By Matthew Lynn for the Telegraph
Peer-to-peer lending. Robot financial advisers. Crowd funding. Alternative currencies. Every day seems to bring news of another whizzy new financial technology start-up.
The industry is exploding, and may be reaching a tipping point where it starts to seriously damage the major banks – a report this week from Capgemini found that 63pc of customers had used a “fintech” product and were more likely to recommend them to friends than any traditional provider.
Perhaps slightly late in the day, the major banks have woken up to that threat, and have started to respond with a hurricane of investments, either trying to create their own platforms, or else partner with one of the fast-growing new challengers. The strategy is fairly clear – if you can’t beat them, join them.
There is a problem, however: it is not going work. The existing players are too big, too burdened down by costs, have operated in an over-regulated market for too long, and are unlikely to pick the winners anyway. In reality, the major banks are in more trouble than either they or their investors yet realise.
The number of companies exploiting the internet to provide new ways of providing financial services is growing all the time. In this country, the best known are the peer-to-peer lenders such as Zopa and Funding Circle, which match up lenders and borrowers, and the fast-growing crowd-funding websites such as Crowdcube or Seedrs, which enable people to invest in new companies. But there are new ones coming along all the time. According to a report by Innovate Finance, the UK was second in the world for fintech funding last year, accounting for £675m of the £8.9bn raised globally. New ones are joining their ranks all the time – this month for example, Loot, a student banking app, said it was raising £1m in investment,
It is not hard to see why so many entrepreneurs and venture capitalists are rushing into the space. The internet is very good at ripping out the middlemen, and there is probably no industry with more of those, and better paid ones, than finance. From basic banking, to lending, to financial advice and broking, financial companies have charged high prices for what are often fairly standard tasks. There will be some big winners in the years ahead, There are already 24 with valuations of more than a $1bn, and the Chinese peer-to-peer lender Lufax was valued at an extraordinary $19bn earlier this year. Even more seriously, customers seem to like them. The Capgemini study found that 80pc of customers said that they had had good customer service from a fintech company – not the kind of numbers reported for the traditional players.
The big banks, inevitably, are starting to fight back. The last year has seen a slew of investments in the sector. JP Morgan has partnered with One Deck, an online lender. Goldman Sachs bought Honest Dollar, an online advisory outfit. In Europe, BNP has partnered with Smart Angels, a crowd-funding platform. The Spanish bank BBVA bought out the Finnish start-up Holvi. Others are collaborating on working together to provide their own services. As the bandwagon gathers pace, expect to see many more examples and perhaps some huge deals. The major banks are still very big companies with deep pockets – one or two may decide to splash out on the fast growing start-ups, just as some of the media companies did at the height of the first dotcom bubble.
There is nothing wrong with the strategy. When your industry is being turned upside down, it makes sense to try to invest in the future. And yet it is going to be far harder than it looks – for four reasons.
First, the traditional banks are weighed down by down by huge costs accumulated over decades. All those branches on the High Street are horribly expensive compared to running a simple website. They have tens of thousands of staff, and even bigger pension funds, and layers of management that were built up in a different era. All that costs money. By contrast, the new start-ups don’t have any of those vast fixed costs. They are cheaper to run, and so can offer far better value – and it won’t take long for the customers to notice.
Second, banking has for a long time been so heavily regulated that it is virtually an oligopoly. This has smothered genuine competition – all the main banks, for example, offered much the same products, at much the same price. Even worse, they have developed a culture of ripping off their customers – a series of mis-selling scandals have shown that. Banks have relied on inertia to keep hold of customers. That’s not going to work if the market becomes super-competitive.
Third, the chances of picking the winners are slim. There are dozens and dozens of fintech start-ups out there. But inevitably only a tiny handful will genuinely prosper, just as only a few of the dotcom stars of the late 1990s really made it big. Will the big banks invest in future hits or those that fall by the wayside? The law of probabilities suggests it will be the latter.
Finally, the weight of history is against them. All the evidence of industrial innovation suggests that legacy companies can virtually never transform themselves. Railway companies didn’t make successful cars. Film companies didn’t create the giants of the TV industry. It wasn’t the established electronics manufacturers that thrived in personal computers.
The real disruptors are always new companies. They start with a clean slate, and a new way of thinking, and that is a big advantage.
First appeared at the Telegraph