When he moved to Pittsburgh in 2004 for graduate school, Joshua Reich was so perplexed about having to write a check to pay for a utility bill, he sought the help of a neighbor.
“I had never before in my life written a check,” the Australian entrepreneur says.
It wasn’t just the checks that he found cumbersome about banking in the United States. Many other practices, to him, seemed designed to confuse customers out of billions of dollars of fees. “It seemed like you have to play all these games to be in control of your money,” recalls Mr. Reich.
Within five years, Reich and his grad school friend Shamir Karkal had launched an online banking software called Simple, featuring a sleek website and mobile app, budgeting tools, and a promise of transparency and no fees. (It will provide a check if needed). Simple is at the forefront of a movement to revolutionize the way people bank, save for their retirement, pay for things, and borrow money.
But despite what appears to be a transformation of financial services, propped by nearly $11 billion of venture capital investment globally in 2015, a radical overhaul of US banking is unlikely, say many industry observers. At least not in way that the taxi and hotel industries have been upended by blazing newcomers.
“We always get the question of what's going to be the Uber or Airbnb moment in this space, but the difference in the markets is tremendous in financial services,” says Amy Nauiokas, co-founder and president of Anthemis Group, a venture capital investment firm and advisor to banks.
That may still be good news for consumers. As ambitious startups continue to enter the financial services fray and take business from traditional institutions like Wells Fargo and Bank of America, they are forcing banks to compete to keep customers who are banking in unprecedented ways.
“In the seven years I’ve been in this business, I’ve never seen [banks] more serious about creating a better user experience,” says Georg Ludviksson. Mr. Ludviksson is the founder and CEO of London-based Meniga, a personal finance software company that sells its tools to banks. “The question is: can they move fast enough?”
New kids on the block
The traditional banking industry is ripe for a challenge. Some customers, like Reich, are frustrated with institutions that are slow to adapt to their financial needs. Others simply don’t have faith in their banks. Only half of the tens of thousands of people surveyed worldwide by public relations firm Edelman in its 2016 annual Trust Barometer study said they trust financial institutions.
The low trust is compounded by the new financial habits of coveted Millennial customers. According to market research these 19- to 35-year-olds manage finances through their phones, pay through apps and debit, and avoid debt. Federal Reserve data shows that the share of Americans under 35 with credit card debt is at its lowest level since 1989, reports the New York Times.
Dozens of digital newcomers have cropped up to capitalize on these habits. There’s Venmo, an app that connects to users’ bank accounts and allows them to pay for things or pay each other through smartphones — no cash, checks, or cards required. There are digital banks like Simple. Online platforms like Lending Club and Prosper use advanced technologies to qualify applicants for loans more efficiently.
These startups promise good customer service and convenient products that make it cheap and easy to manage money with a smartphone. Transferwise, for instance, is a London-based app company that aims to improve the process of transferring money overseas.
“Transferwise . . makes it easier to track where the payment is and when it’s going to arrive,” explains Jesse McWaters, an expert on disruptive innovation in financial services at the World Economic Forum. “With most banks it’s expensive, it’s not transparent, you might not know what the fees are going to be, you might not know when it’s going to arrive.”
Even the giants like Apple, Google and Facebook are getting into the game with their own digital payment systems.
These companies aren’t displacing banks just yet, but they are starting to chip away at their revenues. Anthemis estimates that by 2020, 30 percent of bank revenues – from services like credit cards and loans – could be siphoned off by new technologies.
The shift is already happening in wealth management, Ms. Nauiokas points out. Anthemis has invested in three companies in that sector, including Betterment, popular provider of robo-advisor services.
Change is hard
Banks and credit cards aren’t about to become obsolete. There are formidable challenges for young financial technology – or fintech – companies to contend with.
For one, it’s easier for consumers to take a flyer on a new type of taxi service or vacation rental than on a new bank. As a result unknown startups struggle to convince enough people to hand over their money in order to generate a profit from small transaction fees, says Mr. McWaters. “The reality is that most individuals still trust banks to hold their wealth,” he says.
Another big obstacle is the jumble of federal and state-by-state regulations that make it challenging for new companies to compete with existing ones that are holding America’s wealth and controlling the often slow flow of payments in the country.
