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The Unbundling & Rebundling of Banks

Alex Barrett

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This story originally appeared on iNovia conversations.

“Silicon Valley is good at getting rid of pain points. Banks are good at creating them.” — Jamie Dimon, CEO JPMorgan Chase

FinTech has made massive waves across the world in recent years, with more than 5,000 companies founded, raising nearly $6 billion in venture capital financing.

Let’s take a step back and reflect on why we have seen so many unbelievable entrepreneurs choose banks as the next establishment to disrupt. Of course, the simple answer is that banking is a large sector, with lots of room for improvement; and millennials desire digital experiences in their financial lives. While those are the most often quoted reasons we see in pitch decks today, we believe the real tailwinds behind the growth of this sector lie even deeper.

First off, an attractive quality of a market ripe for disruption is one where the critical infrastructure is already in place for innovation to be built upon. Matt Heiman at Greylock references that critical infrastructure in this post, citing data APIs like PlaidYodlee, and Flinks making it easier to work with financial data; payment APIs like Stripe making it easier to accept payments; and financial market APIs like Xignite, making it possible to pull in live stock prices. Having this foundation in place makes this space all the more attractive for entrepreneurs.

Second is the harsh reality that one’s financial picture today is much different than it was a decade ago.

  • Real annual wages have been stagnant since 2000
  • Education costs are rising exponentially
  • Credit card balances are higher than ever
  • Credit scores are lower than ever, limiting access to capital
  • Home ownership is at its lowest level since the Census starting tracking it
  • High deductible health insurance plans are now the norm
  • Populations are aging and retiring older

As Sarah Tavel points out in this post, called “Saving People Money”, in response to these changing macroeconomic factors, people need new ways to save money, manage money, and invest money. Cue the need for tons of innovation.

Lastly, banks have turned into modern-day conglomerates. The large banks today offer every product you can imagine, from insurance to loans, to mortgages, to cross-border money transfers, etc.

This is a prime example of an institution that does a whole lot of things, but does none of those things really well. This is the perfect landscape for a startup to focus its efforts on a select few of those items and execute to perfection.

The ability for a startup to begin “unbundling” some of those banking services is predicated on the notion that a physical presence in banking is no longer at the core of the customer experience. Alex Rampell, Partner at a16z, makes a great comparison between the financial sector and the retail one, citing Amazon as the retailer that caught these same tailwinds and removed the physical presence from the equation, allowing it to displace WalMart as the biggest retailer in the world. He leaves us with a crucial thought in this video, asking “when will banking have its Amazon moment?”.

These factors have opened up the possibility for thousands of startups to transform the way modern banking is done. Every transformation happens in multiple phases, and the first step in this equation is unbundling. The opportunity at hand is for startups to be exclusively focused on only one banking product (say savings or lending). Consider several examples of this being successful:

Alternative lending platforms such as SoFiKabbage, and Clearbanc have all taken advantage of the inefficiencies in the lending departments of large financial institutions. These lenders all have similar formulas in the way they disrupt traditional banks:

  • High Touch: Start by focusing on a specific user and understand that user really well. This allows the company to underwrite that specific user much more effectively than a bank would. Underwriting more users means more originated loans, and lower loss ratios. For example, SoFi has focused on students, Kabbage on SME’s and Clearbanc on entrepreneurs.
  • Reduce the margins banks earn on loans: A traditional bank accepts money (deposits) and pays a minimum amount of interest (<1%) and then loans that money (primarily on credit cards) for closer to 19% interest. There is a lot of margin there to cut in to for a startup. Given the lenders mentioned above don’t have brick and mortar operations to pay for, they can beat the banks loan rates in most cases, and offer credit to more borrowers.

Robo-Advisors such as WealthfrontBetterment, and Wealthsimple have automated a routine job that was typically done by financial advisors. Large mutual funds and ETFs were already mostly being managed by algorithms, however clients had to consult financial advisors prior to investing. By removing the advisor from the equation and promising individuals a balanced, diversified portfolio that fits their lifestyle, robo-advisors are able to offer equal returns with much less management fees (typically 0.5% vs 1.5% at traditional banks).

  • Savings platforms such as Acorns have found new, innovative ways to encourage people to save money. They are able to offer a fully digital experience, and have ‘gamified’ saving, by incorporating goal setting, rewards points, and a social element. Alternative savings platforms can earn a higher return for clients on their savings all with free accounts that they can contribute to or withdraw from anytime.

These examples continue across every facet of a bank. This image below gives a taste of the FinTech landscape today, and highlights every element of unbundling currently under way. This is the home page of Wells Fargo and it outlines the top startups picking apart every piece of the bank.

