Traditional Banking, as we know today, has existed for centuries. Conceptually, traditional banking has largely been the same since the 1600s – double ledger accounting driving products like lending during the Renaissance era or deposit acceptance across branches during the Rothschild’s.
Technology, as we know today, on the other hand, has come to the fore largely in the last couple of decades, ushered by the advent of the Internet during the dot-com era and mobility post iPhone. Technology, having a loose definition, has always been a disruptive force, reshaping the world since man has come into existence.
Rapid Tech adoption by Banks has often been for multiple reasons.
- Enhanced customer experience
- Improved operational efficiency
- Driving business growth
So, it would be an oxymoron to state that traditional banks are averse to technology or tech-deficient. At the other end of the spectrum are a new set of challenger financial services companies called ‘FinTechs’ that are out to disrupt the ecosystem, often for good. FinTech largely is an umbrella term that function in the domains like
- Lending (Retail, SME, P2P, Crowdfunding)
- Asset & Wealth Management
- Trading & Brokerage
- Payments & Wallets
Banks here is loosely used to define traditional lenders that include both Banks and large NBFCs.
A lot has been said about FinTech firms as well as traditional lending entities; each has their pros and cons across the loan lifecycle. Some key areas where FinTech score over traditional banks are
- Faster Processing Time: a key aspect from a customer standpoint is the speed with which an application is processed. FinTechs, being agiler due to a smaller scale and lower volume, process files at a faster speed in a couple of days for even the most complex cases
- Improved Convenience: a major aspect for the customer is that most of the application can be submitted online including documents, avoiding the hassles of visiting branches, especially true for SME lending due to extensive documentation and paperwork
- Underserved Target Segments: a large portion of the FinTechs’ customers is the customers ignored or unserved by traditional banks. This is especially true for customers in smaller cities and towns or new-to-credit customers shunned by traditional lenders
- Lower Risk Aversion: from a credit risk perspective, FinTechs are often more experimental in their approach to lending to customers by pricing risk appropriately. Banks’ pricing and risk frameworks are very rigid, both from a structural and regulatory standpoint
- Enhanced Data Harvesting: data is one of the key factors driving FinTech firms, who utilize data from alternative sources like social, partners, publicly available sources, etc. Data is also used for smarter, faster and more accurate credit decisions
- Innovative Product Offering: one of the most critical differentiating factors is the innovation in product and processes like mode of repayment, document pickup or disbursal. Banks have largely been conservative in their approach to new product development
While FinTechs score on a lot of fronts, traditional banks still have a lot of traction due to strong operational and risk frameworks, depth in employee experience and knowledge and structured process. Some areas where banks have a stronghold are
- Lower Operational Cost: banks have a very low cost of funds through deposits or lines of credit allowing them to offer highly competitive interest rates compared to FinTechs. Banks also have lower customer acquisition through cross-selling of credit products from its liability segment and branch catchment sourcing
- Larger Geographical Presence: banks often have a very large branch network stretching to remote areas. Regional banks have a very focused geographical presence, servicing customers that are otherwise ignored or unserviceable by FinTechs due to their operational constraints. This also results in brands being embedded deeply in the mind of customers
- Stronger Risk Framework: traditional banks have stronger risk frameworks, credit policies and stringent internal audits. They also follow the Chinese wall principle of isolating Credit function from sales, avoiding conflicts to a good extent. Also, regular fraud control and risk mitigation techniques help banks maintain control over their books and delinquencies
- Stringent Collection Mechanism: driven by RBI regulations on NPAs, traditional banks have developed a strong collection network, stretching across the country with the capability to take legal recourse, both of which are expensive for a FinTech to undertake at a smaller scale. Banks can also monitor transactions due to CASA accounts of borrowers, thus serving as early warning signals in case of probable defaults or delayed repayments
- Diverse Product Offering: while FinTech firms continue to innovate, banks can service customers due to their diverse offerings, from simple products like CASA to complex treasury solutions. They are also able to service a broader range of customers with bigger loan amounts and elongated tenures driven by financial and operational capability
- Bigger Financial Muscle: compared to a typical FinTech firm, any commercial bank or a mid-size NBFC has a massive financial muscle. This not only helps them to expand aggressively but also lend bigger amounts. Most banks can comfortably cover their NPAs and default due to the massive book that they can rely upon
Collaboration between Banks and FinTechs can result in a lot of synergies, both from a strategic and an operational perspective. While collaboration isn’t unheard of, they have been largely restricted to banks and large NBFCs extending lines to FinTech as a means of investment rather than meaningful collaboration.
