Non-bank financial institutions are disrupting financial services

The role of banks as the primary source of financial services is being gradually eroded; they may soon be butting heads with the likes of Amazon and Facebook

Apple Pay allows users to pay for items on their phones
Apple Pay allows users to pay for items on their phones 

At IBM InterConnect 2015, Citigroup’s then-chief client experience, Digital and Marketing Officer Heather Cox made a remarkable statement about the future of finance. “People need banking,” she told the crowd, “but they don’t necessarily need banks.” Two years after this statement was made, the case for finance without banks is even stronger.

Unless something truly radical happens to banking, banks will continue to play a role in personal finances for the time being. However, for standard transactions, current accounts or other services that get used everyday, new competitors in the market are making a compelling argument for customers to switch. It’s a space that has attracted interest from some of the giants in the technology industry, with unlikely names starting to compete for customers’ savings.

Soon, the idea of buying groceries at the same place that manages your finances or provides your internet may not seem so far-fetched. Banks may still have the advantage, but consumer willingness to take advantage of alternatives may have some banks worried.

New money
While banks have been concerned about the risks of rising competition for a long time, they may have been focusing on the wrong target. For many years, the common wisdom was that fintech would soon begin disrupting the industry, leeching away customers from the old, established players that are too big or unwieldy to keep up.

A good example of the threat posed to the industry was PayPal. Founded in 1998 as Coinfinity, PayPal launched in 2001, went public in 2002 and was swiftly purchased by eBay for $1.5bn. One of the success stories of the dotcom boom, eBay made PayPal its default payment option. On an internet rife with scams, used by a public not yet savvy enough to spot a con, the PayPal logo became a sign of legitimacy.

There is one major barrier that may stop Silicon Valley from pivoting to banking: acting as a bank also means being regulated as a bank

With this trust, transaction numbers surged, revenues rose and PayPal made a multitude of acquisitions. If it hadn’t remained a subsidiary of eBay until 2014, it may be even bigger than it is now. The threat of a company levering technology to pull off a similar feat has since loomed.

From international transfers to trading platforms, many competitors have emerged to tempt customers away from the core services that banks offer. This has become particularly prevalent in the UK where, following the introduction of regulations designed to increase competition, a number of challenger banks were launched.

Usually boasting an online-first focus, as well as no physical branches, they promised to offer services, flexibility and functions that the old establishment could not match.

But a new report has suggested that banks’ fears may have been misplaced. Recently released by the World Economic Forum, Beyond Fintech: A Pragmatic Assessment Of Disruptive Potential In Financial Services argues that banks have seen the potential competition from fintech very clearly and fought back admirably.

While fintech businesses have certainly pushed the industry forward and forced the entire sector to innovate, none have adapted enough to shake potential challengers.

What has emerged is competition from technology firms. Lacking their own expertise, tech companies have turned to companies like Facebook and Amazon to assist in the development of their own services.

At the release of the report, lead author Jesse McWaters said this alliance could create competitors: “The partnership between banks and large tech companies risks not staying a reciprocal one. Financial institutions increasingly rely on technology firms for their most strategically sensitive capabilities, but can so far only offer their ongoing business in return.”

The report brings up some specific examples, including Amazon, who provides services to businesses as varied as Capital One, Stripe and Nasdaq. It also mentions banks relying on networks like Facebook to support person-to-person transfers and customer analytics.

This experience, combined with banks’ lack of existing tech systems, could create an opportunity for technology companies to enter the market. “Tech giants would be able to pick and choose their points of entry into financial services, maximising their strengths like rich datasets and strong brands, while taking advantage of incumbent institutions’ dependence on them,” McWaters said.

Another factor that may push technology companies towards setting up their own division is that the public wants them to. According to a report released by Accenture in January, one third of banking and insurance customers would consider switching to an account provided by the likes of Google or Facebook. The card and payment industry is also primed for significant growth, presenting a large number of opportunities.

Morten Jorgensen, Director at Retail Banking Research, said the number of payment cards worldwide increased by eight percent in 2016 to 14 billion, with this trend only set to increase further. “By 2022, the number of cards worldwide is forecast to rise to 17 billion as many people, particularly in parts of Asia-Pacific and the Middle East and Africa, still do not hold a payment card.”

Jorgensen also explained that the way people are using cards is changing, with more people using them for far smaller transactions: “Of particular note is the 81 percent growth in contactless payments in 2016. Many of the barriers to expanding card usage are cultural, especially for lower value transactions and in locations where payments were historically made in cash. The latest figures suggest these cultural barriers are starting to break down.”

Facing opposition
While Facebook, Amazon or Google are unlikely to open a banking division in the immediate future, the impact that such companies are having on the industry is beginning to show.

Apple Pay was first introduced in 2014 and allowed people to use an iPhone in the same way you would a tap-and-go bankcard. Samsung introduced a similar system a year later.

This technology struck a sour note with banks in Australia, and in 2016, several of Australia’s largest banks – the Commonwealth Bank, Westpac, National Australia Bank and the Bendigo and Adelaide Banks – submitted a request to the Australian Competition and Consumer Commission (ACCC) to allow them to collectively bargain with Apple.

Specifically, the banks wanted to gain access to the Near Field Communication antenna in iPhones so that they could create their own competing digital wallets.

Apple firmly fought the claims. “Authorisation of a cartel among the applicant banks who control access to two thirds of all cardholders in Australia would result in significant consumer harm and perpetuate the oligopolistic banking market conditions,” Apple’s submission to the ACCC read. In March 2017, the ACCC took Apple’s side and ordered each of the banks to negotiate with Apple separately.

While it conceded that a collective agreement would place the banks in a strong position to negotiate with Apple, it ultimately ruled that such a situation would leave Apple at a distinct disadvantage to its competitors. The ACCC added that it would also benefit customers, as a digital wallet attached to a specific bank creates a disincentive for switching banks.

Amazon has also been flirting with the idea of entering the financial services market. The e-commerce giant launched Top Up in the UK at the end of August this year, a service that allows customers to transfer cash directly to their Amazon account through PayPoint outlets. Previously, in July, it had launched a similar service in the US called Amazon Cash.

Both services allow the company to access the small portion of consumers that do not have debit or credit cards. While money loaded onto Top Up and Cash can’t be withdrawn, the services are a step towards a traditional bank account.

Amazon’s foray into small business lending aligns it closer still with traditional financial institutions. Since 2011, the company has been looking at the data generated by small businesses that use Amazon Marketplace. The data allows Amazon to identify candidates for loans ranging in size from $1,000 to $75,000.

So far, the system appears to have been successful: Amazon reported it has issued $1bn in loans to 20,000 small businesses over the past 12 months, with more than half of the businesses agreeing to a second loan.

Amazon Marketplace affords the company an insight into businesses that banks are unable to gain, and so it is no surprise that Amazon’s lending experiment has been a success. This insight, combined with a strong incentive to help businesses that use its services, means that Amazon is in a natural position to confidently issue loans.

However, there is one major barrier that may stop Silicon Valley from pivoting to banking: acting as a bank also means being regulated as a bank. This presents myriad difficulties that may distract from the areas businesses lead in.

China may offer a glimpse of what’s to come. Fintech company Alibaba’s affiliate Alipay overtook PayPal to become the world’s largest mobile payments platform in 2014. Meanwhile, digital giant Tencent is offering a range of financial services through its WeChat messaging software.

Although it seems unlikely that technology companies in the rest of the world will soon be letting people open a current account, the gradual merging of technology and finance is inevitable.