CB Insights/iNovia

Of course, unbundling is not the holy grail, it is merely phase one. Entrepreneurs’ ambitions and world domination plans are much larger than simply mastering one banking product. The first product, or the unbundling, is just the “hook” to acquire customers and begin building trust and brand name. Startups exploit the banks on one simple product as a hook to win the consumers’ business in the hopes of then being able to target that same consumer with other financial products in the future, hence phase two: rebundling. The more startups that begin offering additional financial products, the more those startups will begin to resemble traditional banks. Here are some examples of rebundling happening in action:

  • Acorns has now differentiated beyond simply a savings platform by launching Acorns Spend, a debit card product.
  • Square began as an easy-to-use terminal for on-demand workers to receive payment. They have now begun issuing loans to their merchants.
  • Paypal has launched a prepaid debit card that includes bank transfers, deposits, and cashing checks.
  • SoFi has moved beyond just student loans and into mortgages, wealth management, and life insurance.
  • Robinhood has extended its trading services to cryptocurrency
  • Stash has launched core banking and custodial services
  • Credit Karma knows everything (far beyond just credit cards).

What has emerged in the FinTech space is a race to own the end client relationship. Each startup took a different approach, chose a different vertical, and unbundled a different element of the bank. But as all those startups look to layer on, and rebundle the core services of a bank, they will all be vying for mindshare from the same customers. Suddenly, a group of thousands of companies solving various, unrelated problems, will become competitive and will race against each other to be the “go-to” digital bank (or the ‘Amazon Moment’). Despite the numerous examples of rebundling above, we are not quite there yet. As the graph below depicts, we are still at the tail end of the unbundling phase, with startups trying to achieve critical mass in their verticals, prior to commencing the rebundling process.

Once the rebundling phase begins on a macro level, the threat to traditional banks will increase exponentially. Today, consumers excited by digital offerings startups are delivering are faced with the pain of having to piece together all of their financial needs like a puzzle (since every startup only unbundled one product). Getting all of your financial needs serviced, requires interacting with many startups. This pain still generates enough friction for consumers that they maintain their relationship with their traditional bank, and experiment with one or a few new innovative products on the side. Most customers with an Acorns account, also have a traditional savings account at their bank (likewise with investments and loans).

While we don’t expect startups to attempt to put together products that cover everything Wells Fargo offers today, we expect them to bundle a subset of elements that have high synergies. In the past, a HENRY (High Earner, Not Rich Yet) would have one relationship — a big bank; in the future they won’t have 50 relationships (one for each service) but they may have 3–8 relationships with digital rebundlers. Customers will have the opportunity to transfer more and more of their banking relationships to their most trusted digital providers, and will be able to move further away from their traditional banking relationships.

We have yet to see the true threat to banks. But it is around the corner.

Let’s conclude by summarizing what all of this means for inovia in terms of how we allocate capital and make investment decisions in the FinTech space. Here are some of the key elements we look for:

Having a unique and differentiated customer acquisition machine: the ability to acquire customers cost effectively is of utmost importance in the FinTech space. As mentioned above, owning the client relationship is the holy grail, and having a customer not only counts as revenue for the current product, but also allows the startup to target that customer with additional banking products in the future. Here are some examples of unique customer acquisition strategies that have proven successful for FinTech startups;

  • SoFi began by targeting students with its loan products. This led them to be able to use universities as distribution channels and acquire students cheaply (this customer profile was being ignored by traditional lenders). They coined the term HENRY to describe their target customer. This profile was not of interest to banks since they were not wealthy enough (yet) to drive a significant amount of business.
  • Clearbanc offers revenue-based financing to entrepreneurs. They quickly realized that many small businesses use Facebook as their primary advertising channel and that one of the barriers for small businesses is access to capital. Clearbanc partnered with Facebook to help provide capital to these small businesses (much of it to be re-invested in Facebook ads for customer acquisition). This allows Clearbanc to acquire users cheaply through the Facebook merchant network.
  • Affirm allows consumers to pay for large retail purchases in installments. Rather than target consumers directly, Affirm used merchants as their distribution channel. Once a customer reaches the cash, the merchant would ask the customer if they wanted to pay using installment payments (powered by Affirm). This turned the business into a B2B model of selling to merchants rather than a B2C model of competing on customer acquisition.

A well-thought out rebundling strategy that involves owning the end consumer or merchant: Entrepreneurs need to think about pitching the big vision from day one. Building a massive business in the FinTech space will not happen with a series of accidental product additions along the way that we “hope” consumers will enjoy. Owning the end customer should be the objective from day one, it is the core of the business and the reason for existence. Then it is up to the entrepreneur to experiment with various “hooks” to lure in their first batch of customers cheaply. These hooks are more flexible and far less important than the actual master business plan. Here is some advice on choosing the right hook:

  • Test and iterate quickly on initial customer segments you are targeting and the product offering you’re selling. Try something and kill it within a few weeks if you are not luring a unique kind of individual. It is crucial to find a differentiated customer base to initially target, rather than going after the same customers as everyone else.
  • Pick something that resonates with millennials. For example, Ellevestcreates mutual funds tied to the unique career path of women, OpenInvestallows clients to add social impact stocks to their portfolio and Quantopianallows anyone to create financial trading algorithms. The overall vision of all of these companies is to be the trusted financial partner for their target client base, however they have all approached the market with hooks that resonate deeply with that market they are targeting.
  • Once you’ve found a differentiated customer base and a product that resonates with that base you will begin attracting attention to yourself. The idea is that you can use your initial base as a springboard to layer on your rebundling strategies in a more cost effective way. Start with engaged users, build brand awareness among them, garner attention, and then begin rebundling.

