FinTech startups are grabbing a bigger share of the wallet and customers from traditional banks. The FinTechs are unencumbered by needing a physical presence, so what can brick-and-mortar banks do to hold on to their bread and butter?

The startups are already becoming genuine competitors of traditional financial institutions through clever use of AI and data analytics. That means traditional banks must also use them if they wish to remain competitive. To begin, let’s understand what FinTech is.

What is FinTech?

FinTech firms, or financial technology companies, are businesses that aim to provide financial services by making use of software and modern technology to create cutting-edge services for consumers and businesses. FinTech is defined by its reliance on technology as a driver.

Examples of big-name FinTech companies include PayPal’s Venmo, although it is only one type, the “mobile and online payments” sector. But, it is a good showcase of just how prominent FinTech is becoming. In the fourth quarter of 2018 alone, Venmo saw $19 billion in payment volume, an 80% increase over the previous year.

The FinTech industry has radically altered the traditional banking industry, filling a void left by traditional banks in the realm of customer service. It has forced traditional financial institutions to make significant improvements to several aspects of their organizations.

FinTech firms realized that every small and medium-size borrower has unique needs that traditional banks were overlooking. FinTechs offered those customers lower interest rates on loans, and approved borrowers who may not be able to secure loans from banks because of low credit scores.

By taking advantage of AI and data science techniques in the same way FinTech startups have, traditional financial institutions can increase their future viability in the finance industry. This article also covers FinTech’s rise to prominence, why it is a genuine competitor for traditional institutions and how banks can use AI and data analysis to compete with them.

Why is FinTech appealing to consumers?

FinTechs’ appeal to consumers is through the use of technology to create a customizable and highly personalized journey for them. The applications allow individuals to keep track of payments, set financial goals and even receive personalized financial predictions and projections to work toward. That makes their applications more engaging and provides a better customer experiences than do most traditional banks.

FinTech companies rely heavily on technologies such as automation, artificial intelligence and machine learning. Since most of their processes are automated, everything moves at a faster rate, enabling them to provide incredibly quick service on short notice.

How can banks compete?

Digital devices ranging from gaming consoles to smartphones are a part of everyday life, and FinTech exists to accommodate that reliance. The ease with which the technology can be incorporated into the everyday lives of consumers allows the firms to compete realistically with traditional institutions quite easily.

Generation Z already has $44 billion in buying power. Millennials and Gen Zs can navigate technology fluently, making them particularly appealing consumers aged 40 and under. On the other hand, traditional financial institutions still have an edge over FinTech when it comes to funding, particularly for small or medium-size enterprises (SMEs).

To compete with FinTechs, traditional banks must incorporate into their business models the feature differentials that make FinTechs more customer-oriented. Examples are their increased ease of use, customer success and online agency.

Banks targeting SME customers have only digitized to the extent of routine customer transactions, such as online access to bank accounts and remote deposits. Areas such as marketing, underwriting, servicing of SME loans and retail loans are yet to be addressed in the traditional banking industry.

According to a PWC report, “Customers in the spotlight: How FinTech is reshaping banking”, over the next five years,

– Over 90% of banks expect growth in the usage of mobile applications, much higher than any other financial sector.

– A fast-paced user increase is also expected in usage of website and/or web-based platforms (82%).

To survive the latest wave of financial technology, U.S. banks must undergo a complete digital transformation.

 AI and data analysis in banking

In this case, AI is any sort of machine or technology capable of handling tasks once performed by humans. Data analysis is the conversion of data derived from a many sources into actionable information.

According to an analysis by Nucleus Research,  “return on investment for analytics and business intelligence solutions is increasing and currently delivering on average $13.01 for every dollar spent—a whopping 1301% ROI”.

Small-business customers demand banking services that have engaging web and mobile user experiences on a par with the technologies they use in their personal lives. Traditional financial institutions that can leverage the potential of AI can increase revenue, reduce risks, lower costs and deliver better experiences for their customers.

In addition to improving customer experiences for business owners, digitization has the ability to decrease considerably the price of lending at each step. That makes SME customers more lucrative for lenders, and generates possibilities for traditional institutions to service a greater number of SMEs. Since purchasing costs in SME lending can be challenging for small businesses to overcome, sometimes they do not go to banks. If digitization can help banks decrease costs, it could help more small businesses get funded.

Banks can benefit further by optimizing the use of AI and virtual assistants within their organizations. By using AI and virtual assistants, banks can create actionable insights and help streamline customer experiences to provide radically improved experiences. Banks can use data analysis to determine who are the best customers and create products and services aimed at retaining them and attracting others with similar traits.

Traditional banks can either compete or collaborate with emerging FinTechs, and in some cases, both simultaneously. The strategy choice depends on how much of an investment in time and capital a bank is willing to make to enter the FinTech marketplace. There also is the level of integration that a bank wants between the new digital avenues and its traditional operations.

