Why Fintechs Aren't Actually Banks

A PricewaterhouseCoopers (PwC) study showed that financial technology (fintech) market share in 2019 was 1% of US bank assets and is projected to become over 24% by 2030. What are fintechs doing differently? Why is this market share growing?

Fintechs have grown tremendously in the scope of services they provide and the customers they reach in the last decade. They have disrupted all aspects of the financial industry from personal lending (unsecured loans, cards, auto loans, mortgages) to payments, to investments and brokerage. 

For example, Upstart believed there are individuals who are credit-worthy based on more than just a credit score. They underwrite unsecured personal loans and auto refinance loans for individuals, many of whom cannot access credit directly from traditional banks due to the limited credit determination mechanisms. By doing so, this fintech is fulfilling an important yet unmet market need by expanding access to credit for minorities, younger people, new immigrants, and others left behind by traditional banks.  

The surge in fintech growth is driven by two key factors:  

  1. Fintechs are providing innovative products and services to customers that traditional banks are either unable or unwilling to provide due to legacy technology and a limited risk appetite.  

  2. Their novel approach to customer experience and their customer acquisition tactics are disrupting the way the financial industry has traditionally approached and worked with clients. 

“A bank’s advantage lies in having deposits to exploit, even if they do not know whom they should lend them to. Tech firms’ advantage is that they know whom to lend to, even if they do not have the funds.” -The Economist, How fintech will eat into banks’ business

Despite the advantages that they bring to customers, fintechs are operating in a highly regulated industry and therefore still need banks to manage the actual business and operations of banking. Like traditional banks, fintechs need access to capital, they need to develop infrastructure such as payment  processing and card networks, and perhaps most importantly, fintechs need to ensure consumer protection and compliance with banking regulations. This is extremely costly, cumbersome in terms of technological alignment (many banks use technology stacks dating back to the 80s), and takes a long time due to this outdated bank technology and processes.  This high cost and technological misalignment suggest that to minimize their costs, move faster, and create efficiencies through vertical integration, fintechs should investigate becoming banks themselves. But in practice, there are very few fintechs that have made the leap from purely a financial technology company to a fully licensed and regulated bank (e.g., SoFi).

This begs the question - why don’t more fintechs try to become banks themselves? The simplest answer is that the core competencies of fintechs are different than those of banks. Fintechs are innovating in spaces such as AI decision making, underwriting, quicker access to funds, better servicing, and improving customer reach and experiences. But those competencies do not translate to becoming a bank for three primary reasons:  

  1. Cost & Technology – Even to be a small, limited purpose bank, a fintech would need to integrate or build a bank CORE (Centralized Online Real-time Exchange system). Although fintechs are incredible at building innovative technology, the CORE must meet explicit requirements defined by regulators, be examinable, and must be developed in a prescribed way that doesn’t allow for the flexibility and innovation fintechs thrive on. Additionally, it is expensive. Any time and resources spent on building this CORE takes away from areas where fintechs can drive innovation such as the use of artificial intelligence and customer experience. 

  2. Regulatory Processes – Most fintechs make efforts to adhere to all applicable regulatory practices and protect their customers. To do so, they must follow prescribed procedures, add specific compliance, risk management and audit staff, and add processes for tracking and oversight. To be a bank, however, a fintech would have to do significantly more... this includes building further front-end oversight capabilities, back-end reporting, and the organizational structures required of banks. This would add cost and human capital in areas that fintechs do not usually prioritize. Plus, they would have to go through a bank chartering process or acquire a bank, which adds further complexity and uncertainty. For the majority of fintechs, the additional technical, personnel, and regulatory requirements do not make business sense to build and own internally.

  3. Banks Provide Additional Value – Although slow and not exactly customer friendly, legacy consumer banks are generally (and surprisingly) good at some of the basic things they do - that’s why they make money! Functions such as deposit taking, access to capital, scaling of services and more are hard to replicate and compete with, because banks have perfected these processes for decades, if not centuries – all the way from the Medicis to the Rothschilds to the JP Morgan’s. Fintechs, however, bring a much-needed fresh look at the customer experience. 

There is no doubt that fintechs have brought new capabilities to how people interact with their finances and with each other. They are shaping the customer experience, expanding access for customers that may not always have benefited from financial services, taking a larger piece of the market, and doing it at a scale enabled by innovative technology.  

In order to drive profit and create broader reach, fintechs need to either become banks themselves or need modern banks that complement their competencies. To maintain their focus on building better products rather than maintaining legacy technology and regulation, it makes sense that most fintechs would prefer to partner with a bank built for their specific needs. 

The process of finding the right bank for your fintech is complicated and time consuming – as long as 24 to 36 months, based on our research. If you could use some guidance, reach out to us at Illume Financial, we are always happy to chat.