Dave Scola, U.S. CEO, Form3
The financial services industry is one that has been deeply impacted by digital disruption. With innovative products and agile business models, many fintech startups – Stripe, Chime and Bolt to name just a few – have established themselves in the market and become household names in a relatively short space of time.
While the relationship between the new generation of fintech startups and established financial institutions has been characterized in some media reports as cut-throat competition, from my perspective the interconnection between banks and fintechs has generally been more collaborative. However, whether they are cooperating or competing, fintechs and traditional banks are not always operating on equal terms, and this could be an impediment to innovation in this industry.
Banks still call the shots in payments
There are a lot of fintechs particularly in the reg tech and infrastructure tech space that are focused specifically on working with banks. However, there are other areas of finance that do see competition between incumbents and new market entrants. The payment space is an interesting one, because you have fintechs and PSPs (payment service providers) that are very much engaged in bank-like activities, and to some extent are competing with banks for that same client base. At the same time, though, these fintechs and PSPs are very reliant on banks in order to be able to deliver these services.
For example, a fintech can initiate a payment on behalf of a customer, but it’s ultimately reliant on a bank to actually execute that payment. This is due to regulatory and licensing considerations; either the fintech must become a bank themselves, or they must rely on a licensed bank in order to finish the payment with the payment scheme. And this is one of the primary examples of how the uneven nature of financial services in the US is hampering progress.
The fintech sector is finding its natural level
There has been some thinning out happening in the fintech space in recent years. With fintech funding having been on the decline since 2021, the sector is finding its natural level; prior to 2021 there was quite a lot of money being invested in a lot of firms. It was never going to be sustainable, and there’s been something of a correction in the space since, but the result has been that many fintechs have rationalized their staff, to make sure that they are lean and able to compete.
The funding squeeze has also separated the wheat from the chaff to some extent, killing off fintechs that were not profitable or had no long term prospects. Those fintechs that have had more substantive product offerings and that have built up their client base have survived and are still able to attract investment. Having made it through to the other side of this market turmoil, many will feel that they now deserve to be treated as equals to the historic financial institutions.
What fintechs bring to the table
Overall, though, the banks are still in the more dominant position. But where fintechs win business is through enhanced speed, client service and a greater range of products and capabilities. This is why banks will often choose to collaborate with fintechs rather than try to develop competing products themselves; and while many would rather have engaged these clients directly, they also see their fintech partners as a useful way to aggregate client activity in one channel, which is useful if their target is to maximize flow through their system.
A lot of fintech firms were initially founded to solve front end client problems. They had a better client proposition and better user interface than the products provided by established banks. But with regtech and infrastructure tech, you are seeing the focus more on the back end, trying to help the bank solve some of their bigger operational and compliance problems. Fraud is deservedly getting a lot of focus. There’s a perfect coalescence of the focus on AI with the rise in fraudulent activity; AI being a perfect tool to try and address some of that fraudulent activity.
Fraud is the primary area we’re seeing investment and growth in, as well as other operational backend functions. Banks that have traditionally looked to build these systems themselves are now much more likely to partner with financial technology firms who can build faster and be more innovative and agile.
How regulators can help drive innovation in financial services
There is a need for the regulatory environment to catch up with what’s happening with financial technology companies and with banks. As mentioned above, fintechs and PSPs in the US are reliant on banks to execute a payment; but this is not the case in other geographies. There are models in the UK and Europe and virtually every other geography where the fintech companies can become a direct participant in the payment systems. But in the US, payment operators such as the Fed and TCH and the banks that control them have been resistant to creating a tiered system to allow for financial technology firms to participate directly.
This has served to hamper innovation, development and, indeed, client experience. It is an area where there is need for change in the US market because if we hope to grow instant payments through services like FedNow, we need viable use cases to drive this growth. We’ve seen in other markets is that those use cases tend to come from the fintechs, not from the banks, so what’s required are measures that facilitate and encourage innovation.
Takeaway: Greater collaboration is needed to drive instant payment volumes
If we want to see FedNow reach its potential – and help large numbers of citizens access instant payment services in the US – then this situation must change. FedNow is not delivering on its promises yet; we’ve not seen the growth in adoption or in volume that we expected. And that’s because the market has failed to come up with a killer use case to drive that adoption. So we need more innovation and we need more collaboration between banks and financial technology firms to find those use cases and really drive the instant payment journey forward. And to facilitate these collaborations, we need an even playing field.
