How FinTech is Disrupting Traditional Banking And Why Are Banks Getting Worried?

The FinTech industry is composed of firms that use technology to ensure that their financial services are efficient. The innovative sector has changed finance for the better and traditional banks are getting worried for the following reasons:

Banks no longer have exclusive control

FinTech currently offers their users a range of financial services — from underwriting to transactions — that were previously the exclusive business of the banks. Personal finance applications such as Acorns, Mint, and Digit help their users to track spending and remain on a budget without any assistance from a financial advisor. Other personal lending innovators such as Prosper and Lending Club enable users to sidestep traditional intermediaries using a peer-to-peer loaning platform. Firms like Wealthfront and Betterment that facilitate financial planning, investments, and portfolio management have developed as common alternatives to the traditional wealth managers.

Booming investments

Most investors have responded positively to FinTech companies. Only six months into 2015, the FinTech startups raised almost $12.4 billion from their venture investments and they are on track to increase their backing over the preceding year. While the FinTech industry is booming, it is unlikely to replace banks entirely since many FinTech companies rely on bank accounts. However, it is tunneling away the profitability of the banking sector, and this has raised concerns amongst traditional banks on their capacity to sustain low-margin services in a rapidly changing market.

Innovative ideas

Generally, the banks use a loss leader pricing strategy, indicating that they provide some products at a cost below the market value to motivate the sales of other profitable products such as loans and to entice new clients. Presently, FinTech companies are removing the most lucrative portions of a banking model, leaving the banks stuck with less profitable and high overhead products. To recover their resulting market losses as well as mitigate the threat of the FinTech insurgents, the traditional banks are discussing different strategies like closing bank branches as a means of cutting costs, charging higher for low-margin services, and acquiring FinTech companies. Sadly, the impact of these strategies has a potential to upset the financial lives of most low-income families.

The low-income family’s worst-case scenario is FinTech’s drain on their lucrativeness prompts banks to leave their loss leader plans. For those at the margins of financial mainstream, this loss leader strategy is the financial lifeline that allows them to maintain savings and current accounts. If traditional banks compensate for this lost revenue by raising charges and fees on current accounts, account ownership is going to decline.

Life without banks

While life with traditional banks can be rough, life without them can be cruel. Without access to transaction accounts, households turn to substitute financial products with unreasonable fees. The average underbanked home spends roughly $2,412 every year on fees and interest alone. As banks look to reduce costs, so many branches are shutting down in droves (almost 2,599 in 2014). The low-income and smaller neighborhood are the most targeted areas. Since late 2008, an astonishing 93 percent of bank branch shutting have been in ZIP Codes that are below national median family income levels. The rise in digital banking is expected to contribute further to the trend as managers consider a different proposal that will give banks more freedom to choose where they place physical branches.

If the risk to the business grows, the banks may opt to use their greater resources to buy up the FinTech companies. The five biggest banks control over $15 trillion in assets, and when compared to FinTech’s $12.4 billion venture investments of 2015, it looks like peanuts. An acquisition was Capital One’s approach earlier in 2015 when it purchased Level Money, the app that helps its users track all spending. If confirmed profitable, it is likely that the other banks will begin to buy up the competition. Although usurping the risk of FinTech by co-opting may relieve the instant pressure on the traditional banks, it will not necessarily prevent them from attempting to cut costs in some other ways that excessively impact people at the bottom step of the income ladder. With over 50 years of history (or even the last 10), do we want banks seizing every potential competitor? It isn’t a great idea.

The importance of competition

Competition is great, as is innovation, particularly if they make inroads for new and presently underserved customers to access and make use of traditional financial services. As for all their uprising disruption, a few FinTech startups have a vision that the traditional banks have lacked from inception. They see underserved clients as an emergent market, particularly in the developing nations where technological advances such as mobile banking have encouraged and is also an essential driver of financial inclusion.

The upsurge of FinTech gives the policymakers an excellent opportunity to get a report of where the banks have been and where they need to be going when it concerns providing means for the low and medium-income people to save for their future. As the market forces unfold, the policymakers need to be developing and supporting ideas that encourage further financial inclusion, whether it means additional community credit unions, tax credits and subsidies for financial services, or perhaps a government-run solution like postal banking. Irrespective of the provider, the legislators have to make access to functional, secure, and inexpensive financial services for Americans a greater priority — and FinTech’s impression on the banking industry is introducing the need by the day.