Innovate in a new area of banking: Over 40% of all investment dollars into FinTech startups to date have been poured into the alternative lending space, leaving massive industries (such as mortgages and insurance) with few well-funded companies. Additionally, there potentially many innovative ways to improve one’s financial lives that don’t even exist yet and are not even done by banks. Finding a new way to add value financially is a compelling way to disrupt the antiquated banking industry. Examples of radically new financial products are;

  • Mortgage companies like RibbonPoint and Properly that allow consumers the ability to sell their homes more efficiently and even offer the possibility of unlocking some of the equity in their home (things banks don’t do today).
  • Contextualized insurance companies like Lemonade, and Slice. Today, an individual may act as a business one day (renting our their home on Airbnb, or driving their car for Uber) and as a regular citizen the next. Insurance needs to adapt to understand the context in which your assets are being used.

Create your own infrastructure and be self-reliant: Many FinTech companies simply add a new layer or application on top of existing banking infrastructure. This is a great way to validate the problem, but in the long-term the majority of the gains will still accrue to the financial institution serving as the infrastructure layer. FinTechs that are self reliant can be more disruptive and rebundle other apps even easier than those that rely on others. This is one example of a well-planned rebundling strategy from the start.

At inovia we look to partner with audacious founders building enduring technology companies. It is clear that the ability to have an impact on one’s financial experience has the potential to disrupt everything we know about our banking systems. Those are the types of ‘big bets’ we thrive in undertaking.

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How BMO branch technology saves employees up to 30 minutes per day

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When it comes to banking, it comes as little surprise that customers are increasingly preferring tellerless interactions. 

A recent customer insight report from Mercator Advisory Group found that those who don’t like using mobile and online banking prefer to use self-service kiosks at physical branch locations.

Even back in 2015, a study by Source Technologies found that self-service retail banking kiosks improve operations, “reducing the time it takes to get an official check from nine minutes (using a teller) to 40 seconds – 13.5 times faster than a teller-conducted transaction.”

When banks invest in features like remote authentication and mobile deposits, it isn’t just customers who benefit — staff are able to better focus on more complex transactions, and developing relationships with clients.

“We see that more and more of our customers are migrating toward self-serve interactions, especially for the simpler, straightforward transactions,” explained Kyle Barnett, BMO’s chief operating officer for US personal and business banking, in an interview with PYMNTS. 

One of technologies implemented by BMO was a faster, real-time process for scanning and depositing cheques, saving customers from having to fill out a paper deposit slip. This has led to deposits clearing within hours instead of days. 

Another BMO implementation was its easy PIN authentication; instead of using a driver’s licenses or state-issued ID, customers use debit cards to verify their identities. The transaction is therefore accelerated, and data is aggregated instantly on the teller’s screen.

Both of these improvements were implemented in more than 500 branches by the end of 2019.

“If a customer walks in and opens up an account [during the] same interaction, they can actually leave with a fully functioning, embossed card that has their name on it,” Barnett said. 

And unlike before, when a customer was issued a temporary card and had to wait for the fully-functioning replacement to arrive in the mail, “they also get the PIN right there as part of the account opening, and can even set up a custom PIN if they want at the ATM.”

With the in-branch experience changing, and customers requiring fewer interactions with tellers, the result has been “really freeing up our branch bankers to have more time to dedicate to customers, and have better holistic conversations, and create more personalized recommendations.” 

One case study found that employees have saved between 15 and 30 minutes per day on processing forms. Multiply that by the number of employees within BMO, and you get a major win for efficiency and time saving. 

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81% of banking executives would look to collaboration for digital transformation

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According to Finextra’s The Future of Payments 2019 report, it’s been “the year of digital transformation for legacy-era brick-and-mortar banking giants.”

And collaboration is overwhelming the favored path to get there.

At EBADay, hosted by Finextra in association with the EBA, it was reported that 81% of banking executives would seek to collaborate with partners to better, more successfully execute digital transformation. 

