Assume for a moment that most of the services legacy financial companies provide today could get competed away as innovators extend reach and scale across the landscape of financial products. If so, big financial institutions will look to re-establish a foothold. Their only sure competitive advantage seems to be the regulatory compliance (i.e. anti-money-laundering and know-your-customer capabilities) that the government has forced them to develop.
The costs to build out this infrastructure make barriers to entry daunting to say the least. Bain & Co. estimates “governance, risk and compliance (GRC) costs account for 15% to 20% of the total ‘run the bank’ cost base of most major banks.” That, combined with the long and difficult process to establish and validate credibility with regulators, makes the challenge to potential competitors even more imposing.
So, the consequential long-term business model for banks and brokerages could simply be providing custodial services for funds.
That’s right, instead of making money from lending out deposits, or investment banking or capital markets … people will pay banks to simply hold their money and validate their identities and sources of funds.
Not sexy, not high-growth, but certainly predictable, less risky and highly compliant with balance sheet risk avoidance. Bank of New York Mellon and other processors already print money all day long from doing this (though they do this primarily for institutional clients; the value is clearest when end users do not conduct their own compliance, especially as business-to-business fintechs proliferate). Margins will be defendable and could expand as the market realizes the true value-add.
Application programming interfaces will put a twist on this tried-and-true model. Banks will look to compete. When they do, as always, winning will come down to pricing and service. To do so, they’ll set up “financial malls.”
Financial malls are not the newer version of “financial supermarkets” (so popularized in the 1990s). The financial supermarket model subscribes to providing all financial services on balance sheet in a complicated mix of businesses — regardless of core competency or scale.
Conversely, in the financial mall ecosystem, fintech partners (providers with requisite core competency and scale) will open up shop and link with the banks via robust APIs. How this relationship manifests will vary as established players ponder the decision to build, buy or partner. Regardless, front-facing service providers — the fintechs — will operate in the most efficient manner and will lead the charge.
To the extent that financial services move closer to a completely digital presence, customers can still access the “mall” of services by visiting physical locations, but the desire to do so will diminish faster as time progresses.
What’s the benefit to the user of creating a mall? Doing so can eliminate the extra friction from the layer of payment processing between fintechs and banks that occurs today. How much quicker and cheaper would processing be if the interface in this partnership were seamless? Ultimately, the proposition of having desired fintech partners (shops in the mall) and smoother service will attract prospective customers. JPMorgan Chase’s recently announced partnership with Intuit epitomizes the tip of the iceberg in possibilities.
In the way that Gap and Victoria’s Secret are ubiquitous in the malls dotting the suburban landscape, it is unlikely fintechs will be exclusive to one bank. Instead, they’ll choose carefully based on customer base, reputation, etc. Although people will still access fintechs directly through mobile apps (especially if the desired fintech is not part of their financial mall), they’ll likely have to pay for that option as processing fees pass through to customers.