FINANCIAL SERVICES ECOSYSTEMS SERIES — January 2021

The portrayal of fintechs as disruptors, locked in a David and Goliath struggle with the big banks, insurers and pension and asset management companies, has been a recurring motif for the past decade.

But as demand for digitally powered finance has accelerated, fintechs and the powerhouses they were seen as challenging have found a greater willingness — maybe even an imperative — to collaborate more closely and more often. And that’s a situation that has gained considerable momentum with the largescale shift to digital channels during the global pandemic.

While the perception of increased interdependence may exist, many barriers still need to come down for such collaboration to be more frequently actionable and valuable for both sides.

The market evolution is particularly evident within one vibrant start-up scene — in the central belt of Scotland, where a concentration of some of the biggest names in global finance, including NatWest, Lloyds Banking Group and Standard Life Aberdeen, is orbited by about 150 fintechs. What is also clear is that the drivers of success can emerge from across the whole financial services ecosystem, which also extends to big tech companies, academia, government initiatives, business networking groups and social concerns (see our related article: How disruption is accelerating co-creation across financial ecosystems

Imperative for collaborationAt Amiqus, which provides remote identity verification technology for onboarding staff, ensuring compliance and security for financial services and other organizations, CEO and founder Callum Murray is certainly sensing a shift.

“Five years ago big financial companies were thinking about [partnering with fintechs]; three years ago they were planning it; and now they’re actually doing it,” he says. “The whole community has matured significantly in recent years.”

Essentially, there are signs that the risk appetite has changed: there are now many more examples of bigger banks and other financial enterprises engaging with smaller early stage companies and selling or using their products, he says. “It’s been a gradual process of [understanding] how they might engage to how they can best engage. Such enterprises do take a long time to move but when they do move it’s fantastic.”

James Varga, CEO of DirectID which uses open banking data to enhance the credit risk lifecycle, highlights a more immediate influence that’s changing mindsets and practices and moving banks towards new policies and product adoption at a pace that wouldn’t have been dreamt of in previous years.

“The pandemic has really shaken the foundations of a lot of these major businesses. They’re under a lot more pressure and that means people have moved from hype [about the barriers of engaging with fintechs] to action.”

And in an industry that takes pride in insulating itself against risk that may signal some progressive thinking. “Historically within banks, very few people choose to do anything different for fear of getting it wrong. Now there’s an opportunity to reinvent how they do things — to be more agile, experimental, to allow small teams to try and prove new stuff works or, if they fail, to fail fast, giving permission to get it wrong.”

He points to a recent conversation with a senior executive at an international bank who said, “What we’ve done in the bank in moving thousands of people to remote working during Covid has just proven what we always thought we could do, which was to break with preconceptions.‘”

As Varga observers, “Doing what they’ve always done is now no longer acceptable.” Dismantling barriersSuch large financial companies are always keen to talk up their innovation credentials — and keen to point to investment in innovation hubs and incubators designed to deliver on their ambitions. But “many still find it difficult to engage with fintechs,” says Murray.

The way forward involves reshaping the policies and structures — and many of the attitudes — so such collaboration can be both easier and meaningful.

Varga highlights some of the major challenges that need to be overcome. “The relationship between fintechs and big financial services companies has matured. Many fintechs are now medium-sized companies, the banks don’t feel as threatened by them and they’re slowly coming to understand what they’re not so good at. But the biggest problem is that banks are still incredibly risk adverse. The pandemic has been really good for getting people to realize that they can’t always choose the safe route,” says Varga.

And the interaction can’t just be about their financial enterprises’ innovation teams exploring proofs of concept and side projects, he argues “We now have to find ways of bringing those innovations into production environments, at scale. If not, they are never going to have an impact — for anybody.”

Put bluntly: “The Goliaths of the industry need to rethink how they adopt innovation,” says Varga.

“Their risk aversion is completely understandable — after all, the businesses that they have built are all about mitigating risk. And every time something negative happens, new processes are put in place to try to stop it re-occurring in the future. So the reason it’s so hard for them to adopt innovation is because everyone is in the job of managing risk,” he says.

So the focus needs to be on making it easier for the “gatekeepers and process blockers” to embrace innovation. “The group board, the head of innovation or the CIO may make a call to invest £50 million in innovation and commit to changing the way the organization does things. However, when that filters down the organization, what actually happens is we find ‘no-one told the procurement team.’ So a bank might have all the these grand plans but then when it comes down to the procurement exercise it’s just not possible to meet their requirements.”

