Fintechs shaking up the industry

But the investment business is far from the only area facing this sort of challenge. Fintechs also are taking on the payments business, consumer finance and, soon, even the core retail banking relationship.

With an estimated US$1 trillion in total global profits generated by the banking industry last year (according to recent estimates from U.S.-based consulting firm McKinsey & Co.), the financial services sector certainly makes an appealing target. Capturing even a tiny slice of that massive market can be extremely lucrative for a startup.

As a result, venture capital is pouring into fintechs. According to a new report from Germany-based Deutsche Bank AG, investments in fintech startups tripled in 2014 to US$12 billion from US$4 billion.

All of this money is funding the creation of snazzy, new technologies that threaten to disrupt established service delivery models.

McKinsey’s latest annual report on the global banking industry suggests that fintechs pose “a particularly strong threat” to the traditional financial services sector: “They are highly focused companies that continually improve their technology to deliver a more appealing and lower-cost experience to customers. Already, they are detaching customer segments from incumbents, hindering banks’ ability to cross-sell, stranding loss-leader businesses [such as] basic lending, and transferring the ownership of vital customer data with its vast potential for new businesses.”

Amid this sort of threat, the McKinsey report estimates that over the next 10 years, the five major retail banking business lines – wealth management, consumer finance, payments, small-business lending and mortgages – could lose 10%-40% of their revenue, and 20%-60% of their profits, due to the challenge from upstart fintechs.

The consumer finance business is seen as most vulnerable, with 40% of its revenue and 60% of profits possibly imperilled, while the mortgage business appears to be safest. Wealth management falls somewhere in the middle, with the McKinsey report estimating that 15% of revenue and 30% of profits could be at risk by 2025.

That’s not to say that startups are expected to capture a huge chunk of market share from established financial services firms. In fact, the vast majority of the anticipated impact from fintech competition is expected to come through price and margin erosion, as the traditional banking industry is forced to cut prices to compete with these lean, efficient alternatives. Only a small portion of the impact on banks’ revenue and profits will come from a real loss of market share to these sorts of firms.

To see how this shakeup could occur, take the example of Toronto-based Wealthsimple Financial Inc., which charges its advisory clients 50 basis points (bps) in annual fees for the first $250,000 invested, which drops to 35 bps for accounts of more than $1 million (plus product fees). In dollar terms, the firm’s annual invoice would come in at $3,500 for a $1 million account, compared with $10,000 for a traditional advisor charging 1%.

This sort of disparity may become more evident to the average investor over the next couple of years as regulatory reforms that will shine a brighter light on the costs of investing take hold.

The second and final phase of the client relationship model (known as CRM2) reforms are slated to take effect in July next year, with many firms expected to begin delivering the newly mandated annual cost reports for the 2016 calendar year.

But stealing away existing high-value clients is not necessarily the path that many fintechs are seeking. Instead, they seek to capture the younger, less affluent clients (whom the big banks and brokers aren’t particularly interested in at these clients’ current stage of life) and grow alongside them.

At a recent fintech conference in Toronto, the founders of several startups – including Wealthsimple and soon to be launched banking venture, Koho Financial Inc. – described their companies as being complementary to the established financial services sector rather than being adversaries of it.

Yet, there’s no question that if fintechs are to deliver on their mission of upending the traditional advisory business and reducing costs for clients, these firms will be putting downward pressure on bank revenue.

To face this challenge, the McKinsey report says, banks will have to decide whether they want to compete with the fintechs and try to deliver similarly engaging, tech-savvy experiences to clients, or retreat and serve largely as utilities that provide their balance sheets to the customer-focused fintechs on a white-label basis. IE

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