The Creative Destruction Of Banking
The economic principle of replacing existing business processes and models with innovative and more efficient ones is nothing new. In banking, it’s more recently become a burning issue, as banks’ customers and the competition have accelerated the need to think that way: a model that moves banks from an invisible utility that enables banking and payments services to a central player in how customers will enable and experience banking and payments services as part of the connected economy.
In this new model, the competition isn’t the bank down the street or the one with the most convenient branches. In fact, recent PYMNTS studies now show that for the first time, consumers no longer regard physical branches as the criteria for choosing their primary bank. They’re less important than they used to be — at least in terms of how consumers know and use those banking storefronts today.
The competition is the FinTech, the neobank, the mobile-first banking services provider with the slick user experience that consumers are not used to seeing in much of what they do digitally with their bank.
It’s the savings app that offers DDA-like services. It’s the telco that offers a mobile banking-like account for families to use.
It’s the FinTech with an app for teens that teaches financial and money management skills with checking-like and savings functionality. It’s the data aggregator that becomes a data and payments enabler and the next mobile-only bank.
It’s the personal loan platform that buys or builds but otherwise integrates mobile banking capabilities into their platform. It’s the prepaid card that functions as a mobile bank account with bill pay capabilities.
It’s the BNPL provider that adds debit cards and savings account capabilities to their app.
It’s the collective competition that becomes death by a thousand FinTech cuts that chip away at the core business of the bank: attracting deposits, providing services that generate fees and lending money.
The First-Gen Neobanks
In reality, the notion of a “neobank” as a challenger to the existing bank model is nothing new. Neither is the phone or the PC as an enabler of banking services innovation.
The difference today, like so many other early incarnations of technology and new models across banking and payments and the connected economy, is the evolution of technology, software and devices that provide a better user experience and can scale, often globally.
The 1980s landline push-button phone was all a consumer needed back then to do business with a brand-new type of bank that didn’t have branches. Patented technology encrypted account details and other personal data so that consumers and these direct banks could do business securely via call centers. Consumers could use the ubiquitous device on their desk at work or their living room table at home to manage their accounts. Most of these direct banks — and there weren’t many — offered a single banking service, usually high-interest savings accounts, given the newness of this banking concept and the friction for both the bank and the customer in managing more complex banking services using only a landline phone.
Bank-by-phone gave way to banking on the internet in the late 1990s and early aughts. Virtual banks swapped people and call centers with online engagement and a PC. But it didn’t catch on like wildfire, not even after most people had PCs and fast broadband. It would take a good 15 years — until 2015 — before 85 percent of U.S. banks had online banking up and running and 51 percent of consumers were using it.
In 2021, six years hence and 13 years since the birth of the smartphone and app stores, once again it’s the near-ubiquitous availability and accessibility of the phone — this time the one in the consumer’s hand — that connects nearly all consumers to banking services.
And it has fast-tracked the rise of FinTechs to provide them.
Today, 86 percent of U.S. consumers say they engage frequently with a variety of banking services using digital channels, although the frequency of use — and the intensity of their engagement — may vary by age, income and other factors. This finding is from a national study of 15,094 U.S. consumers between April 14 and May 19 that PYMNTS conducted as part of the How Consumers Live in the Connected Economy research released last week.
But unlike the neobanks of old, where going digital had its constraints and built-in frictions, tech and connected devices have leveled the banking services playing field for consumers who aren’t always engaging with a traditional bank when accessing banking services — particularly the stickiest and most strategic services.
Oh no — it’s the neobank.
Jamie Dimon has been using the occasion of his annual letter to shareholders to sound the alarm about the threat of FinTechs to traditional banks since 2015.
In 2015, the same year that online banking penetration by U.S. banks hit 85 percent, neobanks Atom, Chime and Go Bank were celebrating the second birthday of their mobile banking apps, and Revolut, Monzo and Varo were newborns.
Three years later, in 2018, SoFi would add banking services to its personal lending platform and Acorns would do the same to its savings app. J.P. Morgan would launch its own neobank, the mobile banking app Finn, that same year — only to shutter it a year later.
