Banks will use a weapon they know best when dealing with Fintech
It is called M&A
A recent article in FT caught my eye: it told a story of how a large international conglomerate, P&G, is learning its way about the sharing economy vertical via its acquisition of Dollar Shave Club — and how this positioned as a feat of learning, more than of building short-term value.
Yet here is a lesson that fintech can learn about how incumbents can respond to the fintech threat.
Both sectors are influenced by the liquidity glut. Where the incumbents see their capital ratios in check by various regulations that came into effect after the Great Recession.
Seeing the income and profits depressed by both the quantitative easening programs and by more srtingent regulation of lending and investment activity, long-term capital went to buoy alternative economy — tech-driven sectors that went to stay immune to the shocks.
While the numbers of investment in the fintech sector are sound and healty — and are breaking records once again this year — with USD 16–20 billion in investment expected in 2017, this comes largely from the peculiar situation that is driving the investment (and still is dwarfed by banks cumulative IT budgets.
- Not just short-term but long-term interst rates are depressed to zero, making institutional money vying for red-light district real-estate, airport parking slots or mining asteroids.
- Cheap dept allows for long-term temerity — making more audacious bets and planning for moonshot projects, potentially transformational but often rife with outlandish and borderline crazy promises
- Insurance industry, owning the largest reserve piles of money is here as well, feeling the pain of low returns amid the growing population that increases the short-term cost of patient care — so it too does participate, inflating expectations from new medicine (witness the M&A bonanza in biotech) as well as overall investment in life sciences and medtech.
Where banks and incumbents are failing in terms of building on new ideas, they still have the upper hand in terms of financing those ideas — and then bankrolling them via their M&A functions. The big game is the exit — the startup selling itself to the regulated and established player — that knows how to hobnob with the regulator.
Advice for banks:
- Couple fintech with investment functions: better sensing the arbitrage serves one right by providing additional insurance of not spending too much money on a product that you would not be able to integrate;
- Learn from fintechs to rebuilt the core. Some already are learning this, for example, BBVA buying a share of Atom to learn on how to rebuilt their core functions using a completely new stack of technology;
- Still, fully integrating fintech’s culture in the bank is a long-term prospect — and often an unrealistic one, so the best approach is to manage them like a vertical with their own P&L and team motivation — basically managing them like a portfolio of a PE firm that provides liquidity and the regulation umbrella;
- Be mindful that PEs are themselves willing to build new conduits of offering liquidity to the market and its end consumers: Goldman building their online bank, several PEs turning P2P lenders in large-scale marketplace lenders, disrupting the intermediary is here in the FS world.
Advice for startups:
- Seek not those markets with the biggest tags, but those with the largest arbitrage potential. This lures investors much better.
- Don’t expect the free-for-all play — a promised rosy world with all banks connecting through you is a grand illusion: stopped by data privacy protection and other regulations banks would rather own you whole than share with others, fearful of data loss and heavy penalties that come for that.