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Revolution in fintech keeps the bankers awake at night

Shake-up: Revolut and other fintech firms are forcing banks to increase their tech focus

I was more than a little surprised at the response I got to a question I put to a senior banking executive in a recent conversation.

What keeps Irish bankers awake at night these days, I asked. The answer did not include the words ‘risk’, ‘housing’, ‘property’, ‘derivatives’ or ‘crash’.

“We worry about all of these online banks and payment companies,” the banker responded. “Where is it all going, with companies like Revolut and what they seem to be offering?”

It wasn’t so much about future financial risk, as about newer smaller players eating their lunch and pinching their customers.

A northern businessman recently told me about how badly sterling was doing in the exchange rate with the euro and how some new money transfer app “beginning with the letter R” was apparently offering very good deals. The ‘R’ was indeed Revolut and the British-based, Lithuania-licensed operation is planning to increase its staff numbers in Dublin by another 30 in light of Brexit.

The company was founded by Russian-born Nikolay Storonsky and Ukrainian-British Vlad Yatsenko in 2015. It now boasts over seven million customers and a $1.5bn (€1.4bn) valuation.

It says it has 500,000 customers in Ireland. Revolut offers a range of digital banking services in a mobile app and has largely been targeted at young, tech-savvy users. It offers transfer of money abroad in 29 currencies, a pre-paid debit card with limited cash withdrawals and cryptocurrency exchange.

It wasn’t alone in deciding to have a European base in Lithuania. The former Soviet state has over 100 licensed fintech companies and it is deliberately seeking to attract lots of fintech players. IDA Ireland CEO Martin Shanahan recently singled out Lithuania for mention when talking about how countries in eastern Europe were competing for and winning investment in sectors like fintech.

The traditional banks are worried that unless they invest heavily in their mobile digital offering, they will lose tomorrow’s customers, who have little interest in walking into a bank branch.

This is a real challenge for traditional banks because they have to compete with lower-cost digital competitors by investing in new technology, while carrying much larger traditional costs.

The big advantage that traditional banks have, of course, should be trust. Lots of people are doing business with new digital banks but only as secondary accounts.

Sometimes they are not ready to trust these relatively new businesses with their wages or other traditional banking services.

Banks can really only make money from processing wages if they leverage it to sell the customer something else.

The older banks should have the ‘trustworthy’ attribute nailed down. But, of course, this too has taken a blow, whether it is through the massive mis-selling and foreign exchange scandals in the UK, or the tracker mortgage scandal here in Ireland.

Revolut has gained some real scale with its product offering to date. It plans to start lending money in Lithuania and then roll that out to other markets.

It may have seven million customers but the big banks are not going to concede the market without a fight.

Lithuania embraced fintech because it was disappointed with the lack of online digital investment being made by traditional banks in that country. In Lithuania, as in neighbours like Latvia and Estonia, Scandinavian banks had been the big players.

In Ireland, banks have been more tech-savvy and have committed to investing heavily in their online offerings.

But take Spanish banking giant Santander. It has committed to investing €20bn into digital transformation and IT over the next four years. Annually, that works out at one-and-a-half times the total venture capital Europe’s fintech sector received in 2018.

As one venture capital investor, Mark Tluszcz, told Bloomberg, “even though we all love to hate our bank, we still fundamentally trust the bank that, if we put our money there, it is not going to disappear overnight”.

Digital banks have gained massive customer numbers on the back of low-cost money transfers with no foreign transaction fees. But the bigger question is whether customers are ready to use them to receive their salaries or facilitate their retirement investments. Traditional banks are competing through digital investment, and the numbers are big, but they must also carry huge legacy costs.

Santander, for example, may be spending €20bn on IT but €3bn per year will go toward operating expenses, such as maintaining its current technology.

The other €2bn per year will be spent on investment in new technology and new online services.

It is increasingly difficult to predict just how this battle between new digital banks and traditional banks will play out. The newer businesses have a structural lower cost.

Perhaps the opportunity and risk for digital banks will be in lending. This automatically increases their capital costs and how much money they need to carry on their balance sheets.

Traditional banks remain very profitable, but stunted growth prospects and greater capital requirements weigh heavily on their share prices.

In Ireland, for example, mortgage lending was to be the ‘banker’ as it were when it came to profitable future growth after the recession. We had a clapped out housing market, huge demand, rising employment and incomes, and several years of not building which had to be rectified.

However, the need to curtail risk in the system prompted the Central Bank to impose its mortgage lending caps. Banks still could not be trusted to lend prudently.

Despite the performance of the economy and the housing crisis, the prospects for bank profit growth are not what many would have expected. Throw into the mix the challenge to traditional banks from these new online fintech companies, and they are facing a battle on a whole new front.

In a way, the reluctance of consumers to hand over their entire banking requirements to new digital players has bought the traditional banks some valuable time. They have to invest in new technology and improved mobile offerings to capture those younger consumers.

But the banks have shot themselves in the foot when it comes to the question of trust. They could have done a lot better.

Take the Central Bank investigation into the €1bn tracker mortgage scandal and the fact that AIB has now set aside a further €300m on foot of an ombudsman ruling.

Fintech has already become a significant disrupter in the sector, and traditional banks have weakened their own hand by shafting their customers in the past. The fintech and digital bank sector is growing rapidly and the scale of deals is getting bigger.

This week, there has been renewed speculation in the US that online payments group Stripe, founded by the Collison brothers, would be ripe for an IPO.

It was valued at $35bn in its last investment round and has raised around $1.2bn to date.

Fintechs are consolidating with ever bigger deals. Big mergers and acquisitions include Fis’s $43bn deal for Worldpay, Fiserv’s $22bn acquisition of First Data, and Global Payments’ $21bn purchase of TSYS. These fintech newbies are lining up to buy each other out. But none of them appears interested in buying a bank.

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