There’s much talk of “unbundling” in the industry these days. Bankers are fretting about startups nibbling away at their most profitable customers. New technologies from marketplace lending and robo-adviser platforms to real-time payments and the distributed ledger have the potential to dismantle core areas of banks’ traditional business model, and more critically, connectivity to their customer value proposition. Depending on your point of view, the pace of fintech innovation is unsettling, maybe even terrifying to some. As I’ve long warned, with these changes, there will be blood.
But the reality is that banks unbundled themselves.
Unbundling: The Story behind the Buzzword
Like in other industries, the unbundling of financial services seems to have started with the quest for deeper efficiencies and broader profit in response to increasingly complex regulation and demanding investor cycles. In the early 1990s, following the lead from banks like Citicorp, the industry started unbundling products into silos: first the credit card business, then the mortgage business, auto lending, small business, personal loans. Eventually all of the credit business was walled off from the rest of the deposit relationship. Deposit products, insurance and investment services became productized and segmented as well. The rationale was that it made more sense to have individual P&Ls by business line, improving product management and marketing focus, efficiencies, and profitability. And it worked well. Maybe too well.
While it looked good to the markets and banks’ bottom lines, the effect was that they detached the connective tissue between a customer’s accounts, obscuring the broader view of the very relationship consumers and small businesses had with their banks. Systems were segmented and specialized and were no longer able to provide a unified vision of their customers’ relationships, even to bank employees. It was the same for the customer. When online banking came around, the credit card balance or the mortgage relationship did not show up online, even if it was at the same bank as the deposit account.
As banks continued to unbundle the customer relationship and user experience with banks increasingly complex set of financial products, external providers started to build more efficient businesses. When it was time for that consumer to make bigger-ticket purchases financed with instruments such as a mortgage, this business was fulfilled by nonbank credit companies which built better lead generation funnels, like Quicken Loans, Countrywide and its predecessors before the Great Recession. By now, mortgages and consumer credit products have become commodities. Add to this deposit products, from savings to IRAs to CDs, investments, insurance – all siloed and optimized — but not necessarily from the customer’s viewpoint.
This was a big shift from how banking had operated up until a quarter of a century ago. It was the first unbundling of financial services. And it laid the groundwork for the second wave of unbundling by startups that we all talk about today.
The Threat of Disruption Intensifies
In a sense, the industry wanted to provide focus to products like FinTech does today — by creating teams specifically focused on targeted products. But typical layers of decision-making were added which diluted the strengths of the startup across those disjointed business lines, often with competing goals. Banks, being so complex and focused on managing risk and compliance, couldn’t let their teams attack a business problem the way a startup can today.
Banks today have scale, trust and runway. Startups have speed, flexibility, and focus. Banks need to learn from each other — and work with each other. In the pursuit of efficiency and focus, banks put too much priority on short-term profitability and not enough on understanding how the customer was leveraging a product or service — really understanding their overall needs and making banking simple, personal, and fair. The result has been a systematic disenfranchisement of banks’ traditional customer base.
There’s not a single business unit in a bank that is not being challenged in some form or fashion by a startup from outside. Student loans, credit cards, mortgages, deposits, the basic checking account, payments — none of these areas are not being encroached by a startup of some kind. Goldman Sachs’ March “Future of Finance” report says it’s plausible that up to 20% of industry revenues could be captured by external entrants.
The marketplace lenders, for example, are offering an alternative for small business owners who otherwise must wait three to four weeks or more to get a bank loan (if they can get one at all). By looking at different data points and evaluating a business’ financials in a more systematic way, marketplace lenders can get the same thing done in hours or days. That efficiency does make a difference. Think about a restaurateur who needs to quickly replace a broken stove, or someone who needs to finance a couple of trucks to expand their business. It may not be the best deal for them, but speed counts. This is why we’re seeing more nontraditional financial players from PayPal to Square to Google entering this credit marketplace space — it’s good business to focus on small business.
To be fair, banks have consciously made strategic decisions to cede some of this business (such as subprime auto or small-business lending) because of the particular risks or inefficiencies. For the startups, profit margins aren’t really the short-term focus. Right now they’re building market share and mindshare. They’ve got two to four years to ramp up and buy into a business. The problem with that attitude is, again, the banks are teaching another generation, as they did last time with credit cards and mortgages, that the first place to look for certain types of financing isn’t a bank. It would be at one of these providers instead. A generation of consumers is learning that there are banking services from nonbank providers — whether that’s PayPal or Venmo to move money, or alternative lenders like Lending Club. These are the same consumers who will be opening businesses and who will be running the companies of the future. Don’t you think there is collateral damage to the industry as this generation takes the reins?
Think about peer-to-peer lending. Using Lending Club as a proxy for the sector, around 70% of marketplace loans to consumers are for debt consolidation. Whose failure is that? Is the consumer’s fault for taking on too much debt? Is it the industry’s fault for making credit too easy to obtain? Either way, it showed a lack of understanding of the deposit side of the relationship and ability to pay down that debt. An entire generation was taught that using credit was a great idea and following the Great Recession consumers are flipping the switch and switching to debit, not owning cars until much later, and renting instead of buying. Banks have traditionally shied away from helping mass market consumers understand their financial lives, and the appropriate use of credit. It’s no wonder consumers are confused by banks. It’s also another reason fintech companies are broadening the type of product offerings focused on money management and building wealth today, from robo-advisors like Betterment and WealthFront to automated savings tools like Digit, Seed, and Qapital. Banks need to help customers understand how to properly use credit and to maximize their opportunity to build generational wealth. If they don’t, startups will. And in many cases, the latter is already far ahead.
Published thanks to The American Banker