In 2019, Walmart would announce the launch of a FinTech accelerator focused on digital financial services innovation for its customers. In 2020, LendingClub bought a mobile bank, Radius, and Step launched its mobile banking app for teens.
The common denominator across all of these is the use of mobile apps and smartphones to enable access to banking-like services. These FinTechs are not banks, but they function like them, with banks and card networks in the background to power the services they provide.
Those who keep count report that there are now more than two dozen pureplay neobanks in the U.S., and many dozens more that are — or will likely soon — embed banking services into their savings, investment, credit and P2P platforms. FinTechs that provide Banking-as-a-Platform services help businesses simplify the extension of banking services to their end users — consumers and corporates.
Like their 1980s predecessors, the digital-only connection and a discrete set of services get consumers on board. Their banking services playbook is fairly straightforward: Get eyeballs with one basic banking service, and then add more mobile-native features and functions over time.
For those whose app is a prepaid card with a slick mobile UX, their business models are highly dependent upon interchange fee arbitrage on prepaid card transactions via a Durbin amendment loophole, and it is that carve-out (plus venture money) that supports the payment of higher interest rates on deposits stored on those cards.
Regardless, unlike their traditional banking counterparts, digital-first wasn’t a shift they needed to scramble to engineer over the last 18 months — it’s how they were born. And it’s how they have scaled their own growth and captured accounts over that same period of time.
How Consumers View Their Banks
The U.S. consumer and her bank have an interesting dynamic.
First, she trusts her bank. PYMNTS has been doing studies of consumers and their attitudes toward traditional banks for more than five years. Nearly all — 90 percent — of consumers say they trust their bank to keep their money safe, their transactions secure and their information private. The headlines that report how little consumers trust their banks are inconsistent with everything PYMNTS has seen for the vast majority of Americans.
At the same time, she doesn’t think of her bank as particularly innovative.
As we have also consistently seen in our research, consumers and FIs don’t always see eye to eye on what’s innovative and what might have been at one time, but is now expected as table stakes. That perception of innovation has only grown sharper over the last 18 months, as nearly all consumers have become highly knowledgeable critics of their digital and mobile user experiences.
Perhaps for that reason, PYMNTS’ recent Connected Economy research finds that more consumers used mobile wallets for P2P than for paying merchants over the last 12 months. Those who did use P2P opted for third-party P2P apps, Venmo and PayPal more often than bank P2P rails, such as Zelle.
Both Venmo and PayPal have invested in a user experience that is easy, ubiquitous and instant, if that is the desire. Both have invested in QR technology that simplifies the sender experience and extends P2P and merchant payment use cases in-store. For consumers, it’s become a valuable enough experience for both senders and receivers to build the P2P network flywheel and expand the P2P use cases for both sides.
Then there’s bill pay.
According to PYMNTS research, 86 percent of consumers have gone online or used a mobile app to pay bills at least once in the last 12 months, and 70 percent do so several times a month. Just because they do, doesn’t mean they’re using their bank’s online or mobile bill pay function.
More broadly, the consumer’s use of bank bill pay channels has declined over the last several years, even as more consumers pay their bills online. Consumers are using old tech and biller direct channels because suitable options -either online or via mobile from their bank — aren’t available.
PYMNTS’ Connected Economy research also found that 90 percent of average consumers use the bank’s website or mobile app when conducting banking services. But more of them use the bank’s website and not the mobile app — a data point we also see when banks report the number of mobile users. (It’s also hard to tell in many cases, since not all of them report online and mobile separately.)
It’s also not because customers want it that way.
PYMNTS has also observed in other consumer banking studies that consumers consistently report using bank websites to conduct banking activities because they have to.
They report that the functionality on the mobile app is too limited or not available at all for the banking services they want and need to complete. If available via the app, they report a clunky user experience that makes it too difficult to conduct more complicated banking activities via the bank’s mobile app.
