By John San Filippo
At the recent American Banker Digital Banking Conference, held June 12-15 in Austin, Tex., Helen Yang, director of portfolio marketing for FICO, and Darryl Knopp, senior director of portfolio marketing for FICO, presented “Navigating the Fintech Challenge: 5 Key Recommendations for Digital Banking Professionals,” a session based on a study commissioned by FICO with Cornerstone Advisors. The five areas covered in the presentation were:
Saving and investing.
Buy now, pay later (BNPL).
The session opened with data on how banks and credit unions perceive various threats in the coming decade. In 2021, 49% of surveyed financial executives considered Big Tech (e.g., Amazon, Apple, Google, etc.) to be the biggest threat. Fintechs (e.g., Credit Karma, PayPal, Square, etc.) tied for second place along with megabanks (Chase, BofA, Citi, etc.) with a 36% share of the vote. However, in 2022, Fintechs jumped to the top with 47%, while Big Tech fell back to second place with 35%.
“What are financial institutions doing about this threat?” asked Yang. “It’s digital transformation, right? You've been rearchitecting your technology. You've been revamping your processes. You're retraining people to deliver digitally native products and experiences. The trouble is that according to Cornerstone [Advisors], there's very little evidence that banks and credit unions are close to achieving digital transformation.”
Yang then offered interesting stats:
$131 billion was poured into fintech globally in 2021.
Since 2020, the percentage of Gen Z, millennial and Gen X consumers in the U.S. that consider a digital bank as their primary financial institution (PFI) has more than doubled.
More Gen Z and millennials call a digital bank their PFI than those that consider a community bank or credit union to be their PFI.
Seventy percent of bank and credit union executives believe their institution's current technology infrastructure is a barrier to digital transformation.
Seven out of 10 banks and three quarters of credit units said that they don't plan to replace their core systems as part of digital transformation.
“While these stats might be sobering,” added Yang, “we do have some good news that a wholesale transformation isn't necessary for effectively responding to the competition of fintech. Fighting back against fintech isn't an exercise in total war, but rather carefully picking one's battles.”
“When I started as a teller in 1993, a non-sufficient fund (NSF) was $25 to $35,” said Knopp. “Know what it is today? $25 to $35. And it's a small group of individuals that are really fundamentally incurring all of these fees.” He added that only 8% of accounts drive most NSF fees.
“The fintechs are responding by having no charges associated with overdrafts,” said Knopp. “But is that sustainable?”
According to Knopp, how one chooses to answer that question isn’t the point. Whether or not it’s a sustainable business practice, it still represents an immediate threat. Consumers will inevitably gravitate toward lower fees.
“If those balances go away, now your cost for lending goes up,” continued Knopp. “Because deposits in today's market are a cheap source of financing. The other piece here is that as they get anchored into those institutions, they actually become the primary bank and they start to utilize more of their products and services.”
One issue, according to Knopp, is that overdraft fees are arbitrary. “Most institutions don't necessarily have great decisioning or rules or analytics associated with deposit accounts,” he said. “Maybe you do for fraud, but not necessarily for evaluating what that overdraft should be. I don't necessarily think the fee should be zero, but I think you really need to understand the risk price. It’s been $35 for the last 30 years. It's surprising it hasn't changed when there's a great deal more efficiency in the system than there was 30 years ago.”
Saving and Investing
“There have been a lot of fintech apps that have automated savings and investing in stocks, mutual funds and options,” noted Yang. What's interesting is that fintechs like Acorns and Stash have been bringing both savings and investing together and combining them into a single streamlined experience. The threat is reducing the need to come to your banking apps.”
She said that, while banks and credit unions can always adapt their technology, they have one key advantage over the fintechs: data. “You have data that they don't have. You've got data on your customers [and members]. You've got the ability to understand what it is they need and figure out how you can best serve them. Think about providing savings, putting it together with investing and think about what it is that you know about your consumers, that you can bring,” said Yang.