The solution, he says, is for more people in the organization — and among its major technology partners — to spread the message of the legitimacy and value of innovation. “You may have convinced the innovation people at the top of the company and you may have a clear ‘we’d like to work with you’ message at the bottom of the company, but you get to the ‘sticky middle’ and the procurement team is saying it needs to go for a lower-risk solution. We have to start to shift the way we think about these things, if we’re going to move forward.”

Varga gives an example from his company. “Some of DirectID’s customers have seen a fraud reduction of 7.5%. If I could save one of the big banks even 1% of their fraud, I could buy a small island and retire. From the bank’s point of view that fraud is just the cost of doing business and the risk of them doing something different and it not working is astonishingly greater.”

Procurement is not the only gating factor. Fintechs are often lured into large financial institutions to showcase their technology — without any contract ever materializing, which can sap scarce resources. “For any startup revenue is king,” says Varga. “And the real danger is that we spend too much time big game-hunting and end up starving because we never got time to make the spears we need,” says Varga.

One proposed solution is for organizations such as FinTech Scotland and Scottish Financial Enterprise, which represent the interests of the country’s finance startups and the major institutions, to help qualify opportunities and provide evidence that a bank with a problem to solve has serious intention of adopting new, external technology, as well as the budget involved in taking that forward and the hoops the startup will have to jump through.

“What is needed is more of a consultative matchmaking approach,” argues Varga.

“As Fintechs we need to be more cognizant of some of the challenges of big banks.”

But with the pandemic-induced economic downturn resulting in tighter venture funding, there is also pressure on fintechs to align their activities, approaches and offerings more closely to the challenges of the established players.

“Small companies can get to a certain point early on with a great idea. But then they need to build in the various information governance and security standards and structures in order to be able to evolve the potential to the actual. Without those, you’re viewed as too risky by the larger companies,” says Murray.

“As fintechs we need to be more cognizant of some of the challenges of big banks,” echoes Varga. “There’s a lot more that fintechs can do to prepare themselves [for engagement with financial enterprises], to learn from each other’s experiences and build references and use cases.” New models for engagementWhile the dream exit strategy for a startup of a decade ago may have been an initial public offering on New York’s NASDAQ or London’s AIM markets, there is a new realism that is more about maturing the business.

“In the last couple of years there has definitely been a movement towards building a sustainable business and one of significant scale,” says Murray. Rather than embracing the classic model of largescale VC funding that shoots for a billion dollar business, the trend is towards embracing a wider ecosystem that can include angel investor funding, partnerships with more established tech companies and government agencies, and a commitment to the creation of wider stakeholder value. He cites fintech programs run by Fujitsu, FNZ and Lloyds Banking Group as prime examples of such partnerships. Big role for big techIndeed, gaining access to the giants of finance is in many cases more achievable by hooking up with established tech companies that have existing relationships with tech teams across the large financial institutions as their providers of infrastructure, core applications, service desks and so on.

“That’s a huge opportunity for fintechs that hasn’t really been taken advantage of,” says Varga, pointing to Fujitsu’s Sodateru program [named after the Japanese ‘to raise,’ in the sense of bringing up or nurturing]. “One of the easiest ways that we know to get through the procurement process [with big financial companies] is to back yourself on another existing supplier.”

Such tech companies can front a deal by underwriting it financially and offering global support. The size of the initial deal may not be large, says Varga, but “holistically, for technology companies there can be an opportunity to be that bridge builder between one side of the canyon and the other while being viewed as the source of great innovation,” he adds.

Murray agrees that tech companies with their influence and existing relationships bring not just stability but a network through which the fintech’s technology can get much wider exposure. “They act like the trust partner,” he says, “giving the OK on working with a smaller company and pointing to deliverables they’ve seen from previous projects.” (See How tech giants can help to unlock the potential of fintech ecosystems.)

Government forcesOther parts of the financial services ecosystem can also prove invaluable in establishing a fintech’s credibility in the eyes of large financial groups. Murray points to the Scottish Government’s CivTech accelerator, which challenges early stage companies to come up with solutions to internal problems. Those shortlisted are given a small amount of development funding to build a pilot. Having had its pilot selected — an application to support and simplify the vetting process associated with onboarding new government staff — Amiqus went on to be part of a three month acceleration phase, working with government teams before signing a contract. “As well as the benefit of working with the government’s digital teams we have become recognized as a supplier to the Scottish Government.

“So now when I have an objection from a bank or a wealth manager saying it might be too difficult to deal with a startup, we can point to the governance that was necessary to become a supplier to the government — and the objection often disappears,” says Murray.

As that suggests, the traditional David and Goliath adversarial encounter between big finance and fintech may just be turning into a conversation around ‘why wouldn’t we work together.’