Are Fintechs a Threat to Banks?

In the past post titled How Fintechs are Disrupting Traditional Banking? we discussed how the 2008 global financial crisis and the smartphone revolution resulted in the rise of fintech, which has since then created disruption in the global finance and economy. This article will focus more on the banking side and we will try to look at how fintech is affecting the banks.

It is common to think of every new technology as a threat, however, over time it becomes apparent that every new technology can take the place of the previous one to make things better for us. A better way of saying this is to look at Schumpeter`s boom and bust model.

Boom and Bust | Are Fintechs a Threat to Banks?

Schumpeter gave the boom-bust model which basically states that societies and thus economies go through evolutions. These evolutions are driven mainly by advancements in technology. Thus whenever technology reaches a level where it can significantly change the way society works, or in other words increase the efficiency level of society. Society goes through chaos, disruption and breakdown.

Entrepreneurs need to take advantages of these busts because these busts or periods of chaos are followed by a boom and economic development and prosperity. In light of this description if we look at the fintech revolution we can clearly see that the last ten decades have gradually built up towards the mass adoption of fintech.

The pandemic has acted as a trigger, to increase the rate at which new technologies such as blockchain, automation and machine learning are being incorporated into fintech solutions, to provide better and more efficient products and services.

This takes us back to our premise, new technologies are initially seen as threats, during the chaotic phase of the transformation. However, it is the role of entrepreneurs to adopt the new technology and incorporate it into existing systems to increase the level of efficiency. This is exactly what is happening with the banking industry.

At first, the banks resisted or rather ignored the existence of fintechs. When companies like Revolut, Monzo, Freetrade, Wise (former Transferwise) Afterpay, Acorns and other startups started giving alternative solutions to customers banks turned a blind eye as startups could not possibly have been expected to compete with high street banks. Over time, however, an ecosystem of startups created a billion-dollar economy and changed customer preferences.

Customers now understand that

• A bank may take a day or more to verify and complete their transaction while blockchain can do it in a matter of seconds or a few minutes.
• A bank charges a processing fee that raises up the cost of transactions while blockchain-based solutions have lower processing costs.
• Bank transactions are still susceptible to fraud and the threat of data theft is always there while blockchain-based solutions are virtually unhackable. All of these and other features of fintechs have opened up opportunities for customers, who are now asking these questions from the banks.

So a decade ago banks overlooked the rise of fintechs and today fintechs has provided an alternative to every service being provided by banks. But is it a threat? The answer is both yes and no.

No, because as long as you have got a nation-state, a government and a central bank. You will always have the banking industry with a centralized and regulated financial and monetary system.

It can go through improvements and upgradations but in its essence, it will be centralized and thus the banking industry will in some manner be able to overshadow the decentralized fintech industry.

Yes, it is a threat because if the banks decide to remain rigid, upon their old ways of banking conventionally then yes fintech is a major threat that will eventually take a major chunk of their market share.

Are Fintechs a Threat to Banks?

According to PWC banks back in 2016 were already experiencing loss of market share and pressure on their margins. Banks however seemed to have realized that fintech is the future, which is why an industry-wide effort to adopt some of the systems and processes being used by fintechs can be seen.

Banks are now trying to upgrade their core banking mechanisms to increase their efficiency and provide customers with on the go access to their funds, as well as lightning-fast transaction speeds. Most, if not all banks have got smartphone applications now, which can be seen as a way to reclaim their space in the smartphones, that was previously taken over by fintech apps.

Similarly, banks are now investing in blockchain to develop blockchain-based payment systems, to not only secure their own data but also to speed up transaction processing. This will inevitably make banking services better and more competitive as compared to fintech based solutions.

There are however always going to be threats from fintech to the banking industry as a whole. Why? The very phenomenon of fintech took its inception in the concept of decentralized banking. Decentralization? Ok, let’s go deeper on that… Blockchain…

Are Fintechs a Threat to Banks?

Blockchain is a very important driver of the fintech revolution and bitcoin is the most popular blockchain-based cryptocurrency. What does Bitcoin symbolize? Freedom from banks, freedom from the monetary control of governments. Today we have got China, Russia and other countries looking into the concept of Central Bank Digital Currency (CBDC), which is going to be a cryptocurrency controlled by the central bank.

You can call it a government-controlled digital currency but it will, in its true sense not be a cryptocurrency because it will be controlled by a monetary authority. Bitcoin or other cryptocurrencies symbolize freedom from monetary authorities. This is what we call Decentralized Finance or DeFi for short.

While it is good that banks are now taking interest in these new technologies to upgrade their products and services, it is safe to believe that fintech will continue to develop its alternative financial products and services, that will rival mainstream and conventional banks at every point.

The idea of decentralized finance is too exciting to let go of. The opportunities here are virtually limitless. DeFi has the potential to unlock vast amounts of liquidity, thus injecting trillions of dollars into the global economy and these trillions won`t be debt. No, this will be asset-backed finance.

Asset tokenization, for instance, is a process through which real-world assets can be turned into security tokens that can be traded just like stocks. So you can tokenize a hotel building and sell its security tokens like stocks to investors.

What is the benefit? Every investor today cannot buy a hotel. A person earning an average income cannot even dream to buy a hotel, assets such as these are only accessible to a small group of investors. Thus, liquidity remains locked. However, if you tokenize a hotel, for instance, even an average income earning individual can buy a stake in a hotel. What will they get in return? Cash flow from the hotel distributed proportionally to the stake in security tokens. Very much like investing in the stocks of a company.

Tokenization is not only limited to assets like hotels, you can tokenize any asset of value. You can tokenize supercars, paintings or luxury yachts. These are the possibilities that exist now because of the fintech revolution. Banks can try to adopt fintech to improve their systems, workflow and processes but the scope of fintech is too broad for banks to entirely absorb.

Fintechs has the potential to create an alternative financial and economic system that can directly challenge the banks.

So yes, fintechs are a threat to banks but at this moment it would be too early to give a judgement. The role of banks in future is possibly going to change. The two basic functions of banks are to lend money and allow investors with savings products. Fintechs can do both, so why would anybody need centralized banks? The answer to this will only become clearer as time passes.

What do you think? Does it make sense to you? Do you agree? Disagree? Please, leave your comment below!

Are Fintechs a Threat to Banks?