“There's been a tremendous amount of focus on financial wellness in the five years,” added Knopp. “That's where you really start to get into modifying how you talk to your customer with your customer at the center. Technology has to be an enabler.” He said that some institutions’ digital transformation has failed because they started with technology instead of focusing first on the consumer journey.
“I have a love, hate relationship with buy now, pay later (BNPL),” said Knopp. “I spent the bulk of my career as a chief risk officer in the U.S. where you're highly regulated around capacity to pay – all those service ratio things we're required to be responsible. Then BNPL comes along, which is, in most cases, four payments that come either straight out of a debit account or straight onto your credit card. There's no assessment of affordability.”
According to Knopp, BNPL companies are set to syphon off $8-10 billion in transactions from other payment models. On the risk side, however, he stated that 43% of BNPL users have had at least one missed payment. “To me that's a shocking amount of delinquency in a product who's only widely been adopted in the last couple years,” he stated.
“There's a number of ways in which you can approach BNPL, but you are going to have to embrace this customer,” he added. “If you own the risk at a bank, you're going to do a credit assessment that's appropriate for the size of the opportunity. The risk assessment really is just a presumption of how much loss that they're prepared to take and that you have to tweak over time.”
Knopp said that he expects to see more regulation in BNPL. He also said the impact of BNPL on credit reporting will continue to be a challenge. “We pull our metrics to report once a month and we send them all the accounts for 30 days delinquent,” he said, contrasting that with BNPL’s typical four payments over two- or four-months model.
Niche neobanks are popping up everywhere. Just a few of the notable entrants to this market include:
Nerve – for musicians.
Purple – for people with disabilities.
Daylight – for the LGBTQ+ community.
Fair – for Shariah-compliant banking.
Panacea Financial – for physicians.
According to Yang, traditional banks and credit unions can compete in this space, but they need to act quickly. “You have a lot of data on your customers,” she said. “The key challenge is to make sure that you've got a platform or the ability to be able to get a product out the door quickly, because you don't have the time to wait nine to 10 years and develop a product or spend millions of dollars on it. You need to be agile and react quickly.”
It all comes down to personalizing the consumer experience, and that is best achieved through the thoughtful analysis of data. “Look at your customer data, analyze that,” Yang told the audience. “Are there some areas where there are gaps that you've got the data for, that the neobanks don't have? You can start really personalizing your experiences for these specific communities.”
Knopp warned that this is one area where a legacy core platform can be a hindrance. “When you’re talking about product innovation and you're not replacing your core banking system, you really have to look and see what you're able to do,” he said. “That's where we're starting to see a lot of software work, trying to get the core banking systems up.”
“The US is actually the most mature open banking market in the world,” declared Knopp, “but it has regulations. I'm not saying that's a bad thing necessarily in open banking, but I think the lack of the regulations [for fintechs] allows for a lot of innovation in this area.”
Knopp said that he uses the terms “bank aggregation” and “open banking” interchangeably, noting that aggregation has been around since the early 2000s. “It was screen scraping back in those days,” he said. “I think now from 75 to 100 of the largest banks have direct APIs (application programming interfaces) with Plaid.”
Aggregation is especially attractive to fintechs because it gives them a source of data that they don’t have natively. The challenge for banks and credit unions is that by participating in open banking, they risk providing their data to competitors, but by not participating in open banking, they risk alienating those consumers that want to take advantage of such services. For now, suggested Knopp, in makes more sense to participate.
According to the materials provided to attendees of this session, there are two steps banks and credit unions should take in response to open banking. The first is straightforward: building common standards and technical integrations.
“The second step, which is one that few if any banks have taken, is to is to leverage these APIs (and consumers' willingness to permit access to their data) to build new products and services,” the document advised, noting that banks and credit unions have been “strangely reluctant” to use open banking to their advantage.
The document noted that, “utilizing open banking, banks could build new financial management capabilities that pull data together from these disparate fintech providers and deliver unified insights to their customers that could help them protect and improve their financial health.”
The continued growth of the open banking movement appears inevitable. It only makes sense for credit unions to take advantage of the phenomenon to whatever extent they can.