For traditional financial institutions (FIs), especially smaller FIs and credit unions (CUs), the age of disruption is here.
Digital banks are poised to lure consumers away from the JPMorgans, the Citibanks, the Wells Fargos of the world, as digital-centric offerings prove too tempting to resist, sweetened with higher interest rates on deposits, easy-to-use apps, speed and convenience.
As Douglas Brown, senior vice president and general manager of NCR Corporation, told Karen Webster in a recent interview, the concept of just what a bank is — and whether challenger banks actually represent an existential threat — is due for a reassessment.
Turns out, the demise of the traditional banking model has been greatly exaggerated — especially if entrenched firms take stock of their inherent competitive advantages.
The conversation took place against the backdrop of 5-year-old challenger bank Varo saying earlier this month that it got approval from the Federal Deposit Insurance Corporation (FDIC) to receive deposit insurance. With that approval in hand, the mobile banking firm gets closer (in theory, anyway) to being able to hold deposits rather than relying on a model that has been a mainstay of challenger banks so far — where the digital upstarts have enlisted traditional banks to help make loans and offer credit products.
The Existential Question
Perhaps it’s time for some FI soul-searching.
As Brown asked, and then answered, “Just what is a bank? From a consumer perspective, the bank is a place to house your stored value safely, securely and soundly. The bank also guarantees protections of your data, your identity and attributes.”
The bank, he continued, also offers a full range of services that go well beyond checking accounts and deposit accounts, to embrace credit and loans.
“The bank is an all-encompassing stop for all of a consumer’s financial needs,” he told Webster, “and the challenger banks are more like challenger financial services providers.”
One key difference lies, of course, with the traditional FI brick-and-mortar component, which can — and does — still hold value for consumers who want a bit of face-to-face interaction amid life decisions, such as taking out mortgages.
The Appeal Of Challengers
The current appeal of the challenger banks, said Brown, lies with relatively less-affluent consumers.
As he told Webster, the challengers promise individuals that they will receive guidance on how to manage their finances better, following a prescribed path using the challenger’s financial services (of course).
But there’s a key difference in the operating model, he said, one that may hobble the reach of the so-called digital banks.
“They’re fronting it [the bank’s loans and other offerings] and putting an experience around it. And that gets into the question of the business model and of sustainable return,” he said.
Echoes Of The Dot-Com Era?
There may be a cautionary tale here, one that hearkens back to the dot-com era that marked the beginning of the millennium. Getting the “eyeballs” and consumer attention may drum up excitement and publicity, Brown said, but building a profitable business around debit card transactions and interchange revenues is unlikely to keep these challenger banks flying high for long.
The stats tell a cautionary tale. Thus far, the people who have flocked to challenger banks have done so in order to set up secondary accounts that may hold spending money or savings, but are not the main accounts that are used to pay bills — or, crucially, receive direct paycheck deposits.
Brown called the paycheck deposit a “major threshold point — because then that account becomes the main source of value for a household.”
The challenger bank that is not receiving paycheck deposits may find itself pressured to embrace what Brown termed “unnatural acts” to help drive margins.
Those acts include building a repository of data and knowledge about transactions. Call it a Google-esque model, he said — one that is likely to give end users pause about how much permission and access they are granting these challenger banks.
The Labels — And The Real Threats
Brown told Webster the upstarts are clever and deliberate in calling themselves “banks,” when, in fact, they may not deserve the label at all.
No less a banking luminary than Jamie Dimon, CEO of JPMorgan Chase, has said that Silicon Valley represents a significant threat to traditional FIs.
It’s not an immediate risk, Brown said of digital-only challengers, but a longer-term one. Alternative financial services, as offered through Avid, LendingClub the like, are even more dangerous than the challenger banks.
The real, existential threats, he said, may lie not with N26 — at least not yet — but with tech heavyweights like Google and Apple, who are targeting financial services delivered through platforms.
These companies command enough attention and engagement, said Brown, that they can sink money and effort into banking (or bank-like) efforts to challenge banking incumbents in a way that N26 and Monzo can’t.
These deep-pocketed, platform-based challengers (household names in the tech and commerce worlds, of course) nibbling at traditional banks’ heels may face significant legal and legislative hurdles. After all, banking is a highly-regulated industry — but the payoffs can be worth it, especially if they are building out eCommerce ecosystems, said Brown.
The end goal is to reduce friction within those ecosystems, and to offer payments as an integrated source of value. That’s especially apparent in the linkup between Google and Citi, where Google said late last year that it had partnered with the banking giant and a California CU to offer checking accounts.
“The bigger play that is going on is: How do you fuse commerce, banking and financial data that can then be applied to a bigger business model that has yet to be seen?” Brown said.
The Sanctity Of The Bank Account
Perhaps overlooked by the doomsayers predicting the end of entrenched players (and their branches) is that banks themselves have a competitive advantage: the sanctity of the bank account itself.
As Webster noted, regardless of demographics, consumers are wary about granting access to their primary accounts — those main stores of value that have kept individual and family relationships in place over decades.
The jury’s still out as to whether companies such as Google will be able to allow new commerce experiences without violating that sanctity. Uber, said Brown, has made a start in serving the needs of its installed driver base and its ecosystem through Uber Money, financing car loans and enabling instant payout.
The Exit Strategy — And What FIs Can Learn
As to the end game, the exit strategy, and what these challenger banks may be after, Brown speculated, tongue in cheek, that perhaps the end strategy is to annoy behemoths like JPMorgan so much that they are effectively paid to go away — they are acquired, for hefty sums. JPMorgan launched Finn, the app for millennials that ultimately died on the vine last year, and perhaps the buy versus build strategy holds appeal.
Perhaps the exit strategy is to build a consumer database that, ultimately, can be sold.
Despite the competitive threats that are taking shape, Brown also said there are some constructive ways smaller FIs can learn from challenger banks competing for primary and even secondary accounts.
FIs can be proactive in maintaining their end-customer relationships and reducing churn — if they look within. Figuring out what the “secret love sauce” is that powers attraction to N26’s apps, and which of its service offerings is of particular value, for example, can lead to productive introspection on the part of smaller FIs and CUs.
“Know your data,” he cautioned these firms. “You will see patterns and evidence start to build of transfers and payment activity that will clearly be indicative of consumers that are starting to stray.”