The Known Knowns
None of this is news to the banks. What may be, is the diversity and intensity of threats now to their core business — and all at the same time.
Mobile is an area that until recently, banks have undervalued and underinvested in because they didn’t think that neobanks with their mobile apps were much of a threat and particularly, not a threat to the customers that represent their core business.
It’s also largely the case that that the prepaid cards with a better mobile app won’t today pose much of a threat to the bank’s primary customer base.
But there’s the risk that these neobanks will add P2P, bill payment capabilities and BNPL options as part of their already pretty slick mobile experience. Even before that, there’s the risk that more consumers will open accounts with them for specific use cases rather than using their existing bank account or opening one with their bank account because the account onboarding process is too hard. Or they might establish relationships with purpose-built mobile banks that build services around the needs of a particular cohort of consumers, and who have traded a product-first focus for an experience-based, outcomes-driven value proposition.
It’s the risk that more consumers — particularly younger and more affluent 33 to 43-year-old bridge millennials, most of whom have and use credit cards today — will increase their use of BNPL options, cutting into credit card fee income even as banks sweeten the rewards pot.
And there’s the desire on the part of all consumers — in particular, the highly connected, younger and more affluent consumers — to use mobile devices to perform banking services, and who might be willing to build a relationship with a FinTech brand they trust and evolve it over time.
This is also a tough transition for banks, since even moving from batch to real-time clearing and settlement remains a work in progress for many banks. According to The Clearing House, the availability and use of real-time payments remains inconsistent, even as large banks and core banking platforms are now connected. Use cases and applications that ride those rails will drive innovation at scale over time.
In many ways, banks face the same tough transition that millions of traditional brick-and-mortar retailers — with legacy point of sale systems with integrated custom software and a myriad of customer databases — now face, as they, too, suddenly shift digital and mobile. And to deliver one with a user experience that’s on par with established digital and mobile players like Amazon, and mobile- and digital-native innovators at scale.
Like physical retail, the largest of the large have or will invest in making their mobile app best-in-class, and they will consider new tech, platforms and business models to accelerate that path. Grocery stores outsourced eCommerce to Instacart out of necessity, growing sales and acquiring new customers as a result — while at the same time giving customers the option to deal directly with their store. Banks may need to think outside of the box, too, as they contemplate serving a more demanding mobile-first consumer and the need to move faster in delivering on their requirements.
PYMNTS’ Connected Economy research shows that consumers want to live in the connected economy, make their interactions within the pillars that define it more efficient, and even streamline their interactions across many of them.
All but how they bank.
For most consumers, keeping their banking and money management activities separate from other connected economy activities is their preference. They want a more robust banking and financial services ecosystem, but one that is under their control, where their details are private, secure and shared with their permission, and not commingled with other activities.
We see the TCH RTP® network piloting Request for Payment to help banks bring bill pay back into the bank and the mobile banking experience. The opportunity for consumers to pay a bill and have it posted in real time — 24/7/365 — is potentially a game-changer for consumers, provided that bill pay details are enriched inside of the app. On that front, innovators are working with the banks to provide more transaction clarity and digital receipts, which will help.
The ability for Zelle to clear and settle P2P real-time over RTP rails can make bank P2P more competitive as network availability matures. That lack of ubiquity and certainty on the part of the sender and receiver deters bank P2P adoption at scale.
At the same time, card networks are innovating installment credit with existing credit lines for their issuers, at the same time that banks and credit unions are investing in building BNPL options. Big banks are piloting programs to make credit more inclusive by using non-traditional data sources to underwrite consumer credit risk.
It’s progress, but reactive — a response to the FinTechs that are getting traction.
Banks have the trust of the consumer and the building blocks to serve as a key player at the center of the consumer’s financial services ecosystem — with the potential to reimagine what that means for themselves and the consumers and businesses they serve.
Their biggest threat the single-feature mobile app that one day becomes a more robust mobile banking option. It’s taking too long to recognize that consumers won’t keep waiting around for them to play catch-up.
Originally published at https://www.pymnts.com on June 28, 2021.