 

While collaboration was the clearly-favored choice, some respondents did choose options for digital transformation that either kept the process in-house, or completely outsource it:

  • 8% would build a new operating layer on their own
  • 6% would outsource processes
  • 5% would create a new bank “on the side”

When asked to describe digital transformation (DX), 55% said that it means fully changing an institution’s fabric. For others, DX means:

  • Offering more innovative products while reducing costs (20%)
  • Replacing and renewing the core banking operating system (13%) 
  • Offering digital channels such as mobile (12%)

Thanks to consumer demand, banks have been forced to step up and introduce new products and services that leverage current and emerging technologies — all in the name of giving customers better choice. 

As it stands, customers of the retail banks are able to deposit cheques, transfer funds, and apply for loans via their smartphones. 

“This collaborative attitude underscores how the rise of digital banking may not need to be an all-out competition between incumbents and startups,” explains Business Insider, “and may even tilt the scales in the direction of collaboration.”

And it looks like it’s already been happening: Lloyds found that 48% of financial services they polled said they have completed acquisition deals for fintech firms, or have taken a minority or majority stake in them. 

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Why private label banking apps and products are on the rise

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Private labeling has long been a pervasive strategy in retail, where products are made by third party manufacturers and sold under a retailer’s name. The cost to manufacture is often much lower than reselling another brand name, resulting in higher margins and increased revenue for sellers.

Retailers who implement this strategy also maintain wholesale control of the brand, including packaging and pricing, which generates product exclusivity as well as promotes customer recognition of and loyalty to the brand.

Possibly the biggest benefit of private labels, however, is that they eliminate the pains of having to design and build a new product — especially when entering a new market. By outsourcing the entire process and leaving those details to the experts, sellers can instead focus on what they excel at: branding and marketing the finished product.

Because the benefits of this strategy are so multifaceted, it’s no wonder private labeling is moving beyond consumer goods and gaining traction in service-based industries. Businesses looking to develop new offerings and product functionalities can now easily outsource entire technology stacks and tedious regulatory administration.

As tech giants like Apple, Amazon, and Google deepen their financial services plays, banking and personal finance tools have become a prime opportunity for fintechs and smaller firms to leverage private labeling to compete, and for established players to unlock new revenue streams.

Here’s a look inside how private labeling is transforming the banking industry— and which products are on the rise.

What is white label banking?

White label banking is another term for private label banking or banking-as-a-service (BaaS), in which banks open up their application program interfaces (APIs) to let third parties build their own financial products with existing infrastructure. White label banking accelerates the builder’s go-to-market strategy by removing regulatory, legal, and technical obstacles.

White label banking services

White label banking services enable fintechs and third parties to showcase a sleek, company-branded frontend, while leveraging an established bank’s license, regulatory compliance, and technology on the backend to offer core banking features that rival major institutions’.

Common white label banking services include:

  • Savings and checking accounts
  • Current accounts
  • Debit and credit cards
  • Simplified bill payments
  • Online payment transfer systems
  • Personal loans
  • Mortgages
  • Insurance
  • Bank statements with transaction details
  • Balance notifications

White label banking apps

Some examples of mobile banking apps built with white label features include:

  • ADIB
  • Albaraka Mobil
  • Azlo
  • Börse Stuttgart App
  • Chime
  • Compte CO2
  • Digit
  • Dozens
  • Knotist business banking
  • MoneyLion
  • Nationwide Mobile
  • Qapital
  • Qonto
  • Score Kompass
  • Simple
  • Spendesk
  • Stash
  • Tomorrow
  • Trade Republic
  • Van Lanschot
  • Vitesse Mobile
  • Xero Accounting & Invoices

Future of white label banking services

Across industries, digital technologies are democratizing information to spur more competition and innovation. Because of this, the trend towards “open access” will only become more pervasive. In the banking industry, particularly, the open banking movement has been unfurling from its epicenter in the UK and stretching across the globe for the past few years.

White label banking and BaaS technology are no longer brand new technologies in the industry, but firms that get involved now will still be ahead of the curve by the time regulation becomes mainstream. The UK’s Competition and Markets Authority has already enrolled the nine biggest banks and building societies in its Open Banking Directory, and others are coming soon. After that, it won’t be long before other countries follow suit with their own regulations.

Per Accenture estimates, €61 billion ($70 billion) or 7% of total banking revenue in Europe will be associated with open banking-enabled activities by 2020. Incumbent banks around the world that invest in open banking platforms now – before it’s mandated – will be rewarded with new revenue streams, an early boost in demand, partnerships with tech-savvy fintechs, and an overall competitive advantage against newcomers in the space.

To stay ahead of trends like white label banking, Business Insider Intelligence is launching a Banking coverage area in September. Tailored for top decision-makers in the financial services industry, this vertical covers digital transformation across the industry, including open banking and BaaS, consumer and business banking, mobile and online banking, digital account opening, and neobanks.

This article originally appeared on Business Insider and is reprinted with permission. To read the original article, visit this link.

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