Last year, fintech startups raised over $37B globally, up 120% from the previous year and hitting a record high for investment in the space. 49 of the roughly 1,700 deals had participation from some of the largest U.S. banks, and over the past five years banks have acquired or taken majority stake in a total of 20 fintech companies. Despite this participation, however, legacy banks have largely remained uninvolved in the fintech landscape, both in terms of investment and in terms of M&A. NewtonX interviewed 25 senior executives and Heads of Innovation/Fintech at the ten largest banks in the U.S. with the intent of identifying barriers to investment and M&A in the fintech sector. The interviews identified three primary barriers, however they also revealed that many banks are investing in fintech internally rather than investing in startups.
The Three Big Banking Barriers: Why Legacy Banks Are Staying Out of the Fintech Sector
93% of the executives interviewed by NewtonX said that fintech is a strategic priority for their organizations, from process automation to consumer-facing tech. The lack of big banking investment, then, is due more to barriers for mergers and acquisitions, rather than a disregard for FinTech’s potential.
1. Regulatory approval for mergers and acquisitions
Many fintech companies that provide services to financial institutions are themselves subject to the same regulatory frameworks as their clients. However, consumer-facing fintech companies typically aren’t subject ot the same level of supervision by regulators as large banks, which makes due diligence and compliance a major barrier for mergers and acquisitions.
2. Integration barriers with legacy systems
Integrating an existing fintech platform (typically cloud-based) with legacy systems, many of which still rely on on-site data warehousing or processing, was a major challenge cited by the banking executives. Most fintech startups don’t build their products with the intent of eventually integrating it with a global bank’s infrastructure/ data privacy and protection standards.
3. Cultural barriers to bringing in a team of startup-native employees
This is a problem that’s not exclusive to the financial services sector. The cultures of legacy corporations and startups tend to be extremely different, and often startup employees get frustrated with the level of bureaucracy inherent to large companies.
These three factors have contributed to many banks creating their own in-house fintech development teams. For instance, Goldman Sachs launched its consumer financial planning and lending platform, Marcus, several years ago. Since then, the platform has accumulated $26B in deposits and has loaned $3B to customers, generating over $1B in revenue. Online banking customers are a third more profitable than traditional customers, and Goldman was not alone in taking advantage of this fact. Morgan Stanley, ING, the Royal Bank of Scotland, and Capital One have all made similar moves into the fintech sector.
Disruptors Initiate and Big Banks Follow
Many fintech companies need to partner with big banks in order to survive. Even the fintech startups with large user bases can’t compete with big banks — for instance, TransferWise had 1M users as of last year, but compared with JPMorgan’s 50M digital users, the impressive user base appears inconsequential. Many fintech startups see partnering with big banks as the safest and most efficient way to scale up. Even tech giants such as Amazon are considering this strategy: the ecommerce behemoth is considering a potential partnership with JPMorgan that could lead to an Amazon-branded checking account.
Meanwhile, legacy banks tend not to be innovators, but they do have the resources at hand to build their own competing products when a startup with a compelling idea enters the market. This can be seen through the rise of robo-advisors and machine-learning based algorithms to match investing packages and opportunities with clients, as well as through the rise in mobile banking and RPA-based process tools. As fintech startups continue to innovate, many will ultimately partner with big banks or fail after big banks create their own versions of the startup’s technology. A few may survive without doing either (let us remember the early days of PayPal), but these will be few and far between.