Some areas where Banks and FinTech firms can collaborate for a greater impact are
- Improved Sourcing: a key area where FinTech firms would benefit from banks would be their widespread presence when it comes to sourcing and their lower cost of operation. On the other hand, banks stand to gain a lot through enhanced and more targeted digital sourcing mechanism, both from direct sources as well as through affiliates and partners
- Enhanced Serviceability: this is a key benefit of co-pending, where a FinTech works actively with a bank to service customers with a higher requirement of funds. While not entirely a new concept as it works on the line of loan syndication, the customer would largely interact with only the FinTech firm thus improving customer satisfaction and hence, retention
- Structured De-risking: a key component of any bank would be maintaining and containing risk within its financial capability. Due to a large captive customer base and deep learning, FinTech firms stand to gain a lot from risk mitigation and fraud control processes that banks have come to develop over a long period of time combined with complex data modeling that many FinTechs have come to develop in a short period
- Higher Growth: while most FinTech firms are on a high growth trajectory, they need access to a growing customer base to sustain their growth. This is where the banks stand to gain through referral or income sharing model engagement with FinTech firms due to their naturally large captive customer base from their branches
- Improved Decisioning: this is a critical part for any lender. Traditional lenders have largely relied to standard customer declared documents to decide a case. The new age FinTech firms, on the other day, use a combination of traditional and non-traditional data points to process a case faster and more accurately, thus enhancing banks’ credit scoring models
Does this mean that banks and FinTech firms are out to out-compete each other?
While there is no decisive answer, there is a very high probability of them competing head-on in certain segments. Each of these firms has their own target segment for sourcing. There are many instances that the same customer has loans or other similar products from both banks and FinTech firms for a variety of reasons. Also, several risk-taking NBFCs have been competing directly with FinTechs, albeit in smaller loan volume and value by pricing their risk appropriately.
Where do we see Banks, NBFCs, and FinTechs headed towards?
While the latest budget made note of FinTech firms’ contribution to India’s funding ecosystem and plans to support them, they are still a long way from the impact that banks have made, the expectation that the government has from them. While FinTech firms will continue to strengthen their presence on ground and operations, a lot of maturity in processes are yet to mature, even among the most mature FinTech firms. On the other hand, banks would continue to strengthen their technology to enhance credit, collections, and operations. Many NBFCs and private banks are already targeting segments served by FinTech firms.
Will banks and FinTech adopt emerging technologies like AI/ML, Blockchain, etc.?
This is an area where several private banks, large NBFCs, and FinTech firms have already forayed into and have been running POCs. They have already started experimenting with technologies; however, compared to other industries, adoption will not very streamlined due to considerable regulation around data privacy and sharing. That said, there are already a lot of technology driving adoption due to the some of the shortcomings in the each of the business model.
Will banks and FinTech truly collaborate as envisaged by many?
While there are a lot to imbibe from each other, a major area of collaboration would be co-lending and shared risk management. Another area of business engagement would be servicing currently unserviceable or underserved segment using a combination of physical presence and technology. Most banks currently collaborate with FinTech firms only on a transactional basis and they are few use cases. However, strategic business level collaboration with FinTech firms like partnerships and alliances is a highly likely possibility. Some key areas of focus like API Banking and co-lending is expected to drive collaboration, which is the need of the hour.
What remains to be seen is the timeframe when banks adopt FinTech practices and vice versa. Also, if any meaningful collaboration does take place, what would the scope and outcome of the same. With a lot of rapid changes around Technology in the lending sector, a lot of collaboration would also be influenced considerably by RBI and the government’s stance on the FinTech sector.