Inside the power struggle between big banks and fintechs to modernize financial services

March 30, 2019 FinTech and Alternative Finance, Innovation and Resources, Research, Stories No comments

Financial Post | Geoff Zochodne | March 27, 2019

Innovation Nation: Canada is lagging its global peers in adopting new financial technologies and more co-operation between established banks and startup fintechs would help

The federal government put the word out last July: it needed someone to study the landscape for financial technology companies, or fintechs, and figure out how they were getting along with the big banks and other financial institutions.

Sue Britton’s firm, Toronto-based Fintech Growth Syndicate Inc., won the contract for the study. In January, the group said it turned in a 240-page report, the first of its kind in Canada, that used only publicly available data sourced from more than 60 different websites.

What it found, among other things, was that there were approximately 1,000 fintechs across Canada offering services or products related to crowdfunding, insurance, wealth management, cryptocurrency, artificial intelligence, capital markets, lending and payments.

The majority of those companies were startups, founded in the years following 2012, and employed less than 99 people each, though combined they had more than 30,000 people. Perhaps more eye-catching was the estimated value of fintech startups in Canada: $30.5 billion.

What the study did not find, however, was 1,000 partnerships with financial institutions: Canada’s Big Five banks may have been increasing their engagement with fintechs, but “the majority of their efforts” were still on building their own products and digital experiences. They were also busy trying to update their “bowl of spaghetti” technologies and systems, some of which may be decades old.

See: Competition Bureau weighs in on fintech: urgent action required

As a result, one of Canada’s biggest industries is innovating at a relatively tame pace, the country is lagging its peers in adopting new financial technologies and consumers of all types may be paying more for services than they should. The financial industry’s existing business models could eventually come under pressure as well.

“To the extent that we could find publicly available information, we were able to show that, yes, there are some fintechs that are partnering with financial institutions,” Britton said. “But certainly the majority of those partnerships are on the financial institutions’ terms. They’re not groundbreaking new business models … It’s not going to make the marketplace more competitive, because it’s going to, in fact, if anything, grow the business for the incumbent.”

Retaining the status quo may be all well and good for big banks and insurance companies for now. It may even be good for their customers — and most financial consumers have a connection to a big bank or insurer — who may be enjoying a smoother user experience or a new platform at their current institution of choice.

But legacy financial companies face a bit of a conflict of interest when it comes to innovation. After all, they have earnings targets to hit, shareholders to keep happy and thousands of employees and existing systems already in place to meet those goals. Why risk cannibalizing such profitable businesses or, moreover, give the vaunted stability of Canada’s financial industry a jolt?

Yet the incumbents could wake up one day to find their lunches being eaten by big-tech firms such as Amazon.com Inc. and Apple Inc., which are already offering a payments solution, some more aggressively than others.

“What our big banks aren’t doing is moving as quickly as other parts of the world, innovating their business models, extending financial services to more small businesses or reducing their fees,” Fintech Growth Syndicate said. “Perhaps, as Abraham Lincoln famously said, ‘give me six hours to chop down a tree and I will spend the first four sharpening the axe,’ they are still sharpening the axe.”

See: Advancing Competition in a Changing Marketplace

It’s also possible that no one is even swinging an axe in the financial sector, despite the federal government’s efforts to push the innovation envelope in various industries.

Competition Bureau research “points to low levels of financial technology adoption in Canada relative to other countries, and limited consumer engagement driven, in part, by frictions associated with shopping around and switching,” according to a document published in February by the interim commissioner of competition. “These factors are symptoms of a market that is not functioning to its full potential.”

Britton believes the major banks and insurers face the innovator’s dilemma, first outlined in a 1997 book by Harvard professor Clayton Christensen: An incumbent with a big base of existing customers and shareholders demanding good returns is unlikely to welcome a company that could disrupt its own business.

On the other hand, “You don’t want to wake up one day and be Blockbuster,” she said.

Nobody, of course, wants to be compared to a bankrupt video-store chain, which is why the financial sector is certainly aware that the big-tech companies are making inroads into their business.

Royal Bank of Canada chief executive Dave McKay reportedly noted in mid-March that he was increasingly concerned with the prospect of Facebook Inc., Amazon.com, Apple, Netflix Inc. and Alphabet Inc.’s Google (the FANG companies) getting into banking.

“They are getting between us and the moments of truth of our customers, and currently what they do with that is they sell that insight back to us in the form of search and advertising and other perspectives, and they earn a certain amount of economic rent,” he said, according to Bloomberg.

RBC and the other big financial institutions know they need to up their game, something that was noted by Luge Capital, a Canadian venture fund focused on fintech and artificial intelligence, when it did its own scan of the fintech landscape for a report published last October.

See: Open Banking: What’s Really at Stake

Luge Capital, which has been backed by institutions such as the Caisse de dépôt et placement du Québec and Sun Life Financial Inc., found the climate for possible partnerships between startups and big banks or insurers had improved.

“Large incumbents have customers, well-established brands and vaults of financial resources,” the report said. “As a venture capital fund with large financial institutions backers, such as Sunlife, Desjardins, CDPQ and La Capital and Le Fonds FTQ, we see first hand their desire to partner with early stage innovators.”

The biggest banks may still have the “vast majority” of the market share in financial services, but there has been a shift recently, said Karim Gillani, general partner at Luge Capital.

“In the last three to five years, there’s been a widespread recognition amongst the FIs (financial institutions) that they need to work with the early stage or smaller fintech companies in order to enhance their service offering for their customers,” he said.

Gillani said there was value in financial institutions exploring new ways of “offering functionality,” such as robo-advisers as a form of wealth management, something several banks have already done.

“It’s a demonstration of how banks are shifting their view from the traditional wealth-management experience to something that’s more automated and driven by technology so that it becomes appealing to a different segment of the population,” he said.

The federal government might open another door for the fintechs to get to the market. Ottawa is currently considering the idea of open banking, which is supposed to give people more control of their data and make it more portable.

See: Canada’s financial upstarts are lining up behind open banking, but bigger players may need convincing

The competition commissioner, in a submission made in response to a government consultation paper that outlined the benefits and concerns of open banking, said the framework could allow consumers to shop around and compare prices, potentially stirring up competition by lowering search costs.

“Banks would be forced to compete harder for consumers, and consumers would have access to a broader range of services, if the benefits of technology could be more fully exploited through open banking,” the submission stated.

Yet bringing third parties into Canada’s financial system — renowned for its stability — has raised some concern for at least one federal regulator, who pointed out that such decentralization “magnifies non-financial risks and diffuses accountability.”

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