But those types of obstacles aren’t necessarily a bad thing, says Adair Morse, business professor at University of California in Berkeley. “Imagine an online bank that’s not regulated; how would you know when you put your deposits in there that the bank is not going to keep your money?” she points out.
On the other hand, points out Greg Kidd, an entrepreneur and investor in Twitter and payments processor Square, since the US dialed up rules in the wake of the 2008 financial meltdown, the launch of new banks has slowed to a near standstill.
The FDIC, a non-government agency that sells insurance to banks to protect people’s deposits – a federal requirement – has insured only seven new banks since the crisis. Before 2008, it covered about 100 per year.
Meanwhile, developing countries, like India and Kenya, are leading financial innovation, point out entrepreneurs. Since many people in those areas are unbanked, there is still a lot of room for experimentation, unburdened by large institutions and regulators.
The United Kingdom also is held up as a paragon of fintech innovation. To encourage competition and innovation in retail banking, the financial regulator there established an agency to support new banks through the licensing process. “I can think of like five banks that have started in the UK in the last five months alone,” says Reich.
The UK also will require its banks to open up access to their software and customer data to vetted third parties, like other banks or apps. This will make it possible for new companies to make better products, and for money to flow more easily. “Those sort of changes would be fundamentally good for innovation in America,” Reich says.
If you can’t beat ‘em...
The only route today for fintech startups to do business is to work with (or sell to, or get copied by) corporations that own customers and America’s payment-processing infrastructure. In a digital world where everything is instant, the payments could use a reboot, many argue.
The Automated Clearing House for example, or ACH, is a 40-year-old technology that’s responsible for moving 90 percent of money sent electronically in the US. That includes direct paycheck deposits, online bill payments, and those flowing through PayPal or Venmo. Mike Sigal, an entrepreneur and mentor to fintech startups, says it’s like cars using roads that were built for ox carts.
US regulators now require the ACH to make same-day money transfers available. Besides that, no other regulatory banking upgrades appear to be on the horizon.
Reich had to partner with banks even to access the ACH. He originally envisioned Simple as an FDIC-insured digital bank. But after the financial crisis, it seemed impossible. Instead, Simple partnered with insured institutions, layering its attractive software on top of their traditional offerings, like ability to hold deposits. In 2014, its 100,000 Millennial customers were acquired by global banking giant BBVA, where Simple still operates under its own brand.
When it launched in 2008, Betterment, which uses an algorithm to recommend investments to customers online, aspired to become the Charles Schwab of its generation, according to Nauiokas. Last year, however, Charles Schwab launched a competitive service called Intelligent Portfolios. Venmo was acquired in 2012 by payment processor Braintree, which was bought by PayPal in 2013.
Big companies swallowing up startups is hardly an industry disruption, but, “It’s improving user experience in the long-term for regular people,” says Prof. Morse.
Replacing existing banks may not be the answer, Morse adds. “From a consumer point of view, what we want is banks that provide us with better services, banks that don’t try to take advantage of our lapses in paying attention, banks that make our lives easy,” she says. “Whether these startup banks would be better for consumers is not obvious.”
Plus, new technologies have kinks to work out, which can be risky for both startups and consumers at the outset. Take online lending platforms like Lending Club and Prosper which have become popular in recent years for using an algorithm that quickly qualifies loan applicants, as opposed to the weeks-long process at a bank.
This was supposed to help individuals and businesses get loans quickly and affordably. But this year the borrower validation processes of both lenders started to show cracks as more and more borrowers began to miss their payments. The delinquencies have scared off Wall Street investors who had been buying the risky debt, and led the lenders to raise their interest rates to stay afloat.
Financial analysts predict that large banks might now buy them up. “They have good technology and it could ultimately be adopted by the banks themselves,” Todd H. Baker, founder of Broadmoor Consulting, an advisory to financial services companies, told the Times.
That trend could ripple through the rest of the financial services industry. Maybe banks will buy all the new technologies. Maybe, imagines Morse, they’ll contract startups under a royalty model to provide some services to customers. At the very least, industry observers say, with more competition financial services ideally will work better for consumers.
As Ludviksson of Meniga muses, skepticism is normal.
“You don’t anticipate the big change until after the fact,” he says. “The jury is really out there still.”