH business was to buy servers. I don’t need to do that today – I can scale a business on the public cloud.” There has also been a significant demographic shift. Today, in the U.S., alone, 85 million Millennials, all digital natives, are coming of age, and they are considerably more open than the 40 million Gen Xers who came of age during the dot-com boom were to considering a new financial services provider that is not their parents’ bank. But perhaps most significantly for banks, consumers are more open to relationships that are focused on origination/ sales (e.g., Uber, AirBnB, Booking.com, etc.), are personalized, and emphasize seamless or on demand access to an added layer of service separate from the underlying provision of the service or product. FINTECH players have an opportunity for customer disintermediation that could be significant – McKinsey’s 2015 Global Banking Annual Review estimates that banks earn an attractive 22% ROE from origination and sales, much higher than the bare-bones provision of credit, which generates only a 6% ROE.