Even when direct competition between fintech and institutional finance is happening, the degree of that competition varies by geography and the relative maturity of local financial institutions. For instance, in the US, the relationship between fintech startups and large financial institutions is competitive, with both pursuing similar markets. Jeff Hanson, Director, Aon Limited, sees Silicon Valley as both a possible competitor to traditional Wall Street firms as well as an agent for facilitating change. In areas with less developed financial institutions however, big banks and fintech players are working hand-in-hand to cater to local needs. For example, Sub-Saharan Africa is home to some of the world’s most forward-thinking bitcoin remittance startups like Mpesa and BitX. Some of these are developing under incubation programs developed by banks themselves to address the pressing need of better access to different kinds of finance.

Banks can partner with online lenders in a variety of ways, from having an online lender power the bank’s online loan applications to using an online lender’s credit model to better underwrite and service loan applications. Banks should keep in mind that although new underwriting technology is fast and seems efficient, new credit-scoring methods are still in the early days. Such technologies also have yet to be tested in an economic downturn

Another large downside for banks in partnering is the notable amount of resources banks have to dedicate toward making sure they and their partners are compliant with federal regulations. The regulations make banks responsible for the undertakings of vendors and partners they have business with, and that can create considerable headaches for banks if anything goes wrong. In addition, banks have a built-in customer base that provides them with data about which customers are already eligible borrowers. By contrast, online lenders have far less brand recognition, and acquiring lenders online can be expensive and competitive.

Banks will have to incorporate aspects of FinTech into their business models if they want to continue being viable in the near future. Those aspects include increased ease-of-use, customer success and online agency.

 Regulatory Infrastructure & Risks

It’s almost impossible to completely anticipate the full extent of the effects that new technologies will have in the wider economy. An important first step for regulators is to find a balance between maintaining a stable financial sector while keeping up with evolving consumer preferences. In such new markets, there’s complexity from all parties involved: regulators, fintech firms, institutional finance and consumers. Technology could be the solution here – regulation tech could use big data and analytics to identify holes in current models and help regulators formulate appropriate strategies.

FinTech and fraud

Fraud is a major FinTech risk. In fact, China’s FinTech peer-to-peer lending industry, which once was massive, has almost entirely collapsed because of an over-abundance of fraud.

Banks, on the other hand, are much more immune to fraud and represent much better risk-management investments for consumers. Most consumers, however, are probably unaware that fraud is an issue in FinTech, or that banks can provide a safer, more-secure alternative in many cases.

Through ongoing reviews of account activity patterns, and by flagging aberrations in regular patterns of transaction activities, banks proactively manage the risk of frauds. The past decade, AI not only has significantly improved the monitoring process, it is able to respond in real time to potential fraud. Further, by using data analysis to track and identify potential demographics of target customers and using AI to advertise to them, banks can make consumers more aware not only of FinTech pitfalls, they can stress the benefits of banking.

If you can’t beat ‘em, join ‘em

Big banks are too integral to the global economy to make takeovers by fintech startups likely. But at the same time, the value offered by fintech to both customers and financial operators is too big for either to ignore. Therefore, it should be co-operation, rather than outright disruption that may end up being most accurate vision of the future of finance.

Several banks, most notably JPMorgan Chase, are investing heavily in FinTech, and their reasoning is sound. Several FinTech services such as blockchain can be easily adapted into banking systems to improve customer success and make banking more secure.

However, several major impediments inhibit business relations between banks and FinTechs. From the banks’ perspective, FinTechs lack the proper IT security and regulatory certainty, while FinTechs believe banks can be hard to work with due to differences in management and culture as well as differences in operational processes.

While fintechs have gained expertise through an end-to-end process via the Internet, banks have a greater role to fulfil other than meeting the financial needs. Banks are the medium to balance the whole economy, follow the policies that can uplift the poor, provide assistance to entrepreneurs, maintain balance in the economy, check the credit score of the individuals, providing loans, checking the credibility of creditors etc.

By tracking how FinTech’s use AI and data analysis, banks can adopt similar methods into their business model and compete with FinTech and modernize their business simultaneously. The major caveat when using AI is that banking AI is only as powerful as the underlying data, infrastructure and analytical processes in place.

AI cannot be completely automated without some level of internal expertise or external consulting. In other words, banks looking to utilize data analysis and AI to compete with FinTech and remain relevant in the coming years may want to enlist the skills of a professional data sciences consultant and provider.

If you’re searching for a reliable provider that can help your bank modernize and compete with FinTech in the coming years, look no further than Pegasus Knowledge Solutions. PKSI’s expert data scientists and consultants help their clients create value from their data, delivering insights that drive operational improvements.

Bonnya Mukherjee
Financial Analyst, Pegasus Knowledge Solutions